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Implementation of the Basel II capital adequacy framework in New Zealand

Basel II is a new international framework for determining how much capital banks should be required to hold, taking account of the risks that they take. As with the original Basel capital framework, Basel II was developed by the Basel Committee on Banking Supervision.

Latest developments

On 30 June 2008 the Reserve Bank announced that the Bank of New Zealand (BNZ) had been accredited to adopt the internal models approach for credit risk from the third quarter of 2008. The BNZ was accredited to use internal models for operational risk in December 2007.

BNZ is now the fourth New Zealand bank to be accredited to use internal models for credit and operational risk (ANZ National, ASB Bank Limited, and Westpac New Zealand Limited were accredited to use internal models for credit and operational risk in December 2007).

In order for the BNZ to retain its accreditation status it must comply with a number of accreditation requirements. Some of these requirements relate to specific risk parameters to be used in some risk models, and improvements to be made to the bank’s risk models over time. BNZ’s accreditation requirements are similar in nature to those that apply to other accredited banks.

In April 2008 the Reserve Bank released a new version of its working copy of OIC2: Off-Quarter – New Zealand Incorporated Registered Banks Disclosure Order. This new version corrects an error in the disclosure of risk-weighted exposures, only affecting banks subject to the Basel II standardised approach.

In March 2008 the Reserve Bank released a revised version of Capital Adequacy Framework (Internal Models Based Approach) BS2B (PDF 479KB), incorporating minor technical amendments to the version published in February 2008. (A summary of the main points made in submissions on the draft version of BS2B and the Bank’s responses are set out in the document: Response to Submissions from Consultation on Internal Models Based Approach (PDF 33KB).) Consequential amendments to reflect the implementation of Basel II and the recently revised disclosure Orders in Council, were made with the release of revised versions of:

Minor amendments were also made to Capital Adequacy Framework (Basel I Approach) (BS2) (PDF 115KB), which is now used for setting capital floors for banks adopting the internal models approach and for banks that have not yet fully implemented Basel II.

Revised versions of the four Orders in Council that contain the Reserve Bank’s disclosure requirements for banks were published in the New Zealand Gazette on 27 February 2008. Reserve Bank working copies of the revised Orders are available to be downloaded from the Banking Supervision Handbook page. The Orders have been revised to implement Pillar 3 of Basel II, as well as to make a number of other unrelated changes (summarised below). A feedback statement (PDF 60KB) summarises comments received in the consultation process and the Reserve Bank’s responses to them. Also available here is the Regulatory Impact Statement (PDF 32KB) relating to these changes.

The Framework

The Basel II framework is set out in Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework on the website of the Bank for International Settlements.

Basel II is made up of three Pillars. Pillar 1 involves the calculation of minimum capital requirements to cover credit risk, market risk and operational risk. Pillar 2 covers capital for other risks and overall capital adequacy, and Pillar 3 covers disclosure.

For an introduction to Basel II and the Reserve Bank’s approach to its implementation in New Zealand, read A new capital framework (PDF 101KB) by Andrew Yeh, James Twaddle and Mike Frith (published in the Reserve Bank Bulletin, September 2005).

Implementation in New Zealand

The Reserve Bank’s capital adequacy framework for banks is based on the Basel II framework adapted where relevant to take account of the features of the New Zealand financial system.

Locally incorporated New Zealand banks are required to hold capital based on Basel II requirements from the first quarter of 2008. Banks may, if accredited, use the internal models approach to calculate their capital requirements under Basel II or otherwise must use the standardised approach.

For banks registered as branches in New Zealand, Basel II developments will have disclosure implications only.

Standardised approach

Pillar 1 standardised approach: Banks using the standardised approach under Pillar 1 will be subject to conditions of registration that will require capital adequacy to be calculated using the framework set out in the document Capital Adequacy Framework (Standardised Approach) BS2A - November 2007 (PDF 324KB).

A summary of the main points made in submissions on the draft version of BS2A and the Bank’s responses thereto are set out in the document: Response to Submissions from Consultation on Standardised Approach (PDF 26KB)

Internal models based approach

In March 2006, the Reserve Bank published its application requirements for banks seeking accreditation to adopt the internal models based approach in 2008 – i.e. the internal ratings-based approaches to credit risk and the advanced measurement approach to operational risk. See Basel II: Application requirements for banks seeking accreditation to use the internal-models approaches – March 2006 (PDF 142KB)

The Reserve Bank also released an exposure draft Basel II: IRB national discretions – March 2006 (PDF 79KB), outlining the Reserve Bank's preliminary thinking on how to treat the national discretions available under the Basel II internal ratings-based approach to credit risk.

On 10 December 2007 the Reserve Bank announced that four banks had been accredited to adopt the internal models based approach under the Basel II banking supervisory regime.

The banks that were accredited to use internal models for credit and operational risk from the first quarter of 2008 are ANZ National Bank Limited, ASB Bank Limited, and Westpac New Zealand Limited. In addition, the Bank of New Zealand was accredited to use internal models for operational risk from the first quarter of 2008.

On 30 June 2008 the Reserve Bank announced that the Bank of New Zealand had been accredited to adopt the internal models approach for credit risk from the third quarter of 2008.

In order for the four banks accredited banks to retain their accreditation status they must comply with a number of on-going accreditation requirements. Some of these requirements are of a transitional nature, recognising that there is some way to go to fully embed the Basel II regime. In particular, there will be a transitional requirement to maintain capital at a level no less than 90 percent of the previous Basel I capital requirement. Other requirements relate to specific risk parameters to be used in some risk models, and improvements to be made to the banks’ risk models over time.

Banks using the internal models based approach for determining regulatory capital requirements will be required to calculate their regulatory capital requirements using the framework set out in the document the Capital Adequacy Framework (Internal Models Based Approach) BS2B (PDF 479KB).

Pillar 2

In December 2007 the Reserve Bank has finalised its approach to implementing Pillar 2 of Basel II in New Zealand. A summary of the approach, and feedback on the comments received during the consultation, are set out in Pillar 2 approach and feedback on consultation (PDF 41KB). See also Guidelines on a bank’s Internal Capital Adequacy Assessment Process (“ICAAP”) BS12 (PDF 49KB).

Pillar 3

Pillar 3 of Basel II is designed to reinforce market discipline on banks’ capital adequacy by disclosure of relevant details of banks’ capital calculations. The Reserve Bank has revised its disclosure requirements to implement Pillar 3. Reserve Bank working copies of the four Orders in Council that were gazetted on 27 February 2008 and contain the revised disclosure requirements, are available to be downloaded from the Banking Supervision Handbook page. The revisions also include a number of other changes unrelated to Basel II, in particular changes associated with banks’ adoption of New Zealand equivalent of international financial reporting standards and international accounting standards (“NZ IFRSs”). The Reserve Bank prepared a Regulatory Impact Statement (PDF 32KB) as part of the process of getting these changes made.

The Reserve Bank consulted on the proposed revisions to its disclosure requirements over the period 26 September to 26 November 2007. Several submissions were received in the consultation, in the light of which some significant revisions were made to the proposals. See the feedback statement (PDF 60KB) for a summary of the submissions and our responses to them.

An amending order to OIC2 was gazetted on 27 March 2008. This was needed to correct an error in the table of risk-weighted exposures that banks on the Basel II standardised approach must disclose. The Reserve Bank working copy of OIC2 consolidates this amending order.

Other implementation-related information

Securitisation and market risk (May 2007) details the implementation of capital adequacy rules for securitisation and market risk under Basel II.

The high-level principles for the cross-border implementation of Basel II in Australia and New Zealand are set out in the Terms of Engagement between the Reserve Bank of New Zealand and the Australian Prudential Regulation Authority in relation to the implementation of Basel II.