Banking & Finance Technology Forum 2005

1. Banking & Finance Technology Forum 2005 Basel II – The Implementation PhaseSimon ToppingHong Kong Monetary Authority /City University of Hong Kong9 March 2005

2. Basel II – The Implementation Phase • HKMA’s approach to implementation: • Timing / available approaches • Consultation documents / guidance issued • Hong Kong banking industry’s implementation plans • Choice of approaches • Progress being made • Basel II in the context of other concurrent “regulatory” initiatives: • Is there a danger of over-regulation? • If so, what can we do about it?

3. HKMA’s approach to implementation (1) Timing / available approaches: • 1 Jan 2007 • Credit risk: basic, standardised & foundation IRB approaches • Operational risk: basic indicator & standardised approaches • Pillars 2 & 3 • 1 Jan 2008 • Credit risk: advanced IRB approach • 31 Dec 2009 • End of transitional period • To be determined: • Operational risk: AMA approaches

4. HKMA’s approach to implementation (2) Consultation documents / guidance issued: • October 2001 (12) • Proposed implementation approach (high level) • July 2003 (63) • Proposed implementation approach (detailed) • August 2004 (200) • Timing / available approaches • New “basic” approach • Scope of application (e.g. bank holding companies) • Standardised approach (e.g. retail / SME) • National discretions under standardised & IRB • Minimum requirements for internal rating systems / risk quantification under IRB

5. HKMA’s approach to implementation (3) Consultation documents / guidance issued: • September 2004 (155) • Standardised approach (RMLs, past dues, collateral) • IRB application / recognition process • IRB self-assessment of compliance with qualifying criteria • December 2004 (42) • Draft Banking (Amendment) Bill 2005 • Power to make capital rules & disclosure rules • Designation of BHCs • Upper level for minimum CAR increased to 16%

6. HKMA’s approach to implementation (4) Consultation documents / guidance issued: • February 2005 (173) • Weighting framework for credit risk under standardised & IRB approaches • Credit risk mitigation under standardised approach • Criteria for transition to IRB approach • Weighting framework for operational risk • Coming soon… • Calculation of capital base • Credit risk under basic approach • Asset securitisation • Market risk • Pillars 2 & 3

7. Hong Kong banking industry’s implementation plans (1) • HKMA has made adoption of the more advanced approaches (i.e. foundation / advanced IRB) optional, stressing that each AI should weigh up the costs & benefits • It transpires that more AIs than originally expected plan to adopt IRB: 17 AIs comprising mostly the larger banks plus some smaller subsidiaries of foreign banks • This reflects the fact that there is now wider acceptance by the industry that Basel II can deliver real benefits in terms of improved risk management - & market expectations that major banks will adopt IRB

8. Hong Kong banking industry’s implementation plans (2) • Not all of the 17 will implement IRB immediately (transitional period runs to end-2009) • A number of small & medium-sized banks have also initiated IRB-type development programmes focused initially on developing internal ratings • AIs are making extensive use of external assistance (IT / model vendors, management consultants, etc.) • Around 40 RLBs & DTCs will adopt basic approach • HKMA has begun bilateral discussions with AIs on their plans • HKMA’s assessment is that the industry has “bought into” Basel II & is making good progress on implementation

9. Basel II in the context of other concurrent regulatory initiatives (1) • In addition to Basel II, AIs also need to make concurrent changes to systems & procedures in relation to, e.g., changes in international accounting standards & new anti money laundering requirements • This could place a strain on management / IT resources, & create a cost burden • It also raises system integration & prioritisation issues • Is there, therefore, a danger of over-regulation? • If so, what can we do about it?

10. Basel II in the context of other concurrent regulatory initiatives (2) • There are 5 main themes to the regulatory initiatives being pursued currently: • Stability of the banking system / protection of depositors • Improvement of risk management • Enhanced public disclosure / market discipline • Consumer interests • Wider public interests

11. Basel II in the context of other concurrent regulatory initiatives (3) “Stability of the banking system / protection of depositors” initiatives: • Basel II • Deposit protection scheme “Improvement of risk management” initiatives: • Basel II • Commercial credit reference agency • Consumer credit data sharing • Supervisory policies on interest rate risk, FX risk, stress-testing, etc.

12. Basel II in the context of other concurrent regulatory initiatives (4) “Enhanced public disclosure / market discipline” initiatives: • Basel II (Pillar 3) • Adoption of international accounting standards • Listing rules • Corporate governance initiatives

13. Basel II in the context of other concurrent regulatory initiatives (5) “Consumer interests” initiatives: • Basel II • Enhancement of securities regulatory regime • Customer complaints • Deposit protection • Code of Banking Practice • Product regulation “Wider public interests” initiatives • Anti money laundering & terrorist financing

14. Basel II in the context of other concurrent regulatory initiatives (6) From this long list it is clear that: • Basel II is a key initiative which is central to several of the themes • There is a real danger that, unless properly managed, the regulatory burden on AIs could become onerous, notwithstanding the worthiness of each of these initiatives in their own right • In large part this reflects a global trend towards increased regulation & is, therefore, unavoidable (e.g. adoption of international standards & best practices is necessary in order to maintain Hong Kong’s reputation as a well-regulated IFC)

15. Basel II in the context of other concurrent regulatory initiatives (7) However, in order to keep the regulatory burden manageable, & in keeping with a business-friendly orientation, the HKMA is committed to working with the banking industry (&, for that matter, LegCo & consumer interest groups) to try to get the right balance between the risks & rewards of regulation For example, in relation to Basel II the HKMA has: • Consulted the industry extensively throughout • Liaised closely with AIs to ensure that the approaches offered, the timetable for implementation, & the qualifying criteria for approval, are acceptable to the industry

16. Basel II in the context of other concurrent regulatory initiatives (8) • Made adoption of the advanced approaches optional • Developed the basic approach for smaller AIs • Put on hold the proposed regulatory regime for BHCs • Liaised closely with other supervisors to try to encourage harmonisation of requirements • Indicated a willingness to be pragmatic in relation to use test / validation Such an approach – a risk-based approach focusing on cost/benefit analysis, pragmatism, proportionality, & close co-operation with the industry – is aimed at ensuring that Hong Kong gets the right amount - & right type – of regulation

17. Basel II in the context of other concurrent regulatory initiatives (9) Basel II, which is modelled on banks’ own best practices, & can deliver benefits in terms of (1) stability of the banking system / protection of depositors, (2) improvement of risk management (3) enhanced public disclosure / market discipline & (4) consumer interests, is an example of the right type of regulation The winners - in terms both of financial centres & of individual institutions - will be those who implement it most effectively – those who have the best strategy, the best solutions, & get their prioritisation right