An analysis and critique of the BIS proposal on Capital Adequacy and Ratings (#10) 林耕賢 陳淑芳 余冠廷

1. An analysis and critique of the BIS proposal on Capital Adequacy and Ratings(#10) 林耕賢 陳淑芳 余冠廷

2. Outline • 名詞解釋 • 國際清算銀行(BIS) • 巴塞爾組織 • 資本適足率 • BASEL1的起源 • New BASEL (BASEL II) 的改革背景 • BIS 3 stages proposals draft

3. 名詞解釋(1) • 國際清算銀行(BIS) • 根據１９３０年１月２０日簽訂的海牙國際協定組成。 • 現在是西歐多邊清算制度的收付代理人，並接受各國中央銀行的存款，代為買賣黃金、外匯、發行債券，辦理國際性政府借款﹔促進中央銀行之間的合作﹔為國際支付往來提供方便。該行掌握著世界１４０家中央銀行部分國際儲備。

4. BIS的歷史 • BIS的建立 • The BIS was established in 1930, which dealt with the issue of the reparation payments imposed on Germany by the Treaty of Versailles following the First World War. • The new bank was to take over the functions previously performed by the Agent General for Reparations in Berlin: collection, administration and distribution of the annuities payable as reparations. • The BIS was also created to act as a trustee for the Dawes and Young Loans (international loans issued to finance reparations) and to promote central bank cooperation in general. • The reparations issue quickly faded, focusing the Bank's activities entirely on cooperation among central banks and, increasingly, other agencies in pursuit of monetary and financial stability.

5. BIS的角色扮演 • 在財政領域內的角色 • 財政領域之外的角色 • 提供緊急財政支援

6. BIS的角色扮演 • 在財政領域內的角色 • In the immediate aftermath of the Second World War and until the early 1970s ,cooperation at the BIS focused on implementing and defending the Bretton Woods system. • In the 1970s and 1980s, the focus was on managing cross-border capital flows following the oil crises and the international debt crisis. • The 1970s crisis also brought the issue of regulatory supervision of internationally active banks to the fore, resulting in the 1988 Basel Capital Accord and its "Basel II" revision of 2001-06. • More recently, the issue of financial stability in the wake of economic integration and globalisation, as highlighted by the 1997 Asian crisis, has received a lot of attention.

7. BIS的角色扮演 • 財政領域之外的角色 • The BIS has always performed "traditional" banking functions for the central bank community (eg gold and foreign exchange transactions), as well as trustee and agency functions. • The BIS was the agent for the European Payments Union (EPU, 1950-58), helping the European currencies restore convertibility after the Second World War. • The BIS has acted as the agent for various European exchange rate arrangements, including the European Monetary System (EMS, 1979-94) which preceded the move to a single currency.

8. BIS的角色扮演 • 提供緊急財政支援 • During the 1931-33 financial crisis, the BIS organised support credits for both the Austrian and German central banks. • In the 1960s, the BIS arranged special support credits for the Italian lira (1964) and the French franc (1968), and two so-called Group Arrangements (1966 and 1968) to support sterling. • More recently, the BIS has provided finance in the context of IMF-led stabilisation programmes (eg for Mexico in 1982 and Brazil in 1998).

9. 名詞解釋(2) • 巴塞爾組織 • 國際清算銀行(BIS)於1974年結合10大工業國共同設立巴塞爾銀行監理委員會。 • 目標：在『國外銀行業務無法避免監理』和『適當監理』兩項原則下，消弭世界各國監理範圍差異 • 擁有近三十個技術工作團隊，執行每年鎖定的計畫及目標 • 委員會本身不具任何跨國監理的權力，因此其決議沒有也未企圖擁有法律上的強制效力

10. 名詞解釋(3) • 資本適足率 • 巴塞爾銀行監理委員會於1988年7月發布「銀行自有資本之計算與自有資本標準之國際通例」，此一規範一般稱為巴塞爾資本協定，其奠定了現行銀行風險基準資本適足性的基礎。 ８％

11. BASEL 1的起源 • 歷史背景 • 1974年5.6月西德的賀斯塔特銀行及美國第20大的富蘭克林銀行倒閉。 • 在這次事件衝擊下，外匯市場收縮，國際資金緊張。使得銀行業本身的脆弱浮上檯面。譬如自有資金比重下降，放款對存款比例增大，存款準備金不足等。 • 從1960~1974，美國全部商業銀行資本占資產比重從8.1%降到6.9%，放款佔存款比例從56.2%升至82%，存款準備金結構也失衡。

12. BASEL 1的起源 • 協定的設立 • 1975年9月，第一個《巴塞爾協定》提出。 • 核心內容是針對國際性銀行監管主體缺位的現實，提出了兩個基本之監管思想： • 任何銀行的國外機構全都不能逃避監管。 • 母國和地主國應共同承擔相應職責。 • 1988年7月，巴塞爾委員會對協定進行了首次實質性完善，並通過了《關於統一國際銀行的資本計算和資本標準的報告》（簡稱《巴塞爾報告》）。

13. New BASEL 的改革背景 • It give an equal weighting to all coporates credits whether of high or low credit quality. • It fails to incorporate potential capital savings from credit (loan) portfolio diversification. • It has led to extensive regulatory capital arbitrage which adds to the riskness of bank asset portfolios.

14. BIS 3 stages proposals draft • 1999年6月國際清算銀行巴塞爾銀行監理委員會公布一個更具風險敏感性的新資本適足性架構，或稱修正草案諮詢文件第一版(Consultative Paper,CP1)，將以取代1988年資本協定。

15. BIS 3 stages proposals draft • 修正草案內容 • the 8% risk based ratio would be replaced by weighting based on the external credit agency rating of the borrower . • some sophisticated banks have developed their own internal rating systems for loans . • given appropriate model and database development and testing some banks may be able to use their own internal credit risk models to calculate capital requirements .

16. The BIS Stage 1 Proposal • 1988 BIS: All corporate loans have the same 100% risk-weight implying the same minimum capital requirement 8%. • 1999 BIS: The 8% risk based ratio should be replaced by weightings based on the external credit agency rating of the borrower.

17. The BIS Stage 1 Proposal

18. The BIS Stage 1 Proposal • Examine the three-bucket approach for corporate borrowers with two questions: 1. Does this approach lead to bank capital reserves rising prior to recessions? (i.e. before the realization of loan losses occurs) → A well-designed regulatory system should see capital reserves rising during periods of high profitability and earnings for banks and falling during recessions as “unexpected losses” are written off against capital.

19. The BIS Stage 1 Proposal 2. Does the bucketing system make economic sense? That is, how homogeneous in terms of risk are the different buckets. → Bucket 2 encompasses both investment grade debt (A and BBB) as well as below investment grade debt (BB and B). Moreover, if they are not homogenous, what relative risk-weighting scheme would these data suggest?

20. Empirical Result • The lead-lag relationship of capital reserves: • Rating agencies move slowly and their ratings are often inflexible. • A capital adequacy system builts around traditional agency ratings might even follow, rather than lead, the business cycle.

21. Empirical Result

22. Empirical Result • Rather than leading the recession, minimum capital requirements would have been lagging it and also the rising wave of loan defaults. → Some banks would have had to build up their minimum reserve requirements during the recession with a peak minimum capital ratio being achieved at or near the recession’s end.

23. Empirical Result • Bucket risk homogeneity: • We examined data on bond issues (and issuers) over the 1981-1999 period. • Our focus of attention was the degree of homogeneity (heterogeneity) of unexpected loss rates over the sample period.

24. We use the data of bond to represent loan of each company. Collecting the price and coupon of the bonds one year prior to default and the price of the bonds just after defaults, then we obtained the loss rate of each bond default.(From 1981~1999) Using Mean value (loss rate) to represent the “Expected Loss Rate.” The difference between Q% confidence coefficient and mean of data is “Unexpected Loss Rate.”

25. Statistics

26. Empirical Result Fitting the data (loss rate) into two probability models to do the empirical researches. 1. Normal distribution 2. Actual distribution

27. Normal distribution

28. Actual distribution

29. Actual distribution

30. Empirical Result • Nomatter what model we use,the four degree of credit qualities in bucket 2 should not be equally risk weighted. • Comparing with bucket 2 and bucket 3,we find that 100% risk-weighting for bucket 2 and 150% for bucket 3 is not appropriate. The reason is “the degree of homogeneity.”

31. Revised method • Confounding “loan losses” with “bond losses.” • For non-defaulter,we have used the number of “issuers.” • For defaulter,we have used the number of “issues.”

32. Revised method • Way: Only using the most “senior” bond or note of each defaulting issuer. • What is “senior” ? The one with highest price one year prior to default. • Benefit: Since most bank loans have collateral backing and have higher prices.These “senior” bonds are more like loan than others.

33. Statistics

34. Normal distribution

35. Actual distribution

36. Actual distribution

37. Empirical Result • We got the same result. • The problem of heterogeneity dose exist. • Bucket 2 is lack of granularity.

38. Summary & Proposal • This paper has examined two aspects of stage 1 of the BIS’s proposed reforms: • Relying on traditional agency ratings could produce cyclically lagging capital requirements, resulting in an enhanced degree of instability in the banking and financial system. • The current bucketing proposal lacks a sufficient degree of granularity.

39. Summary & Proposal • A revised bucket proposal

40. Summary & Proposal • A revised bucket proposal • The choice of 10% for bucket 1 is arbitrary. Although the results clearly show that no defaults have actually taken place, Altman thought it’s weird to let the weighting be zero. • Use a ratio of about 3.33 to 1 when comparing the BB/B bucket with the A/BBB bucket. This is about the midpoint between the normal distribution and actual distribution’s results.