Risk Management and Basel III

Table of Contents

Introduction1

Systematic risk1

Discussion2

Regulations4

Basel II4

Basel III4

Advantages & Limitations6

Conclusion9

References13

Appendices16

Risk Management and Basel III

Introduction

Capability of banks' risk management practices are revealed by the financial crisis. It has been noted that impact of the financial crisis of 2007 till 2009 on the real economy and as well financial markets still can be felt. Many scholars evaluated the crises in deep details. To avoid future occurrence of such event, alternative approaches need to be developed. The important component need to be solved is a systematic risk. As (Sheldon & Maurer, 1998) argues that everyone is well aware of systematic risk, and also accepts it is omnipresent, but there is no proof encountering it, and its presence cannot be denied. This shows the difficulties for facing systematic risks. Basel II seems incapable for lowering systematic risk. (Bernanke, 2008) Focused on to counter this problem by an alternative approach, macroprudential oversight, this widens the authority of controllers and supervisors to include consideration of weaknesses and strengths of systematic risk.

Systematic risk

Systematic risk is as the risk of distress due to failure of an important area of the financial sector causing an imbalance in the financial system, this imbalance can be caused due to one big or many small financial sectors, and this impact has significant negative impact on the real economy (Acharya et al. 2010) and (BIS, FSB & IMF, 2009a). This failure of banks leads to external negative impact; it has a negative impact on other institutions in system (Brunnermeier et al., 2009). (Acharya et al. 2010) Suggests that particular financial organisations should take steps to prevent themselves and it is not important to take steps for the whole system.

The major issue of the systematic risk lies in the conceptual idea. There are two types of systematic risks, one is time dimensional and other is cross sectional. In cross sectional, risk is around to other banks and financial institutions in continuous effect. The other dimension considers how risk is over time (Borio, 2003).

Discussion

It has been note that impact of the financial crisis of 2007 till 2009 still prevail in the real economy and as well financial markets. Many researchers evaluated the crises in deep details. To avoid future occurrence of such event, alternative approaches need to be developed. The important component need to be solved is a systematic risk (Schwerter, 2011).

To solve the systematic risk, it needs to be clearly analysed and consider its importance. It is found there are some special factors which allow evaluating the systematic importance of financial organisations. The findings show that size and interconnectedness are relevantly significant factors in systematically ranking banks (Acharya et al. 2010) and (BIS, FSB & IMF, 2009b). (Schwerter, 2011) Shows other factors illustrated in figure 1.

It is observed that current regulations are not fully focused on reducing systematic risk. The main ideas are to internalise the risk of banks failure and eliminate the element of external risk and spill over (Schwerter, 2011). If it is not done, the effect of excessive ...