Title: WHAT CAN FINANCIAL REGULATION DO
1- WHAT CAN FINANCIAL REGULATION DO
- TO ENSURE STABLE CREDIT
- IN EMERGING COUNTRIES
- Alicia Garcia Herrero
- BIS, Representative Office for Asia and the
Pacific - Financial Reforms in China an Latin America
- Beijing June 7, 2007
2INTRODUCTION
- Available and stable credit is a wonderful asset
for a countrys sustained growth - There is no one single formula as to how to
achieve it - I will concentrate exclusively on the role of
financial regulation
3ROADMAP TO PRESENTATION
- Quick look at evolution of financial regulation
- How can Basel II contribute to stable credit?
- Issues in introducing Basel II
- 4. Conclusions
41. Evolution of financial regulation
- Regulation is a concept of the 1900s, before
banks were unregulated - And only from 1988, with Basel I, was regulation
harmonized across countries - Basel I achieved
- Equal treatment of banks in terms of capital
requirements - Reversal of trend towards reduction in capital
- But still not perfect
- Not much account of risk
- Its impact on granting credit is controversial
- Chiuri et al (2002) show a reduction while
Barajas, Chami and Cosimano (2005)do not find
such evidence
52. Basel II and stable credit
- Basel II improves in a number of aspects as
compared to Basel I - Better risk measurement and risk management
- The number of firms with a credit rating should
increase (specially for standard approach) - Better understanding of risk
- concept of economic capital
- and risk adjusted return on capital
62. Basel II and stable credit? (cont)
- 2. Improvements in the banks balance sheet
- A larger range of assets can be used as
collateral - Corporate bonds, stocks and even credit
derivatives - Securitization fostered more than under Basel I
- Particularly so for riskier assets
- Probably more demand for emerging countries
assets) - Less incentives to provide short-term lending
- Relevance of short-term lending as driver of
Asian crisis/Mexican crisis points to
contribution of Basel II to provide more stable
credit - See Basel Committee Working Paper No.2 June 1999
72. Basel II and stable credit (cont)
- Increased procyclicality may be an issue (IMF,
2005 and Persaud, 2000) - However, the final version of the Accord has
addressed this concern in several ways - Calculating PDs and LGDs for a full cycle and not
a certain point in time - Requesting banks to consider unexpected adverse
situations when calculating the capital needs - Finally, the steepness of the curve relating the
capital requirement to the PD has been reduced -
- In any event, procyclicality of regulatory
capital not a big issue if regulatory capital not
binding as is the case in many emerging countries
82. Basel II and stable credit? (cont)
- The impact on the external cost of capital for
emerging countries key to assess Basel IIs
contribution to providing stable credit - Garcia-Herrero and Santabarbara (2006) conduct an
empirical analysis to determine the impact of
Basel II on cost of capital for 30 emerging
countries - In order to estimate the impact, need to know
whether - Basel II will be binding (i.e., regulatory
capital will be higher than economic capital
derived from internal models) - They find that it will be less binding that Basel
I, especially under IRB
92. Basel II and stable credit (cont)
- 2. Economic capital and not the regulatory one-
is the key variable for banks to grant financing - Authors estimate model of determinants of
economic capital for 30 emerging countries (6 of
which Asian) - The cost of capital increases for those with the
highest country risk but falls for many - OECD emerging countries are relatively worse
since they lose the OECD umbrella - Basel I distinguished between OECD and non OECD
independently on the rating but not Basel II - Authors also estimate the impact of regulatory
capital on the sovereign spreads and the results
are slightly better
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113. How to introduce Basel II?
- Not single answer
- Depends on the authorities decisions and
readiness of the financial sector - Never quick and easy
12Implementing Basel II is a long road for everybody
13 But road may be very different and so it should
be!
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163. How to introduce Basel II (cont)
Necessary steps for building a road
- Assessing the current environment
- Making a plan
- Where should the road lead to?
- What kind of road are we building?
- Setting up a project
- What is the time schedule for building the road?
- What is required to build the road to Basel II?
- Testing (and, if need be, improving) the
foundation - Constructing the road
17Making a plana. Where should the road lead to?
- Adequately capitalised banks
- Better functioning banks in terms of risk
assessment - This should help improve intermediation
- Generally a sounder and safer financial system
- Precondition for a stable economy and economic
growth
18 Making a planb. What kind of road are we
building? Several approaches
- For credit risk
- Simplified standardised approach
- Standardised approach
- Foundation internal ratings-based approach
- Advanced internal ratings-based approach
- For operational risk
- Basic Indicator approach
- Standardised approach
- Alternative standardised approach
- Advanced measurement approaches
- There is not one way to implement Basel II The
superhighway appears attractive, but traveling at
high speeds brings great risks!!
19Making a planb. The kind of road will depend on
- Readiness of financial system
- Capitalization, risk awareness, risk management
- Readiness of the economy as a whole
- Better if not in a boom or in a financial
liberalization process many opportunities but
also many risks - Readiness of regulators and supervisors
20 Readiness on regulators side
Basel II framework
- Control over banks structure
- Licensing
- Ownership
- Activities, acquisitions
- Risk management and capital
- Provisioning
- Large exposure
- Related party exposure
- Liquidity
- Banks internal control and governance
- On-site, off- site monitoring
- Remedial actions
- Consolidated superv
- Home-host cooperation
- Institutional setting of the supervisor
- Independence, governance, accountability,
transparency - Resources, legal power
- Preconditions
- Sound macro-economic policies
- Legal, accounting, auditing and payment systems
- Systemic protection
21Setting up the projecta. When do we build the
road? Basel II implementation
- Basel II Framework (June 2004)
- This document is being circulated to
supervisory authorities worldwide with a view to
encouraging them to consider adopting this
revised Framework at such time as they believe is
consistent with their broader supervisory
priorities. -
but how to choose?
22Big banks urge emerging markets to move quickly
but not smaller onesAlso IMF board cautions
against moving too quickly
Only national authorities can know
23Setting up the projectb. What is required to
build the road to Basel II?
- Implementing Basel II will be a major challenge
for banks and supervisors - Assessing resource and training needs
- Human resources
- Financial resources
- Information systems
- Ongoing communication between supervisors and
between supervisors and banks
24 Setting up the projectb. What is required to
build the road to Basel II? (cont)
- 1. A solid foundation is essential for building a
road - Appropriate infrastructure
- Otherwise there could be a false sense of
financial stability - Other regulatory measures should be there
- Risk-based supervision, compliance with core
principles, sound accounting and provisioning
standards - 1988 Accord could be a (temporary) alternative,
particularly for small banks - Still, Basel II valuable for supervisors and
banks in all markets
25Setting up the projectb. What is required to
build the road to Basel II? (cont)
- 2. Good use of areas of national discretion
crucial - Recognises countries different realities
- Facilitates the implementation
- Allows to take into account domestic market
practice and experience - Important to share information with other
supervisors
26- In the last two decades, there have been
important improvements in regulation Implementing - Basel II is an improvement in many ways.
- The main challenge for the stable allocation of
credit is probably prociclycality, but regulators
can take measures through the second pillar - 3. As for the implementation of Basel II,
regulators can choose their own road according
to their financial system and their
priorities/constraints
27- THANK YOU FOR YOUR ATTENTION