Taiwan Banks’ Supervision of Risk Must Conform to New Basel Agreement

        On Jan. 4, the Financial Supervisory Commission (FSC) announced revisions of the Regulations Governing the Capital Adequacy Ratio of Banks and the Calculation Methods and Forms for Banks’ Self-Owned Capital and Risk-based Assets. Under the revised rules, the risk supervision systems of Taiwan’s banks should be instituted in reference to the New Basel Capital Accord, which requires two new “pillars” in addition to the original minimum capital requirements: a supervisory review process, and market discipline. This should tighten up Taiwan’s banking supervision system and bring it in line with international standards.

        The FSC notes that the newly-revised rules adjust the calculation method for credit and market risk, and add a definition of operational risk as well as the method of calculating it. They also provide that the competent authority may, based on the results of a bank’s risk assessment, require that bank to improve its risk management, and that a bank must disclose its capital adequacy ratio according to the rules of the competent authority.

        The FSC also points out that Taiwanese financial institutions have begun studying the institution of the New Basel Capital Accord since May 2002, and that more than 300 meetings of industrial, governmental, and academic representatives have been held since that time. Trial calculations and personnel training courses have been carried out as well, and seminars have been held. The results of the most recent trial calculation (in June 2005) show that Taiwan’s banks will face no major difficulty in adopting the capital adequacy requirements of the new accord. Their average capital adequacy ratio will drop by 0.35 percentage points, from 11.77% to 11.42%, indicating that the island’s banks will be able to implement the provisions of the new accord smoothly in 2007. The new rules will also enforce local banks to establish methods for measuring and managing operational risk; this will boost their consciousness of this risk, reduce the probability of loss-incurring incidents, and have a long-term positive effect on the banks’ healthy operations and profitability.

        The New Basel Accord, which was announced by the Basel committee on Banking Supervision of the Bank for International Settlements in June 2004, is designed to establish three pillars of the financial system: minimum capital requirements, supervisory review, and market discipline. The minimum capital requirements take consideration of credit, transaction, and operating risk with the aim of reinforcing risk management within the banking system.

        The biggest difference between the New Basel Accord and the previous agreement is that it divides capital risks in detail and calculates them in accordance with type and term. The new accord also places heavy emphasis on operational risk. The first pillar of the new system, minimum capital requirement, includes methods for the measurement of credit, operational, and market risk, and allows banks to choose between the Standardized Approach and Internal Ratings-Based (IRB) Approach. Under the second pillar Supervisory review, supervisory agencies will evaluate the risk management capabilities of banks, and should they discover deficiencies in this respect, will require the delinquent banks to appropriate additional funds. Banks should follow the rules of the third pillar-market discipline and disclose more quantitative and qualitative information about capital and risk management. In the future, the emphasis of supervision will be on the banks’ risk management strategies and the quality of their implementation, and on the checks and balances of the market function. To view the content of the revisions, please visit http://www.fscey.gov.tw/ct.asp?xItem=2197316&ctNode=1503&mp=2.

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