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SOMRUEDI BANCHONGDUANG
Thailand's commercial banks will adopt the Basel II financial standard at the end of the year, a move aimed at improving risk-management practices, more efficiently matching capital requirements to risk and strengthening the overall stability of the financial system. The existing capital standard, known as Basel I, was adopted decades ago as a rough guide to determine the amount of capital banks must reserve to cover credit and market risks. For instance, the best-known principle of the standard calls for Thai banks to maintain capital funds _ equity and subordinated debt _ of at least 8.5% of their risk assets, which are primarily loans.
The Basel II standard, initially published in 2004, aims to improve on the existing framework by forcing banks to look at other types of risks, such as operational risk. Analysts estimate that the new standard will increase capital requirements by a full percentage point, although this will vary depending on the composition of each bank's loan portfolio and the readiness and comprehensiveness of its risk management practices.
Risk weightings for different types of loans will also be adjusted. Mortgage loans, for instance, will have their risk weight reduced to 35% under Basel II from 50% now, meaning that from a bank's perspective, less capital is required to cover a given housing loan. Auto loans and small and medium-sized company loans also will have their weightings reduced, resulting in many banks already moving to expand their presence in the two markets.
The Basel II framework, drafted under the Bank for International Settlements, calls for banks to use one of two methods to calculate their capital needs.
The first is known as the standardised approach, where credit ratings are used to assess the relative risk of a borrower and derive the minimum capital required to serve as a reserve. Thai banks are expected to use this method for the next several years to comply with Basel II.
The second, more sophisticated method, is known as the internal ratings-based approach, where banks are allowed to use their own risk models to allocate capital. This approach is expected to be used by leading international banks.
Capital allocation is only one of three ''pillars'' outlined under the Basel II framework. The second pillar calls on regulators to strengthen supervisory systems and establishes a framework to deal with various bank risks, such as legal risk, reputation risk or liquidity risk.
The third pillar meanwhile aims to impose market discipline on institutions by increasing the disclosures required by banks.
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