Corporate & Securities Law

By Jim Hamilton

The Basel II Accord will be a crucial element in controlling off-balance sheet entities and other risk exposures as the securitization process is reformed, in the view of Basel Committee Chair Nout Wellink and European Central Bank President Jean-Claude Trichet. In separate remarks, they noted that under Basel II all exposures will be subject to regulatory capital charges, whether on or off the balance sheet. Basel II will also create more neutral incentives between retaining exposures on the balance sheet and transferring them to the capital markets through securitization. It will reinforce capital requirements for banks? trading books and enhance disclosure of banks? risk profiles, notably with regard to structured credit and securitization. Mr. Wellink, who is also President of the Netherlands Bank, delivered his remarks at an Amsterdam economics seminar.

In an interview with the European press, Mr. Trichet said that Basel I was very complacent regarding structured investment vehicles, conduits or other off-balance-sheet entities. Noting that the Basel II rules are fortunately much more stringent, the ECH head speculated that an earlier implementation would likely have curtailed off-balance sheet operations and limited damages.

More broadly, Chairman Wellink noted that, even though Basel II has only been fully implemented in Europe since the beginning of the year and the US is rolling it out more slowly, there is a consensus that the new accord will improve incentives for risk management and market disclosure and enhance capital regulation. For example, under Basel II, banks are required to perform forward-looking stress tests to make sure that they hold enough cushions above the minimum. Basel II will also require much stronger management of risk exposures; and, banks that take on more risk will be required to hold more capital in the first place, helping to prevent the build-up and under pricing of risk.

Although Basel II represents a major improvement, said the chair, the committee is not resting. Rather, Basel has begun to act on pressure points and weak spots in the regulatory regime revealed by the market crisis, including those involving the securitization of complex products, reputational risk and disclosure. Sound risk management and robust liquidity cushions are critical, he said, and the Basel Committee will strengthen practice in these areas.

It is also in the process of finalizing global sound practice standards for liquidity risk management and supervision, which will address many of the lessons learned from the market turmoil. The Committee will also work on stress testing, off-balance sheet management, and valuation practices. Furthermore it is enhancing market discipline through better disclosure. The chair promised that Basel will conduct an ongoing review of the framework over time and make any necessary adjustments based on its findings.

Full post as published by Jim Hamilton's World of Securities Regulation on May 07, 2008 (boomark / email).