Email News Service February 2005
Markets may force Basel II timetable, says Caruana; HSBC sees no capital saving from accord
HONG KONG, February 4 - Markets may set a more demanding timetable for banks and countries to adopt the Basel II upgrade of international bank safety rules than the "soft transition" envisaged by supervisors and institutions, the world's top banking supervisor said today.
That's because financial markets can see the advantages of the complex Basel II rules that seek to get banks to align their capital more accurately to the risks they face, Basel Committee on Banking Supervision chairman Jaime Caruana said.
In the medium and longer-term Basel II will ensure better access to financial flows for the same risk, Caruana told a Basel II conference organised by the Hong Kong Monetary Authority (HKMA), the central bank and chief financial watchdog for China's special administrative region.
"Furthermore, market dynamics may reinforce this process and those banks that adopt higher standards of risk management and capital and countries that embrace the new supervisory approach could be perceived by markets as less risky, resulting in lower risk premiums and better access to financial markets," he said.
Nearly 90 countries in addition to the 13 leading economies that are members of the Basel Committee, the architect of Basel II, have said they plan to apply the Basel II rules to their banking systems.
The Basel Committee recommends its member countries implement Basel II from end-2006 in respect of the simpler and intermediate approaches to measuring risks and from end-2007 for banks using the most advanced risk measurement methods.
Many non-Basel Committee member countries, including Hong Kong, intend following this timetable, but others, particularly in the emerging market and developing world, are taking it more slowly. And both the Basel Committee and the International Monetary Fund have said countries should not implement Basel II until they're ready for it and have at least adopted the Basel Committee's Core Principles for effective banking supervision.
Caruana said Basel II won't materially effect foreign investment in developing economies in the short run.
In the medium and longer term "Basel II's forward-looking elements will probably take over and higher risk efficiency will improve the financing of all kinds of economies," he said.
Some observers suggest that the Basel II capital adequacy rules may reduce the flow of foreign investment in developing economies, since exposure to these economies might be view as more risky.
But Caruana said the lack of any material effect on capital flows that he expects in the short-term is based on the notion that Basel II seeks to align capital regulations more closely to banks' current practices. Those practices are already risk sensitive, he said.
Therefore it will not change the way decide whether to invest in emerging market economies, he added.
Yet some observers have assumed a more risk-sensitive approach might drive up not just capital requirements, but also the pricing of credit to emerging markets, he noted.
Caruana said regulatory capital is important and may represent an overall constraint. But research suggests that banks consider all the economic risks associated with a particular borrower when setting the price of a loan. Factors such as economic capital - the capital banks allocate on their own risk assessment - and the level of competition are more influential in pricing loans than regulatory capital, he said.
Meanwhile, Basel II unlikely to be a capital saving initiative for the UK banking group HSBC on a group-wide basis, said David Sheldon, chairman of HSBC's subsidiary, the Hong Kong and Shanghai Banking Corporation.
That's because of the distribution of HSBC's assets internationally - it's one of the world's largest banking groups - and its conservative approach to ensuring it remains strongly capitalised.
In Canada, for instance, where HSBC is implementing the advanced internal ratings-based (IRB) approach to measuring credit risk there will be capital savings, Sheldon said. But in Hong Kong, the bank expects any capital savings that may arise to be offset by additional capital requirements for operational risk.
But Sheldon said from his perspective the overall aim of Basel II is first and foremost to nurture a stronger risk management culture.
He said not all banks are showing the same degree of readiness or willingness towards Basel II. In Asia banks are in four categories: those well on the way to adoption; those willing but lagging behind the leaders; those adopting a `watch and wait' approach; and those going at their own slow pace, apparently unaware of the progress being made elsewhere.
HSBC has at any one time some 1,000 people in various places around the world engaged in some aspect of preparing for Basel II.
"Our aim is straightforward. We intend to derive the maximum business benefits - with emphasis on the plural - from the adoption of Basel II," Sheldon said.
But he added the bank recognises it's an evolutionary process. In Hong Kong the banks expects to be 85% compliant over three years. It also knows that it won't be feasible to introduce an IRB framework across all 76 jurisdictions in which HSBC operates.
"I do not see all banks in all markets in Asia embracing Basel II. Both because of the complexity of the new rules and because of the diversity within the region."
And Basel II isn't a cure-all for risks. Good loans still go unexpectedly bad.
"I do, however, expect risk management will be one of the defining characteristics by which both banks and banking systems will be judged going forward," he said.
HKMA chief executive Joseph Yam told the conference there are signs that the Basel Committee's practice, encouraged by Caruana, of involving non-Committee members in developing its rules "is turning into a tradition". The views of central bankers and financial regulators in the Southeast Asia are being taken into account. Yam said participation has also been extended to other areas, with Hong Kong, for instance, heavily involved in the current review of the Basel Committee's Core Principles.
HKMA deputy chief executive William Ryback said earlier this week the agency aims to introduce the bill giving legal effect to Basel II into Hong Kong's Legislative Council in the second quarter of this year.
(The texts of all remarks are available on: www.info.gov.hk/hkma)
David Keefe (dkeefe@globalriskregulator.com)
