留學(xué)生dissertation網(wǎng)：工商銀行案例研究BASEL II AND THE
BASEL II AND THE CHINESE INDUSTRY ----A CAST STUDY OF ICBC
Abstract
Basel II is designed to improve the soundness, stability and consistency of international banking system. The objective of this study is to explore main implications and major challenges in Chinese banking 留學(xué)生dissertation網(wǎng)industry to implement Basel II, and how Chinese banking industry will benefit from Basel II to strengthen risk management function. The case study of ICBC is focused on the preparations required for successful implementation of Basel. First, the paper considers the background of Chinese banking industry and the recent reform, and then goes on to examine the main achievements in the process of implementing Basel in respect of risk management framework, capital management, IT system, information disclosure and so on, finally, the major challenges that lie ahead in Chinese banking industry.
Keywords: Basel II, Chinese banking industry, ICBC
1. Introduction
1.1 Background of the Study
In the global financial market, events like the collapse of large financial entities, the Enron bankruptcy and most recently, the US subprime crisis raise the awareness of effective internal control and risk management. Sound risk management is a cornerstone of prudent banking operation, especially in volatile economic environment. Carey (2001) suggests that risk management is more crucial in the financial market than in other parts of the economy. As part of its continued efforts to address bank supervisory issues and improve soundness and efficiency in risk management practice, Basel Committee issued Basel II in 2004 as an enhanced version of 1988 Accord. The implementation of New Basel Capital Accord continues in both Basel Committee member and non-member countries in the past four years.
Implementation of Basel II is a broad topic, therefore, the scope of the study has been focus on one of the emerging markets—China. A number of Chinese banks were established risk management under heterogeneous social and economic environment. Some of them are increasingly following new capital regulation standard to re-model their risk managements systems, however, some analysts state the task remains a major one. This paper describes main progress and potential challenges of China’s latest response to Basel II, in particular, investigates the performance of China’s biggest commercial bank—Industry and Commercial Bank of China Limited (ICBC). We need to get to the very fundamentals, both those of Basel II and China’s banking reform in order to avoid a reckless answer of simple “yes” or “no” to the question that whether China should rejecting or accepting Basel II, before we obtain correct interpretation of China’s response to Basel II.
1.2 Aims and Objectives of the Study
The objective of this study is to explore main progress and major challenges in Chinese banking industry to implement Basel II, and how Chinese banking industry, in particular, Industry and Commercial Bank of China Limited (ICBC) will benefit from the new capital accord to improve risk management framework. Following a literature review, four specific parts were investigated as follows:#p#分頁標(biāo)題#e#
1. How does Basel II improve ICBC’s comprehensive risk management framework and build risk management culture?
2. In what ways could ICBC control its major risks?
3. Would the adoption of Basel II enable ICBC to efficiently regulate its capital management?
4. Would the adoption of Basel II enhance information system building and market discipline?
The structure of the paper is as follows: The next section presents a literature review of the nature of risk involved in banking management, the importance of capital regulation, followed a detailed picture of the evolution of Basel new capital accord and its implications, in particular, a critical assessment in Chinese banking industry, and finally, the ways to think outside regulatory box. The case study section starts with the overview of recent banking reform in China and the brief introduction of ICBC. In-depth discussions are based on the above four questions supported by detailed evidence and data, and the findings and recommendation are discussed in the last part.
2. Literature review
2.1 THE 1988 ACCORD
2.1.1 Key Features of Basel I
The 1988 BIS Accord (Basel I) was the first huge achievement to set international risk-based standards for capital adequacy although it has been criticized for its simplicity and arbitrage. The 1988 Accord has build up two standards, one is the categorization of capital between core capital (tier1) and supplementary capital (tier2), and the other refers to the bank’s total risk-weighted assets, which is a measure of bank’s total credit exposure. Tier 1 consists of common equity, non-cumulative perpetual preferred shares, and minority interests in consolidated subsidiaries less goodwill. Tier2 includes cumulative preferred stock, certain types of 99-year debentures, subordinated debt with an original life of more than 5 years. A risk weight is applied to each on-balance-sheet asset according to its risk, such as 0% to cash and government bonds, 100% to corporate loans, etc.
The framework is almost entirely focused on assessing capital to credit risk and requires banks to keep capital more than 8% of the total risk-weighted assets. The 1996 amendment introduced specific additional capital requirements for the evaluation of market risks, while Basel II allows banks to assessing capital in relation to other types of risks, including operational risk and interest rate risk.
2.1.2 Shortcomings of Basel I
The innovation of 1988 Accord, adopted nearly twenty years ago, has made important progress toward establishing a more equitable basis for competition and for strengthening capital standards. However, it became increasingly inadequate for internationally active banks that are offering more sophisticated products and services, especially with the advent of a number of financial crises in the past decade. Basel I was strongly criticized for its simple use of credit risk equivalents for off-balance sheet instruments and weighting categories. The most critical problem has been the very limited sensitivity to risk. The weights do not provide sufficient degrees of differentiation between different borrowers, for example, resident mortgage loans have a 50% risk weight, while commercial loans have a 100% risk weight. Is that means commercial loans are exactly twice as risky as mortgage loans? In a portfolio aspect, Basel I ignores credit risk portfolio diversification or concentration opportunities. When returns on assets have negative or less than perfectly positive correlations, a financial institution may lower its portfolio risk through diversification. Also, the linear risk measure ignores correlations or covariances among assets and asset group credit risks, such as difference between residential mortgages and commercial loans.#p#分頁標(biāo)題#e#
Another problem is that banks may be engage in “regulatory capital arbitrage” by using a financial innovations and transaction to reduce capital requirements with little or one reduction in overall economic risk (Jones, 2000). Many researches pointed out that Basel I described a single or “one-size-fits-all” credit risk measurement framework, paid limited attention to credit risk mitigation (Akkizidis and Bouchereau, 2006). Furthermore, Scott and Iwahara (1994) argued that tax, accounting and safety net coverage differences across banking system cause the measurement of capital to vary widely among countries, affecting the risk assets ratios comparability. To conclude, Michael K. Ong argued six main pitfalls of Basel I, including capital arbitrage, over simplified approach, failure of “one-size-fit-all”, limited attention to credit risk mitigation, neglecting risk management function and failure to recognize other risks such as operational risk, market risk and liquidity risk.
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2.2 the characteristics of the main content of New Basel Capital Accord
Understanding the banks’ optimal capital structure and how to assess banks’ capital requirement is critical. The point of departure for most modern researches on capital structure is the Modigliani-Miller (M&M, 1958) proposition, which is a firm’s total value is independent of its capital structure in a perfect market. After that, researches have been extended to a set of imperfect assumptions, which indicated that taxes, financial distress, transactions costs and asymmetric information may influence the capital decisions of any firm (Jensen and Meckling 1976, Harris and Raviv 1991, James 1991, Berger 1995). Banks differ substantially from most other firms because they are protected by a ‘regulatory safety net’ , referring to that all government actions are designed to enhance the safety and soundness of the banking system other than the regulation and enforcement of capital requirements.
There are considerable literatures that focus on bank capital structure and capital standards. Traditionally, banks hold capital as a buffer that helps banks absorb expected losses over some time horizon http://www.mythingswp7.com/dissertation_writing/Finance/and temporary losses, thus avoid failure in the long run (Ariss and Sarieddine, 2007). As suggested by Benink and Wihlborg(2001), Shareholder’s capital in banks as in other firms serve three important functions. First, capital is a buffer against unexpected losses causing bankruptcy. Second, equity capital creates incentives for management to manage risk appropriately from the point of view of shareholders. Third, equity capital of sufficient magnitude signals that lenders to the bank will not be taken advantage of. Beger et al (2007) argued most banks optimally increase capital ratios to assure shareholder and creditors the soundness management. Jorion (2002) also describes bank capital is considered as a signal to shareholders, competitors, customers and rating agencies their profitability and solvency.#p#分頁標(biāo)題#e#
From the government’s perspective, the existence of deposit insurance leads to more bank failures and results in an increase of the cost of deposit insurance programs. As a result, governments have found it necessary to combine deposit insurance with regulations on the capital which banks must hold. In addition, governments are more concerned about what is termed systemic risk. Some of the systematic risk can be reduced through the use of risk mitigation and transmission techniques (Oldfield and Santomero, 1997). Furthermore, capital requirement to a particular asset can be symbolized as cost. Given the same capital requirement of assets with different risk-return characteristics, banks generally attempt to choose a relative higher expected rate of risk-return. Benink and Wihlborg (2001) examined how bank capital and its regulation affect the role of bank lending in the transmission of monetary policy. According to the bank capital channel thesis, Skander and Heuvel (2001) argued that monetary policy affects bank lending in part through its impact on bank equity capital. Once a monetary tightening causes a slowdown, borrowers are likely to be downgraded, causing to higher capital requirements. Hence, the bank capital channel is likely to be amplified.
Turning to the empirical literature, there is a line of research that examines the effect of bank capital regulations on bank behavior. Berger (1995) found evidence supporting a positive relationship between capital ratios and earnings for U.S. banks during the 1980s, a period when the probability of bank failure and the expected costs of financial distress raised market capital `requirements'. Banks that did not respond to these 'requirements' paid much higher rates on their uninsured liabilities, which caused them to suffer lower earnings than other banks.
Other studies examined the capital standard on bank portfolio risk. Literature offer contradictory results as to whether changes in capital and portfolio risk would be positively correlated or negatively correlated. Kahane (1977), Koehn and Santomero (1980), Kim and Santomero (1988) and Rochet (1992) demonstrate that banks may choose higher point on the efficiency frontier in response to a higher capital requirement by using mean-variance model, in some cases; it may leads to a higher default probability. Furlong and Keeley (1989) and Keeley and Furlong (1990) argue that an increase in capital reduces the value of the deposit insurance put option by using a contingent-claim model, thereby reducing the incentive of banks to increase portfolio risk, which means it is negatively correlated. According to Besanko and Kanatas, The risk-dependent capital standard could improve level of equity across differing financial institutions, and to reduce incentives for excessive risk-taking.
Based on the literature review above, it is concluded that understanding the banks’ optimal capital structure and how to assess banks’ capital requirement is critical. Most of the researches were focused on insurance, capital standard on earnings and portfolio risks. Theoretical literature offers contradictory results as to the issue of how much capital ratios reduces overall banking risk. The relationship between optimal bank capital requirement and risk remains inconclusive. #p#分頁標(biāo)題#e#
2.2.1 Overview of Basel II
The Basel Committee noted that one of the fundamental objectives to amend the 1998 Accord has been to strengthen the soundness, stability and consistency of international banking system. They also believe that capital regulation will enhance the equal competitive among internationally active banks. Capital is one of the most significant aspects of risk management, for it functions as a safety cushion, provides protections for equity holders and debt holders against their losses and thus avoids failure in the long run (Allen and Santomero, 1999). In revising the 1998 Accord, Basel II places emphasis on internal control, risk sensitivity and prompts an enhanced focus on economic capital management, versus regulatory capital management. The New Accord drives banks to measure their performance against risk factors other than market share or expected return. Compared to Basel I, Committee has also recognized the guiding role of home country supervisors for effective and flexible implementation, therefore provides a range of approaches to allow banks and supervisors to choose that are most suitable for their financial market system.
2.2.2 Three Pillars
Basel II was designed based on three reinforcing pillars:
Pillar I, minimum capital requirement
Pillar I presents the calculation of the total minimum capital requirements for credit, market risk and operational risk. The total capital ratio is calculated no lower than 8%, Tier 2 capital is limited to 100% of Tier 1 capital. As the equation shown below, capital ratio of Basel New Accord Pillar1 is calculated using the definition of regulatory capital and risk-weighted assets. However, for credit risk, the measure is more sophisticated, reflecting the credit rating of counterparties. Market risk remains unchanged, while operational risk is added in.
Basel I
Basel II
Source: Bank for International Settlement (BIS), 2001
Credit Risk refers to risk due to uncertainty in counterparty’s ability to meet its obligations. There are three approaches to calculate minimum capital requirement. Sophisticated approaches have system control on data collection as well as quantitative requirement for risk management. The major change from Basel I is the way to determine risk weight, by utilizing internal and external credit rating and their associated probabilities of default. The credit risk weights for banking-book exposure are categorized into six types and partly depend on credit ratings . Market risk arises due to market price fluctuation, measured by VaR in1996 Amendment, remaining unchanged in Basel II. Operational risk (OR), not explicitly covered in Basel I, defined as ‘risk of loss resulting from inadequate or failed internal processes, people and systems or from external events , including legal risk, but excludes strategic and reputation risk, systemic risks (Basel II).Direct losses are included, but indirect losses (opportunity costs) and near misses are not.#p#分頁標(biāo)題#e#
Pillar II, Supervisory Oversight
Banking risks are classified into the broad categories of market risk, credit risk, operational risk, liquidity risk, strategic risk and business risk. As a general regulation for international active banks, Basel II cannot take account all risks in the capital charge, for the capital cannot control some of them effectively. Aas (2007) and his colleges found that business risk has so far received less attention, probably because no minimum capital linked to it.
Basel Committee emphasis the supervisory of all significant risks and regards the measurement and control requirement as a part of the Internal Capital Adequacy Assessment Process in Pillar II. Banks should hold capital among the regulatory minimum to cover risk (The risk may not be fully captured, for example, concentration risk or risk that is not covered by Pillar II.) and the external effect (e.g. business cycle effects). Supervisors and regulators in different countries are required far more than just ensure the minimum capital requirement under Pillar I, also, they should have the abilities to ensure banks to develop their own advanced risk management methodologies, processes, systems to measure the capital adequacy and should seek to intervene at the early stage if the capital falling below the requirement.
In this part, two important concepts were introduced: the use of economic capital and the corporate governance. Economic capital is the capital banks set aside as a buffer against potential losses inherent in a particular business activity, it enables banks to determine capital adequacy. Ultimately, Pillar II requires a larger trend toward improving corporate governance, evidence are the similarities that can be seen between Pillar II’s Principle 1 and, for example, internal control frameworks developed by (COSO) in US, (CoCo) in Canada, (ROC) in Dutch, (KonTraG) in Germany and so on. In addition, Bruce McCuaig (2004) argues that the Basel II make up for the lack of guidance on how to report accurately on internal controls over financial reporting and the operational risk provision help better corporate governance. Therefore, Basel II facilitates the construction of internal control and consequently fosters a culture of improved risk.
Pillar III, Market Discipline
Market Discipline refer the efforts to promote safety and soundness in banks, it requires banks to disclose the information needed by stakeholders, customers and rating agencies. The purpose, noted by Basel Committee is to form an accurate and complete view of their capital adequacy, therefore improve financial transparency and add pressure to make sound risk management decisions of shareholders. Both qualitative and quantitative disclosure should provide a risk management objective and policies for each separate risk area, scope of application, capital structure, capital adequacy and risk assessment processes.
2.2.3 The Measurement Methodologies
The committee recommends banks a choice among three broad methodologies for calculating their operational risk capital requirement, the standardized approach (SA), the foundation internal ratings based approach (F-IRB) and the Advanced Internal Ratings Based Approach (A-IRB). #p#分頁標(biāo)題#e#
The Standardized Approach is suggested for banks that are not sufficiently sophisticated therefore the range of risk weights is smaller the other two approaches. The Standardized approach is basically an extension of the Basel I in term of the risk weight measurement. However, The Standardized Approach is an improvement on the Basel I; it eliminated the OECD preference, provided clearer differentiation for corporate credits and introduced 150% risk categories.
The migration from the Standardized Approach to the IRB approach is complex, which requires banks to assess credit risk and credit risk in their portfolio on the basis of banks’ internal model (Capital is based on the estimated one-year default rate for asset ). It calculates the probability of default (PD) and the committee lays down other inputs such as Loss Given Default LGD and Exposure at Default EAD , whereas the advanced IRB approach (AIRB) require banks to set all three parameters (see Table1 ).
Table 1 Difference between Two Approaches
Determinants of Risk Weights IRB A-IRB
Probability of Default (PD) Bank Bank determines
Loss Given Default (LGD) Supervisor Bank determines
Exposure At Default (EAD) Supervisor Bank determines
Maturity (M) Maturity adjustment
The following formula explains the calculation of capital requirements under IRB approach:
Where b (PD) = smoothed regression maturity function
The 99% worst case default rate is:
Where,
EAD = exposure at default
LGD = loss given default
WCDR = worst case default rate
PD = probability of default
M = maturity of the loan
b(PD) = Smoothed regression maturity function. The slope of the adjustment function with respect to M decreases as the PD increases.
Basel II presents three methods for calculating operational risk capital charges in a continuum of increasing sophistication and risk sensitivity: The basic indicator approach, the Standardized Approach, and Advanced Measurement Approaches (AMA). In the basic indicator approach, one indicator represents OR a ties capital to a single measure of business activity; however, the standardized one applies different indicators for different business. Besides, Advanced Measurement Approaches (AMA) utilizes the bank's internal OR measurement system and loss data for the OR assessment. The committee does not specify the approach or distributional assumptions used to generate the OR measurement and is criticized for increasing sophistication and risk sensitivity.
2.3 Challenges and the Implications of Basel II
Huge amount of documents demonstrates the complexity and microscope that Basel II represents. Even Basel committee itself has not fully understand how regulators communicated in the past and will Basel II reach the tremendous expectations of globally active banks in multiple countries in the future. The following paragraphs highlight the entire evolution of the theoretical and empirical studies with reference to the implications of this new international regulatory and supervisory architecture. The main heated debates surrounding Basel II’s implementation have been focused on the following issues: economic capital VS regulatory capital, global environment and economic cycles, competition and capital regulation, cross-border challenges of Basel II, compliance costs of Basel, and finally, implementation in China. These issues are discussed in turn below.#p#分頁標(biāo)題#e#
2.5.1 Cross-border Challenges of Basel II
Effective supervisor of complex international banking groups entails an effective communication between participants and supervisors. In addition, the framework requires continuous dialogues in respect of distinguished roles of home country and host country supervisors through bilateral or multilateral arrangements. For example, in USA, all banking agencies encourage regular meetings between bankers and supervisor to identify their main concerns, at regular basis. This so-called home-host issue can cause a lot of problems, entailing compliance with different versions of supervision in different jurisdictions. For instance, it has increased the need to strengthen cooperation and convergence in supervisory practice, and also has imposed higher burden on internationally active banks than on local banks. It will be a decline in the capital flows from the former to the emerging market. In 2001, Committee set up Accord Implementation Group (AIG) for Home-host supervisory cooperation. Home-host information sharing for effective Basel II implementation was issued on June 2006, which confirmed the necessity to develop more robust information-sharing arrangements between home and host supervisors, combining with mutual trust and confidence in respective assessment processes.
2.5.2 Compliance Costs of Basel II
Basel II has undoubtedly succeeded in increasing the complexity of capital regulation but at the same time brings associated compliance costs and benefits. Virtually, all regulators and executives at large banks agree that “regulatory tax” of compliance with Basel II is likely to be relatively high. Prior to initiation of Basel II compliance efforts, every bank was at a different starting-point in its own adoption of risk technologies and risk models, in other words, the costs differ from one bank to another. The risks taken by traders, the models used, and the amount of different business lines can not all be controlled, if not, could be extremely costly through traditional enforcement channels.
One of the most predominant costs is bank’s information-technology installation and development allocated to Basel II compliance. Quantitative methods of Basel II require high-quality, high-frequency data in order to categorize historical defaults, losses, and other information relative to risk rating (VanHoose, 2007). Data management issues are creating unexpected challenges to global financial institutions, especially in Canada. Survey conducted by Ernst & Young LLP (2006) indicates that difficulty of extracting and cleansing inaccurate or inconsistent data from a myriad of source systems is a key problem in Canada. When we look at credit risk, as suggest by Herring (2005), one of the hidden costs of implementing the IRB approach is that it diverts emphasis and resources from some risk management http://www.mythingswp7.com/dissertation_writing/Finance/aspects which are omitted from Basel II. The potential higher expenditures associated with Basel II may outweigh additional gain in risk management process by reducing resources. There are challenges in human resource management for the expenses devoted to Basel II could be relatively large. Senior management must be actively involved in risk control process and supervisors who lack competence in understanding the complex models could impede the implementation. Furthermore, once a senior management and the board assume responsibility for supplying a regulatory model of credit risk and certifying a bank’s own model inputs, it may have the unintended consequence of undermining bank governance (Taylor, 2002). Additionally, different approaches for computing capital charges increase the complexity of translation among these methodologies, especially in multinational financial institutions.#p#分頁標(biāo)題#e#
The Committee believed that the anticipated benefits of implementing Basel II include improvements in banks’ “soundness and stability” of the international banking system and reduction of competitive inequalities among internationally active banks in different countries. However, the academic literature fails to offer a strong support for risk-based capital regulation as an instrument aimed at promoting bank safety and soundness. And even if an improvement seems likely, it is by no means certain-could it be obtained at lower cost? Another argument is that an increased transparency and accountability could be expected whereas Herring (2005) suggested an opposite opinion that “Basel II represents a retreat from a level of transparency achieved by the original Accord.” To conclude, it has argued that Basel II will be very costly for banks and supervisors and researchers are more likely to believe that it has ambiguous welfare effects.
2.5.3 Beyond Basel II
The need of thinking outside the box
Basel II Accord in the UK and its European version Capital Requirements Directive (CRD) are the contemporary advances to the previous regulatory outline, which are the constitutional frameworks for banks and financial institutions. But they can not provide a platform where no risks may ever become crises/disasters for financial institutes. However, even if the players did perfectly according to the 1988 accord, because its severe shortcomings, they could not avoid the disaster or present a satisfactory palliative to the problem at that moment. The regulatory box and further enhancements Prompt Corrective Action (PCA) in the framework is a good approach in the above cases but could someone address the loopholes? Even in some venues, banks are putting themselves at risk by giving mortgages to ineligible people, lending more and more without even having much money in the depository. One consideration is the credit crunch in money markets especially in US that is causing financial institutes to think outside of the regulatory box.
Risk management methods beyond Basel II
One argument encourages the self-regulatory structure for better efficiency and achievement. Stefanadis (2003) addressed that the banking industry is particularly suitable for a self-regulatory framework, given its dynamic and flexible governing institutions. This framework allows greater speed, responsiveness and flexibility than other approaches to enforcement. Having considered the issues associated, political independence for example, Quityn and Taylor (2002) suggest that political interference was a major factor in all recent systemic banking crises (e.g. the Korean crises 1997). Perceptively, Hartcher (1998) document the weaknesses in Japanese financial sector to political interference. Secondly, Mergers and acquisitions has become one of the most dominated reform measures in the banking industry (EZoeha, 2007). This can be appreciated as a buttressing effort to risks associated with financial institutions on a strategic level. Recent failures of such stand alone institutions demand more integrated approach towards a risk-free banking structure. After having considered the above examples, another issue arise that whether to disclose any bank information to all the stakeholders or not was argued by Frolov (2007). Considering both banks and borrowers, getting information about the borrowers is critical, but disclosure of banks information to borrowers may result in some very dreadful experiences, because the investors/borrowers will then know the banks actual position. Basel II Accord addresses the need to have certain capital amount with the bank, for if in case, should something goes wrong. Otherwise consolidation can be idealized or self-regulatory approach can be appraised.#p#分頁標(biāo)題#e#
2.4 Research on the Basel II
research on Bank credit risk in China for, whether in the banking sector or in academia, is still in its infancy, which is the basic credit risk on foreign theories and methods of research articles, and the application of China's banking industry research does not found.China's commercial banks to credit risk analysis of the current situation and the cause of research, such as Chen yan(2003) research the status of the commercial banks on credit risk in our country from the bank's credit risk arising from the theory of root causes, and comprehensively analysis the reasons for credit risk of China's commercial banks from internal and external mechanisms to generate.
China's research on the credit risk is the introduction of the literature of credit risk management model, such as the "City Financial Forum" has a comprehensive introduction on the typical credit risk management model Credit MetricS (huang fangfang, 1999); Shen Pei-Long, Ren Ruoen (2000) study the basic framework with the characteristics of bank loans for credit risk management getting the basic principle of China's commercial banks with credit management practice; Wei Zhou and Yang Bing-bing (2003) introduced the commercial banks the basic elements of credit risk management;Fan nan( 2002) introduced the Credit Metrics model algorithms and basic ideas, and calculated, respectively, a single loan, two loans and a variety of portfolio credit risk loans; Peng, Chong-Feng Wu, Li Bing (2002), reviewed the modern default development of the theory of stock valuation, the market focused on three main credit risk measurement and management methods: Credit Metrics model, KMV model and credit risk a comparative analysis of ten models on the basic principles of their advantages and disadvantages with the corresponding.Wei Jianhua (2001) investigated the regulation of Basel II and to deepen the process of thinking, and this process is divided into three phases: the agreement the formation stage in 1988, added to improve phase out stage of making a new agreement. Of the important characteristics of each stage are described, focusing on the contrast difference between the old and the new Basel Accord, as well as the innovation of the new agreement. Chen Yang (2004) analysis of the basic objectives of the new agreement, the realization of the mechanism and main characteristics, the analysis of a new agreement on China's impact, Zhang and Shi Jing (2004) discusses the risk management of China's banking industry of the status quo, as well as the face of New Basel Capital Accord of the measures to be taken, Tan (2003) from the financial regulators of vision, analysis of China's commercial banks to implement Basel II's difficult to explore the capital of China's implementation of the new agreement must be addressed and methods. YU Li-yong,cao fengqi(2004) analysis the "New Basel Accord," based on the three major focus of China's state-owned commercial banks to analyze the level of capital adequacy and to make relevant recommendations. Zhang Chang (2005) "Interpretation of the new Basel Accord," introduced the credit risk and operational risk measurement methods under the new Basel II.#p#分頁標(biāo)題#e#
Besides US and European countries, a number of Asian countries and regions have expressed a clear intention to test the water of Basel II, several of whom, such as Japan, Korea and Hong Kong have been actively preceding their implementation scheme. China, however, started this movement very late, given the lack of external ratings and week risk management systems for a long period of time. It can not ignore the ever-increasing pressure to implement Basel II from its biggest trading partners all over the world if it still wishes to participate in global capital market (Cai and Wheale, 2007). Most of previous local researches reflect more positive results and implications in detail, while external analysts obtain broader conclusions regarding the potential challenges and at the same time provide valuable suggestions.
China has been pursing a very cautious pace in respect of Basel II. It plans to go through the complete procedure of creating international accounting systems and processing more fundamental banking industry reform before it graduates to Basel II. According to KPMG’s research , the largest banks are required to become compliant on IRB between 2010 and 2013. There has been no clear evidence to show that whether there will be a transitional period during which the qualifying criteria will be relaxed like Hong Kong. One effort reported by Su (2007) was the evolution of credit information system in China. It is claimed that both newly individual credit information database and upgraded enterprise credit information database of Bank of China (BOC) were officially put into operation in 2006, which facilitated China’s credit ranking into top 16 in the world.
Chinese regulators always regard capital adequacy requirement as a crucial element of Basel II, however, it may not sufficiently reflect the actual capital requirement. For example, if one country provides a more comprehensive safety net for banking industry, in this case, a lower capital ratio may be sufficient to cover losses (Scott and Wellons, 2001). The Chinese government appears to have this policy inclination, suggested by Jin (2003), due to the extremely low bankruptcy rate, the current capital ratios of Chinese banks are overrated to some extent. In addition, it is suggested that Chinese banks should explore further instruments besides government injection and profit accumulation to achieve capital adequacy.
Deloitte’s estimation shows that, in China, data available for Basel II compliance in leading banks was less than 20% of the minimum required for compliance under IRB. For some banks, data quality may be undermined due to recent mergers and acquisitions. Chinese banks have committed significant investments for risk management infrastructure under this circumstance. The estimated cost is no less than US$50 million per bank to satisfy Basel II requirements pursuant to Deloitte’s research, which will put further burden on the authorities to embrace and implement market reform; however, many Chinese banks argued that it is exaggerating.#p#分頁標(biāo)題#e#
management of risk in banking
Risk is defined as “Uncertainty of outcome, within a range of exposure, arising from a combination of the impact and probability of potential events.” (HM Treasury, 2001) There is a public misconception that banks are safe place to deposit savings, however it is not the truth. Factors that contributed to the rapid development of banking risk management include the increasing competitiveness in volatile environment, growth in derivative market, advances in information technology and also evolution in risk theory (Hull, 2007, Saunders and Cornett, 2003). Modern banks are exposed to a broad rage of risks including credit risk, operational risk, model risk, market risk, liquidity risk, and so on (Heffernan, 2005).
Credit risk is the risk of loss due to inability or the risk of an unexpected delay on a loan agreement, which usually leads to a default and losses for those extending credit. Credit risk can encompass direct credit risk, trading credit risk, contingent credit risk, correlated credit risk, settlement risk and sovereign risk (Banks and Dunn, 2003). There are three components: probability of default--the probability of a counterparty to fail to make a contractual payment; recovery rate--the proportion of the claim that is recovered after the counterparty defaults; and Credit exposure--the amount one stands to lose in case of default. Financial institutions can manipulate these three factors in order to reduce their credit risk.
There are many different ways in which operational risk can be defined, and more important, measuring it can be even more difficult. Basel Committee defines operational as "the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events.” It usually depends on factors related to day by day operations, for example the risk of failure in the computer system. Moreover, Basel Committee's definition includes legal risk, but neglect reputation risk and strategic risk.
Model risk is the risk related to the inappropriate use of models and analytic tools banks use to price and hedge in derivatives market. As argues by Derman (1996), the use of inadequate model may be due to a number of reasons, including incorrectly implemented, wrong estimation of model parameters and poorly specified models. Market risk is defined as risk arises from adverse fluctuations in the prices of all market instruments, such as interest rates, currency rates and equity prices or a derivative contract (Jorion, 2000)
Liquidity risk appears to compound other risks, such as credit risk, market risk. Banks and Dunn (2003) also indicate that liquidity risk refers to the risks that banks and institutions do not have sufficient cash resources to meet its payment obligations due to an inability to sell a position (asset liquidity risk) and fund an position (funding liquidity risk) due to the inadequate market depth or the uncertainty of market disruption. The Bank of International Settlements (2000) has outlined a maturity ladder approach, which consists of monitoring all cash inflows and outflows, and further strengthened by the publication of Principles for Sound Liquidity Risk Management and Supervision in 2008. #p#分頁標(biāo)題#e#
Inappropriate control of these risks can lead to catastrophe. Evidence from history include Nick Leeson's looses on behalf of Barings, John Rusnak's unauthorized trading at Allied Irish Bank, LTCM bankruptcy in 1998, and so on. A host of mathematical measures are used to quantify risks, among which, two central components are Risk Adjusted Return on Capital (RAROC) and value at risk (VaR). In the late 1970s, Bankers Trust developed a RAPM to measure credit risk and that is called Risk adjusted Return on Capital (RAROC). It is used to manage risks related to different business units within a bank, and it is also widely employed to evaluate performance. Since the mid-1990s, VaR has become an “industry standard” method for management of portfolio risk and extensively used for reporting and limiting risk, allocating capital, and measuring performance (Brian, 1995). VaR concept can be defined as the expected loss on from the adverse movement in identified market risk parameters with a given probability over a period of horizon. There are three main approaches to calculating value-at-risk: variance/covariance matrix method, historical simulation and Monte Carlo simulation (Dowd, 1998).
However, VaR approach fails to indicate what can happen in extreme cases and only applicable to mark-to-market portfolios, therefore, supplementary approach based primarily on economic insight rather than statistics called stress testing or scenario analysis was introduced. In addition, other methodologies created by large international active banks and agencies, for example, JP Morgan’s Credit Metrics , Credit Suisse’s CreditRisk+ model , McKinsey Model and options-based KMV model are studies by other banks.
3. influence for new Basel Capital Accord on Credit Risk Management of China's Industrial and Commercial Bank
3.1 the status of credit risk of Chinese Industrial and Commercial Bank
Credit risk is still the major risks of Chinese Industrial and Commercial Bank, which not only the existence of forms of credit risk within the business, business-balance-sheet credit risk also exists. According to experience, reflect the bank's credit risk indicators are mainly the ratio of non-performing loan ratio, loan concentration, capital adequacy ratio, core capital adequacy ratio and non-performing loans, such as provision for coverage.
3.3.1 1. Non-performing loan ratio.
Non-performing loan ratio is a reflection of the most prominent of credit risk. Chinese Industrial and Commercial Bank is not only a high rate of non-performing loans and a loss rate of the suspiciously large loans based on the distribution. According to the third quarter of 2009 statistical report, China Banking Regulatory Commission, which revealed that major financial institutions and the ratio of non-performing loans is double down, but remains high. According to five categories of loans, the balance of non-performing loans was 1.27 trillion Yuan, the ratio of total loans to 7.33 percent. Among them, the sub-category of 292.3 billion Yuan of loans, total loans ratio was 1.68%; suspicious loans 509.8 billion Yuan, accounting for the ratio of total loans 2.93%; loss of 471.4 billion Yuan loans, total loans ratio of 2.71% ; and foreign banks non-performing loans of only 3.55 billion Yuan, the total loan ratio of 0.81%.#p#分頁標(biāo)題#e#
3.3.2 2. Capital adequacy ratio.
Capital adequacy ratio is a reflection of the capacity of commercial banks to guard against the risk of the key indicators, but Chinese Industrial and Commercial Bank is relatively low capital adequacy ratio.
3.3.3 3. Concentration of loans.
Chinese Industrial and Commercial Bank has a higher concentration of loans, according to "People's Bank of China," the February 2009 disclosure statement to the first 3 quarter of 2008 at the end of all long-term loans accounted for the proportion of loans from financial institutions 39%, in increments, the first three quarters of 2008 accounted for new loans and long-term loans accounting for 46%, of which real estate loans accounted for 37%, real estate loans too easily lead to a bubble economy.
3.3.4 Provision of non-performing loans coverage.
Chinese Industrial and Commercial Bank is the loss reserve is based on 1% of loans drawn, gap loss, and low non-performing loan provision It is not difficult to see that the banking credit risk is a serious risk according to the above indicators; compared with the non-performing loan ratio and capital adequacy ratio of China's Industrial and Commercial Bank and developed countries, the gap is still very great. at the end of 2008, foreign banks in China with total assets of 65.9 billion U.S. dollars, accounting for about China's financial institutions with total assets of 1.80k, loans 3 million, non-performing loan rate of 1.3%. Moreover, the Ministry of People's Bank of business management for Chinese and foreign banks recently the subject of the competitiveness of the findings revealed that Chinese banks for the average non-performing loan ratio 7.87%, which owned 10.81 percent for the Industrial and Commercial Bank of China, Industrial and Commercial Bank of China for the joint-stock 3.96 percent, and 22 foreign banks There are only nine non-performing loans, the average non-performing loan ratio of only 1.47%. If modern Western Industrial and Commercial Bank of China to estimate the empirical data, sub-category loan losses 30 percent, 50 percent of suspicious types of loss, loss type of loss of 100%, then the Industrial and Commercial Bank of China's loss of non-performing loans amounted to 1.49 trillion Yuan, accounting for all loans of 10.80k. If excluding the extraction of one percent and the balance of loans less than 0.2 trillion Yuan loss, the loss gaps in some 1.2 trillion Yuan, accounting for 9% of all loans. If one-to-one ratio of capital to fill the gap in this part of the loss, the bank's capital adequacy ratio of China's objective of not less than the requirements of 9% +8% = 17%, but capital adequacy ratio is very far from this standard.
3.2 Overview of China's Industrial and Commercial Bank of Credit Risk Management
At present, China's Industrial and Commercial Bank have taken a pre-trial, loan, search the three post separation, collective decision-making system, such as credit risk control mechanism, which is more 留學(xué)生dissertation網(wǎng)#p#分頁標(biāo)題#e#effective containment system as a result of the bank's own internal control mechanisms caused by the expansion of credit risk. Moreover, it can be said that the Industrial and Commercial Bank of China's credit risk management are the major review on the part of the loan. Basically, from the Industrial and Commercial Bank of China enterprise's financial and non-financial factors to a comprehensive review of corporate credibility and repayment ability, and attach great importance to enterprises, loan guarantees, loan-to-the former seeks to minimize the risk identification and risk control in the bank can take the framework of . However, major banks and international credit risk management in the use of advanced information technology, management mechanism of the existence of a wide gap between the Industrial and Commercial Bank of China's future direction.
