Basel II risk management hits home
But, at present, central banking representatives from a dozen of the world's most financially active countries are hard at work setting up new guidelines by which the world's banks can weather future financial misfortunes with minimum cost.
They're trying once again to ensure that that risk doesn't hamper their investment strategies.
Thus this year is expected to finally see the completion of the Basel II accord - a work-in-progress set of rules by which banks measure monetary risk of various types and apportion reserves of cash accordingly. Charged with drawing up the guidelines, the Basel Committee on Banking Supervision comprises central bank reps from Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the UK, the USA and Luxembourg.
Nonetheless, absent Poland, with its large and growing market of foreign-owned financial institutions, will feel the effects for the better in the long run. But, as much work is still to be done for Basel II implementation, the country's institutions face potentially expensive challenges in the short term.
The new accord is expected to be implemented by 2007, with initial adoption in 2006.
Until that time, Polish banks have a lot of internal changes to make, and banking software companies and financial consultants will see a lot of business opportunities open up.
"This is a major task," says Dr. Andrzej Kulik, the risk manager at Pioneer Pekao Investments and vice-chair at the Professional Risk Managers' International Association.
"In the beginning this will cost money, but after a while you should have simply more capital freed to invest somewhere else. This is a challenge for all banks."
On top of that, Europe's answer to Basel, the Capital Adequacy Initiative III is also expected in the near future.
As always, a new challenge equals new opportunity.
Kulik adds: "And what will be earned by IT firms? What will be earned by consultants?"
The answers to those questions are still to be determined.
Basel II has been launched to address the risks in the increasingly complicated global market in which financial debacles at one firm - such as that of Long Term Capital Management in 1998 - could trigger utter disaster across the globe.
But while many of the world's top firms have suffered at the hands of their own risky investments, what's clear in the Basel II accord (named after Basel, Switzerland, where the first accord was created) is that one thing banking professionals still see as necessary is risk itself:
"No risk, no fun," says Kulik.
Kulik and colleagues will be presenting their views on the Basel II accord at the 'BASEL II/CAD III Challenges in the Implementation of the New Capital Accords' conference to be held in Warsaw next week and organized by TopConsulting.
The existing Basel accord has its origins in 1988 when the central bankers for G7 countries met to craft a simple document outlining how the world's banks should apportion reserves of capital for the money they lend. Thus the Basel accord categorizes lending, such as whether it's to a corporation or a country, and then assigns a risk and a percentage of capital to each category.
This 'relatively simple' regulation was adopted in over 100 countries.
In the 80s the financial markets were much simpler. Times have changed. The 1988 accord only dealt with what is known as credit risk, the risk of the lender not receiving back its principal.
As markets became more sophisticated and investors performed more complex transactions, the necessity for a new kind of risk assessment emerged; that of market risk. In 1996 the Basel Committee amended its 1988 document to include market risk, such as the monetary dangers associated with exposure to the uncertain market value of portfolios. This had implications for securities firms, such as Kulik's Pioneer.
But, as any securities trader will attest, in 2004 the financial markets have moved many steps farther and are now even more complicated. As such, they are more open to fraud and crisis. And the Basel accord needs amending still.
Which is why the committee has opted to re-write the regulations to create a three-pillar system: focusing on capital adequacy in market risk; awarding market regulators greater policing power; and enforcing better reporting of financial institutions' risk profiles.
Larger international banks will install the most complicated versions of these regulations, smaller locally-owned Polish banks will opt for minimum requirements.
Kulik points out that one of the reasons this is necessary is that the potential for financial disaster closer to Poland has increased. And now banks need to allow for it without incurring too much cost.
The Long Term Capital Management hedge fund disaster originated in the USA and spread, he pointed out. Recently, however, a smaller scale crisis hit Croatia, he adds.
By 2002 Eduardo Nobilo, former chief foreign exchange dealer at Rijecka Banka, racked up nearly $100 million in losses as a result of fraudulent trades in betting on the appreciation of the euro against the dollar.
"This is something that we're not just talking about in the USA and Great Britain," Kulik says, "It could also happen here."
Polish banks need to be able to better manage the potential for crisis.
In that event - through the 1996 amendment and the future Basel II adoption - banks will better be able to evaluate the exact amount of capital to set aside for potential problems, such as valuations fluctuation or trading fraud. The accord won't help police the markets but it will ensure that reserve capital is used the most efficiently so banks are not hamstrung by setting aside rainy-day funds for future problems.
Implementation of the project will require the use of complex risk assessment models requiring stockpiles of data. This is where IT firms such as Softbank come in.
Mariusz Darecki, consulting director at Softbank, says that IT companies see this as a business opportunity because, "Basel is important for all companies."
He explains that depending on when Basel II is finalized, bank-focused software houses would begin in earnest to ensure that their customers are up to scratch with the new rules. And locally, he says, he sees competition. "At the moment ComputerLand is our most important competitor," he says.
But the IT industry is not alone as banks across Poland, such as BRE Bank, are hiring consultants to iron out their Basel plans.
Dr. Łukasz Witkowski, a deputy director at BRE Bank, says that the bank has an initial strategy ready and is waiting to review it with its consultants.
But BRE has company in amassing its Basel-compliant costs.
"The most advanced methods [of risk assessment] cost enormous amounts of money," says Kulik.
They're trying once again to ensure that that risk doesn't hamper their investment strategies.
Thus this year is expected to finally see the completion of the Basel II accord - a work-in-progress set of rules by which banks measure monetary risk of various types and apportion reserves of cash accordingly. Charged with drawing up the guidelines, the Basel Committee on Banking Supervision comprises central bank reps from Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the UK, the USA and Luxembourg.
Nonetheless, absent Poland, with its large and growing market of foreign-owned financial institutions, will feel the effects for the better in the long run. But, as much work is still to be done for Basel II implementation, the country's institutions face potentially expensive challenges in the short term.
The new accord is expected to be implemented by 2007, with initial adoption in 2006.
Until that time, Polish banks have a lot of internal changes to make, and banking software companies and financial consultants will see a lot of business opportunities open up.
"This is a major task," says Dr. Andrzej Kulik, the risk manager at Pioneer Pekao Investments and vice-chair at the Professional Risk Managers' International Association.
"In the beginning this will cost money, but after a while you should have simply more capital freed to invest somewhere else. This is a challenge for all banks."
On top of that, Europe's answer to Basel, the Capital Adequacy Initiative III is also expected in the near future.
As always, a new challenge equals new opportunity.
Kulik adds: "And what will be earned by IT firms? What will be earned by consultants?"
The answers to those questions are still to be determined.
Basel II has been launched to address the risks in the increasingly complicated global market in which financial debacles at one firm - such as that of Long Term Capital Management in 1998 - could trigger utter disaster across the globe.
But while many of the world's top firms have suffered at the hands of their own risky investments, what's clear in the Basel II accord (named after Basel, Switzerland, where the first accord was created) is that one thing banking professionals still see as necessary is risk itself:
"No risk, no fun," says Kulik.
Kulik and colleagues will be presenting their views on the Basel II accord at the 'BASEL II/CAD III Challenges in the Implementation of the New Capital Accords' conference to be held in Warsaw next week and organized by TopConsulting.
The existing Basel accord has its origins in 1988 when the central bankers for G7 countries met to craft a simple document outlining how the world's banks should apportion reserves of capital for the money they lend. Thus the Basel accord categorizes lending, such as whether it's to a corporation or a country, and then assigns a risk and a percentage of capital to each category.
This 'relatively simple' regulation was adopted in over 100 countries.
In the 80s the financial markets were much simpler. Times have changed. The 1988 accord only dealt with what is known as credit risk, the risk of the lender not receiving back its principal.
As markets became more sophisticated and investors performed more complex transactions, the necessity for a new kind of risk assessment emerged; that of market risk. In 1996 the Basel Committee amended its 1988 document to include market risk, such as the monetary dangers associated with exposure to the uncertain market value of portfolios. This had implications for securities firms, such as Kulik's Pioneer.
But, as any securities trader will attest, in 2004 the financial markets have moved many steps farther and are now even more complicated. As such, they are more open to fraud and crisis. And the Basel accord needs amending still.
Which is why the committee has opted to re-write the regulations to create a three-pillar system: focusing on capital adequacy in market risk; awarding market regulators greater policing power; and enforcing better reporting of financial institutions' risk profiles.
Larger international banks will install the most complicated versions of these regulations, smaller locally-owned Polish banks will opt for minimum requirements.
Kulik points out that one of the reasons this is necessary is that the potential for financial disaster closer to Poland has increased. And now banks need to allow for it without incurring too much cost.
The Long Term Capital Management hedge fund disaster originated in the USA and spread, he pointed out. Recently, however, a smaller scale crisis hit Croatia, he adds.
By 2002 Eduardo Nobilo, former chief foreign exchange dealer at Rijecka Banka, racked up nearly $100 million in losses as a result of fraudulent trades in betting on the appreciation of the euro against the dollar.
"This is something that we're not just talking about in the USA and Great Britain," Kulik says, "It could also happen here."
Polish banks need to be able to better manage the potential for crisis.
In that event - through the 1996 amendment and the future Basel II adoption - banks will better be able to evaluate the exact amount of capital to set aside for potential problems, such as valuations fluctuation or trading fraud. The accord won't help police the markets but it will ensure that reserve capital is used the most efficiently so banks are not hamstrung by setting aside rainy-day funds for future problems.
Implementation of the project will require the use of complex risk assessment models requiring stockpiles of data. This is where IT firms such as Softbank come in.
Mariusz Darecki, consulting director at Softbank, says that IT companies see this as a business opportunity because, "Basel is important for all companies."
He explains that depending on when Basel II is finalized, bank-focused software houses would begin in earnest to ensure that their customers are up to scratch with the new rules. And locally, he says, he sees competition. "At the moment ComputerLand is our most important competitor," he says.
But the IT industry is not alone as banks across Poland, such as BRE Bank, are hiring consultants to iron out their Basel plans.
Dr. Łukasz Witkowski, a deputy director at BRE Bank, says that the bank has an initial strategy ready and is waiting to review it with its consultants.
But BRE has company in amassing its Basel-compliant costs.
"The most advanced methods [of risk assessment] cost enormous amounts of money," says Kulik.
