17 January 2009

BCBS consults on enhancements to the Basel II framework

The Committee published a consultative document which covers the Committee's proposals to strengthen Pillar 1 minimum capital requirements - in addition to those covered under the trading book proposals, Pillar 2 - supervisory review process and Pillar 3 - market discipline.

The Pillar 1 enhancements focus on strengthening the risk capture of the framework calling for a higher capital charge for resecuritisations. The Committee also proposes to increase capital requirements for liquidity lines extended to support asset-backed commercial paper (ABCP) conduits by eliminating the distinction between short-term and long-term liquidity facilities. The Committee also proposes to require that banks obtain comprehensive information about the underlying exposure characteristics of their externally-rated securitisation positions, both within and across structures. Failure to obtain such information would result in higher capital requirements.

Enhancements to Pillar 2 intend to strengthen its supervisory guidance:

Ø       Firm-wide governance and risk management: The Committee's enhanced guidance sets clear expectations for boards of directors and senior management to understand the firm-wide risk profile; to aggregate firm-wide exposure information in a timely manner using easy to understand and multiple metrics; to define the risk appetite in a manner that considers long-term performance over the cycle; and to set clear incentives across the firm to control risk exposures and concentrations in accordance with the stated risk appetite.

Ø       Capturing the risk of off-balance sheet exposures and securitisation activities: The Committee's proposed enhanced guidance will strengthen supervisory expectations for capturing firm-wide risk concentrations arising from both on- and off-balance sheet exposures and securitisation activities. This includes both contractual risks, as well as the potential impact on risk exposures, capital, and liquidity of non-contractual commitments, implicit support, and reputation risk.

Ø       Incentives to manage risk and returns over the long-term: The Committee's enhanced Pillar 2 guidance will set the expectation that banks establish appropriate incentives throughout the firm to reflect the long-term risks and rewards associated with their respective business models. The supplemental Pillar 2 guidance will be a key tool for supervisors to reinforce sound compensation schemes as part of the risk management and capital planning process.

Enhancements to Pillar 3 focus on the following six areas:

Ø       securitisation exposures in the trading book;

Ø       sponsorship of off-balance sheet vehicles;

Ø       the Internal Assessment Approach (IAA) for securitisations and other ABCP liquidity facilities;

Ø       resecuritisation exposures;

Ø       valuation with regard to securitisation exposures; and

Ø       pipeline and warehousing risks with regard to securitisation exposures.

Ø       These disclosures are intended to complement the other two pillars of the Basel II framework by allowing market participants to assess capital adequacy of a bank through key pieces of information on the scope of application, capital, risk exposure and risk assessment process.

The Committee's proposal includes certain disclosure requirements that are not solely related to the understanding of Pillar 1 capital requirements (eg disclosures concerning a bank's sponsorship of off-balance sheet vehicles). These are intended to help market participants better understand a bank's overall risk profile. The Committee believes that these proposed enhanced disclosure requirements will help to avoid a recurrence of market uncertainties about the strength of banks' balance sheets related to their securitisation activities.

Deadline for consultation is 17 April 2009.

Press release

Consultation on enhancements to the Basel II framework

Overall press release

See also consultation on regulatory capital treatment for trading book exposures

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