Adoption of Basel II brings Trinidad and Tobago's banks in line with global best practices

The most important regulatory change under way for Trinidad and Tobago’s banking sector is the adoption of Basel II financial reporting standards. The Basel Committee on Banking Supervision – a division of the Bank of International Settlements, a multilateral financial institution supported by central banks from around the globe – is tasked with establishing the comprehensive Basel II reform measures. This institution not only must ensure international cooperation on various financial and monetary policy issues, but also serves as a central bank for the world’s central banks.

Standard-Setter

The Basel Committee on Banking Supervision is recognised as the world’s leading standard-setter for the prudent regulation of banks, and it is the top forum for fostering cooperation on banking regulations. It has 45 members, including central banks and bank supervisors from 28 different jurisdictions. In a world that has increasingly inter-connected and inter-dependent financial sectors, Basel II is seen as one of the most important efforts to foster the international convergence of capital adequacy measures in major economies across the globe.

Basel II standards were established in 2006 as a set of voluntary metrics that countries agree to adopt. The Basel Committee on Banking Supervision does not have any legal powers to enforce compliance, and it is not a supranational supervisory authority. Rather, it acts as an advisory body that helps bring member countries in line with globally recognised best practices. The Economist describes Basel II as “a gentlemen’s agreement among leading regulators which all countries with international banks are encouraged to adopt, but which relies on national law for its implementation”.

Focus Areas

Basel II is based around three main principles. First, it addresses minimum capital requirements, mitigating banks’ three primary categories of risk: credit, operational and market risk. Basel II recommendations are designed to create standardised and specific requirements that are tailored to each category. Second, the agreed standards set out a supervisory framework, which outlines the regulatory response to the types of risk that banks take on. Basel II is designed to create a system for confronting legal, liquidity, reputational, strategic, concentration, systemic and pension risks.

The third component of Basel II deals with market discipline. It is designed to encourage greater transparency through disclosure requirements, which allow financial sector participants to access and evaluate critical information about risk exposure. Overall, Basel II creates a common framework for disclosure, which intends to allow investors, analysts, customers, other banks and ratings agencies to more easily assess risk across various financial institutions in different markets.

T&T Today

The domestic banking sector follows the norms established by Basel I, an accord adopted in 1988 and implemented in the twin-island nation in 1994. In line with this, banks respect an 8% minimum capital requirement for risk-weighted assets, which will be maintained under Basel II. While the central bank is working to adopt Basel II by early 2019, no timeline has been set for the adoption of Basel III, the most recent iteration of the agreement, which promotes the use of liquidity buffers.

The adoption of Basel II in T&T is a development that has been carefully rolled out over for several years. In late 2014 the central bank began consulting banks on how they could most effectively implement Basel II. The regulator then sought commentary and feedback from bankers in 2015 and formed a technical working group to discuss the timeline and strategy for the operationalisation of Basel II. Next, the central bank carried out two separate quantitative impact studies in 2016 and 2017 to assess the potential ramifications of shifting the market to adopting to Basel II standards.

In 2018 the central bank is coordinating with financial institutions as well as consultants from the IMF’s Caribbean Training Centre to design a strategy to effectively implement and operationalise the Basel II platform. The adoption of the Basel II framework will require financial institutions to standardise their approaches to credit and operational risk, as well as adopt a higher, Tier-1 capital ratio and new minimum capital adequacy ratio.

“Our central bank is currently rolling out Basel II, so the adoption of those standards is in progress,” Reshard Mohammed, vice-president and CFO of Scotiabank T&T, told OBG. “We have been working with the central bank to get that operationalised, and all banks will be moved to Basel II in early 2019.”

Getting There

The IMF’s report and concluding statement on its 2018 Article IV Mission, released in July 2018, found that T&T is on track to implement the Basel II standards by January 2019. The IMF concluded that the financial system is sound, with banks being well capitalised and commercial banks having capital far exceeding the requirements. According to the statement, this puts domestic financial institutions in a favourable position to meet both Basel II and Basel III requirements.

These findings suggest the time is right to shift the focus to operationalisation.“I think the central bank has a structured and reasonable approach, which makes it likely that the authorities will successfully implement Basel II by early 2019,” Jason Cotton, an economist at the Caribbean Development Bank and former advisor to T&T’s central bank, told OBG.

Industry Impact

Advocates of Basel II say the agreement offers participating countries key strategic advantages. Within T&T’s financial sector, many executives are optimistic about the impact of Basel II implementation. “This is a positive development, as it provides a framework for a more conservative management of capital,” Mohammed told OBG. “Generally, banks within T&T are well capitalised, and this change to Basel II is not expected to have any significant impact for our industry.”

It is often easier for small countries to adapt to comply with Basel II standards rather than engage in the time-consuming and costly effort of designing their own updates to banking regulations. In the implementation of these policies, T&T is joining more than 70 countries using this common standard. Advocates for Basel II say current regulations in T&T, which are based on the 1988 Basel I standards, are no longer adequate or sufficiently granular for addressing the risks facing the modern banking industry. Adopting the Basel II standards will also make it easier for multinational financial institutions to either enter into or continue operating in T&T.

However, critics say Basel II also comes with distinct costs. Some sector experts warn that the rules give large banks an unfair advantage over small ones. Policymakers will thus be looking to gauge the performance of smaller financial institutions as the Basel II standards are operationalised. As with any other change in policy, the relevant authorities will have ongoing work to monitor and evaluate whether Basel II is both operating optimally and adequately shielding the financial sector from unnecessary risk.

Road Ahead

The adoption of the Basel II framework is an important step for the banking sector, as it brings domestic policy in line with that of more developed global economies. These standards will also allow T&T’s banks to adopt global best practices, strengthening the minimum capital requirement and improving the central bank’s risk-management framework. However, with public and private institutions both having key roles to play in, smaller banks may have particular difficulty in the near term, as Basel II brings substantial operational changes.