Alert April 14, 2009

Basel Committee Responses to Financial Crisis

Nout Wellink, the Chairman of the Basel Committee on Banking Supervision (the “Basel Committee”) delivered a speech regarding the initiatives of the Basel Committee in response to the financial crisis.  His speech focused on four areas:  regulatory capital, liquidity, risk management and supervision, and transparency.  He also stated that he welcomed the actions of the G-20 and other bodies, such as the Financial Stability Board to regulate bank-like activities engaged in by non-banks to ensure a comprehensive regulatory response to the current crisis.

Regulatory Capital.  Chairman Wellink emphasized that to prevent future crises of this magnitude the level of capital in the banking system must be strengthened.  In fact, he wishes to require capital levels above those mandated by either the Basel I or Basel II frameworks, although he does not want to increase the requirements immediately and thereby deepen the current credit crisis.  Of particular concern, Chairman Wellink stated that the Basel Committee must enhance the Basel II framework so that exposures not adequately captured under the current framework, including from securitization activities and trading book exposures, will be more comprehensively covered in the future.  Moreover, he stated that the highest form of Tier 1 capital must be simplified, with standards that are both transparent and global.  To dampen procyclicality, among other things the Basel Committee will be developing proposals to build countercyclical buffers into the capital requirements, so as to ensure that during robust periods adequate reserves are developed to blunt the impact of stressful times.  Finally, and perhaps must significantly with respect to capital, the Chairman stated that the Basel II risk capital framework needs to be supplemented by a “non-risk based supplemental measure”.  Indicating that it will be like the current leverage ratio in the US, but perhaps even broader, Chairman Wellink stated that this non-risk based measure “must be simple and transparent, and it must address issues related to accounting differences and off-balance sheet exposures, among others.” 

Liquidity.  As to liquidity initiatives, Chairman Wellink cited the publication last September by the Basel Committee of its “Principles of Sound Liquidity Risk Management and Supervision.”  He stated that the next step is to develop a framework to monitor implementation of those principles, including by “developing benchmarks, tools and metrics that supervisors can use to promote more consistent liquidity standards for cross-border banks.”

Risk Management and Supervision.  Chairman Wellink also discussed initiatives the Basel Committee is pursuing to improve risk management and supervision at banks.  He stated that such improvements largely would be accomplished by the regulators raising the bar of oversight under Pillar 2 (Supervisory Review Process) of Basel II.  He specified that the Basel Committee would look at ways of strengthening “firm-wide governance and risk management; capturing the risk of off-balance sheet exposures and securitization activities; more effectively managing risk concentrations; and providing incentives to better manage risks and returns over the long-term, including compensation practices.”  Chairman Wellink also noted that the Basel Committee also was examining a more “macroprudential approach” to supervision, focusing not just on individual banks but on broader financial stability objectives.  See the January 13, 2009 Alert.

Transparency.  As to transparency, Chairman Wellink focused on Pillar 3, market discipline, of Basel II.  He stated that the Basel Committee was working on enhanced disclosures relating to securitization, off-balance-sheet exposures, and trading activities.  He hoped these measures would prevent future crises based on a lack of investor knowledge about the true strength of a bank’s balance sheet.