An important stage in the implementation of Basel II has been reached this week with the commencement of the statutory consultation on the draft Banking (Capital) Rules.
This column has on a number of occasions reviewed the progress being made on the implementation of Basel II, the revised capital adequacy standards for authorized institutions (AIs). An important milestone was reached this week with the commencement of the statutory consultation on the draft Banking (Capital) Rules, which set out how locally incorporated AIs' capital adequacy ratios will be calculated from January next year. Given the length and complexity of the Basel II requirements - the draft Rules run to some 1,000 pages - it is quite an achievement to have produced this draft on schedule. This would not have been possible without the hard work and close collaboration of many in the HKMA, the Financial Services and Treasury Bureau, and the Department of Justice, and without the very significant contributions from the industry at all stages of development of the draft Rules.
Basel II is important to Hong Kong because it will contribute to greater robustness of the banking system and to banking stability. The improvements in risk management necessary to implement Basel II will also stand the banks in good stead for future development of their business, and will contribute to the efficiency and effective working of the banking system.
The statutory consultation is an important step in ensuring that the implementing legislation for Basel II is "fit for purpose" and is suitably tailored to Hong Kong circumstances. With this in mind, the consultation will be extensive. Comments are being sought from a broad spectrum of society, including Legislative Council Members, the Consumer Council, the business community (through trade associations and Chambers of Commerce), the accounting and legal professions, academics, credit rating agencies, financial regulatory bodies, and of course the financial industry. This is to ensure broad support and to identify issues of relevance to industry players, other professionals and the general public so that they can be properly considered before the Rules are gazetted and introduced into the Legislative Council. I would therefore encourage any parties interested in this subject to review the draft Rules (available on our website at www.hkma.gov.hk) and to provide us with their comments as early as possible, since we hope to have the Rules passed by the end of the year.
Hong Kong will be in the first wave of jurisdictions to implement Basel II. It is important for Hong Kong, being a major financial centre, to keep up with the best practices adopted by the top-tier financial centres. And it is important for our banks to move in step with major international banks in adopting more advanced risk management, which Basel II promotes.
The banking industry is firmly behind adoption of Basel II, although some concerns have been expressed from time to time that perhaps the pace of change is a little too fast for some AIs. However, there is a great deal of flexibility in the implementation approach. First, we have not mandated that AIs should use the more advanced approaches available to them; this is a matter for each individual institution to consider, based on their business mix, risk profile and risk measurement and management practices, and cost-benefit analysis. We do not expect that institutions will incur significant compliance costs or resource requirements in adopting the "default" approaches, that is the standardised approach to credit and market risk and the basic indicator approach to operational risk. Secondly, we have developed a "basic approach" to credit risk, which is essentially a modified version of the existing regime, for smaller institutions, whose small asset size and relatively simple operations may not justify the cost of adopting the more advanced approaches of Basel II. The vast majority of the restricted licence banks and deposit-taking companies will adopt this approach. Thirdly, a transitional period from 1 January 2007 to 31 December 2009 will be allowed for institutions that intend to adopt the more advanced Internal Ratings-Based (IRB) approach eventually to use the basic approach if they can demonstrate that they have an adequate plan for implementing the IRB approach by the end of the transitional period. AIs can therefore start with a more simple approach, and then migrate to a more advanced one when it suits them, as long as they can meet the qualifying criteria.
Given this flexibility, and the range of approaches available to AIs, adoption of Basel II is something that is achievable by all AIs in Hong Kong by the planned introduction date of January 2007. There has been very extensive consultation throughout the long process of development of Basel II. The consultation currently underway provides the opportunity for the banking industry and other interested parties to review the detailed requirements and see exactly what is proposed. All comments received will of course be given full and careful consideration before the Rules are finalised.
Simon Topping
3 August 2006
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