COMMUNITY DEVELOPMENT FINANCIAL INSTITUTIONS: Considerations for Securitization of CDFI Loan Assets
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Considerations for Securitization of CDFI Loan Assets

Considerations for Securitization of CDFI Loan Assets

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COMMUNITY DEVELOPMENT FINANCIAL INSTITUTIONS: Considerations for Securitization of CDFI Loan Assets Presentation Transcript

  • 1. Remarks by Andrew Crockett GARP 2005, 6th Annual Risk Management Convention and Exhibition New York, February 2, 2005 F   E   B   R   U   A   R   Y     2   0   0   5 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ? S   T   R   I   C   T   L   Y     P   R   I   V   A   T   E     A   N   D     C   O   N   F   I   D   E   N   T   I   A   L
  • 2. Outline
      • History and development of Basel-based supervision
      • The thinking behind Basel II
      • A look to the future:
        • Implementation of Basel II
        • Adaptation through time
        • Development of new approaches
    1 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 3. The Basel Process: History
      • Basel Committee formed, 1974
      • Basel Concordat, 1983
      • Basel I, 1992
      • Market Risk Accord, 1996
      • Basel II begun, 2001
      • Continuation through guidance papers
    2 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 4. Basel Process: Operating Principles
      • Voluntary principle . Consensus among leading (G10) supervisors
      • Professionalism and Seniority . International rules made by practicing supervisors with power to commit their authorities
      • Comprehensiveness . Basel guidance on all aspects of risk management, not just capital adequacy
      • Inclusiveness . Consultation in advance of new rules
    3 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 5. Basel I
      • Made necessary by capital weakness of major banks (LA debt crisis) and divergent rules among different countries (playing field not level)
      • Introduced risk-based capital adequacy regulation
      • 8% requirement, based on rough average of actual capital holding
      • No attempt to fine-tune risk management
      • Largely successful in dealing with problem of undercapitalization
    4 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 6. Building on Basel I
      • Additional supervisory guidance
      • Regular consultation among supervisors on implementation issues
      • Market Risk Accord, 1996
      • Core Principles, 1996 (aimed at emerging markets)
    5 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 7. The Need for Basel II
      • Inadequate risk discrimination: institutions could “game” system
      • Basel I did not cover operational risk
      • Basel I did not take adequate account of new instruments and techniques for hedging and risk mitigation
    Basel II process launched by G10 Governors in Basel in 2001 6 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 8. Design of Basel II: The 3-Pillar Approach
      • Pillar 1 . Minimum capital adequacy ratios. Similar to Basel I, but intended to be more risk-sensitive
      • Pillar 2 . Supervisory oversight. Enables supervisors to introduce flexibility where ratios are too rigid
      • Pillar 3 . Market discipline. Recognition of the superiority (in principle) of market discipline, where feasible
    7 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 9. Pillar I: Capital Adequacy Ratios
      • Choice in ratio framework to reflect degree of sophistication in banks’ risk management systems:
        • Standardized
        • Internal Ratings Based (IRB)
        • Advanced IRB.
      • Comprehensive approach to quantifying risk
      • Calibration of risk weights to ensure:
        • maintenance of adequate capital in the system
        • incentives for regulated institutions to use high-quality risk management
      • Larger number of risk weights
      • Better recognition of risk mitigation techniques
    8 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 10. Pillar II: Supervisory Oversight
      • Was always a tool in supervisors’ armory, but was not adequately harmonized across countries.
      • Helps reflect non-quantifiable factors (e.g., quality of risk governance)
      • Takes account of factors that are, in principle, quantifiable, but where quantification methods not yet sufficiently advanced (e.g., diversification effects on risk)
    Basel II aims to introduce greater consistency into the application of supervisory oversight 9 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 11. Pillar III: Market Discipline
      • Operating Assumptions:
        • Most effective incentive for high quality risk management is commercial reward
        • Counterparties expected to apply discipline
    Basel II aims to increase transparency of banks’ risk management practices and results 10 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 12. The Future: Dealing with the Criticisms of Basel II
      • Criticism of Basel II:
        • Too complex
        • Insufficient recognition of latest techniques of risk management
        • Insufficient recognition of special situation of small banks and banks in emerging markets
      • Criticism not completely fair:
        • Banking is complex
        • New risk management techniques have not all been adequately tested under stress situations
        • Consultation has addressed many special situations
    11 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 13. The Future: Implementation, Modification, and Development
      • 2007 Implementation
        • Needs data series and back-testing of results
      • Modification: Modify rules according to results, as data and testing become available
      • Future Development
        • Possible change of relative reliance on each pillar
        • How to give more effect to market-based techniques?
    12 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 14. Appropriate Implementation of Basel II
      • Supervised institutions need to choose which Pillar 1 regime
      • Those that choose more advanced techniques will need robust risk measurement system
      • Data collection and testing needed to establish risk factors
      • Strengthen risk management practices and governance under Pillar 2
      • Implement Operational risk control practices
    13 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 15. Modification of Basel II
      • “ Bank regulation is an evolutionary process.” Basel II should accommodate evolution
      • New risk management techniques. Banks can reduce risk by hedging, securitization and diversification
      • Need for a sensitive and robust accounting regime
      • Openness of Committee to issue additional guidance and modify quantification of risks
      • Important for procedures to be flexible and open-minded. Avoid over-bureaucratization of the process
    14 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 16. Development of New Supervisory Techniques
      • Where will risk management and bank regulation will be 10 years? Recognize two key considerations:
        • Risks are normally better understood by professional practitioners than supervisors
        • Markets, if given the information and incentive, can regulate risk-taking effectively and less arbitrarily
    The future of regulation will be found in strengthening Pillar 3. This will reduce need for complexity in Pillar 1. 15 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 17. Strengthening Pillar 3
      • How to give markets the incentives and the information necessary for credit and market counterparties to do their job?
      • How to avoid moral hazard?
        • So long as markets believe that supervisors and central banks will ensure high-quality risk management, why should they expend resources to verify it?
    16 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?
  • 18. Specific Proposals
      • Subordinated Debt . Make major institutions issue a minimum amount of subordinated debt
        • Price of debt in secondary market will be an index of confidence in risk management at institution concerned
      • Precommitment of Capital . Banks make estimates of capital needed to cover Value at Risk (VaR). Penalties for insufficient estimates.
    17 B   E   Y   O   N   D     B   A   S   E   L     I   I   :     W   H   A   T     C   O   M   E   S     N   E   X   T   ?