The international banking watchdog — the Basel Committee on Banking Supervision — has released what it calls a series of steps to make banks “more resilient to financial shocks.” The quartet of measures aims to enhance various aspects of the Basel II Framework guidelines, strengthen global standards for liquidity risk management, improve banks’ risk-management, and bolster disclosure and valuation practices.
“A resilient banking system is central to sound financial markets and growth,” noted Nout Wellink, chairman of the Basel Committee and president of the Netherlands Bank, in a statement. “Supervisors cannot predict the next crisis but they can carry forward the lessons from recent events to promote a more resilient banking system that can weather shocks,” he added.
In response to the subprime crisis many banks have taken massive write-downs to account for losses related to investments in the collapsing mortgage industry. As a result, some banks have been unable to retain the proper level of regulatory capital under U.S. banking rules. To adjust their capital cushion, banks have had to rein in lending activity, causing a credit squeeze for some corporate borrowers. To counter that kind of chain reaction in the future, the Basel Committee steps announced Wednesday aim to mitigate bank risk before it spirals into a credit crisis.
For example, the committee’s focus on improving the Basel II Framework includes enhancing the capital treatment of complex structured-credit products, liquidity facilities that support asset-backed commercial paper (ABCP) conduits, and credit exposures held in the trading book. The Basel II capital rules are intended to recognize advances in risk management, by allowing banks to reduce the amount of capital on their balance sheets relative to their risk position. However, now banks are likely to find themselves under renewed scrutiny from red-faced regulators who could toughen those capital requirements.
The committee said that it also will revise the Framework to establish higher capital requirements for structured credit products, such as so-called resecuritizations or collateralized debt obligations of asset-backed securities. These financial instruments have produced the majority of losses during the recent subprime crisis.
The group is also initiating efforts to strengthen banks’ risk-management practices and supervision, paying particular attention to stress testing, off-balance sheet management, and valuation practices. For example, the committee plans to issue guidance in several areas of the supervisory review process, called Pillar 2. The guidance relates to management of firm-wide risks, risk management practices related to securitizations, and off-balance sheet exposures and associated reputational risk, among other efforts.
In addition, the committee will issue for public comment a proposal linked to strengthening practice standards for managing liquidity risk, that will likely include a discussion about achieving more consist global liquidity regulation and supervision of cross-border banks.
The committee acknowledged that weakness in bank transparency and valuation practices for complex products have contributed to the build-up of concentrations of illiquid structured credit products. To address that issue, the watchdog group plans to promote enhanced disclosures of securitization exposures, ABCP conduits, and the sponsoring off-balance-sheet vehicles.