The Basel Committee on Banking Supervision is in the process of devising new standards for the capital adequacy for banks. The changes have important implications for Hong Kong banks.
For several years now the Basel Committee on Banking Supervision, the primary international standard-setter in the field of banking supervision, has been working on revising the international standards for determining the amount of "regulatory capital" that banks should be required to hold to cover their risks. This is an important task, because the current international standards, which date back to 1988, have become less and less appropriate, particularly for the largest internationally-active banks, as banking has become more sophisticated and - dare I say it - banks have found clever ways to circumvent the rules.
So now is certainly a good time to consider how these international standards might be improved. The approach the Committee has taken is an interesting one, in that they came to the conclusion early on that it was not going to be possible to produce one single standard that would be applicable to all banks. This is because banks these days are simply too diverse for a "one size fits all" approach. So, instead, the Committee determined to produce a menu from which the most appropriate approach for particular banks, and particular banking systems, could be selected. As far as credit risk is concerned - which is still the major type of risk run by most banks - three approaches have been developed. These range from the "standardised approach", which is basically an update of the current approach, to the "foundation internal ratings-based approach" and "advanced internal ratings-based approach", which, as the names suggest, draw on banks' own internal assessments of credit risk.
If the Committee had just stopped here this would already have represented a considerable step forward. However, credit risk is not the only type of risk which banks incur. They are also, to a lesser or greater degree, exposed to a range of other risks, including operational risk, liquidity risk, interest rate risk and foreign exchange risk. Traditionally such risks and the quality of a bank's systems to manage such risks have not been comprehensively captured in banks' regulatory capital requirements, although, importantly, banks have always held a certain amount of additional capital to cover such risks. The Committee, therefore, determined to extend the scope of regulatory capital requirements to cover such risks - indeed, in principle, to cover all risks to which banks are exposed. As with credit risk, a range of approaches has been developed.
As a final element, the Committee also determined that banks should increase their public disclosure, so that more information is available to enable the market to assess banks, and thereby to exert effective market discipline.
So, how does all this affect Hong Kong, and what changes are we likely to see in the HKMA's regulatory regime? The first thing to say is that the HKMA certainly supports such measures aimed at making regulatory capital requirements more risk-sensitive, encouraging banks to develop more sophisticated ratings systems and risk management practices, focusing on a greater range of risks, and fostering improved market discipline. We believe it will be beneficial to Hong Kong's banking system - and to Hong Kong's position as a major international financial centre - to embrace the concepts put forward by the Committee.
But determining how exactly these concepts are to be put into practice in Hong Kong is not straightforward. The Committee has set out a range of approaches, and we must ensure that the appropriate choices for the particular circumstances of Hong Kong are made. This will involve weighing up very carefully the pros and cons of the alternative approaches and, in particular, the costs and benefits. Certainly, we don't want to add unnecessarily to the cost and complexity of regulatory requirements unless there are clear and obvious benefits, for example, in the form of improved risk management, and there is support from the banking industry. So careful consideration of the options in close co-operation with the industry will be paramount. We will shortly be writing to the industry to seek their views.
Joseph Yam
8 May 2003
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