Standard & Poor’s official response to the Basel Committee’s proposal

陳解柔 黃郁婷

Agenda

• Introduction

(1) Structure of Basel II

(2) Background on Standard & Poor’s and its

operation• Credit assessments and risk adjustment process

(1) Use of bank’s own internal ratings

(2) Use of external credit assessments

-S&P views on regulation• Rating agency authorization / regulation• Conclusion

Structure of Basel II

Part 1 : Scope of Application

Part 3 :The Second

Pillar-Supervisory

Review Process

Part 4 :The Third Pillar

-Market Discipline

Part 2 : The First Pillar – Minimum Capital Requirements

I. Calculation of minimum capital requirements

II. Credit risk -The

StandardisedApproach

III. Credit risk -The Internal Rating Based

ApproachIV. Credit risk -Securitisation

Framework

V.Operational

Risk

VI. Trading Book

Issues(including Market risk)

Background on Standard & Poor’s and its operations

• Who S&P is ? A global brand.

A financial powerhouse. An icon of integrity. S&P is more than the provider of information. S&P is setting the standard.

• Three Core Services

• Credit Market Services • Investment Service• Corporate Value Consulting

From http://www2.standardandpoors.com/servlet/Satellite?pagename=sp/Page/HomePg&r=1&l=EN

Credit assessments and risk adjustment process

• Use of bank’s own internal ratings

1.Advantages of IRB approach :

(1) The internal credit assessments of institutions with advanced credit management systems may serve as an appropriate basis for the risk adjustment process.(2) Encouraging banks to lend prudently and carefully monitor their portfolios.

2.Issues: (1) The ongoing integrity of banks’ systems (2) What is the regulators’ process and criteria for approving them? (3) The reliance, based solely on local regulatory judgment and not companied by strong disclosure could diminish the

market’s role.

3.Response :

S&P believes a necessary underpinning is a commonly agreed global standard of assessing bank risk ranking systems and common disclosure standards.

(1)The need for third parties to review these

systems so they are consistent or comparable.

(2)The need for disclosure so regulators and other

third parties understand the differences among

methodologies and how they perform.

• Use of external credit assessments

1.Adventages :

(1) More closely approximate

(2) Being more easily adapted to serve as a common language of credit

(3) Being public and continuously subject to market scrutiny and its self-correcting disciplines

(4) Impartially determined

2.S&P views on regulation :

◆Technical rating policy issues which need to be resolved :

(1) Globally comparable ratings and local domestic scale ratings

We need to compare these ratings to avoid ‘rating shopping’ for the highest rating and to ensure quantity ratings.

(2) No difference between solicited and unsolicited ratings

Transparency could be compromised. S&P believe ongoing cooperative

relationship with management provide the soundest basis for rendering credit opinions.

◆ Standard Method

Table1

Claim Assessment

AAA toAA-

A+ to A-

BBB+ to BBB-

BB+ to B-

Below B-

Unrated

Sovereign 0% 20% 50% 100% 150% 100%

Banks Option11 20% 50% 100% 100% 150% 100%

Option22 20% 50%3 50%3 100%3 150% 50%3

Corporates 20% 100% 100% 100% 150% 100%

1Risk weighting based on risk weighting of sovereign in which the bank is incorporated.2Risk weighting based on the assessment of the individual bank.3Claims on banks of a short original maturity, for example less than six months, would receive a weighting that is one category more favourable than the usual risk weight on the bank’s claims.

◆ Standard Method-S&P Comments

(1)Equivalently rated entities in different industries/sectors are given different weightings

→ Moral hazard → Adversely distort fund flows

eg. The proposal give lower weightings to sovereigns than to banks/corporations.

(2)The proposal’s weightings are sharply graduated. →A small change in ratings will result in large increase in capital requirement.

(3)The proposal’s treatment to debt of non-sovereign public sector enterprises(PSE) is the same as a claim on bank of that country.

→Not all PSE are close to sovereign’s credit risk.

◆ Standard Method-S&P Comments

◆ Standard Method-S&P Comments

(4)The option 1 of assessing banks is not so appropriate ： It may penalize better-quality banks but benefit weaker ones.

eg. Sovereign’s rating is AA→All banks in that country will be rated as A.

◆ Standard Method-S&P Comments

(5)Any preferential weightings for short-term exposures should be adopted carefully.

→Suggestion: Limit this preferential treatment to higher-rated entities but expanding to include corporate and sovereigns as well as banks to mitigate potential adverse consequences.

◆ Standard Method-S&P Comments

(6)Corporate loans:20%,100%,150% weights. →

1.A little downward in rating(AA- to A+) will result in great increase in risk weightings.(20% to 100%)

2.The suggested weighting may overweight high-quality exposures and underweight low-quality exposures.

◆ Standard Method-S&P Comments

(7)Securitized Assets:Most differentiated treatment：

Highest rating ： 20% Capital charge

Lowest rating (B+ or below) ： 100% Capital charge

→May stimulate new structure to remove risk from balance sheet.

◆ Other Issues

(1)Proposal ： Separate capital charge for interest rate risk and operational risk

→For high-quality government bonds, it’s not required to charge additional capital but still carry interest rate risk.

(2)Credit derivative → Hard to quantify

→Suggestion: Overall assessment is better.

◆ Rating Agency Authorization/Regulation

• Authorization Criteria:

Objectivity, Independence, Transparency, Creditability, International Access, Resources, Recognition.

◆ Rating Agency Regulation-S&PComments

(1)S&P ： Reputation for being credible, objective and operate independently

→Best service provided.

S&P doesn’t support use of ratings in regulation because it will increase regulators’ efforts to influence/control agency.

(2)Regulators must prevent to use ratings as an improper substitute for management disciplines.

(3)The substantive regulation does not ensure the quality of ratings or rating agencies.

(4)The potential for the use of external assessment to introduce an incremental element of systematic risk.

◆ Rating Agency Regulation-S&PComments

◆ Conclusion

S&P Basically agrees with the proposal and points out some questions to think.