Issues in International Banking

This article focuses on the International Banking Supervision system and how the Bank of International Settlements and the Basel Committee on Banking Supervision relate to it. The establishment of the Basel Committee was a significant point in the history of international banking supervision. The Basel Committee has made two major contributions since its inception.

Keywords Bank of International Settlements; Basel Committee on Banking Supervision; Basel II; G-10 Group; Gramm-Leach-Bilely Act; Market Risk; Operational Risk

Finances > Finances of International Banking

Overview

"The present international, regional, and national rules on banking supervision are strongly permeated by a high degree of fluidity directly descendent both from the revolution of principles and techniques steering the global financial markets, and from the connected difficulty of the nation States to face the new technological challenges" (Ortino, 2004, p. 715). Policymakers, experts, and scholars will need to analyze and evaluate the level of fluidity when attempting to implement policies and regulations to govern global financial markets. The changes in information technology have challenged the European States by requiring them to evaluate the political and economic systems that they have in place.

International Banking Supervision

According to Ortino (2004), there are two specific features of the institutional order as it relates to banking supervision at an international level.

• First of all, national legislators are responsible for setting up the legal norms and developing the foundation for the proper power structure and procedures.
• Second, the powers of the banking supervision authorities are assigned by the banking sector.

These features are encouraging banking supervision authorities to work together as well as with supervisory authorities in other financial sectors.

Basel Committee on Banking Supervision

One entity that works at the international level is the Basel Committee on Banking Supervision. This entity was set up in December, 1974 by the central bank governors of the group 10 nations, and meets four times a year. The membership includes representation from countries such as Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States. The countries meet in order to consult on economic, monetary and financial matters. The purpose of the committee is to discuss how to handle supervisory problems, such as global financial crises. Although the Committee coordinates the supervisory responsibilities among the national authorities and monitors the effectiveness of supervision of banks' activities, it does not have formal status as an international organization (Ortino, 2004). However, the establishment of the Basel Committee was a significant point in the history of international banking supervision.

G-10

In 1999, there was a section that was added to the Gramm-Leach-Bilely Act, which broadened the range of activities that banking institutions in the United States could participate in, especially those institutions that elected to become financial holding companies. Although this was a significant step, financial institutions in the United States still had a narrower range than most of the other countries that were members of the G-10 group. What are some of the differences between some of the countries?

As a rule, most G-10 countries have allowed their banks to provide a full range of securities market activities (i.e. underwriting, brokering, and dealing) versus performing the transactions through a subsidiary. Also, there are a few G-10 countries that will allow a full range of insurance activities. However, the main restrictions tend not to be on the types of insurance activities. Rather, many of the restrictions tend to focus on where the activities are performed (i.e. some of the activities are required to be performed via a subsidiary). In addition, there are also restrictions on real estate activities for banks based on the range of activities, whether or not the activities are performed at a subsidiary or bank, or both. Nolle (2003) provided research that compared which G-10 country banks were allowed to own nonfinancial firms and which nonfinancial firms were allowed to own banks. The results showed that most G-10 countries were allowed to own nonfinancial firms and nonfinancial firms were allowed to own banks. However, the United States is one of the countries that have greater restrictions on having a mixture of the above-mentioned combination of activities. Japan was the only country to have a greater level of restrictiveness than the United States.

G-10 Supervisory Systems & their Effects

"The United States' supervisory system has the most complex structure in the G-10, and in several key respects its banking supervisory structure puts it among the minority of G-10 countries. However, in one key respect--the funding of bank supervision as practiced by the OCC--the U.S. is similar to the majority of G-10 countries" (Nolle, 2003, par. 10). Nolle's report (2003) showed that nine of the 11 G-10 countries assign banking supervision to a single authority. The United States and Germany were the only two countries that had more than one federal level bank supervisor. In addition, the United States is one of four G-10 countries that assigns bank supervisory responsibility to the central bank. The majority of G-10 countries' bank supervisory authorities have responsibilities beyond the banking industry, either for securities firms, insurance firms, or both.

The type of supervision is important because the type of funding received could have an effect on how bank supervisors make decisions, especially if there is an opportunity for some type of political influence. For example, supervisory agencies that receive funding from the institutions they supervise may have less pressure to pursue a political agenda than supervisory agencies that are dependent on general government revenues (Nolle, 2003). Nolle's report showed that the United States tends to have a hands on approach in performing the bank supervision role. They tend to conduct on-site exams on an annual basis and have a good ratio of total supervisory organization staff to the number of banks as well as a good ratio of banking system assets to the banking system. The United States ratio of banking assets per supervisory staff member is the lowest among the G-10 countries. This finding indicates that there is a significant amount of coverage on the banking system activities on a per staff member basis. With the exception of Italy, all of the G-10 countries require an external audit as part of the bank supervision role. However, the United States does not require external auditors to report bank misconduct to the supervisory authorities, but there is a commitment to the external auditing process.

Basel Committee Contributions

The Basel Committee has made two major contributions since its inception.

The first contribution occurred in 1975 when the Committee took a lead role in making sure that countries share responsibilities when making international banking transactions. The Basel Concordate was an agreement that established the foundation for this process. The first stipulation was that the parent and host authorities shared responsibility for the supervision of the foreign banking establishments.

The second stipulation stated that the host authorities had primary responsibility for supervision of liquidity. The third stipulation indicated that the solvency of foreign branches and subsidiaries was the primary responsibility of the home authority of the parent and the host authority. The second major contribution was a standard that would assist in: Adequately measuring a bank's capital, and; establishing minimum capital standards.

Application

Bank of International Settlements

The Bank of International Settlements is responsible for promoting monetary and financial stability. This organization meets on a bimonthly basis to discuss monetary and financial matters. The organization is composed of four major committees, and they are: The Basel Committee on Banking Supervision, The Committee on the Global Financial System, The Committee on Payment and Settlement Systems, and The Markets Committee. In addition, there are several independent organizations involved in the international cooperation in the area of financial stability, and these organizations have their secretariats at the Bank of International Settlements. These organizations are the Financial Stability Forum, the International Association of Insurance Supervisors, and the International Association of Deposit Insurers.

The Basel Committee on Banking Supervision will be discussed in greater detail during the next section of the paper. The Committee on the Global Financial System is responsible for monitoring developments in global financial markets for the central bank Governors of the G10 countries. The Committee on Payment and Settlement Systems serves as a forum for central banks to monitor and analyze developments in domestic payment, settlement and clearing systems as well as in cross-border and multicurrency settlement schemes.

The Markets Committee was established in 1962 following the initiation of the Gold Pool. When the Gold Pool arrangements collapsed in 1968, members continued to meet at the BIS in order to exchange views. However, the focus has shifted toward coverage of recent developments in foreign exchange and related financial markets, an exchange of views on possible future trends, and consideration of the short term implications of particular current events for the functioning of these markets.

Viewpoint

Basel Committee on Banking Supervision

The Basel Committee on Banking Supervision provides an avenue for the banking industry to discuss banking supervisory matters. The overall objective of this entity is to increase knowledge and understanding of key supervisory issues and improve the quality of banking supervision worldwide. In order to achieve this objective, the organization seeks to exchange information on national supervisory issues, approaches and techniques and promote a common understanding around the world (Bank for International Settlements, n.d.). Mr. Nout Wellink, the president of the Netherlands Bank, is the current chairman of the committee. The Committee's Secretariat is located at the Bank for International Settlements in Basel, Switzerland and it is staffed by professional supervisors from member institutions.

Basel II

In January 1999, the Basel Committee proposed a new concept, which became known as Basel II. However, it was a work in progress and additional proposals for consultation occurred in January 2001 and April 2003. The final version of the Basel II Accord was distributed in June 2004. The foundation of Basel II relies on three pillars, which are minimum capital requirements, supervisory review and market discipline (Riskglossary.com).

Basel II tends to retain the definition of bank capital and the market risk provisions that were a part of the 1996 Amendment. However, there is a replacement of how credit risk is treated as well as the requirement of capital for operational risks. The basic capital requirement for banks can be calculated as:

Based on the level of market risk allowed under the 1996 Amendment, banks have options to determine how they will value their credit risk and market risk. For credit risk, they may select a standardized approach, a foundation internal rating-based approach and/or an advanced internal rating-based approach. As far as operational risk, they may choose a basic indicator approach, a standardized approach and/or an internal measurement approach.

Mixed Acceptance of Basel II

Although Basel II became effective in December 2006, it was not as widely embraced as the first Basel. The purpose of Basel II was to achieve the European regulators' objectives of addressing shortcomings in the original accord's treatment of credit risk, incorporating operational risk and harmonizing capital requirements for banks and securities firms. Although banks in Europe applied Basel II, regulators in the United States did not embrace it. While they shared the same goal of addressing shortcomings in the original accord's treatment of credit risk, there was a belief that the existing bank supervision in the United States already addresses operational risk. In addition, harmonization had never been a priority for US regulators. Their perception was that Basel II was more relevant for international banking activities. Therefore, only ten of the largest banks in the United States initially applied Basel II.

Basel II was slow to be adopted because of its complexity and the difficulty of implementing it (Samuels, 2013). In the wake of the 2008 global financial crisis, Basel III addressed many of the shortcomings of Basel II. Basel III attempts to increase bank liquidity and reduce bank leverage. In the United States, the Final Rule — a U.S. version of Basel III's Liquidity Coverage Ratio (LCR) — was proposed by the Federal Reserve Board. The Final Rule would apply to U.S. financial institutions and significant foreign banks with U.S. subsidiaries and would require banks to hold more capital (How US Basel III rules, 2013).

Committee Reorganization

The Committee reorganized in October, 2006, and is being operated by four main subcommittees. These subcommittees are the Accord Implementation Group, The Policy Development Group, The Accounting Task Force, and the International Liaison Group (Bank for International Settlements, n.d.).

• The Accord Implementation Group (AIG) — The purpose of this group was to share information and promote consistency in the implementation of Basel II. Although the AIG provided a forum for members to discuss how they intended to implement Basel II, the purpose of the subcommittee was not to mandate uniformity of application of the revised framework. There were three subgroups in this subcommittee, and they shared information and discussed specific issues related to Basel II implementation. The group was superceded by the Standards Implementation Group.

The three subgroups were: The Validation Subgroup, the Operational Risk Subgroup, and the Trading Book Subgroup. The Validation Subgroup was chaired by Maarten Gelderman, the Head of Quantitative Risk Management at the Netherlands Bank, and the subgroup was charged with exploring issues related to the validation systems used to generate the rating and parameters that serve as inputs into the internal ratings-based approaches to credit risk. The Operational Risk Subgroup was chaired by Kevin Bailey, Deputy Comptroller, Office of the Comptroller of the Currency in the United States, and the subgroup was responsible for addressing issues related primarily to the banks' implementation of advanced measurement approaches for operational risk. The final subgroup, Trading Book, was co-chaired by Norah Berger, Associate Director of the Board of Governors of the Federal Reserve System in the United States and Thomas McGowan, Assistant Director of the Securities and Exchange Commission in the United States. This subgroup dealt with issues that were related to the implementation of the recommendations in the Committee's July 2005 paper entitled "The Application of Basel II to Trading Activities and The Treatment of Double Default Effects." Another function of this subgroup was to develop principles that would provide a treatment for default risk in the trading book.

• The Standards Implementation Group (SIG) — The purpose of the group is to assist in implementing the accords. There are four main subcommittees: the Operational Risk Subgroup, the Task Force on Colleges, the Task Force on Remuneration, and the Standards Monitoring Procedures Task Force.
• The Policy Development Group — This subgroup replaced the Committee's former Capital Task Force and has the objective of assisting the Committee with identifying and reviewing emerging supervisory issues. In addition, the subgroup proposes and develops policies to promote a sound banking system and high supervisory standards. There are five working groups that report to this subgroup: the Risk Management and Modeling Group, the Research Task Force, the Trading Book Group, the Liquidity Group, the Definition of Capital Group, the Cross-border Bank Resolution Group, and the Capital Monitoring Group.
• The Accounting Task Force — This subgroup has been charged with ensuring that the international accounting and auditing standards and practices promote sound risk management at financial institutions, support market discipline through transparency, and reinforce the safety and soundness of the banking system. There are three working groups which consist of the Conceptual Framework Issues Subgroup, The Financial Instruments Practices Subgroup, and the Audit Subgroup.
• The Basel Consultative Group (BCG) — This subgroup replaced the International Liaison Group, which in turn replaced the former Core Principles Liaison Group, and is charged with facilitating engagement between banking supervisors among member and non-member countries.

Conclusion

According to Ortino (2004), there are two specific features of the institutional order as it relates to banking supervision at an international level. First of all, national legislators are responsible for setting up the legal norms and developing the foundation for the proper power structure and procedures. Second, the powers of the banking supervision authorities are assigned by the banking sector. These features are encouraging banking supervision authorities to work together as well as with supervisory authorities in other financial sectors.

In 1999, there was a section that was added to the Gramm-Leach-Bilely Act, which broadened the range of activities that banking institutions in the United States could participate in, especially those institutions that elected to become financial holding companies. Although this was a significant step, financial institutions in the United States still had a narrower range than most of the other countries that were members of the G-10 group.

The Bank of International Settlements is responsible for promoting monetary and financial stability. This organization meets on a bimonthly basis to discuss monetary and financial matters. The organization is composed of four major committees, and they are: The Basel Committee on Banking Supervision, The Committee on the Global Financial System, and The Markets Committee. In addition, there are several independent organizations involved in international cooperation in the area of financial stability, and these organizations have their secretariats at the Bank of International Settlements. These organizations are the Financial Stability Forum, the International Association of Insurance Supervisors, and the International Association of Deposit Insurers.

In January 1999, the Basel Committee proposed a new concept, which became known as Basel II. However, it was a work in progress and additional proposals for consultation occurred in January 2001 and April 2003. The final version of the Basel II Accord was distributed in June 2004. The foundation of Basel II relies on three pillars, which are minimum capital requirements, supervisory review and market discipline (Riskglossary.com). The accord was slow to be adopted, however, because of its complexity and the difficulty of implementing it (Samuels, 2013). In the wake of the 2008 global financial crisis, Basel III addressed many of the shortcomings of Basel II. Basel III attempts to increase bank liquidity and reduce bank leverage. In the United States, the Final Rule — a U.S. version of Basel III's Liquidity Coverage Ratio (LCR) — was proposed by the Federal Reserve Board. The Final Rule would apply to U.S. financial institutions and significant foreign banks with U.S. subsidiaries and would require banks to hold more capital (How US Basel III rules, 2013).

Terms & Concepts

Bank of International Settlements: Serves the world's central banks as well as other official monetary institutions and nations. The bank does not take deposits from or offer financial services to individuals or corporations.

Basel Committee on Banking Supervision: An institution created by the central bank Governors of the Group of Ten nations. It was created in 1974 and meets regularly four times a year.

G-10 Group: The Group of Ten is made up of eleven industrial countries (Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States) which consult and co-operate on economic, monetary and financial matters. The Ministers of Finance and Central Bank Governors of the Group of Ten usually meet once a year in connection with the autumn meetings of the Interim Committee of the International Monetary Fund. The Deputies of the Group of Ten meet as needed, but usually between two and four times a year. Ad hoc committees and working parties of the Group of Ten are set up as needed.

Gramm-Leach-Bilely Act: A federal law enacted in the United States to control the ways that financial institutions deal with the private information of individuals. The Act consists of three sections: The Financial Privacy Rule, which regulates the collection and disclosure of private financial information; the Safeguards Rule, which stipulates that financial institutions must implement security programs to protect such information; and the Pretexting provisions, which prohibit the practice of pretexting (accessing private information using false pretenses). The Act also requires financial institutions to give customers written privacy notices that explain their information-sharing practices.

Market Risk: Exposure to the uncertain market value of a portfolio.

Operational Risk: Risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.

Bibliography

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Guégan, D., & Hassani, B.K. (2013). Operational risk: A Basel II + + step before Basel III. Journal of Risk Management in Financial Institutions, 6, 37–53. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=85512292&site=ehost-live

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Nolle, D. (2003, June). Bank supervision in the U.S. and the G-10: Implications for Basel II. Retrieved July 5, 2007, from http://findarticles.com/p/articles/mi%5fm0ITW/is%5f9%5f85/ai%5fn14897313/pg%5f2

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Samuels, S. (2013). Why markets do not trust Basel II Internal Ratings-Based Approach: What can be done about it?. Journal of Risk Management in Financial Institutions, 6, 10–22. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=85512289&site=ehost-live

Schwerter, S. (2011). Basel III's ability to mitigate systemic risk. Journal of Financial Regulation & Compliance, 19, 337–354. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=70605449&site=ehost-live

Triana, P. (2013, September 6). Global banks are undercapitalized. Is that so wrong? American Banker, 178, 20. Retrieved November 17, 2014, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=90117525&site=bsi-live

Suggested Reading

Borak, D. (2013, January 8). Qualified Praise for Easing of Basel Rules. American Banker, 178, 1–3. Retrieved November 17, 2014, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=84739196&site=bsi-live

Cornford, A. (2007). Trade, investment and competition in international banking. Journal of Banking Regulation, 8, 195–197. Retrieved September 21, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=24654913&site=ehost-live

Haines, C. (2007). Global banking and national regulation: A conference summary. Chicago Fed Letter, , 1–4. Retrieved September 21, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=24265777&site=ehost-live

Natter, R. (2007). Ensure that U.S. rules mesh with foreign ones. American Banker, 172, 11. Retrieved September 21, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=24730498&site=ehost-live

Sloan, S. (2007). Basel issues spur S&P to form its own standards. American Banker, 172, 20. Retrieved September 21, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=25330488&site=ehost-live