The impact of the proposed new capital adequacy framework on credit risk management practices of South African banks
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Date
Nov-02
Authors
De Beer, Jesse Ada
Journal Title
Journal ISSN
Volume Title
Publisher
University of the Free State
Abstract
Afrikaans: Die omvang van risiko’s in die finansiële dienste-industrie is groter as ooit tevore in die huidige omgewing van globalisering en toenemende mededinging. Om in pas te bly met veranderings in die risiko omgewing sowel as met die nuutste ontwikkelings in risiko- bestuurspraktyke, word aansienlike uitdagings aan beide banke en bankreguleerders gestel. Vir banktoesighouers is die grootste uitdaging om ‘n benadering tot kapitaalregulering te ontwikkel wat vir ‘n diverse en dinamiese omgewing geskik is. Vir finansiële instellings is die grootste uitdaging om verbeterings in risikometing en bestuurspraktyke op ‘n sistematiese wyse te implementeer en terselftertyd konsepsuele probleme rakende risiko-modelspesifikasie en databeperkings te hanteer. Die Nuwe Kapitaal Reguleringsraamwerk, soos voorgestel deur die Baselse Komitee is ‘n poging om hierdie uitdagings aan te spreek.
Die voorgestelde nuwe Baselse Ooreenkoms is ‘n sleutelinisiatief om bankveiligheid en gevolglik ook stabiliteit in die finansiële sektor te versterk. Dit is beide ‘n verreikende en ambisieuse hervorming gemik op die belyning van regulerende kapitaalvereistes en ekonomiese risiko. Die nuwe kapitaalraamwerk hou besliste voordele in bo die bestaande benadering. Die voorstel beweeg weg van ‘n “one size fits all” benadering tot die toesighoudende benadering tot kapitaalvereistes. In plaas van die gebruik van slegs een opsie vir die berekening van kapitaalvereistes, bestaan daar nou ‘n keuse tussen ‘n verskeidenheid benaderings tot die berekening en bestuur van kapitaal. Banke wat ‘n gesofistikeerde benadering tot risikometing en -bestuur volg, sal uit laer kapitaalvereistes kan voordeel trek. Die implementering van die voorgestelde Baselse Ooreenkoms sal verreikende implikasies vir beide individuele banke en finansiële markte inhou.
Die implementering van die voorgestelde Baselse ooreenkoms sal egter verskeie uitdagings daarstel, veral in ‘n ontluikende markte konteks. Die doel van hierdie studie is om die uitdagings wat die implementering van die voorgestelde kapitaal ooreenkoms aan Suid- Afrikaanse banke en banktoesighouers stel, te identifiseer. Die mate waartoe Suid-Afrikaanse banke en banktoesighouers voorbereid is om hierdie uitdagings die hoof te bied, word ook aangespreek. Die studie konsentreer op die kredietrisikovoorstelle van die nuwe Kapitaal Ooreenkoms, asook die impak van hierdie voorstelle op Suid-Afrikaanse banke se krediet- risikobestuurspraktyke.
‘n Oorsig van die struktuur van die Suid-Afrikaanse bank sektor word teen die agtergrond van die gesofistikeerde en effektiewe Suid-Afrikaanse finansiële markte gegee en die kwesbaarheid van Suid-Afrika se status as ‘n ontluikende mark word ook aangetoon.
Kwanitatiewe indikatore van die veiligheid van ‘n finansiële sektor, soos verskeie aanduiders van kredietrisiko en kapitaaltoereikendheid word gegee. Die studie sluit ook ‘n oorsig in van Suid-Afrikaanse banke se benadering tot kredietrisikobestuur, sowel as die toesighoudende benadering van die Bank Toesighoudings Departement van die Suid-Afrikaanse Reserwebank.
Hoewel Suid-Afrikaanse banke ‘n gesofistikeerde benadering tot kredietrisikobestuur en kredietrisikograderings volg, voldoen huidige risiko graderingstelsels nie aan al die vereistes gestel deur die Baselse Kommitee om vir die interne graderingsbenadering (“IRB”) vir die berekening van kapitaalvereistes te kwalifiseer nie .
Verskeie waarnemers waarsku dat belangrike voorvereistes vir die suksesvolle implementering van belangrike komponente van die Baselse Ooreenkoms in verskeie ontluikende markte afwesig is. Die resultate van hierdie studie dui daarop dat dit nie die geval in Suid-Afrika is nie. Die FSAP missie beskou Suid-Afrikaanse banktoesighouers as bekwaam en effektief. Die faktore wat die effektiwiteit van minimum kapitaalvereistes in die bevordering van bank veiligheid en stabiliteit in verskeie ontluikende markte bemoeilik, is skynbaar afwesig in die Suid-Afrikaanse banksektor. Hierdie faktore sluit die gebrek aan ‘n likiede kapitaalmark in, wat dit moontlik maak om “lae kwaliteit” kapitaal te verkry, asook ‘n gebrek aan beleidsmaatreëls soos voorsiening vir leningsverliesregulasies wat minimum kapitaalvereistes komplimenteer. Die regulerende raamwerk ten opsigte van Suid-Afrikaanse banke is inderdaad onlangs gewysig ten einde dit in ooreenstemming met internasionale praktyke te bring en om enige beperkings, soos aangedui deur die FSAP, aan te spreek.
Implementering van die voorgestelde Baselse Ooreenkoms verteenwoordig nuwe terrein vir Suid-Afrikaanse bankreguleerders, insluitende die evaluering van banke se interne risiko- graderingstelsels. Suid-Afrikaanse bankreguleerders het reeds begin met spesifieke maatreëls om uitdagings, gestel deur die implementering van die nuwe Ooreekoms die hoof te bied. Suid-Afrikaanse banke het ook reeds met voorbereidings vir die implementering van die nuwe Ooreenkoms begin. Al die banke wat in die steekproef ingesluit is, het aangedui dat hulle beplan om die gevorderde interne risikograderingsbenadering (“advanced IRB”) te volg. Die huidige gesofistikeerde benadering tot kredietrisikobestuur en die gebruik van gesofistikeerde modelle in hierdie verband, verteenwoordig ‘n waardevolle platform vir die implementering van die IRB benadering. Die huidige struktuur van Suid-Afrikaanse banke se interne risiko- graderings en die algemene benadering tot die toekenning van risikograderings voldoen egter nie aan al die vereistes gestel deur die Basel Komitee vir kwalifisering vir die gebruik van die interne risiko-graderingsbenadering nie en verskeie wesenlike logistiese uitdagings bly oor.
Oor die algemeen blyk dit dat Suid-Afrikaanse banke ‘n gesofistikeerde benadering tot kredietrisikobestuur volg, in ooreenstemming met internasionale standaarde. Die bevindinge van die studie dui daarop dat die groot Suid-Afrikaanse banke die uitdagings voortspruitend uit veraderings in die krediet risiko omgewing aanvaar en reeds geruime tyd besig is met die indentifisering, ontwikkeling en implementering van gesofistikeerde kredietrisiko-modelle en die organisatoriese konteks vir portefeulje-georiënteerde kredietrisikobestuur. Die studie het ook die huidige benadering van Suid-Afrikaanse banke tot interne krediet risikograderings geskets en verskeie internasionale vergelykings getref. Oor die algemeen lyk dit of Suid-Afrikaanse banke se risikograderings praktyke in lyn is met hulle internasionale eweknieë.
Die gebrek aan betroubare langtermyn data rakende banklenings is ‘n sleutel uitdaging vir alle gebruikers van interne krediet-gradering stelsels wêreldwyd. Gebruikers sluit in bank- toesighouers wat die risikograderingstelsels moet evalueer vir regulerende kapitaalvereistes. Die gebrek aan sodanige data het negatiewe implikasies vir die vermoë van banke om effektiewe graderingsinstrumente te ontwikkel. Dit bemoeilik ook die verifikasie van die akkuraatheid van banke se gradering stelsels, ten einde onder andere betroubare kwantitatiewe beanderings van waarskynlikheid van wanbetaling te bereken. Al hierdie toepassings is belangrik, nie net uit die oogpunt van banke nie, maar ook uit die oogpunt van bankreguleerders (spesifiek in die lig van die voorstelle om banke se interne risikograderings vir regulerende kapitaalvereistes te gebruik).
Die empiriese studie beklemtoon veral op een aspek waar die huidige Suid-Afrikaanse bankpraktyke agterweë bly by internasionale praktyke: die bekendmaking van inligting rakende krediet- risikomodelering en veral kredietrisikograderingstelsels. Dit verteenwoordig ‘n sleutel aspek wat aangespreek behoort te word alvorens die IRB benadering suksesvol geïmplementeer kan word.
Behalwe die implemteringsuitdagings in individuele lande, bestaan daar kommer oor die impak van die nuwe Baselse Ooreenkoms op die stabiliteit van wêreldwye finansiële stelsels. Spesifieke faktore wat hierby ingesluit word, is die vrae oor die impak op kapitaalvloeie na ontluikende markte en die potensiële pro-sikliese impak van die nuwe Baselse Ooreenkoms. Die behoefte aan verhoogde koördinasie binne die internasionale gemeenskap ten opsigte van die agenda vir verandering in ’n toenemend geïntegreerde internasionale finansiële stelsel word uitgelig.
English: In the current environment of globalization and increasing competition in the financial services industry, risks are larger in scope and scale than ever before. Keeping pace with the changes in the risk environment, as well as with the latest developments in risk management practices, poses significant challenges to regulators and banks alike. For supervisors, the most important challenge involves developing an approach to capital regulation that works in a world of diversity and near-constant change. Financial institutions face the challenge of implementing advances in risk modeling in a coherent and systematic fashion, and of coping with conceptual difficulties regarding model specification and data limitations. The New Capital Adequacy Framework proposed by the Basel Committee is an attempt to address these challenges. The proposed new Basel Capital Accord is one of the key initiatives for strengthening bank soundness, and thus financial sector stability. This is both a wide-ranging and ambitious reform that seeks to better align regulatory capital with economic risk. It represents a real advance on the 1988 Capital Accord, and the proposals mark a decisive step away from a “one size fits all” supervisory approach to capital. Rather than imposing a single method for calculating capital requirements, institutions will be able to select from a range of approaches for capturing, measuring, and controlling credit and operational risks. More sophisticated control structures will be rewarded by lower capital charges. If the Basel proposals are implemented as planned, they will have important effects both on individual banks and on financial markets as a whole. However, implementation of the proposed Accord creates additional challenges, especially in an emerging market context. The main aim of the study is to identify the challenges posed by the implementation of the proposed capital adequacy framework to South African banks and bank supervisors, and to see how prepared they are for these challenges. This study is mainly concerned with the credit risk proposals of the new Accord, and the impact of the proposed new Accord on the credit risk management practices of South African banks. Against the background of South Africa∗s sophisticated and efficient financial markets, and yet its vulnerability as an emerging market, an overview is given of the structure of the South African banking sector. This includes quantitative indicators of financial system soundness, like various indicators of credit risk and capital adequacy. An overview is given of the risk management practices of South African banks, as well as of the supervisory approach of the South African Reserve Bank. All of this is compared to international “best practice” policy guidelines. Although a review of annual reports of South African banks suggests a relatively sophisticated approach to credit risk management and the use of internal credit risk ratings, the rating systems of South African banks do not meet all the requirements set out by the Basel Committee for the internal ratings-based approach to setting regulatory capital requirements. Several observers warn that the preconditions for implementing important components of the Basel Accord are absent in most emerging market economies. The findings of this study suggest that this is not the case in the South African situation. South African bank supervisors are efficient, as evident in the findings of the FSAP. The factors that seemingly cause minimum capital requirements to be an inefficient tool in enhancing bank system soundness in many emerging market countries do not seem to be present in the South African banking sector. These factors are the lack of a sufficiently deep and liquid capital market that makes the raising of “low quality” capital possible, and the lack of policy measures such as loan-loss provision regulations that complement minimum capital requirements. Indeed, the regulatory framework in South Africa was recently amended so as to be in line with international best practice standards, and to address any limitations pointed out by the FSAP. However, the new Accord does represent new ground for South African supervisors in several aspects, such as with the evaluation of banks’ internal credit risk rating systems. South African bank supervisors have already started with specific measures to address challenges posed by the implementation of the new Accord. South African banks have also started with preparations for the implementation of the Accord. All the surveyed banks indicated that they want to adopt the advanced IRB approach. The current sophisticated approach to credit risk management and the use of sophisticated models in this regard, constitute a useful platform for this to take place from. However, current practice does not conform to all the requirements set by the Basel Committee, and substantial logistical challenges remain. In general, the credit risk management practices of South African banks seem to be sophisticated and in line with international best practice. The survey has shown that the large South African banks have recognized this challenge and have been working for some time on identifying, modifying, developing and implementing sophisticated credit risk models and the organizational context for a portfolio-orientated credit risk management. The survey also outlined the current state of play regarding credit risk rating among South African banks, and provided some international comparisons. Generally speaking, South African banks’ credit risk rating practices appear to be in line with those of their international peers. A key challenge faced worldwide by virtually all developers and users of internal credit risk rating systems, including prudential supervisors looking to utilize banks’ internal ratings for regulatory capital and other purposes, is the widespread lack of good long-run data on the performance of banks’ loans. The lack of such data can impact on the ability of an institution to develop effective rating tools. It can also impede efforts to verify the accuracy and robustness of institutions’ rating systems, to assign reliable quantitative loss estimates to risk grades, and to make reliable comparisons of ratings from different institutions: all important tasks, not only from the perspective of the banks themselves, but also from the point of view of their prudential supervisors (particularly in the context of proposals to utilize banks’ internal ratings for regulatory capital purposes). The survey highlighted one important aspect where current South African practice lags behind Basel requirements: disclosure regarding credit risk modeling and specifically rating systems. This would be one of the key areas that need to be addressed before the IRB approach can be implemented. Apart from implementation challenges in individual countries, there is concern over the impact of the proposed new Basel Accord on global financial system stability. This includes questions about its impact on capital flows to emerging market countries and the potential pro-cyclical impact of the new Accord. These concerns highlight the need for greater coordination within the international community on the reform agenda in an increasingly integrated international financial system.
English: In the current environment of globalization and increasing competition in the financial services industry, risks are larger in scope and scale than ever before. Keeping pace with the changes in the risk environment, as well as with the latest developments in risk management practices, poses significant challenges to regulators and banks alike. For supervisors, the most important challenge involves developing an approach to capital regulation that works in a world of diversity and near-constant change. Financial institutions face the challenge of implementing advances in risk modeling in a coherent and systematic fashion, and of coping with conceptual difficulties regarding model specification and data limitations. The New Capital Adequacy Framework proposed by the Basel Committee is an attempt to address these challenges. The proposed new Basel Capital Accord is one of the key initiatives for strengthening bank soundness, and thus financial sector stability. This is both a wide-ranging and ambitious reform that seeks to better align regulatory capital with economic risk. It represents a real advance on the 1988 Capital Accord, and the proposals mark a decisive step away from a “one size fits all” supervisory approach to capital. Rather than imposing a single method for calculating capital requirements, institutions will be able to select from a range of approaches for capturing, measuring, and controlling credit and operational risks. More sophisticated control structures will be rewarded by lower capital charges. If the Basel proposals are implemented as planned, they will have important effects both on individual banks and on financial markets as a whole. However, implementation of the proposed Accord creates additional challenges, especially in an emerging market context. The main aim of the study is to identify the challenges posed by the implementation of the proposed capital adequacy framework to South African banks and bank supervisors, and to see how prepared they are for these challenges. This study is mainly concerned with the credit risk proposals of the new Accord, and the impact of the proposed new Accord on the credit risk management practices of South African banks. Against the background of South Africa∗s sophisticated and efficient financial markets, and yet its vulnerability as an emerging market, an overview is given of the structure of the South African banking sector. This includes quantitative indicators of financial system soundness, like various indicators of credit risk and capital adequacy. An overview is given of the risk management practices of South African banks, as well as of the supervisory approach of the South African Reserve Bank. All of this is compared to international “best practice” policy guidelines. Although a review of annual reports of South African banks suggests a relatively sophisticated approach to credit risk management and the use of internal credit risk ratings, the rating systems of South African banks do not meet all the requirements set out by the Basel Committee for the internal ratings-based approach to setting regulatory capital requirements. Several observers warn that the preconditions for implementing important components of the Basel Accord are absent in most emerging market economies. The findings of this study suggest that this is not the case in the South African situation. South African bank supervisors are efficient, as evident in the findings of the FSAP. The factors that seemingly cause minimum capital requirements to be an inefficient tool in enhancing bank system soundness in many emerging market countries do not seem to be present in the South African banking sector. These factors are the lack of a sufficiently deep and liquid capital market that makes the raising of “low quality” capital possible, and the lack of policy measures such as loan-loss provision regulations that complement minimum capital requirements. Indeed, the regulatory framework in South Africa was recently amended so as to be in line with international best practice standards, and to address any limitations pointed out by the FSAP. However, the new Accord does represent new ground for South African supervisors in several aspects, such as with the evaluation of banks’ internal credit risk rating systems. South African bank supervisors have already started with specific measures to address challenges posed by the implementation of the new Accord. South African banks have also started with preparations for the implementation of the Accord. All the surveyed banks indicated that they want to adopt the advanced IRB approach. The current sophisticated approach to credit risk management and the use of sophisticated models in this regard, constitute a useful platform for this to take place from. However, current practice does not conform to all the requirements set by the Basel Committee, and substantial logistical challenges remain. In general, the credit risk management practices of South African banks seem to be sophisticated and in line with international best practice. The survey has shown that the large South African banks have recognized this challenge and have been working for some time on identifying, modifying, developing and implementing sophisticated credit risk models and the organizational context for a portfolio-orientated credit risk management. The survey also outlined the current state of play regarding credit risk rating among South African banks, and provided some international comparisons. Generally speaking, South African banks’ credit risk rating practices appear to be in line with those of their international peers. A key challenge faced worldwide by virtually all developers and users of internal credit risk rating systems, including prudential supervisors looking to utilize banks’ internal ratings for regulatory capital and other purposes, is the widespread lack of good long-run data on the performance of banks’ loans. The lack of such data can impact on the ability of an institution to develop effective rating tools. It can also impede efforts to verify the accuracy and robustness of institutions’ rating systems, to assign reliable quantitative loss estimates to risk grades, and to make reliable comparisons of ratings from different institutions: all important tasks, not only from the perspective of the banks themselves, but also from the point of view of their prudential supervisors (particularly in the context of proposals to utilize banks’ internal ratings for regulatory capital purposes). The survey highlighted one important aspect where current South African practice lags behind Basel requirements: disclosure regarding credit risk modeling and specifically rating systems. This would be one of the key areas that need to be addressed before the IRB approach can be implemented. Apart from implementation challenges in individual countries, there is concern over the impact of the proposed new Basel Accord on global financial system stability. This includes questions about its impact on capital flows to emerging market countries and the potential pro-cyclical impact of the new Accord. These concerns highlight the need for greater coordination within the international community on the reform agenda in an increasingly integrated international financial system.
Description
Thesis (Ph.D. (Economics))--University of the Free State, 2002
Keywords
Credit risk, Basel Capital Accord, Minimum capital requirements, Credit risk ratings, Credit risk models, Credit -- Management, Risk management, Bank loans, Bank management -- South Africa