Former Industry Minister and CGD Vice-President, Dr. Luís Mira Amaral, explained new international banking rules and guidelines on risk management to a gathering of British-Portuguese Chamber of Commerce members at the Hotel Tivoli in Lisbon recently.
The Basel (Basileia) II accord (May/June 2004) is a group of measures for the banking sector, which should regulate and improve the processes and management of financial risk. Due to be implemented at the end of 2006, it follows on the heels of the largely outdated Basel I Capital Accord of 1988 – so-called because it was laid down and hammered out in the Swiss town of Basel by Central Bank Governors of the G10 countries and corresponding heads of the Bank Supervisory Authority.
Dr. Amaral addressed the questions: “what does it do and what do the measures mean?” For many years, banks have calculated financial risk in three main areas: Market Risk – which is difficult to control; Credit Risk – when banks stand to gain or lose from lending to clients representing varying degrees of risk; and Operational Risk – which is the risk of direct or indirect losses from inadequate or failed internal processes, people and systems.
Dr. Amaral explained that, under the new capital accord, there are new requirements that banks in over 100 countries are obliged to adhere to. For example, banks now have to have an internal ranking system of all clients in that bank for all departments concerned. Also, banks must now set aside more provision in funds to cover the risks they run in lending money. The 1988 rules and regulations were more general, with greater fluidity and leeway for the banks in terms of client-client, operation-operation and country-country.
For example, the regulations governing Operational Risk are completely new and cover all the banks’ inside costs and product development costs. A simple example might be a project for a certain kind of credit card, which, as a product, could present a risk to the bank. As well as being expensive for the bank to research and develop the service, an entire structure needs to be created for the new product and costs tend to be higher for specific products geared for specific situations and clients.
Dr. Amaral said that the general aim was to “synchronise and regulate all the financial activities of banks worldwide to create more stability within the industry and, at the same time, lower costs, risks and raise profits.”
He explained that the Accord basically created a capital framework for the committee member countries to drive home the fact that “the banks must have a healthy and secure capital risk management strategy”.
Basel II sets down the amount of capital those financial institutions should have in reserve to cover risks and potential losses in any given situation. When Basel II comes into effect, all banks – some 30,000 worldwide – will have to abide by the rules. “If the accord is applied in an intelligent and correct manner, it can help the banking industry reduce the necessary capital reserves needed in its loan business, while increasing the amount of available capital for bank investments, and, as a consequence, help to increase the values of bank shares and profits from better risk management practices,” he concluded.
The Chamber acknowledges the generous support of De La Rue Systems – Automatização S.A. for the sponsorship of this event.
