Banks have to increase paid up capital gradually within six years

The banks will have to increase their paid up capital within next six years as the central bank is planning to implement the Basel III to minimise the market risk.

The paid up capital for the new commercial banks will be Rs 5 billion, under the Basel III requirement as they have to increase minimum capital, equity capital ratio and buffer capital. Currently, they have to have Rs 2 billion paid up capital. They have to gradually increase the paid upto capital like in the next two years, they have to increase their paid up capital to Rs 3 billion, in five years Rs 4 billion and six years, Rs 5 billion. "It is expected to make the banks stronger," the central bank said, adding that the development banks also have to be ready to implement Basel III, though it's implemented for the commercial banks only in the beginning.

After the successful six years of the Basel II in commercial banks, the new challenges have called for the Basel III that is going to bring changes in the capital adequacy framework, the central bank said.

There were three pillars – minimum capital requirement, supervisory review and disclosure – under the capital adequacy framework of Basel II, but after the global financial crisis, there has been significant addition.

There were challenges towards managing risk within the banking system as well as reducing the spillover risk from the financial sector to the real economy. Basel Committee on Banking Supervision (BCBS) issued 'Basel III: A global regulatory framework for more resilient banks and banking systems' in December 2010. Basel III has set its objectives to improve the shock absorbing capacity of each and every individual bank as the first order of defense. In addition to the measures, the efforts were directed to ensure that banking

system as a whole does not weaken and its spillover impact on the real economy is minimised.

Thus central bank has also planned to implement the Basel III – after consultation with the banks and financial institutions – in s month to safeguard the financial system, the Nepal Rastra Bank (NRB) said.

Basel III has included some micro-prudential elements – like definition of capital, better risk coverage, leverage ratio and international liquidity framework – so that risk is managed in each individual institution and macro-prudential elements will take care of issues relating to the systemic risk.

Likewise, the leverage ratio has been proposed at three per cent and capital conservation buffer 2.5 per cent of risk weighted average to strengthen the banks and financial institutions.

Similarly, counter cyclical capital buffer has also been proposed to 2.5 per cent apart from a forward looking and dynamic provisioning, and addressing systemic risk and interconnectedness. "The capital requirement has also been doubled," it said, adding that Tier 1 and Tier 2 capital has also been increased.

The new arrangements calls for an increase in paid up capital, according to the central bank.

NRB hikes capital charge to mitigate operational risk

The central bank has hiked the capital charge of banks and financial institutions to mitigate growing operational risks.
As most banks and financial institutions have been exposed to operational risks lately, the additional capital charge will help mitigate the risk, Nepal Rastra Bank (NRB) said today.
Updating the supervisory adjustments in risk weighted assets and capital of Capital Adequacy Framework, 2007, under the unified directives of banks and financial institutions, NRB said that if banks do not adopt sound practices to manage operational risks, they shall be levied an additional capital charge of two per cent to five per cent of gross income of the immediate previous financial year for operational risks.
Operational risk losses have often led to the downfall of financial institutions globally also. According to Basel II, operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.
Likewise, the central bank has asked class 'B' and 'C' financial institutions to also increase their risk weighted assets to mitigate operational risks in a phasewise manner.
Development banks and finance companies have to add two per cent by the end of the current fiscal year 2012-13, four per cent by the end of next fiscal year 2013-14, and five per cent by the end of fiscal year 2014-15, additional capital charge in their risk weighted assets.
Lately, banks and financial institutions have been undergoing a sea change and facing an environment marked by growing consolidation, rising customer expectations, increasing regulatory requirements, proliferating financial engineering, enhanced technological innovation and mounting competition, which has also increased the probability of failures or mistakes from the operations point of view, resulting in increased focus on managing operational risks.
A key component of risk management is measuring the size and scope of the firm's risk exposures, though there is no clearly established, single way to measure operational risk on a firm-wide basis. But the central bank's move could help banks and financial institutions adopt sound practices to manage operational risks.

Top global central banks aim for tougher financial rules

ZURICH: Leading central bankers and national regulators said on Thursday they were aiming to introduce proposals to strengthen international financial requirements on banks by the end of 2012.
The agreed reforms, which have been in the offing for several months, are part of a "comprehensive response" to the financial crisis, the Basel Committee on Banking Supervision said.
"The capital and liquidity proposals will result in more resilient banks and a sounder banking and financial system," said Dutch central bank chief Nout Wellink, chairman of the Basel Committee.
However, the Committee said it was still reviewing possible additional measures on "systemically important institutions," banks that are big enough to have an impact on whole economies and the rest of the financial system if they run into trouble. It will also assess the potential impact of its package of measures and refine them next year.
"The fully calibrated set of standards will be developed by the end of 2010 to be phased in as financial conditions improve and the economic recovery is assured, with the aim of implementation by end-2012," the statement said. "The Committee is mindful of the need to introduce these measures in a manner that raises the resilience of the banking sector over the longer term, while avoiding negative effects on bank lending activity that could impair the economic recovery."
The group of central bankers and national financial regulators from 27 leading economies had alreday approved stregthened regualtion and supervision and revised "Basel II" capital requirements in July and September. AFP

Rock nationalisation is best deal for the taxpayer: Brown

London: Gordon Brown yesterday mounted a strong defence of his decision to preside over the first nationalisation of a major British high street bank in a quarter of a century when he declared that the government had put the interests of taxpayers first in its handling of Northern Rock.
As the Tory leader David Cameron called on Brown to sack Alistair Darling, his chancellor (finance minister), the prime minister dismissed Tory charges that the government had created an 'economic calamity' by delaying its decision on Northern Rock.
In a joint appearance with Darling in Downing Street less than 24 hours after the government's decision to place Northern Rock into "temporary public ownership", Brown said the government would have been failing in its duty if every possible option had not been considered.This meant giving time for private sector bids to be put forward — from Virgin, Olivant and a Northern Rock management buyout — and for the government to take time in considering whether they were fair to the taxpayer.
"We will and always have put the interests of taxpayers first," the prime minister said at his monthly press conference. "The soft option would have been taking the easy road out and putting it into the new private sector bidders. The long-term question was what was the best interests of the taxpayer."Brown said both final bids — Virgin and the management buyout — failed tooffer sufficient guarantees to the taxpayer. "Given that both bids that came forward involved a subsidy from government without an appropriate level of return for taxpayers, after detailed consideration and independent advice, the chancellor concluded that the right decision is to hold Northern Rock in temporary public ownership, to be run at arms' length fromthe government under professional management until market conditions change.
"The prime minister dismissed claims that the government was to blame for the first run on a British bank since the 1860s as he blamed the worldwide credit crunch. "We are dealing with a global financial turbulence that is affecting every country, but particularly the main industrialised continents," he said.
Within hours of Brown's appearance in Downing Street, Cameron called for the chancellor to be sacked. George Osborne, the shadow chancellor, described Darling as a 'dead man walking'.Drawing a parallel with Black Wednesday in 1992, his formative political experience when as an adviser to Norman Lamont he witnessed at first hand Britain's ejection from the European exchange rate mechanism, Cameron said chancellors should resign when they presided over an 'economic calamity'.
"As soon as legislation goes through parliament the prime minister must restructure his government," the Tory leader said as he spoke of how he had learned lessons from Black Wednesday when Lamont remained in office for a year until he left the cabinet. "He needs to have a chancellor with credibility and he needs to do it quickly." The Tories, who will vote against the legislation that will nationalise Northern Rock this week, said the government should have placed it under Bank of England reconstruction, a form of public administration.Cameron said this would have halved the taxpayers' liability and would not lead, as the government claims, to a 'fire sale' of the bank.
"The Conservative party will not be supporting nationalisation. We will not back a decision that takes our country back to the dark days of the 1970s." Cameron blamed Brown's flirtation with the idea of a snap election last autumn for the delay in deciding the bank's future. "We have heard from a number of sources, from people who were advising the government, they were being told: get on with it. There is only one thing worse than a decision to sell badly or nationalise badly - the worst thing of all is to delay. I think the election probably had something to do with it."
But Darling rebuffed Tory claims of government dithering, insisting that there was no need for the taxpayer to make a big loss. He said, "At the moment the Bank of England has lent money to Northern Rock, every penny ofwhich is secured against Northern Rock's assets." He added that not one of the guarantees offered by the Bank had been called in.
He said, "Northern Rock does have a good mortgage book, and when the market conditions improve and the housing market comes back, we will be able to return the bank to the private sector, and will get the Bank of England's money back." Liberal Democrat treasury spokesman Vincent Cable, who called from the start for temporary nationalisation, called for an independent audit supervised by the Bank of England to establish the quality of Northern Rock's assets and loan book. Pledging his party's support for the legislation, Cable said job losses were inevitable, but added, "At least the bank and the north-east have some long-term hope." - The Guardian

Basel II and its history

From the next fiscal year Nepal is adopting Basel II and this year Nepali banks are using Base II in parallel basis, for the familarization. What is basel and how can Basel II make our banks more competitive and transparent in accounting system so the depositors feel save and the banking sector grow as it should be. Lets have a look at it:
The Basel Committee, established by the central-bank Governors of the Group of Ten countries at the end of 1974, meets regularly four times a year. It has four main working groups which also meet regularly.

The Committee's members come from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, United Kingdom and United States. Countries are represented by their central bank and also by the authority with formal responsibility for the prudential supervision of banking business where this is not the central bank. The present chairman of the Committee is Nout Wellink, President of the Netherlands Bank, who succeeded Jaime Caruana on 1 July 2006.

The Committee does not possess any formal supranational supervisory authority, and its conclusions do not, and were never intended to, have legal force. Rather, it formulates broad supervisory standards and guidelines and recommends statements of best practice in the expectation that individual authorities will take steps to implement them through detailed arrangements - statutory or otherwise - which are best suited to their own national systems. In this way, the Committee encourages convergence towards common approaches and common standards without attempting detailed harmonisation of member countries' supervisory techniques.

The Committee reports to the central bank Governors of the Group of Ten countries and to the heads of supervisory authorities of these countries where the central bank does not have formal responsibility. It seeks their endorsement for its major initiatives. These decisions cover a very wide range of financial issues. One important objective of the Committee's work has been to close gaps in international supervisory coverage in pursuit of two basic principles: that no foreign banking establishment should escape supervision; and that supervision should be adequate. To achieve this, the Committee has issued a long series of documents since 1975.

In 1988, the Committee decided to introduce a capital measurement system commonly referred to as the Basel Capital Accord. This system provided for the implementation of a credit risk measurement framework with a minimum capital standard of 8% by end-1992. Since 1988, this framework has been progressively introduced not only in member countries but also in virtually all other countries with internationally active banks. In June 1999, the Committee issued a proposal for a revised Capital Adequacy Framework. The proposed capital framework consists of three pillars: minimum capital requirements, which seek to refine the standardised rules set forth in the 1988 Accord; supervisory review of an institution's internal assessment process and capital adequacy; and effective use of disclosure to strengthen market discipline as a complement to supervisory efforts. Following extensive interaction with banks, industry groups and supervisory authorities that are not members of the Committee, the revised framework was issued on 26 June 2004. This text serves as a basis for national rule-making and for banks to complete their preparations for the new framework's implementation.

Over the past few years, the Committee has moved more aggressively to promote sound supervisory standards worldwide. In close collaboration with many non-G10 supervisory authorities, the Committee in 1997 developed a set of "Core Principles for Effective Banking Supervision", which provides a comprehensive blueprint for an effective supervisory system. To facilitate implementation and assessment, the Committee in October 1999 developed the "Core Principles Methodology". The Core Principles and the Methodology were revised recently and released in October 2006.

In order to enable a wider group of countries to be associated with the work being pursued in Basel, the Committee has always encouraged contacts and cooperation between its members and other banking supervisory authorities. It circulates to supervisors throughout the world published and unpublished papers. In many cases, supervisory authorities in non-G10 countries have seen fit publicly to associate themselves with the Committee's initiatives. Contacts have been further strengthened by International Conferences of Banking Supervisors (ICBS) which take place every two years. The last ICBS was held in Mexico in the autumn of 2006.

The Committee's Secretariat is provided by the Bank for International Settlements in Basel. The fifteen person Secretariat is mainly staffed by professional supervisors on temporary secondment from member institutions. In addition to undertaking the secretarial work for the Committee and its many expert sub-committees, it stands ready to give advice to supervisory authorities in all countries.

Basel II: Revised international capital framework
The Basel II Framework describes a more comprehensive measure and minimum standard for capital adequacy that national supervisory authorities are now working to implement through domestic rule-making and adoption procedures. It seeks to improve on the existing rules by aligning regulatory capital requirements more closely to the underlying risks that banks face. In addition, the Basel II Framework is intended to promote a more forward-looking approach to capital supervision, one that encourages banks to identify the risks they may face, today and in the future, and to develop or improve their ability to manage those risks. As a result, it is intended to be more flexible and better able to evolve with advances in markets and risk management practices.

The efforts of the Basel Committee on Banking Supervision to revise the standards governing the capital adequacy of internationally active banks achieved a critical milestone in the publication of an agreed text in June 2004.

Basel II: An introduction to the Capital Adequacy Accord and the Capital Requirements Directive. It is based on an international agreement. It was written in February 2006.

Background

Capital requirements rules state that credit institutions, like banks and building societies, must at all times maintain a minimum amount of financial capital, in order to cover the risks to which they are exposed. The aim is to ensure the financial soundness of such institutions, to maintain customer confidence in the solvency of the institutions, to ensure the stability of the financial system at large, and to protect depositors against losses.

The Basel Committee on Banking Supervision was established at the end of 1974 to provide a forum for banking supervisory matters. The Basel Committee is made up of senior officials responsible for banking supervision or financial stability issues in central banks and other authorities in charge of the prudential supervision of banking businesses. Members of the Basel Committee come from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the UK and the US.

Although the Basel Committee is not a formal regulatory authority in itself, it has great influence over the supervising authorities in many countries. The hope is that by agreeing basic goals, the Committee can achieve common approaches and common standards across many member countries, without attempting detailed harmonisation of each member country's supervisory techniques.

In 1988, recognising the emergence of larger more global financial services companies, the Committee introduced the Basel Capital Accord (Basel I). This sought to strengthen the soundness and stability of the international banking system by requiring higher capital ratios.

Since 1988, the framework contained in Basel I has been progressively introduced not only in member countries but also in virtually all other countries with active international banks. In June 1999, the Committee issued a proposal for a new Capital Adequacy Framework to replace Basel I. Following extensive communication with banks and industry groups, the revised framework was issued on 26th June 2004 and is known as Basel II.

Basel II basics

The objective of Basel II is to modernise the existing capital requirements framework to make it more comprehensive and risk-sensitive, taking account of many modern financial institutions' thorough risk management practices.

The Basel II framework is therefore more sensitive to the real risks that firms face. As well as looking at financial figures, such as how much money the firm controls, it also considers operational risks, such as the risk of systems breaking down or people doing the wrong things.

It reflects improvements in firms' risk management practices, for example by the introduction of the internal ratings based approach ( IRB ). The IRB approach allows firms to rely to a certain extent on their own estimates of credit risk. It also introduced the Advanced Measurement Approach ( AMA ) which allows firms to take account of their operational risks in assessing capital adequacy.

A key aspect of the new framework is its flexibility. It provides institutions with the opportunity to adopt the approaches most appropriate to their situation and to the sophistication of their risk management.

The Basel II framework consists of three 'pillars':

* Pillar 1 sets out the minimum capital requirements firms will be required to meet to cover credit, market and operational risk.

* The rules under Pillar 2 create a new supervisory review process. This requires financial institutions to have their own internal processes to assess their capital needs and appoint supervisors to evaluate an institutions' overall risk profile, to ensure that they hold adequate capital.

* The aim of Pillar 3 is to improve market discipline by requiring firms to publish certain details of their risks, capital and risk management.

Basel II and the Capital Requirements Directive

Basel II applies to internationally-active banks. In the European Union, the new capital requirements framework is being implemented through the Capital Requirements Directive ( CRD ). The CRD will directly affect certain types of investment firms and all deposit-takers (including banks and building societies), except credit unions.

The framework under the CRD reflects the flexible structure and the major components of Basel II. It has been based on the three 'pillars', but has been tailored to the specific features of the EU market. Member States must apply the Directive from the start of 2007, but the more sophisticated risk measurement approaches won't be available until 2008. The CRD is not a stand-alone directive, rather it implements the new framework by making significant changes to two existing directives: the Banking Consolidation Directive and the Capital Adequacy Directive, both of which were based on Basel I.

In the UK , the Financial Services Authority ( FSA ) is working with the Basel Committee, the EU and the banking industry to develop its policies for implementing the new capital adequacy framework via the Capital Requirements Directive.

Measuring operational risk

One of the key changes in Basel II is the addition of an operational risk measurement to the calculation of minimum capital requirements. This has been included in the CRD . Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, such as exposure to fines, penalties and private settlements. It does not, however, include strategic or reputational risk.

In February 2003, the Basel Committee published guidance on the Sound Practices for the Management and Supervision of Operational Risk (20-page / 101KB PDF). In this guidance, the Committee recognised that developing banking practices and the growing sophistication of financial technology meant that banks were facing new and more complex risks other than credit and market risk.

For example, the greater use of more highly automated technology and a greater reliance on globally integrated systems transforms risks from manual processing errors to system failure. The growth of e-commerce brings risks such as internal and external fraud and system security issues. The emergence of banks acting as large-volume service providers creates the need for continual maintenance of high-grade internal controls and back-up systems. The growing use of outsourcing arrangements and the participation in clearing and settlement systems can mitigate some risks but can also present significant other risks to banks. The Committee listed a number of operational risk events which were identified (with co-operation from the industry) as having the potential to result in substantial losses:

* Internal fraud - for example, intentional misreporting of positions, employee theft, and insider trading on an employee's own account.

* External fraud - for example, robbery, forgery, cheque kiting, and damage from computer hacking.

* Employment practices and workplace safety - for example, workers compensation claims, violation of employee health and safety rules, organised labour activities and discrimination claims.

* Clients, products and business practices - for example, misuse of confidential customer information, improper trading activities on the bank's account, money laundering, and sale of unauthorised products.

* Damage to physical assets - for example, terrorism, vandalism, earthquakes, fires and floods.

* Business disruption and system failures - for example, hardware and software failures, telecommunication problems, and power failures.

* Execution, delivery and process management - for example, data entry errors, incomplete legal documentation and unapproved access given to client accounts.

Three approaches for calculating capital adequacy

In calculating operational risk capital charges, Basel II and the CRD set out three different methods which may be adopted:

* The Basic Indicator Approach

* The Standardised Approach

* The Advanced Measurement Approach

The Basic Indicator Approach is the simplest of the three approaches, and will be the default option for most firms. It applies a relatively straightforward calculation based on the firms' income to determine its capital requirements.

The Standardised Approach again relies on calculations based on income, but with different percentages applying across different business lines. To be able to take advantage of the Standardised Approach firms will have to meet certain qualifying criteria.

The Advanced Measurement Approach is the most complicated of the three options. Under this approach, each firm calculates it own capital requirements, by developing and applying its own internal risk measurement system. As with the Standardised Approach the firm must meet certain qualifying criteria, and the risk measurement system must be validated by the FSA before it will be allowed to take advantage of the AMA.

The Advanced Measurement Approach (AMA)

In its consultation paper Strengthening Capital Standards, the FSA stated that given the "potential reduction in capital for firms that qualify for the AMA , we will be looking for evidence that carefully thought-through plans for improving systems in such firms will deliver high standards of risk management and monitoring".

In addition to the general risk management standards which firms employ, a firm must meet certain qualifying criteria to use the AMA :

* The firm's internal operational risk measurement system must be closely integrated into its day-to-day risk management processes. The FSA will be looking, for example, at whether the purpose and the use of the risk management system is limited to determining regulatory capital and whether the use of the system provides tangible benefits to the organisation.

* There must be regular reporting of operational risk exposures and loss experience, and the firm must have procedures for taking appropriate corrective action.

* The firm's risk management system must be well documented. The firm should have routines in place for ensuring compliance and policies for the treatment of non-compliance.

* The operational risk management processes and measurement systems shall be subject to regular reviews performed by internal and/or external auditors.

* The FSA is required to validate the operational risk measurement system including verifying that the internal validation processes operate in a satisfactory manner and ensuring that data flows and processes associated with the risk measurement system are transparent and accessible.

* The FSA requires each firm to show that it has a credible risk management system. It must show that the assumptions, techniques and practices used are appropriate and relevant to managing operational risk in the business. The firm should also be able to show how the individual parts (whether inputs or outputs) of the risk management system are used in the management of operational risk. A firm must be able to demonstrate that data inputs are accurate, reliable and credible and that the firm's validation techniques are robust.

* The operational risk management system should include the following elements: internal loss data; external data; scenario analysis (to evaluate the firm's exposure to high severity risk events); and key business environment and internal control factors (that could change the firm's operational risk profile). The FSA has said that while firms must consider all four elements, they do not necessarily have to consider each in the same way or to give them equal weight, provided that the firm can justify its approach.

General Risk Management Standards

It is sometimes too easy to concentrate on the operational risk standards which apply if firms want to benefit from the AMA . However, the CRD requires firms to have robust governance arrangements for all risks including operational risks. These should include:

* a clear organisational structure with well defined, transparent and consistent lines of responsibility;

* effective processes to identify, manage, monitor and report the risks it is or might be exposed to; and

* adequate internal control mechanisms, including sound administrative and accounting procedures.

The content of these arrangements, processes and mechanisms must be comprehensive and proportionate to the nature, scale and complexity of the firms' activities.

The CRD also requires that firms should have sound, effective and complete strategies and processes to assess and maintain on an ongoing basis the amounts, types and distribution of internal capital that they consider adequate to cover the nature and level of the risks to which they are or might be exposed. These strategies and process should be subject to regular internal review to ensure they remain comprehensive and proportionate to the nature, scale and complexity of the firms' activities.