Hungarian Approach to Basel II. Katalin Mérő National Bank of Hungary September 2002

Outline: Capital regulation In Hungary Credit Risk - standardised approach Credit risk - IRB approach Operational Risk Pillar II. and III. Implementation issues

Capital regulation in Hungary - brief history

Capital regulation in Hungary - general problems of the regulation Problems of the “one size fits all” approach in the case of transition economies Questions of the mystic 8 % low “cherry-picking” effect

Capital regulation in Hungary - special Hungarian problems of the regulation lack of consolidated capital requirement problems with the method of calculation  BIS method: total capital. Credit risk+market risk  Hungarian method: total capital-market risk capital credit risk

Credit risk-standardised approach Claims on sovereigns Double disadvantage for the best rated OECD member EU accession countries: higher capital requirement for A rated sovereign claims  higher risk premium changing rule of national discretion for domestic currency denominated exposures

Credit risk-standardised approach Claims on Banks present capital requirement for domestic inter-bank market 20% possible preferential treatment of short term claims denominated and funded in domestic currency  increasing capital charge for exposures with original maturity more than 3 month

Credit risk-standardised approach Claims on corporates The number of rated companies are very few Unchanged capital requirement for unrated companies Increased (150%) weight for: – past due for more than 90 days assets – venture capital

Credit risk -IRB approach Rating practice of banks International practice - BIS Models Task Force (2000) scope: large international banks number of grades: 2-20 for performing and 0- 6 for non-performing loans average:10 and 3 distribution among grades: max 30% of rated exp. in a single grade (range:16- 70%) Hungarian practice - NBH Survey (2000) Scope: 22 Hungarian banks (80% of corporate loans) number of grades: 3-10 for all loans average: 5 distribution among grades: most of the exposures in one ore two grades

Credit risk -IRB approach Pros to use of IRB Higher risk sensitivity Ownership structure of the Hungarian banking sector Strong competition on the banking market disadvantages of the standardised approach for Hungary

Credit risk -IRB approach Cons to use of IRB High level of capital lack of historical data lack of proper IT systems Deficiencies of present risk management practices solvency ratio

Operational risk Basic Indicator approach: α estimation for Hungary

Operational risk Basic Indicator approach -consequences of the α estimation Using basic indicator approach: higher capital requirement for Hungarian banks (as a % of minimum regulatory capital)

Pillar II - Legal systems and discretionary right of supervision rigidity of Hungarian civil law based legal system lack of experience of using discretionary regulation and supervision (regulators) lack of experience of living together with discretionary regulation and supervision (financial institutions)

Pillar II - Discretionary right of supervisions and the competition different supervisory practices against competition under equal terms need for develop and disclose international standards and best practices need for international harmonisation of supervisory activities

Pillar III. - Market discipline market discipline  disclosures more public information  more transparency the developing capital markets and the use of disclosed information additional cost of disclosures need for harmonisation with other disclosure rules

Implementation issues Urgent tasks: develop proper IT systems to use IRB approach: –transformation of rating systems –collecting PD data (PD,LGD and EAD for retail portfolio) Operational risk - to use the standardised approach: –build up effective risk management and control –begin to collect operational risk data by business lines Pillar 2.: –preparation of the supervision for the increased requirements