Coso II and Basel III Analysis

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In response to the financial crisis of 2008, Basel III was released, trying to prevent same events to happen in the future, through more rigorous supervisory guidelines, to reinforce the risk supervision and supervision management. In the latest version, they required to keep proper leverage ratios and meet certain criteria of a minimum percentage of capital requirements. The measure reforms made in the latest version, aim to develop an ability in the banking sector for absorbing the shocks that can destabilize the financial market, no matter where are they coming from. Also, they try to reinforce the risk management ability and to make the transactions more transparence and disclosures.

The basic three pillars of Basel III, are:

- Enhanced minimum capital and liquidity requirements: While keeping the capital calculated thought credit, market risk and operational risk, this is based on the risk weighted assets.

- Enhanced supervisory review process for firm-wide risk management and capital planning: Norming tools and frameworks to deal with the risk challenges faced by investment banking institutions.

- Enhanced risk disclosure & market discipline: Increasing transparency while disclosing information that should be provided by the banks.

Even though Basel III basic aspects remained almost steady, some important changes where done. One of the most important is the introduction of a higher loss-absorbing capacity through a more rigorous definition of capital. Also, the banks now require holding a conservation buffer of 2.5% in order to ensure more safety during difficult financial periods. The concept of a countercyclical buffer has been included, which means that the capital requirements should increase during good times and decrease in the same proportion during difficult times, to encourage lending when the situation doesn’t seem like the right time.

The implementation of the Basel III standards is quite complicated, therefore, the Basel established a Regulatory Consistency Program (RCAP) in 2012, to control the adoption of the standards, to provide a more transparent and reliable environment for international banks. This program has two complementary branches, the first one is the monitoring, which is based on semiannual checks based on information that each member organization must provide. And, the second one is assessment, where the consistency on the adoption of the regulations is evaluated, including any deviation where some organizations might have incurred.

Despite the effort of Basel to ensure a better regulatory framework, this is still subject to criticism from some entities of the industry. One of the important to notice is the one coming from the Institute of International Finance, who is against these accords, establishing that this requirement would actually affect negatively the banks and the economic growth while decreasing the GDP growth. It is also criticized for destabilizing the financial system, due to the difficulty of implementation, matter that incentive the investment bank to find ways to avoid these regulations.

In conclusion, it is quite simple to notice that COSO and Basel have several and remarked differences, however, it is important to take into consideration, that the common shared factor, is the fact that both of them set conditions to a better risk management communicating the potential risks that could be facing and ensuring a better responding from the entities. Providing a safer environment for the shareholders.

Analysis of Enterprise Risk Management (ERM) relative to the Basel III Capital Accord

To be able to discuss the manner in which the Basel III accord practically achieves the theoretical goals of Enterprise Risk Management, it is necessary to consider some previous concepts first.

Enterprise Risk Management (ERM)

It is defined by the Committee of Sponsoring Organizations (COSO) as "a process, effected by an entity's board of directors, management and other personnel, applied in strategy-setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives". Being a broad concept, further, than just including risks associated with accidental losses or hazard risks, it also covers the relative with financial, strategic, and operational risks, which will be a matter of a further discussion. One of the most characteristic features of ERM is that it includes as part of their annual reports, an action plan available publicly available.

In order to provide a guidance on how to implement the enterprise risk management, this outline, requires a meticulous inspection of the complete risk portfolio, taking into consideration the individual risks that could be interrelated, to elaborate a proper approach to reducing the derived risks, in accordance with the enterprise strategy and risk aversion.

Types of risk

Among the risks that are considered, there core four are:

1. Hazard risk: Loss derived from unfortunate events such as personal injuries, property damage, that are generally safeguarded by an insurance.

2. Financial risk: Refers to the danger of losing money from the effects of the market, contemplating market risk, credit risk, liquidity risk and price risk.

3. Operational risk: Threat of losing value due to a poor internal process, people or system, which was unexpected. Also includes external events, such as legal risk.

4. Strategic risk: Meaning losses that one can incur if making wrong business decisions, or inadequate allocation of resources, among others.

Basel III and Enterprise Risk Management

Disregarding the origin of the risk, when they are managed separately, is different from managing them all together, and here is where the main pillars of ERM work, being interdependency, correlation, and portfolio theory. The typical risk management does not take into consideration the interdependencies that exist between each type of risk, therefore, it was considered that the occurrence event of one of them, do not affect the probability of occurrence of the others. It is possible to establish that this has been one of the major mistakes while estimating the risks over the past decades, that is progressing with the implementation of the ERM process.

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