Basel I, Basel Il, andSolvencyIlChapter 12RiskManagementandFinanciallnstitutions3e,Chapter12,CopyrightJohnC.Hull2012
Basel I, Basel II, and Solvency II Chapter 12 Risk Management and Financial Institutions 3e, Chapter 12, Copyright © John C. Hull 2012 1
History ofBankRegulationPre-19881988: BIS Accord (Basel I)1996: Amendment to BlS Accord1999: Basel Il first proposed2RiskManagementandFinancialInstitutions3e,Chapter12,CopyrightJohnC.Hull2012
History of Bank Regulation ⚫ Pre-1988 ⚫ 1988: BIS Accord (Basel I) ⚫ 1996: Amendment to BIS Accord ⚫ 1999: Basel II first proposed Risk Management and Financial Institutions 3e, Chapter 12, Copyright © John C. Hull 2012 2
TheModelusedbyRegulators(Figure12.1,page272)X%WorstExpectedCase LossLossRequiredCapitalLoss overtimehorizonRiskManagementandFinancialInstitutions3e,Chapter12,CopyrightJohnC.Hull20123
The Model used by Regulators (Figure 12.1, page 272) Risk Management and Financial Institutions 3e, Chapter 12, Copyright © John C. Hull 2012 0 1 2 3 4 Expected Loss X% Worst Case Loss Required Capital Loss over time horizon 0 1 2 3 4 Expected Loss X% Worst Case Loss Required Capital Loss over time horizon 3
Pre-1988Banks were regulated using balance sheet measuressuch as the ratio of capital to assetsDefinitions and required ratios varied from country tocountryEnforcement of regulations varied from country tocountryBankleverageincreased in1980sOff-balance sheet derivatives trading increasedLDC debt was a major problemBasel Committee on Bank Supervision set upRiskManagementandFinancialInstitutions3e,Chapter12,CopyrightJohnC.Hull20124
Pre-1988 ⚫ Banks were regulated using balance sheet measures such as the ratio of capital to assets ⚫ Definitions and required ratios varied from country to country ⚫ Enforcement of regulations varied from country to country ⚫ Bank leverage increased in 1980s ⚫ Off-balance sheet derivatives trading increased ⚫ LDC debt was a major problem ⚫ Basel Committee on Bank Supervision set up Risk Management and Financial Institutions 3e, Chapter 12, Copyright © John C. Hull 2012 4
1988: BIS Accord (page 259) The assets:capital ratio must be less than20. Assets includes off-balance sheetitems that are direct credit substitutes suchas letters of credit and guarantees Cooke Ratio: Capital must be 8% of riskweighted amount. At least 50% of capitalmust be Tier 1.RiskManagementandFinancialInstitutions3e,Chapter12,CopyrightJohnC.Hull20125
1988: BIS Accord (page 259) ⚫ The assets:capital ratio must be less than 20. Assets includes off-balance sheet items that are direct credit substitutes such as letters of credit and guarantees ⚫ Cooke Ratio: Capital must be 8% of risk weighted amount. At least 50% of capital must be Tier 1. Risk Management and Financial Institutions 3e, Chapter 12, Copyright © John C. Hull 2012 5