Ομιλία του Διοικητή κ. Νικολάου Χ. Γκαργκάνα " On the Practice of Financial Stability in Greece: The Implications of Basel II", Conference on Financial Stability and Implications of Basel II, Central Bank of the Republic of Turkey, Istanbul
16/05/2005 - Ομιλίες
Ladies and Gentlemen,
I thank the organizers of this conference for inviting me to
be here today. I am especially pleased to be speaking on such an important
issue. The concept of financial stability, considered from different
perspectives, which is the main focus of the Conference, is appropriately
receiving considerable attention in the light of the variety of risks
confronting financial systems. My presentation will deal with the practice of
financial stability assessment in Greece, key aspects of the Basel II
implementation process in Greece, and some implications of Basel II for
It is generally agreed that the objective of financial
stability assessment is to review the main sources of risks and vulnerabilities
likely to affect the stability of the financial sector and to evaluate its
capacity to absorb the impact of adverse disturbances.
The Bank of Greece's assessment of the stability of the Greek
financial sector is contained in a section devoted to that issue of its
semi-annual report to the Greek Parliament. Moreover, the Bank's Annual Report
to the General Meeting of its shareholders also contains a section on the
stability and the supervision of the Greek banking sector.
Before presenting the Bank's approach to financial stability
assessment, let me provide some key aspects of the Greek supervisory framework
and of the Greek financial sector.
Effectively there are three bodies responsible for
supervision of the financial system as a whole.
· The Bank of Greece regulates and supervises credit
institutions and some special institutions such as credit companies, financial
leasing and factoring companies, etc. It also has a mandate to contribute to the
overall stability of the financial sector.
· The Hellenic Capital Market Commission regulates the
capital markets and supervises investment firms and collective investment funds.
· Finally, the recently-established Commission for the
Supervision of Private Insurance is responsible for insurance companies.
Cooperation between the three domestic supervisory
authorities is crucial to the pursuit of financial stability. To this end, a
Memorandum of Understanding has been signed between the Bank and the Capital
Markets Commission which lays down the practical arrangements for cooperation;
in addition a representative of the Bank sits on the Commission's Board.
Cooperation with the new supervisory body for the insurance industry is expected
to be organized along similar lines once the authority is fully operational.
Banks dominate the Greek financial sector, accounting in
terms of assets for approximately 85% of the entire financial sector. The
banking sector itself is characterized by relatively high concentration with the
5 largest banks controlling 65% of the total assets of the banking sector. The
Bank of Greece's regulatory framework is essentially based on the relevant EU
Directives which are closely aligned to the Basel I framework. In the Greek
context, credit risk is the main component of banking risks. Overall the
profitability and capital adequacy of Greek banking groups is satisfactory. On a
consolidated basis, the rate of return on equity and the rate of return on
assets before taxes were respectively 16,1% and 1% for 2004 and the capital
adequacy ratio reached 12,8% at the end of 2004.
In view of the dominance of the banking sector in the Greek
financial system, I will focus on this sector.
First, let me outline the approach followed by the Bank to
assess the stability of the Greek banking sector. On the one hand, this approach
involves an evaluation of the information provided by a number of indicators
relating to the risk profile of banks and the economic condition of households
and firms, and an assessment from a stability perspective, of developments in
key macroeconomic variables and markets. On the other hand, the Bank seeks to
determine the banking sector's capacity to absorb negative shocks. For this
purpose, it utilizes data on bank profitability and capital adequacy and also
takes account of the results obtained from stress tests.
To derive the main indicators, the Bank makes use of
information submitted by banks in their supervisory reports on exposures in
default, provisions, concentration ratios and credit migrations of individual
exposures. Alongside ratios calculated from this source, data from household and
firm surveys on both debt and income/profit levels provide information on the
debt-bearing capacity of the household and business sectors.
Data from supervisory returns also provide information on
market and liquidity risks. In its evaluation of the information provided by all
these indicators, the Bank takes into account the corresponding EU and Eurozone
average values of these indicators where available.
As regards macroeconomic variables and markets that may
affect the stability of the banking sector, the Bank focuses on developments in
the GDP growth rate, interest rates and exchange rates, and in the stock and
real-estate markets. The direct impact on the financial condition of the banking
sector of adverse developments in interest rates and exchange rates and in share
and real-estate prices can be quantified using data on bank exposures to each of
these risk factors. The indirect impact on banks of adverse developments in GDP
growth and the aforementioned risk factors on banks mainly consists of an
increase in credit risk arising from the effect of such developments on the
financial condition of households and enterprises and thus on their
debt-servicing ability. At present, the Bank makes only a broad qualitative
assessment of this indirect impact in its published stability analysis.
In order to assess the banking sector's capacity to absorb
the impact of adverse disturbances, the Bank focuses on a number of developments
in banks' financial condition and makes use of stress testing. The latter
involves the Bank asking banks to quantify the impact on their own funds and
capital adequacy ratios of pre-specified adverse changes in the values of
certain basic risk factors. The risk factors considered are the probability of
default and the loss given default, interest rates, share prices and exchange
rates. In addition, the Bank is working towards developing a macro
stress-testing framework, especially for credit risk.
Let me now move on to discuss issues related to Basel II,
which represents a major change in the supervisory framework and a challenge to
both supervisors and banks. Before considering some implications of Basel II for
the stability of the banking sector, I would like to refer to the preparations
for Basel II implementation in Greece and to the choices Greek banks are
expected to make between the alternative approaches for calculating capital
A large majority of Greek banks are expected to adopt the
standardized approach in determining capital requirements for credit risk.
However, a number of banks, comprising a share of around 50% of the total assets
of the banking sector, are reasonably expected to adopt the foundation IRB
approach for a significant part of their total portfolio. The Bank of Greece is
encouraging banks to move to the IRB approach because this approach will require
an improvement in their risk measurement and management systems. Thus, it will
strengthen their competitive position and their capacity to successfully adapt
to changes in the economic environment.
For operational risk, although the majority of Greek banks
are expected to adopt the basic indicator approach to determine capital
requirements, most of the large banks plan to adopt the more refined
The Bank of Greece is working closely with the banks to help
them prepare for the implementation of the new rules. In this connection, it has
already put out 5 consultation documents dealing with issues where there is
national discretion. These documents discuss measures which the Bank intends to
adopt as well as other matters requiring clarification and supervisory guidance.
Detailed consultations with each bank planning to use the IRB approach have
begun so that problems can be identified and resolved, while the preparations of
banks intending to use the standardized approach will be reviewed at a later
stage - - sometime before the end of 2006. An important issue for the Bank of
Greece is to evaluate not only the technical aspects of the banks' internal
systems and the methodologies used to validate their output, but also to
ascertain whether the output of these systems is utilized in managerial
decision-making in such areas as loan approval and pricing, provisioning, and
At this stage it is difficult to determine the overall impact
of Basel II on the total capital requirements of the Greek banking sector. The
impact will depend not only on the alternative approaches adopted by the banks,
but also on the composition and quality of their assets, both of which are
affected by economic conditions. However, one limited preliminary indication was
provided by the result of the 2003 quantitative impact study. For the 6 Greek
banks that participated using only the standardized approach at that time, there
was a 7.5% net increase in the combined capital requirement for credit and
operating risk compared to the corresponding requirement under the existing
framework (a 2.5% decrease of the requirement for credit risk and a 10% increase
for operating risk).
Pillar II on supervisory review requires the conduct of
risk-based supervision and the existence of detailed systems and policies at
each bank to determine, maintain and allocate economic capital in accordance
with its risk profile. This increases the pressure on supervisory resources as
well as banks. In Greece, supervision has traditionally focused more on
examining the accuracy of supervisory returns submitted by the banks, on a
point-in-time evaluation of the quality of loan portfolios, and on the technical
calculation of capital requirements to cover credit and market risk. In recent
years, however, increasing emphasis has been placed on the assessment of
internal control and risk-management systems, taking into account the risk
profile of each bank. In this respect, the Bank of Greece found it necessary to
impose a minimum capital adequacy ratio above the statutory minimum of 8% on
some banks. To enhance its ability to conduct risk-based supervision, the Bank
has taken steps to improve the skills of existing supervisory staff through
specialized training and has also recruited personnel with skills in
quantitative risk analysis. The banks have also strengthened their risk
management units, but, in order to successfully implement Pillar II further
efforts will be required.
Pillar III enhances market discipline by requiring credit
institutions to disclose appropriate risk information, allowing the market to
reward well-managed and well-capitalized credit institutions.
Let me now turn to some implications of Basel II for the
stability of the banking sector.
To successfully implement Basel II, Greek banks will need to
further improve their risk measurement and management systems and to develop
their contingency planning. This will enable them to react more promptly and
effectively to disturbances affecting their risk profile. In addition, the Bank
of Greece, in its stability assessment, will utilize the output of the banks'
improved internal systems to undertake more timely and accurate estimates of the
total impact of alternative stress scenarios on the risk exposures and capital
adequacy of the banking sector. Therefore, it will be in a better position to
evaluate the sector's overall resilience.
It has been argued that Basel II is likely to produce a
procyclical effect. According to this line of reasoning, for banks using the IRB
approach, capital requirements for credit risk will increase during cyclical
downturns because of a deterioration in the quality of loan portfolios and,
conversely, decrease during cyclical upturns. As a result, bank capital adequacy
will deteriorate during downturns, given the difficulty of raising new capital
in such conditions. Consequently, Banks will be under pressure to restrict their
lending during downturns, while during upturns they will tend to unduly expand
it. It should be kept in mind, however, that bank lending is likely to be
pro-cyclical to some degree, irrespective of the supervisory framework. Yet, the
possible additional pro-cyclical effect arising from the IRB approach can be
mitigated. In the context of Pillar II, supervisors should insist that banks
hold capital comfortably above minimum requirements under normal conditions and
also require banks to conduct rigorous stress tests in order to assess the
adequacy of capital buffers. In addition, it would be advisable to encourage
banks to adopt a more forward-looking through-the-cycle approach in their credit
quality assessments and in their provisioning policy. At present, even the more
sophisticated Greek banks tend to employ only a point-in-time approach to
determine the values of the main credit risk parameters.
In its consultation document regarding the minimum
requirements for the Internal Rating Systems, the Bank of Greece has announced
that, although it will accept Point in Time systems, it encourages banks to
incorporate the effects of the economic cycle in their assessments.
During the various consultation phases preceding the
finalization of Basel II, concerns were also expressed with respect to the
impact of Basel II on small and medium enterprises (SMEs). It was argued that
capital requirements applicable to loans to these firms, especially under the
IRB approach, would increase compared to the existing framework, leading to an
increase in their financing costs or, possibly, to a decrease in the amount of
credit supplied to them. Both these factors would adversely affect their
financial condition. This, in turn, would have negative consequences for
economic growth and employment and would impact on financial stability,
particularly in countries such as Greece, where SMEs account for a large share
of total output and employment. I believe, however, that the final version of
Basel II substantially alleviates these concerns. In Greece, the majority of
banks will adopt the standardized approach. For the significant part of their
total exposures to SMEs, which will qualify as retail exposures, the applicable
risk weight will actually decrease compared to the existing framework. For most
of the remainder, the risk weight will remain unchanged. Even in the case of
banks adopting the IRB approach, most of their SME customers are expected to
derive some benefit either from the firm-size adjustment for corporate exposures
or from the generally lower risk-weight function for retail exposures.
Increased disclosure under Pillar III is expected to
strengthen market discipline by increasing transparency. This will have a
positive effect on stability to the extent that anticipated market reaction
dampens banks' incentives to assume excessive risks. However, the influence on
bank behavior of the direct market discipline exercised by depositors, other
creditors, and shareholders, is often limited either because these stakeholders
lack sufficiently strong incentives or because, in some cases, the interests of
the different stakeholders do not coincide. In particular, the actual or
presumed existence of public safety nets may dampen the incentives of depositors
to exercise discipline. Wider and more pertinent public disclosure is expected
to enhance the information content of listed banks' share prices and of interest
spreads on subordinated bank debt. This will increase the accuracy and
predictive power of fragility indicators based on market data, such as the
distance to default, an indicator derived from market prices of bank shares. At
this point, I may mention that the 10 banks whose shares are listed in the
Athens Stock Exchange account for over 75% of the total assets of all credit
institutions operating in Greece. Based on empirical evidence, changes in the
distance to default represent a useful forward-looking indicator for stability
assessment purposes, especially if based on weighted average values for the
entire banking sector rather than for each individual bank. In general,
market-based fragility indicators are a useful supplement to supervisory data,
which are derived as a rule from accounting records.
In concluding, I would like to stress the increasing
importance of maintaining financial stability in the increasingly competitive
environment of recent years, following the deregulation of the Greek financial
system and the liberalization of capital movements. These changes have made the
Greek banking system more sensitive to international capital flows, which can
sometimes be volatile and unpredictable. The internationalization of the
activities of Greek banking groups, Greece's entry into the eurozone, and the
integration of European financial markets, although generating significant
benefits, have also increased the exposure of the Greek financial system to
contagion risks. In the light of these developments, the Bank of Greece has
instituted - - and continues to institute - - changes that improve the quality
of its financial stability analysis, so that timely and accurate assessment of
risks be made and, where necessary, appropriate policy responses can be
formulated. I believe that the implementation of Basel II in Greece will yield
significant benefits because of its effects on the risk profile and the risk
management systems of banks in the evaluation of their capital adequacy. This,
after all, is a key determinant of their capacity to absorb adverse shocks.
Therefore, both from a supervisory and a financial stability perspective, the
difficult task of implementing Basel II in Greece will be well worth the effort.
Thank you for your attention.