Author Topic: Basel III and financial stability risks  (Read 450 times)

Offline Rozina Akter

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Basel III and financial stability risks
« on: September 17, 2015, 04:32:20 PM »
It is recognised that financial stability is crucial to attain the goal of sustainable development. Environment is a critical stability and sustainability concern and is connected with Bangladesh's poverty and growth. The public concern of the state of environment has been growing rapidly mainly due to increasing environmental degradation, growing energy use, rising greenhouse gases, and declining non-renewable energy resources.

Poverty, growth and environmental sustainability are closely bound together in Bangladesh. Common people live in an over-exploited and degrading natural resource base. Industrial and urban growths are contributing to economic livelihoods but have already posed serious threats to environmental and human health because of inadequate attention to environment and sustainable development. Recent studies have revealed that annually about 4 per cent of GDP is lost and 22 per cent of diseases are due to environmental degradation.

In line with the needs, banks and non-banking financial institutions (NBFIs) of the country are undertaking environmental sustainability initiatives mainly as part of their green banking and financing activities. Policy-makers including the Bangladesh Bank have been playing a remarkable role in this connection. However, a lot has to be achieved to attain the targeted level of environmental sustainability in the country.

Enforcements of Basel Capital Accords have been connected with ensuring a safe and sound banking system i.e. banking sector stability. One of the vital functions of the Basel Accord has been to facilitate efficient allocation of capital in line with the risks. While risk taking is a central element of financial intermediation, it is important that risks do not become excessive. Excessive risk-taking can create imbalances in the financial system, result in financial crises and create periods of low or negative growth. Based on the global experiences, the structure, dimension, and coverage of Basel Accords changed.

Before the global financial crisis, financial supervision was primarily directed at supervision of individual financial institutions, focusing on risk- weighted capital ratios. The underlying assumption of this approach was that the system as a whole can be made safe by making the individual financial institutions safe. After the global financial crisis, it is widely recognised that the macro perspective was lacking. In line with that, in addition to enhancing the resilience of individual banks, the Basel III framework incorporated macro prudential elements with a greater emphasis on system wide stability.

The Basel Committee addressed both micro-prudential and macro-prudential systemic risks in the banking sector under Basel III by increasing capital and liquidity requirements and requiring regulators to challenge banks more in the construction of their risk models and for banks to undergo more frequent and demanding stress tests. Moreover, under Pillar 2, as the Basel III required, banks must undergo a supervisory review of their corporate governance and risk management practices that aim, among other things, to diversify risk exposures across asset classes and to detect macro-prudential risks across the financial sector. Now, in connection with environmental concerns, an important question arises as to whether systemic environmental risks are addressed in Basel III or not.

From the Basel III framework, it can be observed that regarding environmental risks, it requires banks to assess the impact of specific environmental risks on the bank's credit and operational risk exposures. However, these are mainly transaction-specific risks that affect the borrower's ability to repay a loan or lender liability for damages and the cost of property clean-up. These transaction specific risks are not thoroughly covered and do not constitute broader macro-prudential or portfolio-wide risks for the bank that could arise from its exposure to systemic environmental risks.

A recent joint report  by the United Nations Environment Programme and the University of Cambridge suggests that Basel III is not being used to its full capacity to address systemic environmental risks and that such risks are in the 'collective blind spot of bank supervisors'. The report added, despite the fact that history demonstrates direct and indirect links between systemic environmental risks and banking sector stability, the current Basel Capital Accord does not take explicit account of, and therefore only marginally addresses these issues. And, by failing to addresses systemic environmental risks, Basel III is arguably overlooking an important source of risk to the ?nancial system and broader economy despite its overriding objective of guaranteeing banking stability.

Several recent studies pointed out the necessity of addressing the issue of 'Systemic Environmental Risk' by the bank supervisors. There are arguments that such risks may be among the biggest risks that humanity faces today. Environmental systemic risk is a 'ticking time bomb' and with the industry needs to develop a response urgently, according to joint research. A number of ?nancial development institutions, such as the International Finance Corporation (IFC) which currently hosts an informal group of bank regulators and banking associations called the Sustainable Banking Network (SBN), have sought to promote dialogue between practitioners and regulators on environmental sustainability issues and to encourage a better understanding of these issues by ?nancial regulators.

Recognising the materiality of systemic environmental risks to banking stability, some developing countries like China, Brazil and Peru, under the aegis of the SBN, have embarked on innovative risk assessment programmes to assess systemic environmental risks from a macro-prudential perspective and are already engaged in a variety of innovative regulatory and market practices to control environmental systemic risks and adopt practices to mitigate the banking sector's exposure to environmentally unsustainable activity.

In the context of Bangladesh, circulation and enforcement of 'Green banking policy framework' in 2011 by the Bangladesh Bank is a remarkable step on the way to attain environmental sustainability in the country. The central bank also prepared and circulated a guideline on environmental risk management in the same year to streamline solutions for managing the environmental risks in the financial sector that prescribed a set of sector specific 'Environmental Due-diligence Checklist' for financing environmentally sensitive sectors by banks. The Bangladesh Bank's initiatives have already brought notable changes in several fronts of green banking. About environmental risk management in financing, banks have mainly undertaken initiatives to manage environmental risks at transaction levels. For ensuring financial sector stability, it would be desirable to identify and manage environmental risks of banks both at the transaction specific level and at the broader portfolio level.
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Offline ummekulsum

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Re: Basel III and financial stability risks
« Reply #1 on: September 20, 2015, 04:42:43 PM »
thanks for sharing.....

Offline Farhadalam

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Re: Basel III and financial stability risks
« Reply #2 on: September 21, 2015, 01:12:39 PM »
Thabk u. Can u plz explain basel ll.

Offline munna99185

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Re: Basel III and financial stability risks
« Reply #3 on: October 04, 2015, 09:27:54 AM »
Thanks for sharing.

Sayed Farrukh Ahmed
Assistant Professor
Faculty of Business & Economics
Daffodil International University


Offline Rozina Akter

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Re: Basel III and financial stability risks
« Reply #4 on: October 08, 2015, 04:00:25 PM »
 :)
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Offline shahanasumi35

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Re: Basel III and financial stability risks
« Reply #5 on: November 04, 2015, 04:40:09 PM »
Nice post.Thanks for sharing.