Editorial
Reports
Calendar of Monetary and Economic Highlights
Economic Background
Money and Credit in the First Half of 2000
Balance of Payments in the First Quarter of 2000
Austria’s International Investment Position in 1999 − The External Sector of the Financial Account
Studies “On a New Capital Adequacy Framework as Proposed by Basel and Brussels”
Regulatory Capital Requirements for Austrian Banks − A Supervisory Tool Subject to Change
Irrespective of its legal structure, every enterprise must hold equity capital, which may take various forms, and record it in its balance sheet. Pursuant to Article 5 para 5 and Article 22 Austrian Banking Act (ABA), credit institutions, too, are required to hold own funds. Article 23 ABA provides a definition of own funds. Credit institutions rank among the economic sectors that are subject to the most stringent regulatory and supervisory provisions. This stringency may be traced to the role credit institutions play as financial intermediaries. After all, the banking system as a whole is key to maintaining national and international confidence in a country’s financial market.
Supervisory regulations are designed to map the amount of own funds to the risk inherent in the business transactions effected as well as to create an assets buffer to cover potential loss. This paper sheds light on the evolution of capital adequacy legislation, which is again about to change.
In light of the building block approach towards regulatory capital requirements and the differentiated use of individual own funds components, the methods applied to the computation of capital ratios differ greatly and the data do not really lend themselves to comparisons. Consequently, a more thorough analysis seems useful.
Supervisory Review
Supervisory review (by which is meant the review of the adequacy of capital requirements at an individual bank by the supervisory authority) is an essential part of the new capital adequacy framework, complementing and linking the other two pillars − minimum capital requirements and market discipline. The key innovations proposed by the new capital standards, which are discussed in detail in this study, comprise the possibility of applying differentiated regulatory capital requirements, increased consistency between a bank’s capital and its overall risk profile, and the provision for early supervisory intervention, when a bank’s capital ratio declines but still exceeds 8%.
The central principle of supervisory review is that not even the most comprehensive list of regulations governing minimum capital requirements can adequately cover all potential risks a bank, let alone a complex banking group, is exposed to. Supervisory review is primarily intended to be a practical tool of banking supervision, but by no means an instrument for shadow management by the supervisory authority. It is crucial that a stronger emphasis is being placed on the risk-focused supervisory elements in addition to compliance with quantitative standards. Essential questions remain unanswered and will have to be resolved in cooperation with banks.
Credit Risk
The reform of the capital requirements for credit risks is a crucial part of the first pillar of the new capital adequacy framework. The minimum levels of capital are to be made consistent with the actual credit risk and are to take into account the recent developments in credit risk management. The minimum capital charge for the credit risk is to be assessed by means of a modified standardized approach and an internal ratings-based approach. The modified standardized approach is a gradual refinement of the 1988 Basel Accord. Instead of classifying borrowers in rather crude risk categories, risk differentiation will be provided through ratings by external institutions. Under the internal ratings-based approach, internal risk assessment and valuation systems of banks will be used to assess the capital charge for credit risks. The regulatory recognition and permanent supervision of external rating agencies and internal rating systems of banks require new and comprehensive instruments and procedures.
Critical Evaluation of the Basel Committee’s and the European Commission’s
Proposals on the Treatment of Other Risks in the New Capital Adequacy Framework The 1988 Basel Accord and the Solvency Ratio Directive are based on a simple approach that should cover not only credit risk but also any other risks. One objective of the new capital adequacy framework is to align regulatory capital more closely with economic capital, the capital necessary to cover the risks incurred. Thus, other risks are no longer covered and have to be made subject to a specific capital charge. This study gives an insight into the present discussion, from both the supervisors’ and the practitioners’ points of view. Since other risks are primarily defined as a residual, i.e. as all risks other than credit and market risks, it is crucial to identify the risks which should be made subject to capital requirements; operational, legal, and reputational risks are mentioned in this context. The study provides an overview on the various attempts to define other risks, and it compares the proposals put forward in the Basel Committee’s and the European Commission’s consultative papers. It also gives an insight into current risk management procedures in banks and into first methodologies to quantify and manage other risks.
Interest Rate Risk in the Banking Book
Interest rate risk is the exposure of a bank’s financial condition to future, possibly adverse movements in interest rates. Accepting this risk is a normal part of banking and can be an important source of profitability and shareholder value. However, excessive interest rate risk can pose a significant threat to a bank’s earnings and capital base. Accordingly, an effective risk management process that maintains interest rate risk within prudent levels is essential to the safety and soundness of banks. The 1999 consultation documents published by the Basel Committee and the EU suggest for the first time additional capital charges for interest rate risk in the banking book. This paper presents these proposals and the pertinent legal provisions and also provides an overview of the different sources and most common management methods of interest rate risk.
Studies
The New Millennium − Time for a New Economic Paradigm?
Results of the 28th Economics Conference of the Oesterreichische Nationalbank
The growth and output differentials between the European and the U.S. economies over the past decade have often been linked with the rapid development of information and communication technology. Yet technological innovation appears to be only one element of the far-reaching changes in the economic framework conditions: Experts have detected a new economic paradigm which has materialized in the U.S.A. but not in Europe. Both the concept and the empirical relevance of this presumed new paradigm are controversial. The 28th Economics Conference of the Oesterreichische Nationalbank dealt at length with this phenomenon. The topics of discussion included definitions and possible statistical evidence of the so-called New Economy, economic and monetary implications, aspects of capital markets and growth perspectives. While the question of whether a New Economy in fact existed or not had to be left unanswered, the sessions produced a variety of essential economic interpretations and recommendations. European economic policy is faced with enormous challenges: According to most speakers, the chance that Europe may head towards a period of sustained growth does exist, but the necessary framework conditions are − to a large extent − still lacking. Among other things, the integration of the European market is not advanced enough, an efficient risk capital market has yet to be created, there is no European network for technology and science, and too little is being invested in a knowledge-based economy. As to monetary policy, it is vital to bear in mind that uncertainty − especially about the usefulness of certain economic variables − has undoubtedly increased. Therefore, the ECB’s monetary policy with its two-pillar strategy, which is based on a broad range of indicators and thus gives policymakers a great deal of flexibility in their decisions, seems to be well chosen.
The opinions expressed in the section “Studies” are those of the individual authors and may differ from the views of the Oesterreichische Nationalbank.