ABA Position Paper on Implementation of Basel II & Pillar 3

Strengthening the region’s capacity for the cross-border implementation of the Basel II Framework and the implementation of Pillar 3

1. The Asian Bankers’ Association believes that the implementation of Basel II presents an opportunity for banks to enhance their strengths and competitiveness and will strengthen financial systems as risk is more closely aligned with capital. As we have stated in many of our previous position papers, for its full benefits to be attained, the implementation of Basel II should be clearly understood, properly integrated with existing financial structures, institutional practices and supervisory systems, appropriately adapted to local conditions, and accompanied by efforts to strengthen the financial structure, corporate governance and data capabilities within banking institutions.


2. We understand that the global financial turmoil that started with the sub-prime mortgage crisis in the United States has called attention to a number of issues related to Basel II. Among these are investors’ over-reliance on credit ratings and a consequent failure to exercise due diligence, underestimation of risks involved in structured credit securitization, the pro-cyclical impact of Basel II, and inadequate capital buffers for risks that are not fully captured by Pillar 1. These underscore the importance, especially for Asia’s emerging markets, of pursuing Basel II implementation as part of an overall financial development program, including the development of bond and equity markets and cross-border arrangements to reduce the prospects of future disruptions in the region’s financial systems.


3. The ABA recognizes that there is considerable diversity among Asia-Pacific economies with respect to the implementation of Basel II, and that some major economies do not expect to adopt the framework in whole or in part within the near future. With regard to Pillar 1, we observe that mature banking markets that are implementing Basel II have mostly reached the final stage of testing and validation, while most emerging markets still have to complete a number of tasks, including assessments of detailed requirements and design and building of systems and models. With regard to Pillars 2 and 3, we note that both mature and emerging markets are still completing their preparations, with emerging markets in general lagging behind. These issues have implications for the cross-border implementation of Basel II in the region.


2008 Policy advocacy2 700 x 4664. In relation to this, the ABA notes that a key issue now arising for banks and banking supervisory authorities in the region is how to deal with differences in implementation timetable and those arising from the use of national discretion, such as in the definition of default, which varies across jurisdictions. Effectively addressing this issue would require close collaboration between home and host supervisors, in particular with regard to their roles in the supervision of foreign bank subsidiaries, approval processes, interpretation and practical application of Basel principles, and sharing information on these various issues. This underscores the importance to the region of the role of supervisory colleges and regional dialogue.


5. The ABA notes that there are overlaps between Pillar 3 and IFRS 7 with respect to credit, market, interest rate, equity and operational risk, with IFRS 7 also covering liquidity and commodity risks, which are not covered by Pillar 3. We note that IFRS has been revised to reflect the evolution of techniques in risk management and exposure, while Basel II allows banks to rely on disclosures made under accounting requirements to fulfill the applicable Pillar 3 expectations. Mindful of these overlaps, the ABA believes that the successful implementation of IFRS can facilitate the implementation of Pillar 3, and that synergy between Pillar 3 and IFRS should be harnessed in a number of areas, such as improved common education of senior management, common verification and internal audit regimes, availability of skilled resources, experience of IFRS implementation, closer collaboration between finance and risk functions, improved data quality and availability, universally enhancing qualitative risk disclosure and promoting integrated risk reporting for Basel II and IFRS.


6. The ABA notes that banks in the region face several challenges in implementing IFRS. These include implementation costs (particularly the cost of software, data collection and validation and construction of valuation models), human resources limitations, earnings volatility, capital management, governance, tax issues (particularly the treatment of unrecognized gains and losses and impairment losses) and the current economic environment, which is characterized by high inflation and extreme volatility of domestic interest rates. There are also technical issues, including those related to IAS 39’s fair value option, the complexity of hedge accounting, the fair valuation of liabilities and the impact of presentation of debt and equity on banks’ pre-tax earnings, among many others, that need to be addressed. Convergence toward IFRS is inevitable, but it should be seen in the context of local conditions and challenges. Given this reality, it is important for regulators to understand its impact and the challenges that are specific to the local environment and adopt a measured approach toward implementation, rather than rushing to achieve convergence within a single time frame.


7. The ABA also notes the need to address with care the issue of how much disclosure should be required. On one hand, excessive disclosures can result in making valuable information available to competitors, managers becoming extremely risk averse and additional costs and effort, even as the value of voluminous reports to users of disclosed information may still be limited. On the other hand, inadequate disclosures can result in external auditors making qualifications on financial statements, the risk of non-compliance with accounting standards and possible violation of directors’ legal obligations with respect to financial reporting, and a poor corporate image. The ABA believes in the need to strike a healthy balance in determining the amount of disclosure that is required of banks and promoting meaningful disclosure that effectively fulfills Basel II requirements.


8. We appreciate the role of open, active and continuing regional dialogue between bank regulatory authorities and the financial industry in providing valuable insights on the various issues related to the implementation of Basel II.. The ABA is pleased to collaborate with the APEC Business Advisory Council (ABAC), the Pacific Economic Cooperation Council (PECC) and the South East Asian Central Banks (SEACEN) Centre in jointly organizing the annual Public-Private Dialogue for the Asia-Pacific Region, which this year was hosted by SEACEN on 18-19 August 2008 in Kuala Lumpur. We believe that collaboration among financial regulators and officials through regional organizations such as APEC and SEACEN, in dialogue with the private sector, is very important for the effective implementation of Basel II and the efforts to ensure the stability and development of the region’s financial systems. We urge financial regulators and officials in the region to continue and intensify their collaboration with ABA in further strengthening this regional dialogue.