The ERM Current™

Yesterday, JP Morgan Chase CEO Jamie Dimon shared his views on the financial crisis with Charlie Rose at the Securities Industry and Financial Markets Association annual meeting in New York.  In the interview, Mr. Dimon reflected on risk management approaches taken by many financial institutions leading up to the crisis.  He stated, “You should never rely solely on VaR, Basel I or Basel II for risk management practices.  If you did, it was a mistake.”   He went on to explain that sound risk management practices require both quantitative analysis and management judgment to be effective.  He also noted that there are legitimate failures in the application of the Basel II Capital Accord that left many institutions with insufficient capital positions.   His full remarks can be viewed in the video web link below.

Jamie Dimon speaks with Charlie Rose at SIFMA Annual Meeting

This week, the Basel Committee on Bank Supervision released a statement regarding proposed changes to the Basel II Capital Accord that will significantly impact the capital requirements for financial institutions across the globe.  The intent of the proposal is to increase transparency into the capital reserves as well as reduce risk across a number of categories.  The following changes are slated to be assessed and implemented throughout 2010.

• Raise the quality, consistency and transparency of the Tier 1 capital base. The predominant form of Tier 1 capital must be common shares and retained earnings. Appropriate principles will be developed for non-joint stock companies to ensure they hold comparable levels of high quality Tier 1 capital. Moreover, deductions and prudential filters will be harmonised internationally and generally applied at the level of common equity or its equivalent in the case of non-joint stock companies. Finally, all components of the capital base will be fully disclosed.
• Introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework with a view to migrating to a Pillar 1 treatment based on appropriate review and calibration. To ensure comparability, the details of the leverage ratio will be harmonised internationally, fully adjusting for differences in accounting.
• Introduce a minimum global standard for funding liquidity that includes a stressed liquidity coverage ratio requirement, underpinned by a longer-term structural liquidity ratio.
• Introduce a framework for countercyclical capital buffers above the minimum requirement. The framework will include capital conservation measures such as constraints on capital distributions. The Basel Committee will review an appropriate set of indicators, such as earnings and credit-based variables, as a way to condition the build up and release of capital buffers. In addition, the Committee will promote more forward-looking provisions based on expected losses.
• Issue recommendations to reduce the systemic risk associated with the resolution of cross-border banks.
• Assess the need for a capital surcharge to mitigate the risk of systemic banks.

These changes will have a sizeable impact on the way financial institutions manage and disclose risk in the coming years.  However, given the complexity and interconnectivity of our financial markets, it is certainly the prudent course to take.

Dr. Nout Wellink, Chairman of the Basel Committee on Banking Supervision, delivered a speech earlier this week on the work planned by his committee to address reforms in the global banking system.  Based in Basel, Switzerland, the Basel Committee is part of the Bank for International Settlements which fosters international monetary and financial cooperation and serves as a bank for central banks across the globe.  Here is what Dr. Wellink had to say about the Committee’s long-term initiatives: 

When it comes to the long term, we need to establish a clear target for the future regulatory system which substantially reduces both the probability and severity of a crisis like the one we currently are working though. By providing clarity about the future regulatory framework, we will help re-establish near term confidence, reduce the risk of competitive distortions and limit the degrees of uncertainty for the public and private sector. Also, by emphasising that these reforms will be phased in over an appropriate horizon, we reduce the risk that our own actions contribute to procyclicality in the system.

Let me now say a few words about the steps the Basel Committee has and will be undertaking to produce a more robust supervisory and regulatory framework for the banking sector. Such a framework needs to have four key components:

1. Strong regulatory capital,

2. Robust standards for bank liquidity,

3. Enhanced risk management, governance and supervision, and

4. Better transparency

Needless to say, major changes are needed and will be promulgated by organizations such as the Basel Committee.  Is your company ready to adjust to the coming changes?  Wheelhouse Advisors can help you prepare.  Visit www.WheelhouseAdvisors.com to learn more.