Alert December 02, 2008

Basel Committee Issues Strategy to Respond to Banking Crisis

The Basel Committee on Banking Supervision (“Basel Committee”), via a notice on its website and a speech by its Chairman, Nout Wellink, issued a strategy to respond to the current banking crisis.  The strategy focuses on strengthening several areas of bank operation and supervision:  capital buffers; liquidity risk management and buffers; risk management practices; counterparty credit risk; and globally coordinated supervision.

Capital Buffers.  The Basel Committee does not propose to raise minimum capital ratios during a crisis.  However, the Basel Committee will remain focused on several areas of risk capture, including by issuing proposals in early 2009 regarding capital treatment of off-balance sheet exposures and securitizations, strengthening the capital treatment of illiquid securities in the trading book, disclosure requirements relating to the foregoing, and reviewing the role of external ratings in the Basel II framework.  The Basel Committee also will provide guidance on the key elements of the proper composition of tier 1 capital in light of recent developments, and will explore the ability of strong capital buffers to reduce the cyclical nature of lending.  Moreover, the Basel Committee is reviewing whether to supplement risk-capital based approaches with “simple, transparent gross measures of risk” to “provide a further check on the build-up of leverage at financial institutions and the underestimation of risk during rapid periods of credit growth.”

Liquidity Risk Management and Buffers.  The Basel Committee pledged to redouble its efforts to develop more consistent benchmarks for sound liquidity at global banks, including benchmarks for liquidity cushions, maturity mismatch, funding liquidity diversification, and resilience to stress.  The Basel Committee also will implement its recently issued “Principles for Sound Liquidity Risk Management” (see the July 1, 2008 Alert).

Risk Management Practices.  The Basel Committee expects the private sector to take the lead in developing risk management frameworks.  Nonetheless, the Basel Committee expects to issue in 2009 further guidance on risk management with respect to securitizations, contractual and non-contractual obligations to off-balance sheet vehicles, and stress testing. 

Counterparty Credit Risk Practices.  The Basel Committee also will use the 3 pillars of Basel II to strengthen the minimum capital, risk management, and disclosure relating to counterparty credit risk and its management.  The purpose of the effort is to help banks better withstand the failure of one or more major counterparties. 

Globally Coordinated Supervision.  The Basel Committee also is assessing global incompatibilities in the resolution of global banking groups.  Among other things, the Basel Committee will be assessing gaps in global regulations and ways to correct them, assessing different ways to promote better risk management of participants in major payment systems and other global networks, and establishing stronger links between the objectives of central bank liquidity operations, regulation and supervision.