Regulation vs. Implementation

1
Regulation vs. Implementation
The New Capital Accord. Work Progress

• Tereza Cristina Grossi Togni
• Central Bank of Brazil

2
Capital requirements in Brazil
Overview

• Implementation of the 1988 Accord 1994
• Capital ratio 11
• Additional capital requirements for
• Swaps (1997)
• Foreign exchange Exposures (1999)
• Interest Rates (2000)

3
General Environment - June 2002
Overview

• Banking system statistics
• Total Assets US 309 MM
• 20 largest banks 87
• Banks are capitalized above the minimum ratio in
  Brazil
• Basel ratio 16,1

4
Main reactions
Overview

• Supervision
• Welcomes the idea of a more risk-based approach
  for regulatory capital requirements
• Banks
• Large banks closely following the New Capital
  Accord proposals

5
Supervisory actions
Overview

• Meetings with banks
• Surveys
• Range of practice on internal rating systems
  credit risk
• Operational Risk
• Data collection exercises
• QIS
• Operational Risk
• Disclosure

6
QIS 2 Exercise (2001)
Quantitative Impact Study

• Scope
• 6 domestic banks
• 1 bank produced IRB foundation data
• Results
• In line with the BCBS consolidated results from
  the exercise
• Increase on the capital requirements under the
  standardized approach

7
QIS 3 Exercise (in process)
Quantitative Impact Study

• Scope
• 9 domestic banks
• 3 banks produced IRB foundation data
• Preliminary Findings
• Apparently follow the incentive structure aimed
  by the Committee
• Less capital required on the foundation IRB when
  compared with the standardized approach

8
General Considerations
Implementation - Credit Risk

• Positive aspects for implementation
• All Financial Institutions must have a credit
  classification system
• Res. 2682/99
• Credit Risk Center

9
Resolution 2682/99
Implementation Credit Risk

• Financial institutions are required to classify
  loan exposures into nine levels of risk
• Establishes
• general criteria for borrower and transaction
  analysis
• levels of risk from AA to H (for performing and
  non-performing loans)
• percentages of provisioning related to those
  levels of risk
• guidance on credit reviews

10
Resolution 2682/99
Implementation Credit Risk

• Central Bank's internal criteria
• AA prime companies
• A, B, C low probability of default
• D (risk level 1)
• E,F,G (risk level 2)
• H high probability of default

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Resolution 2682/99
Implementation Credit Risk

• Helped to strengthen the credit risk management
  in Brazil
• Initial step towards the implementation of the
  New Capital Accord
• Lacks granularity for performing loans (as a
  general internal rating system)

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Credit Risk Center
Implementation Credit Risk

• Currently collects data on
• exposures, write-offs, ratings, ranges of
  maturities and past dues.
• New Credit Risk Center
• wider range of information
• sub portfolios (retail, corporate etc.), types of
  loans, collateral, commitments, provisions and
  restructured loans, among others
• (more details at http//www.bcb.gov.br/centralderi
  sco )

13
New Credit Risk Center
Implementation Credit Risk

• Supervision tool
• Main objective Credit Risk Monitoring
• It will also allow capital adequacy analysis
• Bank's Risk Management tool
• Incentive for structuring databases
• Feed back on aggregate credit information

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Implementation Operational Risk
General Considerations

• Supervision
• Resolution 2554/98
• Data Collection
• Banks
• Various Initiatives
• Res. 2554
• New Capital Accord Proposals

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Implementation Operational Risk
Resolution 2554/98

• It is a general framework
• Financial Institutions must have an Internal
  Controls Framework over their
• activities
• financial and operational management reports
• framework for compliance of regulations
• Internal controls in place must correspond to the
  type, complexity and risk profile of the banking
  operations.

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Implementation Operational Risk
Resolution 2554/98

• Accomplishments
• Promotion of sound practices
• Important step towards implementing the New
  Capital Accord proposals
• internal controls framework
• collecting qualitative information

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Constraints on the proposals
Implementation Operational Risk

• Business Lines
• to split some financial information within the
  business lines.
• Usual segmentation in Brazil retail, investment,
  asset management, private, insurance
• Exposure indicator
• gross income as the exposure indicator for the
  Basic and Standardized approaches

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Implementation Operational Risk
General Considerations

• Few domestic banks are currently able to
  calculate capital for operational risk
• Trade off between the costs and benefits of
  implementing advanced approaches
• still under consideration by banks
• The loss events for which the Brazilian banks
  have more reliable past operational risk data
  are
• internal and external fraud
• employment practices and workplace safety

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Lessons Learned by banks
Implementation Operational Risk

• The introduction of an operational risk culture
  is key on the process
• Risk management plays more and more a key role in
  financial institutions
• Should be incorporated throughout the financial
  institutions

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CHALLENGES
Challenges
21
Credit Risk
Challenges

• Legal framework for different approaches
• Lack of penetration of rating agencies
• Complexity (for smaller, non-sophisticated banks)
• IRB
• Data
• Validation

22
Operational Risk Internal Models
Challenges

• Structuring databases
• Data Capture framework
• Costs
• Modeling
• Sophisticated techniques
• Cultural changes

23
Supervision
Challenges

• Cross border
• Authorization for the more risk-sensitive
  approaches
• host and home supervisors
• Significant banks
• definition

24
Supervision
Challenges

• Level playing field
• Banks with different levels of sophistication
• Foreign and domestic banks
• Peer groups

25
Supervision
Challenges

• Pillar 2
• Legal framework to impose different levels of
  capital requirements at the discretion of the
  supervisor
• Cultural change within Supervision active role
  in evaluating capital adequacy

26
Supervision
Challenges

• Pillar 3
• To assure an increase on the disclosure levels
• To establish a certain level of homogeneity
  within financial institutions
• to allow easier comparisons
• To evaluate the adequacy of disclosure provided
  by banks

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Challenges
Challenges

• Supervisory skills
• Preparing supervisors for modeling validation
• Readiness for Pillar 2 assessments (cultural
  changes)
• Rating for supervisory purposes
• Taking into account on the rating some components
  related particularly to Pillars 2 and 3
• Level of disclosure
• Risk profile
• Risk Management Structure

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Future Steps (Central Bank)
Final Remarks

• Banks
• Deepen the analysis
• To increase the number of banks surveyed
• Foreign banks
• Staff
• Seminars
• Training programs

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The New Capital Accord. Work Progress
Regulation vs. Implementation
Tereza Cristina Grossi Togni Central Bank of
Brazil