ABA Banking Journal - July 2008 - (Page 7)

briefing Searching for new paradigms at BIS Market turmoil has thrown VaR, and Basel II, a curve INSIDE BRIEFING Snapshot: C&I asset quality—a few cautionary signals. . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 8 “Then & Now,” a yearlong review of banking history during ABA Banking Journal’s 100th Anniversary. This month: “In support of the Greatest Generation” . . . . . . . . . . . . . . . . . p. 10 Award-winning “event concept” . . . . . . . . p. 12 ABA Resources . . . . . . . . . . . . . . . . . . . . . . p. 15 Bank for International Settlements office in Basel, Switzerland o central bankers, the implementation of the volatility was deceptively low. As a result, the VaR Basel II Capital Accord was planned as a stimutechniques “should be complemented by stress testlant to improve banks’ risk management pracing and by basic judgment and simple indicators,” tices, as well as to formulate appropriate, risk-sensithe deputy general manager of the Bank for Internative capital levels for the global banking system. tional Settlements, Herve Hannoun, told a group of Now, after building up very high expectations and central bankers meeting in Ottawa on May 8. investing enormous intellectual capital in the reforAmong the “simple indicators” to be considered, mulation of Basel II, many bankers and regulators, Hannoun proposed maximum loan-to-value ratios not to mention bank investors, have fallen disapfor mortgage loans, capital charges on structured Malcolm Knight, BIS pointed at the unexpected deficiencies in banking investment vehicles, leverage ratios, and dynamic capital, especially for complex global financial instiprovisioning. Each of these has a precedent in one or tutions, that have been exposed by the recent market turmoil. more national regulatory structures, he pointed out. Even the improved risk management systems of these large Three weeks later, his boss at BIS, general manager Malcolm banks—as stimulated by Basel II—have become orphaned by Knight, told a meeting of international securities regulators in their erstwhile supporters. Paris on May 29 that “risk managers must rely on a wider range of Consider that, for the past dozen years or so, the most popu- tools to capture the multi-dimensionality of risk,” because “tail lar risk paradigm has been VaR, or, value at risk. Central risk exposures—including the risk of illiquidity—are not well bankers seem to have concluded that banks that relied on VaR measured by simple tools such as value at risk.” Despite the relatended to operate in ways which exaggerated the banking sys- tive rarity of losses out on the “tails” of a risk distribution, in tems’ natural “procyclicality.” That is, banks using VaR made some cases the bell-curve-shaped distribution is so flat that the too many loans into the credit boom economy, resulting in an actual value of losses can bankrupt banks and threaten financial overstimulation of the business cycle. VaR failed to prevent par- markets. The bottom line on VaR is that it is so reliant on volatiliticipants from building excess leverage, especially when market ty as a measure of risk, that VaR adherents missed the entire accumulation of risky positions since there was very low volatility. By Ed Blount, contributing editor and executive director, Knight recommended several corrective actions in order to Center for the Study of Financial Market Evolution, reduce the risks in today’s market-dependent financial system. www.csfme.org To begin, he emphasized the need for less complexity and more T Subscribe at www.ababj.com ABA BANKING JOURNAL/JULY 2008 7 http://www.bis.org http://www.csfme.org http://www.ababj.com

Table of Contents Feed for the Digital Edition of ABA Banking Journal - July 2008

ABA Banking Journal - July 2008 Contents Editor’s Column Searching for New Paradigms at BIS Snapshot: C&I Asset Quality 100th Anniversary: Then & Now BofA "Event Concept" Wins Awards, and Customers ABA Resources ABA Chairman’s Position M&A: Beat Today's Market Blues Pass the Aspirin Cover Story: Workout Time Correspondent Banking: No Longer Just a Handshake Business Getting IT Right By Thinking It Through Webnotes Are You "Red Flag" Ready? Mailbox Banker’s Mart To Advertise/Index of Advertisers The Economy

ABA Banking Journal - July 2008

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