1 BASEL II In the Australian Context Charles Littrell Executive General Manager Australian Prudential Regulation Authority 17 October 2003

2 International Accord on minimum Bank Capital Established 1988 but becoming obsolete – Still works for simple ADIs – Economic equity models superior for large ADIs Basel II – planned update Final rules and timing uncertain What is Basel II?

3 Australia’s ADIs – a Snapshot Assets $bn % of Total Typical Credit Rating # of Entities Largest Banks AA-4 Regional and Foreign Banks A47 Credit Unions & Building Societies (CUBS) 423.7N/A201

4 Ensure sufficiency – Core issue in avoiding failures – International requirement Increase risk sensitivity – Basel I too blunt – Basel II an improvement Avoid excess – Efficiency issue – Complacency risk Minimise transition costs – Dollars – Distraction APRA Objectives for ADI Capital (in order)

5 Disaggregates credit, operational, “other” risks Relies on internal risk models Scope for supervisory discretion More disclosure Likely outcomes – Lower average capital – Higher marginal capital Best of both worlds? – Justifies effort and expense Basel II for Sophisticated Banks

6 Update on Basel I Simplistic but workable Increased disclosure applies APRA attempting to minimise transition costs Likely outcome – Slightly lower capital – More operational risk focus Basel II for Small Banks & CUBS

7 Flexible, Dynamic Risk Based Linked to personal incentives Discourages silly risks Reduces failure probability and Capital Requirements Both safety and efficiency Why is Basel II Good?

8 Model Risk – Data and assumptions – Response time – Model myopia – Mathematics Unspecified Risks – Cyclicality – Strategic/Business – Interest Rate Mismatch Supervisory Complexity Cost and Distraction Why Isn’t Basel II Good?

9 Australia v rest of world – Relative improvement Large banks v other ADIs – Both do better Continues long term trends Competitive Effects

10 Conversion uncertainty – Schedule – Rules – Applicability Australian Rules – We need to be tougher – But not too tough Outstanding Issues

11 APRA supports Basel II Safety and efficiency benefits We are prepared for implementation Not cheap, easy, or risk free… But will be good for Australia Summary

12 BASEL II In the Australian Context Charles Littrell Executive General Manager Australian Prudential Regulation Authority 17 October 2003