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New Capital Accord Basel II Challenges for the Asia-Pacific Region Stephen Y. L. Cheung New Capital Accord Basel II Challenges for the Asia-Pacific Region Stephen Y. L. Cheung Department of Economics and Finance City University of Hong Kong Stephen Cheung New Capital Accord Basel II

The New Accord Three Basic Pillars Minimum Capital Requirements Weighted Risks Credit Risk Standardized The New Accord Three Basic Pillars Minimum Capital Requirements Weighted Risks Credit Risk Standardized Approach (SA) Supervisory Review Process Market Disciple Definition of Capital Operational Risk Market Risk Internal Ratings Based Approach (IRB) Foundation Approach Advanced Approach New Capital Accord Basel II 2

Three approaches on credit risk u u Ø SA – relies on external credit Three approaches on credit risk u u Ø SA – relies on external credit assessments IRB – Internal risk management systems - Lack of historical data on losses - Absence of benchmark risk weight assessments - IT system - Investment in human resources - Training How many banks in Asia are ready yet? New Capital Accord Basel II 3

Role of external credit rating agencies u Few external credit rating agencies in developing Role of external credit rating agencies u Few external credit rating agencies in developing countries u The number of rated firms in G-10 countries is 24 times greater than in low-income countries u International credit rating agencies have to play a greater role New Capital Accord Basel II 4

Role of external credit rating agencies u Investors overreact to the rapidly revised credit Role of external credit rating agencies u Investors overreact to the rapidly revised credit information u Mass withdrawal of capital u Little information on Asian corporations - u Poor corporate governance Lack of transparency High cost Creditability of national credit rating agencies New Capital Accord Basel II 5

Role of external credit rating agencies u Reduction in the flow of capital to Role of external credit rating agencies u Reduction in the flow of capital to developing countries that tend to be lower-rated u Indonesia, sovereign rating foreign currency loans below B- faces a loan risk weight of 150% u Singapore assigned a 0% sovereign risk weight and a low 20% corporate and inter-bank loan risk weight. New Capital Accord Basel II 6

Role of external credit rating agencies u Greater transparency and disclosure on the criteria Role of external credit rating agencies u Greater transparency and disclosure on the criteria used in assigning ratings u Consistent with best practice New Capital Accord Basel II 7

Challenges for banking sector in the region u Loans secured by non-residential land assets, Challenges for banking sector in the region u Loans secured by non-residential land assets, 100% capital change u Common practice in many Asian banks u Further inflate capital requirements and may be detrimental to economic growth. u Lending to SMEs New Capital Accord Basel II 8

Challenges for regulators u More emphasis on the supervisory review process - Training - Challenges for regulators u More emphasis on the supervisory review process - Training - u Human resources Funding Cross border coordination New Capital Accord Basel II 9

Remarks u In wake of Enron, World. Com & co. - Will this really Remarks u In wake of Enron, World. Com & co. - Will this really work? u Regulatory arbitrage u Could we keep it simple u Allow for more room - when economy needs to slow down - u Capital adequacy ratio when economy needs to expanse Design a new risk assessment system for S&M banks New Capital Accord Basel II 10

Thank you New Capital Accord Basel II 11 Thank you New Capital Accord Basel II 11