Financial Crisis and the Implementation

of Basel II:
Potential Economic Impact for Trinidad
and Tobago

Lester Henry and Michelle Majid

Roadmap of the Paper

Introduction
Overview of Basel I & II
Financial Crisis and Basel II: Are they
linked?
The TnT Financial System
Some issues of concern to T&T
The way Forward for T&T
Summary and Conclusion

Introduction
Financial Crisis partly seen as regulatory failure.
Basel I and Basel II were supposed to prevent such
Many Caribbean Countries were expected to adopt
Basel II over the next few years (from 1 or 2 in
2007 to 4-6 between 2010 2015)
Examine Basel IIs role in the crisis
Identify issues arising from possible adopting
Basel II
determine the extent to which Basel II may impact
T&T and by extension the region
Inform policymakers whether focus should be on
getting Basel I right or introducing Basel II or not
adopting any at all.

Overview of Basel I
Basel I

Pillar 1:

Regulatory capital
Minimum capital
requirements
Risk-weighted
Assets
(Denominator)
Credit Risk
(1988)

8%
Risk-weighted assets

Definition of
Capital
(Numerator)

Market Risk
(1996)
Standardized
Approach

Models
Approach

Shortcomings of Basel I
Capital required did not mirror a

banks true risk profile

Too simple for advanced banks
Inflexible against new developments
Covers only credit and market risks
Only quantitative in nature
Limited recognition of collateral
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Basel II in a Nutshell
Basel II
Pillar 1

Pillar 2

Pillar 3
Three
Pillars

Minimum capital
requirements

Supervisory review
process

Risk weighted
assets

Standardized
Approach

Internal
Ratings-based
Approach

Definition of
capital

Operational
risk

Credit risk

Basic
Indicator
Approach

Standardized
Approach

Market
discipline

Market
risks

Advanced
Measurement
Approaches

Standardized
Approach

Core
Capital

Supplementary
Capital

Models
Approach

Objectives of Basel II
Greater emphasis on banks own

assessment of risk
Comprehensive framework for credit,
market and operational risk
Encourages rigorous bank supervision
Ensures market transparency,
disclosure
More risk sensitive; better align regulatory
capital with actual risk exposure

Basel II and the Financial Crisis

I. the average level of capital required by the new

discipline is inadequate and this is one of the reasons

of the recent collapse of many banks;
II. the new Capital Accord, interacting with fair-value
accounting, has caused remarkable losses in the
portfolios of intermediaries;
III. capital requirements based on the Basel II
regulations are cyclical and therefore tend to reinforce
business cycle fluctuations;
IV. in the Basel II framework, the assessment of credit
risk is delegated to non-banking institutions, such as
rating agencies, subject to possible conflicts of interest;

Basel II and the Financial

Crisis.continued

V. the key assumption that banks internal

models for measuring risk exposures are

superior than any other has proved wrong;
VI. the new Framework provides incentives
to intermediaries to deconsolidate from
their
balance-sheets some very risky exposures
Source: Francesco Cannata Mario Quagliariello (2009)
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In Defense of Basel II
Only recently implemented
In US only applies to top tier banks operating

internationally -- most of system is exempted

Pillar II and Pillar II have been given very little
attention, a careful application would involve;
Remuneration packages in investment banking and of
management boards;
Transparency of a bank's risk profile;
Management's true understanding of both the bank's risk profile
and its risk positions.

source Van Kemper, Cris (2009)

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Can Basel X work? A Minskyian

alternative View

Can help in some cases but ultimately limited in

preventing crises
Sources of instability are built-in to the system
During expansions managers competence will be
questioned if they dont go after higher returns
In normal times the three-six-three rule applies
During Busts credit supply dries up regardless of
any stimulus policy

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Snapshot of TnT Financial

System:
Eight commercial

Asset
Growth banks and 19
NBFIs

12

Snapshot of the Financial

System:
Capital Adequacy

13

Snapshot of the Financial

System:
Asset Quality
NPL to Gross Total loans (% )
6
5
4
3
2
1
0
1999

2000

2001

2002

2003

2004

2005 -Mar

Source: Financial Sector Assessment Program Report, 2005

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FSAP (2005): T&Ts

deficiencies
Inadequate financial sector laws
High-levels of connected exposures

across banking and insurance

companies
BCP Non Compliance with Market Risk,
Large and related exposure limits
0% risk weighting all sovereign debt
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Some Areas of Concern

Credit Risk Assessments
Macroeconomic Issues
Capital Requirements
Distortion of allocation of credit
Interbank Lending
Regulators in emerging economies
Home-host Issues
Local Banks in T&T
BCP Compliance
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Credit Risk Assessments

Shallow credit rating market (reduced to

flat rate)
Rating linked to level and volatility of
capital flows
Prohibitive cost and incentive to become
rated
Who will rate the rating agency?
Potential pro-cyclicality and circularity
(Powell, 2002)
17

Macroeconomic Issues
Three factors indicate that tighter

regulatory capital requirements are

likely to cause a domestic credit
crunch:
* economies are shallow
* banking sector concentrated
* presence of government in the real
economy

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Regulators
Deficient regulators can be an

important determinant of banking

crisis (much more than adequate
capital provisions) (Barth, Caprio and
Levine (2001))
Increased skills of examiners
Shift from generalists to specialists
(BCBS, 2004)
19

Local Banks in T&T

Banks would need to improve

infrastructure for measuring and

monitoring risk COSTS!!!!
Foreign-banks within T&T can piggyback on parent
Where does that leave T&T local
banks?
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Limitations and Areas of

Further Research
Limitations:
Lack of data to do QIS
Basel I shortfalls to address
Credit rating assessments
Regional workshop to resolve
common issues

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The Way Forward for T&T

Get the Vision combined with preconditions

right
Create detailed and specific gap assessments
Produce detailed plans to address gaps with
sufficient lead times
Establish a process to oversee and deploy
Basel II implementation
There is no substitute for extreme vigilance
on the part of regulators
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Selected References
Francesco Cannata and Mario Quagliariello (2009)
The role of Basel II in the subprime financial
crisis: guilty or not guilty?, CAREFIN Working
paper 3/09.

Wray, Randall can Basel II enhance financial

stability? A Pessimistic View, Working paper 84,

Jerome Levy Institute.

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Thank You and enjoy the

rest of the show!!!

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