|
The May
2009 edition of the Basel ii
Compliance Professionals Association (BCPA)
newsletter
The BCPA is the largest association of Basel ii
Professionals in the
world |
Welcome to the May 2009
edition of the BCPA Newsletter.
Basel ii related news...
Tougher international capital
standards are coming for banks...
"There's almost certainly going to be a leverage ratio, or
a minimum amount of capital that everybody's going to have
to have"
Edward Yingling, president of the
American Bankers Association, at the Reuters Global
Financial Regulation Summit.
"Basel II needs to be modified to take into account the
learning of the last couple of years"
Hector Sants, chief executive of UK
FSA - Financial Services Authority - at the Reuters
Financial Regulation Summit.
G-20 and Systemic Risk
The system in its entirety, not just individual
institutions, must be regulated. This is the message from
the G-20 meeting, and it is discussed around the world in
an effort to understand what is going to happen. Systemic
risk is becoming much more important, this is for sure.
Basel Committee on Banking
Supervision
Supervisory guidance for assessing banks' financial
instrument fair value practices - April 2009
Over the past year, risk management and reporting issues
related to
bank valuations of complex or
illiquid financial instruments,
and the implications for regulatory
capital requirements and bank supervision, have received
considerable attention.
The application of fair value accounting to a wider range
of financial instruments, together with experiences from
the recent market turmoil, have emphasised the critical
importance of robust risk
management and control processes around the measurement of
fair values and their reliability.
Moreover, given the
significance of fair value
measurements
for regulatory capital adequacy and
internal bank risk management it is equally important that
supervisors assess the soundness of banks' valuation
practices through the Pillar 2 supervisory review process
under the Basel II Framework.
The principles in this document cover supervisory
expectations regarding bank practices and the supervisory
assessment of valuation practices.
This guidance
applies to all financial
instruments that are measured at fair value, both in
normal market conditions and during periods of stress,
and regardless of the financial
reporting designation within a fair value hierarchy.
This guidance does not set forth additional accounting
requirements beyond those established by the accounting
standard setters.
The supervisory expectations set forth in this guidance
are applicable to all banks. However, the extent of
application should be commensurate with the significance
and complexity of a bank's fair valued exposures.
Supervisory expectations relevant
to financial instrument valuations
A. Valuation governance and controls
Principle 1
Supervisors expect a bank's board to ensure adequate
governance structures and control processes for all
financial instruments that are measured at fair value for
risk management and financial reporting purposes.
These processes should be consistently applied across the
bank and integrated with risk measurement and management
processes.
Governance
The valuation governance structures and related processes
should be embedded in the overall governance structure of
the bank, and consistent for both risk management and
reporting purposes.
The governance structures and processes are expected to
explicitly
cover the role of the board.
The board might delegate some of these responsibilities to
board
committees or senior management, but should continue to be
ultimately responsible for the overall execution of
governance.
Specifically, the responsibilities for governance
structures applicable to all financial instruments
measured at fair value should include:
· Reviewing and approving written policies related to fair
valuations;
· Ongoing review of significant valuation model
performance for issues escalated for resolution and all
significant changes to valuation policies;
· Ensuring
adequate resources are devoted to the valuation process;
· Articulating the bank's tolerance for exposures subject
to valuation uncertainty and monitoring compliance with
the board's overall policy settings at an aggregate
firmwide level;
· Ensuring the
independence in the valuation process between
risk taking and control units;
· Ensuring the appropriate internal and external audit
coverage of fair valuations and related processes and
controls;
· Ensuring the consistent application of accounting and
disclosures with the applicable accounting framework; and
Ensuring the identification of significant differences, if
any, between accounting and risk management measurements
and that these are well documented and monitored.
Controls
Controls and procedures should be designed to ensure all
financial instruments that are measured at fair value are
reliable and have clear and robust production,
assignment and verification.
Among other things the controls and
procedures should:
· Include well documented policies for all significant
valuation methodologies, which would be approved by senior
management and reported to the board as frequently as
necessary and at least annually.
· Detail the range of acceptable practices for the initial
pricing, marking-tomarket/ model, valuation adjustments,
observability and reliability of inputs, and periodic
independent revaluation depending on the nature of the
financial instruments and sources of independent prices;
and
· Establish the information feeds and thresholds for
determining when there is a presumptive case for
challenging the valuation model.
The
valuation model may be challenged
when valuations or valuation inputs
are materially different from available external market
information and that information is deemed to be reliable
(eg
objective thresholds that indicate when IPV, test trades
or other cross-checks indicate significant differences
with model-based valuations).
A thorough understanding of the instrument being valued
and its markets allows a bank to identify and evaluate the
relevant market information available about identical or
similar instruments.
A bank uses such information to measure the fair value of
its financial instruments by assessing all available
information and applying it as appropriate.
For inactive markets,
a bank needs to put more work into
the valuation process to gain assurance that the
transaction price provides evidence of fair value or to
determine the adjustments to transaction prices that are
necessary to measure the fair value of the instrument.
When a market is not active, a bank measures fair value
using a valuation technique (eg, a model). The technique
chosen should reflect current market conditions.
Therefore, a transaction price in the same or a similar
instrument should be considered in the assessment of fair
value as a current transaction price is likely to reflect
current market conditions.
A bank should consider such transaction prices, but does
not conclude
automatically that any transaction price is determinative
of fair value.
If such transaction prices are used,
they might require significant
adjustment based on unobservable data.
Determining fair value in a market that has become
inactive depends on the facts and circumstances and may
require the use of significant judgment.
Banks should maintain sound controls over valuations
involving inactive markets, including appropriate
documentation to support valuations.
Institutions should follow the relevant accounting
standards and guidance for such valuations.
For risk management purposes, there
needs to be consideration of all factors in valuation and
clear and approved documentation regarding
factors included in, or excluded from, the valuation
technique.
Valuation controls should be applied consistently across
similar instruments (risks) and across business lines
(books).
These controls should be subject to
internal audit review with the resources and
expertise required to identify and provide an effective
review of practices.
A fundamental feature of adequate control processes is
that the final approval of valuations should not be the
responsibility of the risk taking units.
There should be
clear and independent reporting
lines to ensure that valuations are
independently determined and assessed.
Banks should maintain functional separation between the
front office (the risk taking units that typically provide
the initial fair valuation estimates) and the measurement
and control unit (the unit providing independent price
verification - IPV) at all times.
In addition, the unit responsible for IPV within the bank
should source prices independently of the relevant trading
desk.
New product approval processes should include all internal
stakeholders relevant to risk measurement, risk control,
financial reporting and the assignment and verification of
valuations of financial instruments.
Moreover, the process should be supported by a
transparent, well-documented inventory of acceptable
valuation methodologies that are
specific and relevant to products and businesses.
Principle 2
Supervisors expect that a bank will have
adequate capacity,
including during periods of stress,
to establish and verify valuations for instruments in
which it engages.
A bank is expected to have adequate capacity and
capability to produce valuations and determine the
appropriateness of valuations obtained from third-party
pricing services.
This capacity should be commensurate with the importance
and riskiness of these exposures in the context of the
business profile of the institution.
A bank's capacity should also be sufficiently resilient to periods
of rapid growth
in a business and periods of market
stress.
Furthermore, senior management should ensure that the bank
has the resources and capabilities to estimate
appropriately the inherent risks and the value of
financial instruments, including complex and illiquid
instruments.
During stressed market conditions, market discontinuity or
illiquidity can make valuation of many instruments
particularly challenging.
For exposures that represent
material risk,
a bank is expected to have the
capacity to produce valuations using alternative methods
in the event that primary inputs and approaches become
unreliable, unavailable or not relevant due to market
discontinuities or illiquidity.
A bank is expected to test and review the performance of
its valuation models under possible stress conditions, so
that it understands the limitations of the models under
such conditions.
Bank valuation methodologies are expected to
not place undue reliance on a
single information source (eg external ratings)
especially when valuing complex or
illiquid products.
Bank processes should emphasise the importance of
assessing fair value using a diversity of approaches and
having in place a range of mechanisms to cross-check
valuations.
The use of a
third-party pricing service for fair
valuations for financial instruments does not relieve the
board of its oversight responsibility or senior management
of its responsibility to ensure appropriate fair
valuations and provide appropriate supervision, monitoring
and
management of risks.
Management should have a due diligence process by which it
assesses third party pricing services that it uses for
fair valuations so that it has a sufficient basis upon
which to determine the appropriateness of the techniques
used, the underlying
assumptions and selection of inputs and the consistency of
application.
Principle 3
Supervisors expect a bank's senior management to ensure
that policies for
categorising financial instruments
on the balance sheet
are consistent, insofar as
possible, for accounting, regulatory and management
purposes.
Moreover, senior management should ensure that these
policies are strictly aligned with the valuation
capabilities of the bank.
Supervisors expect that a bank will initially categorise and report financial instruments in financial
reports in accordance with applicable accounting and
regulatory reporting requirements.
Senior management should ensure that the classification
for accounting, regulatory and risk management purposes
are consistent insofar as possible.
Any significant
differences in categorisation for the measurement and management
of risk and that necessary for the applicable accounting
framework should be well documented and approved by senior
management and advised to the appropriate board level
committees.
Supervisors acknowledge that a bank's strategy and
therefore the management of financial instruments may
change based on changes in economic conditions.
In these circumstances, any subsequent reclassification of
financial instruments should be made under the control of
the bank's senior management and appropriate board level
committees and strictly in
accordance with accounting requirements.
When financial instruments are
transferred into another portfolio, the accounting and regulatory
capital requirements of this portfolio should be strictly
applied.
Classification and reclassification practices should not be used with
the
view to circumvent accounting requirements in order to
achieve a particular result.
Of particular importance is the specific information
related to reclassifications (eg reasons and impacts) that
should be disclosed in accordance with accounting rules.
Senior management should ensure that appropriate control
policies and practices are in place as regards
classification and any subsequent reclassification of
financial instruments.
Moreover, senior management should ensure that internal
policies related to classification and reclassification of
financial instruments are applied consistently over time
and within a group.
The bank should, for instance, maintain documentation that
supports the initial classification and any subsequent
transfers between asset categories.
B. Risk management and reporting
for valuation
Principle 4
Supervisors expect a bank to have in place sound processes
for the design and validation of methodologies used to
produce valuations.
Key characteristics of sound processes for valuation
methodology design and validation include:
(i) independence of the validation
from the design function;
(ii) rigorous validation;
(iii) integrated control processes; and
(iv) sufficiently resourced internal and external audit
programmes.
Independence of model validation
A valuation model, including any material changes to it,
must be validated by an independent, suitably qualified
group prior to usage, with periodic reviews to ensure the
model remains suitable for its intended use.
Independent validation requires the human and financial
resources needed to provide an effective challenge.
The validation group should have reporting lines that are
independent of the risk taking units.
Rigorous validation
Model validation processes should be systematically
applied for both internally generated and, to the extent
possible, vendor provided models.
Validation includes evaluations of:
· the model's theoretical soundness and mathematical
integrity;
· the appropriateness of model assumptions, including
consistency with market practices and consistency with
relevant contractual terms of transactions;
· sensitivity analyses performed to assess the impact of
variations in model parameters on fair value, including
under stress conditions;
· benchmarking of the valuation result with the observed
market price at the time of valuation or independent
benchmark model.
A bank must understand and document the limitations to the
performance of the model so as to understand the
conditions under which valuations would not reasonably
reflect an exit price.
Appropriate action should be taken when performance of the
model is not acceptable.
This action could include valuation adjustments for model
limitations or model risk, or if necessary, changes to the
model.
Integrated control processes
A bank is expected to have in place policies defining a
regular cycle for valuation model review that reflects the
vulnerabilities of individual models.
Policies should also identify specific triggers (eg
indications of deterioration in model performance or
quality) that will cause the review cycle for a valuation
model to be accelerated.
A bank should have explicit links between the results of
the IPV process or indicators of performance of positions
and the review process of models.
Whenever possible, these links should be expressed in
terms of explicit quantitative thresholds, the crossing of
which should trigger a review of the valuation model and
or valuation procedure.
These triggers should be consistent with sound practices
in risk management.
Profit and loss (P&L) attribution processes are a key
aspect of valuation control.
For fair valuations where changes in fair value are
reflected in the P&L statement, these processes should
take place no less frequently than the risk management
horizon and with a priority given to portfolios with
significant valuation risk so that management understands
the reliability and sources of P&L in a timely manner.
The results of these processes can then feed back into
periodic processes such as IPV and model validation.
Audit programme
Sound internal and external audit programmes play an
important role in the bank's validation process.
Supervisors should expect external and internal audit to
devote considerable resources to reviewing the control
environment, the availability and reliability of
information or evidence used in the valuation process, and
the reliability of estimated fair values.
This includes the price verification processes and testing
valuations of significant transactions.
Audit programmes should also evaluate whether the
disclosures about fair values made by the bank are in
accordance with the applicable accounting standards.
Principle 5
Supervisors expect that a bank will maximise the use of
relevant and reliable inputs and incorporate all other
important information so that fair value estimates are as
reliable as possible.
The relevance and reliability of valuations are directly
related to the quality and reliability of the inputs.
A bank is expected to apply the accounting guidance
provided to determine the relevant market information and
other factors likely to have a material effect on an
instrument's fair value when selecting the appropriate
inputs to use in the valuation process.
Assessing data sources and input factors is
a judgemental process in which all facts and
circumstances have to be taken into account.
Where values are determined to be in an active market, a
bank should maximise the use of relevant observable inputs
and minimise
the use of unobservable inputs when estimating fair value
using a valuation technique.
However, where a market is deemed inactive, observable
inputs or transactions may not be relevant, such as in a
forced liquidation or distressed sale, or transactions may
not be observable, such as when markets are inactive.
In such cases, the accounting fair value guidance provides
assistance on what should be considered, but may not be
determinative.
In assessing whether a source is reliable and relevant,
the following factors should be considered:
· The frequency and availability of the prices/quotes and
whether those prices represent actual regularly occurring
transactions on an arm's length basis. Whether the
price/quote is an indicative price or a binding offer.
· Whether the available prices are relatively consistent
with available corroborating market information and if the
prices vary significantly across market participants.
· Whether prices are transparent
and generally available to market participants.
· The timeliness of the pricing data relative to the
frequency of valuations, such that the pricing data can be
relied upon. Recent pricing data will tend to be more
reliable than stale data.
· The number of independent sources that produce the
quotes/prices. It is also important to consider the
dispersion of prices/quotes available. This will assist
market participants in assessing the quality of the
pricing data.
· The maturity of the market.
The similarity between the financial instrument sold in a
transaction and the instrument held by the institution.
· The nature of a transaction, especially in inactive
markets, and whether it reflected a forced or distressed
sale (which are not relevant) or otherwise involved a
seller that needed to sell and one or very few buyers
(which may require consideration of other information and
management judgement in determining the implications for
the
estimate of fair value).
A bank has to be able to
identify when active markets become
inactive as this will affect the quality,
transparency and reliability of inputs to a valuation.
It should have in place appropriate procedures for valuing
financial instruments when markets are inactive.
These procedures should be well documented and approved by
senior management.
Principle 6
Supervisors expect a bank to have a rigorous and
consistent process to determine
valuation adjustments for risk management, regulatory
and financial reporting purposes, where appropriate.
A fair value estimate should be made in accordance with
applicable standards and guidance (eg accounting, risk
management, or prudential requirements or guidelines).
In some circumstances, adjustments may be necessary to
result in a valuation estimate that meets the applicable
valuation definition.
Accordingly, the overall governance and control framework
for valuations should include a policy to identify the
types of valuation adjustments that could affect the
valuation estimate and valuation processes.
These processes should ensure an
appropriate segregation of duties and ensure an
appropriate level of management
review.
Furthermore, procedures for the resolution and escalation
of valuation issues and exceptions to the board of
directors or a committee thereof (such as the audit or
risk committee) should be defined and documented.
Valuation adjustments should be initially authorised and
monitored subsequently by an independent control group (eg
IPV or financial control unit, and/or independent
modelvalidation unit).
Valuation adjustments should be
supported by appropriate and
regularly maintained documentation.
Senior management responsible for control and oversight of
the
valuation process should ensure that the control and
oversight process incorporates the valuation adjustment
process.
Accordingly, significant valuation adjustments and
significant
differences between fair values included in financial
reporting and those used in risk management or regulatory
reporting, if any, should be reported to and agreed on by
senior management.
In addition, there should be a clear process to timely
resolve significant disagreements about valuation
adjustments and to escalate material valuation issues to
the bank's board of directors or appropriate governance
committee.
Senior management would include the
Chief Risk Officer and/or the Chief Financial Officer (or
equivalent positions).
Routine reporting to the board or appropriate governance
committee, including material valuation issues, should be
on a regular basis in an appropriately aggregated and
understandable form.
Fair value measurements may involve a significant amount
of judgment, including determinations about whether a
market is active or inactive and whether a price in a
market f
or the same or similar instrument is representative of
fair value.
Judgment is also used in the selection and use of
observable and unobservable inputs.
A bank's valuation process and the judgments made should
be determined pursuant to applicable standards and
implementation guidance.
Senior management should have appropriate rigor and
consistency in its processes and be able to recognise and
react when changes to a valuation estimate are necessary.
Based on facts and circumstances, including changes in market
conditions, a bank may need to use judgment to determine
whether an adjustment to a valuation estimate or a
valuation input is needed to reflect an appropriate fair
value measurement.
For financial reporting purposes, an entity must include
appropriate risk factors that market participants would
consider in determining fair value.
Risk factors include risk related to model uncertainty,
liquidity, credit or other risks (such as a risk premium
that a market participant would consider in pricing a
complex financial instrument).
To the extent that risks are
not incorporated in the valuation estimate or
valuation model, supervisors expect banks to make
adjustments to estimates of fair value to ensure the
valuation properly reflects all
appropriate risks, consistent with a market participant
view, in accordance with applicable standards and
guidance.
If changing market conditions and associated risks are not
included
in a model valuation, adjustments to the model or to the
valuation may be necessary under accounting standards to
reflect what the transaction price would have been on the
measurement date for a financial instrument.
These adjustments should be
made consistently with the
assessment of risk and uncertainty surrounding the
valuation of the item.
However, adjustments should not be made if they do not
result in a better estimate of fair value. Institutions
should follow the relevant accounting guidance for such
valuations and related adjustments.
Banks should be aware that some regulatory adjustments
required by prudential filters or used for risk management
purposes may not be appropriate for financial reporting
purposes.
For example, discount adjustments for a large block of
financial instruments cannot be made to fair valuations
when these instruments are market observable (ie level 1)
for financial reporting purposes, but may be considered
for risk management purposes under prudent valuation
guidance.
However, supervisors expect banks to have rigorous
governance and
control processes for all valuation adjustments,
regardless of whether they are for risk management,
regulatory or financial reporting.
Significant differences, if any, between fair values used
for financial reporting purposes and valuations used for
risk management and
regulatory purposes should be understood by senior
management and appropriately documented, including
reporting to the board or appropriate governance
committee.
Principle 7
Supervisors expect that a bank will have valuation and
risk management processes that
explicitly assess valuation
uncertainty and that assessments of all
material valuation uncertainy are included in the
information communicated to the board and senior
management.
Outside of actual transactions, uncertainty about the
current value of a financial instrument should be viewed
as an inherent characteristic of the valuation process.
Uncertainty is specific to the
instrument and to the point in time the
valuation is effected, and is not exclusive to any
specific valuation methodology.
Many factors can give rise to valuation uncertainty. Some
are related to the characteristics of the instruments
being valued.
These may include, for example, complexity of payoffs
stemming from embedded non-linearities and option-type
structures; longer term maturity; and the absence of
readily available market prices on closely related
instruments that can
Supervisory guidance for assessing banks' financial
instrument fair value practices guide the valuation
through arbitrage and comparison.
Each of these are features that can lead to greater
uncertainty about current valuation.
Other factors that can influence valuation uncertainty are
related to the trading environment.
For instance, the
depth and breadth of the market in which it is traded will affect
its liquidity and hence the price at which a transaction
can take place.
In addition, characteristics of the holder can be
important. The liquidation of a position that represents a
significant share of the overall supply of a particular
instrument will likely affect the market price and so will
have an impact on the realised value for the seller.
Such adjustments may not be appropriate in all cases for
financial reporting purposes.
Many
drivers of uncertainty around
current values
also
affect the risk in the future value of an
instrument (eg liquidity risk and counterparty risk).
Similarly, the structure of cash flows associated with an
instrument affects both the sensitivity of future value to
market and credit
risk, and also affects the way these risks are discounted
to produce an estimate of current value.
There is a close link between the assessment of valuation
uncertainty and the measurement of financial risk
associated with a specific instrument or exposure.
Supervisors expect bank valuation and risk measurement
systems to systematically recognise and account for
valuation uncertainty. In particular, valuation processes
and methodologies should produce an explicit assessment of
uncertainty related to the assignment of value for all
instruments or portfolios.
When appropriate this may simply be a statement that
uncertainty for a particular set of exposures is very
small.
While qualitative assessments are a useful starting point,
it is desirable that banks develop methodologies that
provide, to the extent possible, quantitative assessments.
These methodologies may gauge the sensitivity of value to
the use of alternative models and modelling assumptions
(when applicable), to the use of alternative values for
key input parameters to the pricing process, and to
alternative scenarios to the presumed availability of
counterparties.
The extent of this analysis should
be commensurate to the importance of the specific exposure
for the overall solvency of the institution.
Assessments of valuation uncertainty are expected to be
fully integrated in the internal decision-making process
of the institution.
Quantitative and qualitative assessments of uncertainty
should accompany all internal reports of valuation
information as well as the
reports containing risk information across the
institution.
It is important that this information reaches all relevant
bodies in the institution where investment and risk
management decisions are made, including senior management
and the board.
It is also important that the information is communicated
with the same frequency and timeliness that information
about value of positions and associated risks is
communicated to the same bodies.
Principle 8
Supervisors expect that a bank's
external reporting will promote transparency by
providing timely, relevant, reliable and decision-useful
information.
The purpose of external reporting is to
provide relevant and useful
information for the intended users for an intended
purpose.
Supervisors expect that a bank's external financial
reporting will provide transparent information related to
fair value.
Financial disclosures should be made in accordance with
the applicable financial reporting standards and other
applicable regulatory reporting requirements.
Standard setters continue to assess the adequacy of
disclosure frameworks and make amendments to improve
transparency.
Accordingly, it is important that banks ensure that the
required disclosures are being made.
Information particularly useful to users includes descriptions of valuation
techniques used to determine fair value and the
instruments to which they are applied.
Disclosures that provide explanations of the valuation
inputs and assumptions used in the fair value measurements
help inform users about the judgments made in determining
fair Supervisory guidance for assessing banks' financial
instrument fair value practices value.
In addition, appropriate disclosure about the sensitivity
of fair value measurements to reasonably possible
alternatives that would significantly affect the valuation
is also of particular interest to users.
A disclosed description of the bank's valuation governance
and
controls processes can improve understanding of the
quality of the bank's fair valuations and the robustness
of related risk management processes.
These disclosures are
especially important in times of
market stress and uncertainty.
Accordingly, senior management should consider whether
disclosures around valuation uncertainty can be made more
meaningful.
Moreover, appropriate disclosures should also be provided
with respect to financial asset reclassifications.
A bank should regularly review its disclosure policies to
ensure that the information disclosed continues to be
relevant to its business model and products and to current
market conditions.
C. Supervisory assessment of
valuation practices
Principle 9
Supervisors may require banks to provide
supplemental information to assist them in assessing
valuation and governance processes.
In connection with assessing fair values, banks are to
disclose information about fair values, including
corporate governance, controls, and methodologies, and on
the use of the fair value option required by their
relevant accounting framework (eg International Financial
Reporting Standards (IFRS) 7 disclosures).
In addition to this
publicly available information, supervisors may wish to
periodically obtain
supplemental information about fair values and related
internal processes from their banks. Normally, this will
be information that a bank should have developed for
internal purposes.
Such information would assist supervisors, for example, in
assessing the quality of valuations and in better
understanding the risk of
instruments measured at fair value, the volatility and
impact on earnings and capital adequacy.
When a bank has made
significant transfers between asset categories involving
assets reported at their fair values, the supervisor may
also want to obtain additional supplemental information
about these transfers.
To assess the engagement of senior management in valuation
issues, supervisors may request valuation reports provided
to the board or information from assessments by external
auditors or by a bank's internal auditors or independent
risk management groups.
Where there is material uncertainty surrounding valuation
practices and where feasible, supervisors may consider
undertaking test portfolio exercises.
Supervisors should ensure that such exercises are not
viewed as providing model validation.
Principle 10
Supervisors should evaluate a bank's financial instruments
valuation practices including relevant
governance, risk management and
control practices;
and incorporate their evaluation
when assessing
capital adequacy.
Supervisors expect banks to
promptly address any deficiencies identified by internal and
external auditors with respect to their valuations and
related corporate governance, controls, risk management
and disclosure policies and practices.
When supervisors bring any risk management or control
deficiencies regarding valuations and related processes to
the attention of management, they should consider the full
range of supervisory measures at their disposal to ensure
that deficiencies receive appropriate attention from
management and are corrected in a timely manner.
Supervisory responses could include the following
approaches and measures:
· Communicating supervisors' concerns routinely to the
bank's senior management and supervisors' significant
concerns to the bank's board and evaluating management's
and the board's responses as to how they are addressing
these concerns.
· Factoring into supervisory ratings any concerns with
respect to a bank's fair value practices (eg factoring
this into prudential risk management or capital adequacy
assessments).
· Taking
informal or formal supervisory
actions (which can be of a non-public or
public nature) requiring management and the board to
remedy the deficiencies in a specified timeframe and to
provide the supervisor with periodic written progress
reports.
While supervisors expect banks to have strong processes
and controls and to promptly correct deficiencies, there
may be certain circumstances in which deficiencies exist
and warrant some adjustments to regulatory capital.
For example:
· A change in regulatory classification of financial
instruments may be necessary for capital adequacy or
regulatory reporting purposes.
This may be the case if a bank exhibits weaknesses in the
valuation processes or controls relating to trading book
positions or if a bank is not reporting fair valued
financial instruments for regulatory
purposes consistent with the way the bank measures and
manages risk.
· If a bank
exhibits significant weaknesses in its risk management policies,
systems and controls related to valuations, this may
result in a supervisory determination that the bank needs
to hold more capital in relation to its overall risk
exposure (eg under Pillar 2 of the Basel II Framework).
Furthermore, if such weaknesses call into question the
reliability of the fair values, it is appropriate in
certain circumstances for
a supervisor to exclude from or make adjustments to Tier 1
capital for the associated unrealised gains (and perhaps
non-impairment losses), or require other prudential
adjustments for capital purposes (eg for potential
overstatement of fair value based on a third party
valuation).
Dear members,
- Visit the website of our association.
www.basel-ii-association.com
- Write in your CV, resume, websites etc. that you are
members of the Basel ii Compliance Professionals
Association (BCPA)
- Take advantage of the distance learning and online
certification program of our Association - at a cost that
is unheard of.
http://www.basel-ii-association.com/Distance_Learning_Online_Certification.htm
My best wishes,
George Lekatis
President of the Basel ii Compliance Professionals
Association (BCPA)
General Manager, Compliance LLC
1200 G Street NW Suite 800, Washington DC 20005, USA
Tel: (202) 449-9750
Email:
lekatis@basel-ii-association.com
Web:
www.basel-ii-association.com
| |
