News Article on BASEL III

Expert: Basel III needs to address three areas

BY DALJIT DHESI
daljit@thestar.com.my

Vital to ensure effective risk management to avert future financial crisis

KUALA LUMPUR: While the Basel III rules on the whole are positive, three things still need to be urgently addressed to ensure their effectiveness in managing risks to avert future financial crises, according to a financial and risk management expert.

Canada-based Black Ice Partners managing partner Mukhtar Kalyan said these included having a proper forward-looking framework of risk weights, more transparent rating of financial instruments and performance and accountability based on risk taking.

In terms of risk weights, the Basel Committee needs to take into account unforeseeable risk which is not measured by current risk management practices such as value at risk.

Mukhtar Kalyan... ‘If the risk measurement framework of (Basel III) does not become more holistic, I would not be surprised if another crisis happens.’

Mukhtar said banks should focus on the 1% or tail risk and not the 99% risk which it measured and also focus less on models based on probabilities but rather create new models built on possibilities.

“This was the key lesson of the recent financial crisis. Triple AAA-rated instruments can default. No asset should be assumed to be zero risk, like the sovereign risk of a country, to prevent any future debt defaults.

“At the moment Basel III framework attaches a zero risk weight on sovereign risks for almost all countries. Sovereign default is possible and needs to be addressed by Basel III.

“There needs to be some form of mechanism or framework to look into possible risk events and not just probabilistic risk events to avert future financial meltdowns,” he said during an interview.

“If the risk measurement framework of (Basel III) does not become more holistic, I would not be surprised if another crisis happens,” he said.

According to Mukhtar, lack of transparency in the financial instrument ratings by rating agencies was also another major reason for the global financial crisis of 2008. He said the framework should incorporate this requirement to make it clear how the ratings and due diligence were derived.
Bankers and chief credit officers should also be held accountable for the risks they took, he noted. At the same time, financial institutions should reward their staff who were prudent in risk management, he said.

The Basel Committee recently agreed that banks be required to hold more capital under the Basel III rules when they come into force in 2019. Banks are required to hold top quality capital totalling 7% of their risk-bearing assets, from 2% now. Of the 7%, 4.5% comprises core tier 1 capital, which consists of shares and retained earnings, and the balance 2.5% capital conservation buffer. Banks are required to meet the framework’s tier 1 capital requirement by 2015 and capital buffer by 2019. Without specifying the time frame, the rules also spelt out the need to set aside counter-cyclical capital buffer of zero to 2.5%, which central banks would use during periods of excess credit growth. Generally the rules would not impact Malaysian banks negatively as the banking system in the country was well capitalised, Mukhtar said, adding that Bank Negara had put proper risk management and surveillance system in place to avoid any future financial crisis.
He also said Basel III would not affect the banks’ risk-pricing and likelihood of undercutting in terms of pricing and profits.

“The rules are not trying to tell banks how they should run their businesses but instead require them to have sufficient capital to undertake risks,” he added. Black Ice Partners, which has offices worldwide, comprises a group of senior globally experienced financial experts, regulators and portfolio managers. Its clients are global and regional banks in North America and Asia.
An acknowledged industry specialist, Mukhtar has been extensively involved in several Basel rollouts in North America and Asia, and most recently in South Korea and Malaysia. He is considered by many as an industry veteran with a career spanning three decades in capital markets, finance and risk management. With an extensive knowledge of the regulatory and compliance environment in several G-20 countries, Mukhtar has acted in an advisory capacity to banks, central banks and regulatory agencies in both South East Asia and North East Asia.