BASEL II: PROBLEMS AND USAGE

post-on-site visitations, prudential interviews, annual tripartite meetings
and annual meetings with the board of directors at appropriate phases of the
supervisory cycle.
The risk assessment process of this risk-based supervisory approach
incorporates an AI’s risk profile into the CAMEL rating system. The
HKMA identifies eight types of inherent risks: credit, interest rate, market,
liquidity, operational, reputation, legal and strategic risks. An AI’s level of
risk in each of the inherent risk by business activity, the direction of risk,
the adequacy of existing risk management systems and the impact of external
risk factors are assessed and a risk-matrix method is applied to determine
the AI’s overall risk profile. Based on the risk assessment exercise, a
risk management rating is assigned and factored into the AI’s CAMEL rating.
The rating scale ranges from one to five, where a score of one denotes
the effectiveness of the AI in managing risk and a score of five indicates a
critical absence of effective risk management practices. The latter requires
immediate and close supervisory attention.
The risk-based supervisory approach and the CAMEL rating system
are complimentary to each other. In accordance with the Banking Ordinance,
all AIs have to maintain adequate liquidity and capital adequacy, to
submit to the HKMA on the required financial information, and to comply
with other provisions of the Ordinance. In particular, the Banking (Amendment)
Ordinance enacted in July 2005, which stipulates the Capital Rules
and Disclosure Rules, provides the legal basis for the HKMA to implement
Basel II.
The capital adequacy framework in Hong Kong is in line with the requirements
of Basel II as set out under Pillar I. All locally incorporated AIs
are required to maintain a minimum capital adequacy ratio (CAR) of 8 %
calculated in accordance with the Capital Rules. The ratio is based on an
AI’s capital base to a value representing the AI’s exposure to credit risk,
market risk and operational risk. The Capital Rules set out in detail the different
calculation approaches that can be adopted. Moreover, in line with
Pillar II of Basel II the HKMA is empowered to require a licensed bank to
maintain a CAR up to 12 %, and up to 16 % for a restricted licence bank or
a deposit-taking company.
Besides CAR, AIs are required to maintain a statutory liquid ratio of
25 % in accordance with the amendment to the Banking Ordinance in 1986.
An AI has to hold liquefiable assets (currency notes and coins, gold, etc)
against its qualifying liabilities (basically all liabilities due within a month).
To meet the developments in international standards and best practices over
the years, the HKMA has released supervisory policy guidelines (the latest
one released in 2004) so as to strengthen the effectiveness of AIs’ liquidity
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