Tarisa Watanagase: Future regulatory challenges for emerging markets -
a case for Thailand
Speech by Dr Tarisa Watanagase, Governor of the Bank of Thailand, at the Association of
International Banks (AIB) Dinner Talk, Bangkok, 19 October 2009.
* * *
Chairman, Board members and members of the Association of International Banks,
Distinguished Guests, Ladies and Gentlemen
First of all, I would like to thank you for inviting me to join you today. I welcome the honour
and look forward to the opportunity of meeting you, especially at this important juncture in the
history of global financial system development. In the past two years, we witnessed one of
the most severe financial crises in modern time, and with it, a sharp impact on the global
economy, especially after the demise of Lehman. Today, the global financial market has
stabilized, albeit not having returned to normal, with many major parts still in retrenchment
such as securtisation market.
Today, an almost one year anniversary of the global fallout, the Dow Jones once again
retraced its step, and touched 10,000 points. There are increasing positive signs of global
economic recovery. Nevertheless, there are still significant uncertainty and downside risk,
going forward. These include uncertainty on the exit policy of stabilization measures of
various countries, the differential speed of adjustment of various regional economies, and not
least, the impending challenge of regulatory reform demanded by the public at large.
Throughout this turbulent period, Thailand's financial system has remained resilient and
stable. Significant credit is, of course, due to your part, especially your ability and willingness
to uphold normal service for your clients here, as well as your cooperation with your
supervisors in ensuring strong risk-management. Going forward, we look forward to this
strong and beneficial relationship, to help us meet the challenges posed by the global
economic and financial developments.
Therefore, I would like to take this opportunity today to convey our appreciation, as well as to
share with you the key challenges we see going forward, and to outline the reforms which in
our views are key for Thailand and emerging markets in this context.
My talk today will be divided into two parts.
First, I will look at the current debate on regulatory reform, focusing on the
measures being
discussed at the Basel Committee for Banking Supervision. I will highlight the key
proposals, the timeline, and the process being discussed.
Secondly, I will share with you our input on the debate at global forums, and the reform
that we consider to be our priority, going forward. I believe our reform agenda will be
useful for you as practitioners, as the global reform covers a very expansive and
comprehensive set of policy, and for banks operating in many jurisdictions, the required
adjustment to ensure compliance can be significant. This process can be facilitated by
setting a clear and transparent priority.
Let me now turn to the first part of my talk, the update on global debate on regulatory
reform.
While the current precept of risk-based supervision, as implemented by many, is still a robust
and valid concept, there are many weaknesses when it comes to putting the precept into
practice, as shown by the lesson of this crisis. These weaknesses include the inability to deal
with complexity arising from such mechanism as securtisation, OTC derivatives, as well as
the problem of procyclicality and systemic risk associated with valuation and performance
management issues. Nevertheless, risk-base principle remains the key anchor to coherent
risk management and supervision, even more so given the increasing complexity of the
financial market. So, we must remain anchored to its principles.
What then needs to be done is to strengthen risk measurement, management, and
supervision, so that we can truly capture risk of individual institutions, overtime, and risk
arising from interconnectedness of key components of the system, to safeguard financial
stability. In short, we need to strengthen both micro- and macro-prudential regulations.
The shift in policy paradigm from this crisis has been the increasing acceptance of the
concept of macroprudential policy, which takes into account the interconnectedness within
the financial systems as well as between the financial system and the real economy, that is,
the issue of systemic risk and procyclicality.
The proposals by G20, the BCBS, as well as international accounting standards are in line
with the risk-based principle. While the range of policy is extensive, the key thrusts are
strengthening of risk-based microprudential regulation, and emergence of the explicit
importance given to macroprudential supervision to tackle the problem of procyclicality and
systemic risk.
As we can see, there will be a new paradigm and context to international supervisory
standard. While the macro orientation is in fact not new, and has always been in the classic
tool-kit of central bank in ensuring financial stability, the current explicit articulation and
specification of such tool as global standard is.
The key macroprudential policy framework that has received wide support to deal with
procyclicality problems includes the followings.
First, there is a proposal on the build-up of capital buffer in the good times to be run down in
the bad times and to prevent excessive credit growth. Second, as being discussed with
accounting standard setters, provisioning should be linked with expected loss rather than
incurred loss, which is the prevailing practice. Finally, the primarily simple and transparent
"leverage ratio" should be applied as a complement to risk-based capital requirement under
Basel II.
Implementation of many such policies is still subjected to significant work on calibration as
well as qualitative issues such as consistency with risk-sensitive capital framework, and
international level-playing field. Such problems magnify in the case of emerging markets,
which face constraint on data and institutional capacity. Moreover, much of the work done on
calibration would tend to serve the need of IRB rather than SA banks that are the core in
emerging market. Thus, the reform agenda will need to pay proper attention to capacity
building of banks and regulators. Nevertheless, there are warranted rationales for its use in
financial stability tool kit in an appropriate manner, given national context.
In terms of measures to address systemic risk, the proposed ideas include systemic capital
charge, capital for OTC derivatives, and cross-border bank resolution framework. Again, the
same emerging market issue and dimension should be properly recognized.
Turning to the key microprudential policy framework currently being discussed at the
international forums to ensure individual financial institution's stability, the BCBS has
proposed a package to address previous shortcomings in risk-based supervision as follows.
For Pillar I, regulatory capital for securitisation exposure is enhanced. In addition, the quality
and transparency of capital is strengthened especially Tier I capital, which would consist
mainly of common equity and retained earnings.
For Pillar II, supplemental guidelines are issued by requiring banks to manage firm-wide,
concentration and reputational risks more effectively. Valuation and stress-testing practices
are also improved. Moreover, compensation and bonus scheme should be aligned with
longterm risk taking behaviour and performance.
Turning to Pillar III, focus is given to disclosure requirements to reduce uncertainties
associating with securitization exposures. Additional requirements include, for example,
sponsorship of off-balance sheet vehicles, and resecuritisation exposures. On top of these, a
new regulation on liquidity risk management, namely the so-called liquidity coverage ratio
could be introduced, going forward, subjected to further work. This new regulation is
designed to ensure that banks, particularly global banks, maintain adequate liquidity at all
times, underpinned by longer-tern structural liquidity ratio. In this regard, liquidity stress
scenarios would be determined by supervisors.
The BCBS will issue concrete proposals on these measures by the end of this year, after
which, an impact assessment and calibration exercise would be completed by the end of
next year. For Thailand, implementation of these new international standards would depend
on needs and appropriateness, based on our context.
Let me now turn to the second part of my talk, the Bank of Thailand's input on these
ongoing regulatory debates.
It is true that many reforms being discussed are in the context of complex financial markets
and institutions, much more complex than our markets, and that emerging markets were
affected by indirect rather than direct impact of the financial crisis. But, market failures in key
market structure, such as securitization, will in the future be our issues. Moreover, global
standards will have an impact on risk management culture, as well as level playing field
issue, globally. Thus, the Bank of Thailand gives high priority to the global debate and
participates actively.
Through our involvement in various international forums, such as the bi-monthly BIS
Governor Meetings, as well as Standard Implementation Group of BCBS, of which we are a
member, the BOT has proposed that developing countries be invited to participate in the
development process of these new standards right at the beginning rather than be informed
of them at the very end. Moreover, the BOT has also voiced our concern over the use of a
simple leverage ratio, which does not take into account inherent risk because this would tend
to penalize banks in developing countries since they generally hold less risky assets
compared to developed countries.
Recently, the BOT was invited to take part in the newly created Basel Consultative Group
(BCG), which will meet for the first time during 28 to 29 October this year. The BCG's main
agenda is to be a discussion platform for ongoing Basel Committee on Banking Supervision's
prudential standards and their implementation issues, such as those mentioned earlier.
In this regard, our stance on the implementation of any new regulatory and supervisory
change includes the following points.
First, regarding microprudential policy framework, the BOT already has the process to
enhance understanding and adjustment of banks for the implementation of related standards,
for example, through hearings. Macroprudential policy framework is a more challenging area,
particularly in terms of data limitations and policy calibration. Despite this challenge, the BOT
remains committed to maintain overall stability of the financial system. As such, we stand
ready to guard against any build up of bubble and imbalance within the system.
Let me now share with you what I believe are our priorities, going forward.
Amongst these, Basel II implementation, especially adequacy of capital, ICAAP and stress
testing practices is on top of our list.
The principles stipulated in Pillar II, which came into effect in September this year, are in line
with the existing risk-based supervision used by the BOT, but places greater focus on the
qualitative aspect of risk management and assessment of capital adequacy. For example,
the role of the Board of directors and senior management in the assessment and formulation
of strategy on capital management for the current and future periods, has been stressed.
In this regard, we hope that banks would ensure they have a good risk management system,
with an ICAAP that covers all significant risks, including those stipulated under Pillar I as well
as other risks. These other risks should at least include credit concentration risk, interest rate
risk in banking book, liquidity risk, strategic risk and reputational risk.
Moreover, it is desirable that banks maintain capital above the minimum regulatory
requirement to withstand future losses both in normal and stress situations. To achieve this,
banks should conduct stress tests and formulate capital plan in accordance with the stress
test results, in a systematic and continuous manner.
We expect banks to be able to finalize and start using their ICAAP by the end of December
2010, with the first ICAAP Report submitted to the BOT within the first quarter of the following
year. The BOT would then begin reviewing banks' ICAAP during bank examination that year.
In assuring adequacy of capital over the business cycle, we believe it is very important to
focus on countering procyclicality by ensuring capital and provision buffer, as well as to
introduce IAS 39 which incorporates correction from problem or procyclicality as being
considered by international standard setters and BCBS. Importantly, we emphasise the
importance of consolidated supervision to ensure adequacy not only in capital but also
riskmanagement of the entire banking group, particularly liquidity risk. In this regard, with respect
to foreign banks, an important issue to push forward, in our view, is that of crossborder
supervisory coordination, particularly better information sharing between home-host
supervisors should be warranted. This is particularly important as the current crisis shows
that there is a need for home supervisor of global financial conglomerate and banks to
recognizing that global bank's local operations may be systemically important for the host
economies.
In closing, I would like to share with you what I believe are the key changes in our
financial landscape, resulting from this global crisis.
First, bank business model would likely become more conservative, placing less reliance on
wholesale financing and use of leverage, while focusing more on risk management and
higher liquidity buffer. Consumers themselves would be more risk averse and prefer to stick
with simple transactions and products. As mentioned already, regulatory framework would be
strengthened, especially the use of macroprudential oversight that focuses on system-wide
stability. As such, closer supervision of systemically important financial institutions, including
non-banks, would be required. Finally, the microprudential oversight would also be
strengthened to rectify previously identified shortcomings, particularly the Basel II framework,
corporate governance, and incentive misalignment.
Though it looks as if we could be in the process of creating a "new world order", given what
we have done so far in strengthening our financial sector resilience, I believe that this
transition would be a smooth one and add further strength to our financial system. Needless
to say, a strong financial system is the backbone of sustainable economic growth in the
longterm.
Thank you for your attention.