Supervisory Challenges under Basel II

Transcription

1 Supervisory Challenges under Basel II Bank of Israel Conference Tel Aviv, March 18, 2010 Hugh Kelly, Partner, National Lead - Bank Regulatory Advisory KPMG LLP, US ADVISORY Risk and Compliance Services

2 Basel II Advanced Capital Adequacy Framework Basel II is a highly complex set of guidelines and regulations related to measurement, management and monitoring of capital Promotes more sophisticated capital framework intended to accommodate the banking industry's risk diversity. Better aligns regulatory capital requirements with the industry s risk measurement & management practices and more comprehensive view of bank s risks through inclusion of operational risk. Results in more flexible and risk-sensitive capital requirements. Promotes better and more integrated risk and capital management practices and more formalized risk management programs. 2

3 KPMG Basel II Implementation Insights Through KPMG s experience with our Basel II clients and ongoing discussions with the US Banking Regulators, the KPMG Basel II team has a good perspective on Basel II implementation, including: Impact and expectations relative to bridging economic capital allocation (ECA) requirements to Basel II qualification, including the ICAAP Leading industry practices of mandatory and opt-in banks regarding Basel II Implementation Plan Regulatory expectations for the Basel II implementation plan, gap analysis and qualification Impact of the Supervisory Capital Assessment Program (SCAP) which allowed supervisors to measure how much of an additional capital buffer, if any, each bank would need to establish today to ensure that it would have sufficient capital if the economy weak ens more than expected. 3

4 Evolution of Bank Supervision expectations Risk-Based Supervision, ERM, Operational Risk Management & Basel II Operational Risk Compliance Financial Reporting Board Oversight Enterprise Risk Management Stress Testing Basel II Credit Risk Liquidity Risk Market Risk Large banks assume varied and and complex risks that that warrant a riskoriented supervisory approach. Under this this approach, examiners do do not not attempt to to restrict risk-taking but but rather determine whether banks identify, understand, and and control the the risks they assume. Large Large Bank Bank Supervision, Supervision, Comptroller s Comptroller s Handbook Handbook 4

5 KPMG Basel II Implementation Success Factors Based on KPMG s experience with our Basel II clients, critical success factors for successful Basel II implementation include: Strong support from Senior Management and the Board Comprehensive implementation plan for advanced credit and operational risk measurement and management systems Detailed gap analysis of current/planned state of advanced methods Strong risk governance around implementation Robust processes for collecting, measuring and modeling Credit Risk and Operational Risk loss data Comprehensive Risk & Control Self-Assessment (RCSA) process Enhanced model governance/validation processes Involved internal audit program 5

6 Key Basel Focus Areas for 2nd Wave of U.S. Basel II Banks The following areas require additional investment to meet the Basel II criteria: Development of a formal Implementation Plan to meet the Regulators requirements, including a comprehensive gap analysis Setting up a formal Basel II PMO, with Executive Management Steering Committee oversight, to run the program with multiple business unit workstreams Training of staff to support Basel II initiative Setting up of data warehouse to house and manage data requirements Developing documentation to evidence meeting Basel II requirements Involvement of internal audit to self assess Basel II implementation prior to parallel run 6

7 Pillar 1- Credit Risk Focus Areas for 2 nd Wave of U.S. Basel II Banks Underneath Pillar 1 Credit Risk IRB the following areas require additional investment to meet the Basel II criteria: Enhanced credit risk modeling development and validation of models to support credit risk Credit risk data to substantiate and model PD, LGD, EAD Segregation of credit risk data to Basel II categories Alignment of definitions used within bank to Basel II such as default Development of or acquisition of missing data elements Securitizations require detailed analysis to identify capital requirements Treatment of equity investments for capital requirements 7

8 Pillar 1- Operational Risk Focus Areas 2 nd Wave of U.S. Basel II Banks Underneath Pillar 1 Operational Risk AMA the following areas require additional investment to meet the Basel II criteria: Integrated operational risk framework, including linkage to existing operations, compliance, IT, HR and legal silos (see chart on next page) Development of an operational risk methodology to quantify OpRisk capital component Operational risk modeling including development and validation of models Identification, collection and usage of internal and external operational risk data Development of or acquisition of missing data elements including Business Environment and Internal Control Factors Development of scenarios to support operational risk capital charge Definition of loss event, near miss and classification into Basel II categories 8

9 Focus on Integrated Operational Risk Management Key Elements: People Processes Enterprise OpR vision and policy Executive champion Consistent methodology for risk identification, assessment, measurement & reporting Clarity of roles, responsibilities, key interfaces and reporting infrastructure for the three lines of defense SOX Compliance Information Security Model Validation Change Risk Management Operational Risk Management New Product assessment & approval Event/Issue Management AML** Business Continuity Vendor Management Systems External Events 9

10 Pillar 2 Focus Areas for 2 nd Wave of U.S. Basel II Banks Underneath Pillar 2 (including the ICAAP and SREP requirements), the following areas require additional investment to meet the Basel II criteria: Comprehensive documentation of risk assessment and management processes across all products, business units, geographies etc. showing how risk is governed, identified, aggregated, adjusted (diversification or add on) and how capital requirement is linked to risk Development of scenario and stress analysis to review risk assessment process Identifying add on capital requirements for risks such as concentration risk, interest rate risk in the banking book, strategy risk, liquidity, reputational, business risk Building out a sustainable ICAAP function that acts as a bridge between risk, capital and strategy Ensuring that adequate capital is held against all material risks and over time, to account for changes in a bank's strategic direction, evolving economic conditions, and volatility in the financial environment. Specifically, Management should be cognizant of the impact of market-driven valuations on the volatility of capital. The sensitivity of capital to economic and financial cycles should be a critical component of a bank's planning for current and future capital needs (e.g., during downturns or other times of stress ). 10

11 Basel II Pillar 3 Focus Areas for 2nd Wave of U.S. Basel II Banks Underneath Pillar 3 Market Discipline the following areas require additional investment to meet the Basel II criteria: Development of reporting processes to meet Basel II requirements specifically FFIEC 101 and 102 schedules Risk-Based Capital Regulatory Reports Pillar 3 disclosure 11

12 KPMG Basel II Implementation Challenges The KPMG Basel II team has observed the following challenges of Basel II implementation: Underestimation of the burden involved in bringing separate and disparate parts of the process together for calculating capital and integrating with ERM. This necessitates a reevaluation of system capabilities and enhanced risk management protocols. Understanding what the regulators require, particularly as some parts of the rules/proposals are still unclear Having adequate data for both the Credit and Operational Risk advanced measurement approaches, and knowing how to bridge the gaps Initial tendency to treat the Basel II process as a compliance exercise when the primary focus should be business improvement and integration with the ERM process. This results in a significant cultural challenge across the organization. Underestimation the cost of Basel II implementation Lack of consistent documentation of Basel II compliance across the various workstreams Lack of early involvement of internal audit 12

13 Enhancements to Basel II are Expected Two Basel Committee papers issued last summer described final changes to the international Basel II framework, while two December papers outlined additional proposed changes. The new changes are intended to promote a more resilient banking sector by strengthening the standards for capital, liquidity, and risk management. Of particular importance, is the Basel Committee s focus on the quality of capital, as well as the focus on liquidity. The Basel Committee is addressing the liquidity issue by proposing a global minimum liquidity standard for internationally active banks that includes both a 30-day liquidity coverage ratio and a longer-term structural liquidity ratio. The Basel Committee has also begun a new Quantitative Impact Study to better evaluate and assess the proposals, including to help answer the critical how much questions -- How much additional capital and liquidity should be required for each of the proposed new standards, and how much higher should overall capital and liquidity be for each bank? How do the new proposed standards fit together and work together? This calibration exercise, is intended to help supervisors fine tune the rules to ensure they are appropriately reflective of risk -- and help balance capital and liquidity on the one hand and credit availability on the other. 13

14 Questions and Comments 14

15 KPMG Bank Regulatory/Basel II Knowledge Leadership and Contact The Washington Report -- This weekly federal regulatory and legislative newsletter provides updates on current issues impacting the U.S. financial services industry Hugh Kelly, Partner & National Lead for Bank Regulatory Advisory Services KPMG LLP