27 February 2008

Basel Committee chair outlines BIS initiatives to tackle financial turmoil

“Some of the lessons learnt from the turmoil point to the importance of risk management fundamentals”, Nout Wellink, Chairman of the Basel Committee on Banking Supervision said. “Recent difficulties also highlighted the lack of transparency due to insufficient disclosure”, he added.

Wellnik identified three fundamental shortcomings that contributed to and amplified the turmoil:

- Industry failed to consistently employ sound underwriting standards. In many cases, firms also neglected to define prudent firm-wide risk limits on these exposures.  

- Risk management and measurement capabilities did not keep pace with rapid financial innovation and the evolution to market-based credit intermediation.

- Certain aspects of regulation, supervision and market transparency failed to reflect financial market developments and therefore contributed to weak practices at banks.

“Investors did not make full use of available information and placed excessive reliance on external ratings”, he added. “Taken together, these factors resulted in banks and investors assuming excessive risk and concentration to the subprime sector – either directly or indirectly through structured products based on subprime mortgages”.

As a consequence, the Basel Committee addressed three priority initiatives:

Implementation of and further improvements to Basel II

Wellnik outlined the areas where Basel II has to be strengthened. “These relate to the Pillar 1 capital treatment of certain securitisations of complex products. In Pillar 2 we need to make sure that banks perform adequate stress tests and hold capital for uncertainties related to exposures coming back to the balance sheet for legal, reputational or liquidity reasons. And we need to build on the Pillar 3 disclosure requirements of the framework to strengthen banks’ transparency around exposures to structured credit products and securitised assets, including banks’ involvement as sponsors”, he explained.

Liquidity risk

“We have identified a range of common weaknesses in liquidity risk management, including stress testing, contingency funding plans, disclosure and the management of off-balance sheet exposures”, he said.

Wellnik announced a fundamental review of the ‘Sound practices for managing liquidity in banking organisations” to be published for public comment in summer 2008.

Strengthening other risk management practices

“There is a need to strengthen various aspects of firm-wide risk governance and management practices”, he said mentioning valuations and stress testing as two specific areas.  

“The Committee is carefully analysing how to help put valuation practices on a sounder long term footing”, he said. “This is a topic the Committee is deeply concerned with, given the growing share of exposures that have been subject to mark-to-market valuations and which then flow through to earnings and capital.”

“Firms must develop the governance and infrastructure to carry out rigorous stress tests that identify where the major vulnerabilities and firm-wide concentrations lie”, he said.

Full speech

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