It is vital to increase the strengths of banks and hence their abilities to absorb economic stress and financial constrains. The global financial crunch was accelerated with the high vulnerability or susceptibility of the banking system and if this is to be avoided again, strong banking systems need be adopted.
Poor definition of capital, a lack of ability to build common banking system and generally the low quality of capital were the main causes the economic downturn.
With the increase in the capital quality, the banks are in a better position to absorb economic shocks on both a going concern and a gone concern basis; this will mean a better ability to withstand stress.
The definition that includes a keen focus on the common equity element which is the highest quality module of a bank’s system, this galvanises the system from financial paralysis. This could be achieved by the banks taking deductions from the common equity. These institutions from which banks will be taking deductions (regulatory capital instruments), must have the ability to absorb at least on their own a gone concern circumstance.
Summarily, the above improvements in the capital definition will be enhanced better by the bringing forth of buffers and an advanced minimum capital desires.
Materiality is the ability of a financial situation affecting the economic stability of a business entity. When a material risk faces banks and the other financial institutions, it is of essence to identify in the capital framework. The failure to identify and work on the risks to capture main on and off financial situation statements was a major contributor to the economic down turn. Addressing these risks is of essence in an attempt to avoid an occurrence of a similar situation.
Increasing the securitisations of the financial institutions would help reduce the economic vulnerability and hence strengthen financial structures of these institutions. E.g. the CDOs of ABS
Raising the level of capital
Raising the minimum equity capital base form 2% to 4.5 %, factoring in the buffering and the capital conservation raises the equity requirements to about 7%. However, supervisors are supposed to call for increased buffers in times of excess credit growth and for key banks and financial situations.
This will act as a backstop to the risk-based capital need. Higher Tier 1based risk ratios go hand in hand with on- and off- balance sheet leverage, included in the new capital definition.
Liquidity is the availability of liquid money or the ability to access the hard cash easily.
Global liquidity standards and supervisory monitoring
An increase in the liquidity standards will ensure that banks and the financial institutions are able to resiliently absorb potential short-term disruptions. These disruptions are often brought about by insufficient funding by the responsible institutions. This was witnessed during the global financial crisis when there was underfunding by the supervising authorities. These regular underfunding normally affect bank’s normal operations leading periodical instabilities thus exposing the banks to high calibre of vulnerability. This gives any possible financial inconsistency(s), the ability to impact these banks heavily as it was evident in the recent financial crisis
3. Risk management and supervision
Without risk management and keen supervision, then the adjusted capital definition and the raised liquidity standards would be a flop, this is extremely vital in a financially contemporary environment. Some of the loop holes identified in the risk management process include:
Risk management and firm-wide governance
Provision of adequate compensation practices and incentives for banks to better cope with risks and returns in the long term
Securitisation activities and identification of the risk of off-balance sheet exposures
Management of risk concentrations
Supervisory should as a result be concentrated: liquidity risk management. It is important that supervisors concentrate on the assessment of the adequacy of a bank’s liquidity in terms of risk management and the level of liquidity. Supervisors should as such ensure that after the assessment and others are found not compliant, then the institution should be called to explain their compliance procedures failure to which the institution should be liquidated if it can’t be bailed out, especially in times of financial stress. This will make banks eager to comply and thus stability in the system
Valuation practices: It evaluates bank’s value at all times to ensure stability
Stress testing: This evaluates the ability of the banking institution to absorb financial stress. The tests include detailed set of principles for the rational governance, plan and implementation of stress testing programmes at banks. The weaknesses in banks will be highlighted and addressed.
Supervisory colleges: Institution that will ensure compliance to the agreed
Corporate governance: Banks should have healthy corporate governance plans.
Sound compensation practices: compensation of financial institutions should comply with the Principles for Methodologies for Risk and Performance Alignment of Remuneration.
4. Market discipline
Banks should be consistent and provide reliable information of their financial situations. During the crisis, banks and other financial institutions were providing inadequate or inconsistent information about their situations. A revision of the pillar 3 requirements relating to securitisation of the of off-balance sheet vehicles is necessary to ensure the information provided by the banks about themselves are not only consistent but also true.
In their websites, they should provide all requirements for capital provision and reconciled statement of accounts.
Bank for International Settlements. The Basel Committee. .n.: Bank for International Settlements, 2010.