1. B RITISH B ANKERS' A SSOCIATION Implementing Basel II a trade association view Simon Hills Director Prudential Capital & Risk

2. Implementing Basel II What does a trade association do? n Mission: to work with our members to create an environment in which financial services is valued and can prosper n Roles: representation, information, promotion

3. Implementing Basel II What is going on in Europe? n Capital Requirements Directive Implements in 27 member states n 140+ national Discretions n Lobbying of European Parliament n Role of CEBS – http://www.c-ebs.org http://www.c-ebs.org n GENPRU & BIPRU text n FSA standing groups

4. Implementing Basel II FSA standing groups n Credit, operational, credit mitigation, pillar 2, capital, securitisation n FSA policy & supervision experts n Industry experts n Reviewing FSA proposals n Writing ‘advice/interpretations’ E.g. independence, risk appetite, EAD, LGD, stress testing

5. Implementing Basel II Industry issues n Level of application n Intra-group exposures n Materiality n Senior management involvement n Stress testing n Demonstrating use n Waiver review

6. Implementing Basel II Waiver applications Implementing Basel II Waiver applications Management n Time and resource input to compete waivers not always fully appreciated n More rigour needed in management/planning n Regular communication between regulator and banks n Waiver applications lacked clarity and transparency Gaps exist n Developing waiver has tested compliance with key aspects of banks IRB/AMA frameworks n Corporate IRB models have lagged Retail IRB models and required increased resource n Validation work still being completed n Work needs to be done on stress testing frameworks

7. Implementing Basel II Pillar 2 principles n Banks should asses capital wrt risk profile n Supervisors review and evaluate bank’s own capital adequacy n Supervisors expect banks to operate above minimum capital requirements n Supervisors should intervene at an early stage

8. Implementing Basel II Pillar 2 risks interest rate risk in banking book Concentration risk liquidity risk securitisation reputational/strategic risk

9. Implementing Basel II Doing an ICAAP n Identify key risks n Quantify impact of risks n Quantify impact of market down turn n Identify action to take if risks crystallise n Document and communicate

10. Implementing Basel II Identify key risks Significant change in business – e.g. outsourcing Persistent poor/good performance Key clients/business producers Market downturn Unauthorised/Insider trading Telecoms/IT systems Internal/external fraud

11. Implementing Basel II Identify action to take if risks crystallise Meet costs of errors from profits Reduce costs in line with revenues Improve systems and controls Use insurance Restrict particular activities ↑ capital ↓ dividends Merge/take-over Low probability/high impact – capital is not the only answer

12. Implementing Basel II Stress testing n Examine strategic decisions – liquidate portfolios, cut back businesses, expand others? n Chose long term horizon (3 months to 3 years) – according to businesses and risks n Focus on long term risks and their dependencies New risk types (reputational and systemic) External factors (competitor behaviour) as well as management strategic decisions

13. Implementing Basel II Stress testing – doing it well Close engagement by senior management  CEO involved personally in review and challenge. CRO having personal charge of the stress testing programme. Plausible scenarios which challenge key assumptions  Scenarios should not give rise to mild scenario impacts due to benign credit cycle Use of group-wide stress testing and scenario analysis to challenge business plans  Clear and substantive use of stress testing outputs to challenge business planning assumptions. Clear and accessible communication of results  Results presented to senior management showing impact over a multi-year time horizon

14. Implementing Basel II Post waiver issues Implementing Basel II Post waiver issues n Demonstrating appropriate levels of conservatism in models Low default portfolios/statistical significance for model inputs/outputs Regulator requires conservatism at each stage in rating process n Key regulatory focus on embedding models into decision making process Senior management need to understand models Models parameters should be used in business decision making pricing, provisioning, limit approval n Need to embed models in organisation to meet use test Senior management training Document differences in way tools are used fro RWA calculations and pricing purposes n Stress testing should be part of business as usual

15. Implementing Basel II Demonstrating commercial value to the businesses Need to demonstrate that the Basel framework is commercially valuable – to do this the risk function needs to engage more with the business: n Understanding the benefits of risk-adjusted performance n Using Basel models as true decision-support tools n Potential for capital relief from collateral management and effective asset distribution n Improving recoveries and management of impaired assets n Demonstrating the value of effective operational risk management n Developing a capital-based strategy