Basel
ii in the United States of America
From the
Basel ii
Compliance Professionals Association (BCPA),
the largest association of Basel ii Professionals in the
world
Final Rule, USA: Risk-Based Capital Standards:
Advanced Capital Adequacy Framework — Basel II
B.
Qualification Requirements
Because the advanced approaches use banks’ estimates of
certain key risk parameters to determine risk-based
capital requirements, they introduce greater complexity
to the regulatory capital framework and require banks to
possess a high level of sophistication in risk
measurement and risk management systems.
As a
result, the final rule requires each core or opt-in bank
to meet the qualification requirements described in
section 22 of the final rule to the satisfaction of its
primary Federal supervisor for a period of at least four
consecutive calendar quarters before using the advanced
approaches to calculate its minimum risk-based capital
requirements (subject to the transitional floor
provisions for at least an additional three years).
The
qualification requirements are written broadly to
accommodate the many ways a bank may design and
implement robust internal credit and operational risk
measurement and management systems, and to permit
industry practice to evolve.
Many
of the qualification requirements relate to a bank’s
advanced IRB systems.
A
bank’s advanced IRB systems must incorporate five
interdependent components in a framework for evaluating
credit risk and measuring regulatory capital:
(i) A
risk rating and segmentation system that assigns ratings
to individual wholesale obligors and exposures and
assigns individual retail exposures to segments;
(ii) A
quantification process that translates the risk
characteristics of wholesale obligors and exposures and
segments of retail exposures into numerical risk
parameters that are used as inputs to the IRB risk-based
capital formulas;
(iii)
An ongoing process that validates the accuracy of the
rating assignments, segmentations, and risk parameters;
(iv) A
data management and maintenance system that supports the
advanced IRB systems; and
(v)
Oversight and control mechanisms that ensure the
advanced IRB systems are functioning effectively and
producing accurate results.
1.
Process and systems requirements
One of
the objectives of the advanced approaches framework is
to provide appropriate incentives for banks to develop
and use better techniques for measuring and managing
their risks and to ensure that capital is adequate to
support those risks.
Section 3 of the final rule requires a bank to hold
capital commensurate with the level and nature of all
risks to which the bank is exposed. Section 22 of the
final rule specifically requires a bank to have a
rigorous process for assessing its overall capital
adequacy in relation to its risk profile and a
comprehensive strategy for maintaining appropriate
capital levels (known as the internal capital adequacy
assessment process or ICAAP).
Another objective of the advanced approaches framework
is to ensure comprehensive supervisory
review
of capital adequacy.
On
February 28, 2007, the agencies issued proposed guidance
setting forth supervisory expectations for a bank’s
ICAAP and addressing the process for a comprehensive
supervisory assessment of capital adequacy.
As set
forth in that guidance, and consistent with existing
supervisory practice, a bank’s primary Federal
supervisor will evaluate how well the bank is assessing
its capital needs relative to its risks.
The
supervisor will assess the bank’s overall capital
adequacy and will take into account a bank’s ICAAP, its
compliance with the minimum capital requirements set
forth in this rule, and all other relevant information.
The
primary Federal supervisor will require a bank to
increase its capital levels or ratios if the supervisor
determines that current levels or ratios are deficient
or some element of the bank’s business practices
suggests the need for higher capital levels or ratios.
In
addition, the primary Federal supervisor may, under its
enforcement authority, require a bank to modify or
enhance risk management and internal control authority,
or reduce risk exposures, or take any other
action
as deemed necessary to address identified supervisory
concerns.
As
outlined in the proposed guidance, the agencies expect
banks to implement and continually update the
fundamental elements of a sound ICAAP – identifying and
measuring material risks, setting capital adequacy goals
that relate to risk, and ensuring the integrity of
internal capital adequacy assessments.
A bank
is expected to ensure adequate capital is held against
all material risks.
In
developing its ICAAP, a bank should be particularly
mindful of the limitations of regulatory risk-based
capital requirements as a measure of its full risk
profile – including risks not covered or not adequately
quantified in the risk-based capital requirements – as
well as specific assumptions embedded in risk-based
regulatory capital requirements (such as diversification
in credit portfolios).
A bank
should also be mindful of the capital adequacy effects
of concentrations that may arise within each risk type
or across risk types.
In
general, a bank’s ICAAP should reflect an appropriate
level of conservatism to account for uncertainty in risk
identification, risk mitigation or control, quantitative
processes, and any use of modeling.
In
most cases, this conservatism will result in higher
levels of capital or higher capital ratios being
regarded as adequate.
As
noted above, each core and opt-in bank must apply the
advanced approaches for risk-based capital purposes at
the consolidated top-tier U.S. legal entity level
(either the top-tier U.S. BHC or top-tier DI that is a
core or opt-in bank) and at each DI that is a subsidiary
of such a top-tier legal entity (unless a primary
Federal supervisor provides an exemption under section
1(b)(3) of the final rule).
Each
bank that applies the advanced approaches must have an
appropriate infrastructure with risk measurement and
management processes that meet the final rule’s
qualification requirements and that are
appropriate given the bank’s size and level of
complexity.
Regardless of whether the systems and models that
generate the risk parameters necessary for calculating a
bank’s risk-based capital requirements are located at an
affiliate of the bank, each legal entity that applies
the advanced approaches must ensure that the risk
parameters (PD, LGD,
EAD, and, for
wholesale exposures, M) and reference data used to
determine its risk
based capital requirements are representative of its own
credit and operational risk exposures.
The
final rule also requires that the systems and processes
that an advanced approaches bank uses for risk-based
capital purposes must be consistent with the bank's
internal risk management processes and management
information reporting systems.
This
means, for example, that data from the latter processes
and systems can be used to verify the reasonableness of
the inputs the bank uses for calculating risk-based
capital ratios.
2. Risk rating and segmentation
systems for wholesale and retail exposures
To
implement the IRB approach, a bank must have internal
risk rating and segmentation systems that accurately and
reliably differentiate between degrees of credit risk
for wholesale and retail exposures.
As
described below, wholesale exposures include most credit
exposures to companies, sovereigns, and other
governmental entities, as well as some exposures to
individuals.
Retail
exposures include most credit exposures to individuals
and small credit exposures to businesses that are
managed as part of a segment of exposures with
homogeneous risk characteristics.
Together, wholesale and retail exposures cover most
credit exposures of banks.
To
differentiate among degrees of credit risk, a bank must
be able to make meaningful and consistent distinctions
among credit exposures along two dimensions—default risk
and loss severity in the event of a default.
In
addition, a bank must be able to assign wholesale
obligors to rating grades that approximately reflect
likelihood of default and must be able to assign
wholesale exposures to loss severity rating grades (or
LGD estimates) that approximately reflect the loss
severity expected in the event of default during
economic downturn conditions.
As
discussed below, the final rule requires banks to treat
wholesale exposures differently from retail exposures
when differentiating among degrees of credit risk;
specifically, risk parameters for retail exposures are
assigned at the segment level.
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