8:30 AM Jan 21, 1997

NEW PROPOSALS ON MANAGING INTEREST RATE RISKS

Geneva 21 Jan (Chakravarthi Raghavan) -- The Basle Committee on Banking Supervision has published proposals, for comments by banks and other financial market participants by 15 April 1997, on general principles to be used by banking supervisory authorities in evaluating interest rate risk management.

The 12 principles set out in the proposal cover the role of a bank's board and senior management, the policies and procedures, measurement and monitoring of the system, independent controls and information for supervisory authorities.

The Basle Committee of Banking Supervisors, with its secretariat based at the Bank of International Settlements (BIS) in Basle, was set up in 1975 by the central bank Governors of the Group of 10 (Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Sweden, Switzerland, the UK and the USA).

The concern of the Basle Committee and the BIS on the interest rate risk issues date to 1993 (when it issued a consultative proposal on measuring exposure of Banks). The subsequent bank crises of Baring and Daiwa etc, all of which are directly or indirectly relate to interest rate risks and derivatives, have borne out these concerns.

The supervisory capital requirements, established by the Basle Committee in January 1996, as an amendment to the Capital Accord to incorporate market risks, to cover interest rate risk in trading activities of banks is set to take effect from end of 1997.

The latest paper sets out principles of more general application for management of interest rate risk, irrespective of whether the positions are trading of a bank's trading book or reflect its non-trading activities.

The Committee says that the principles set out in its draft have drawn on supervisory guidance in member-countries and the comments of the banking industry on its earlier paper on measure of Banks exposure to interest rate risk, issued in April 1993.

In the light of those comments, the Committee has set out principles for sound interest rate risk management rather than a more standardised measure for interest rate risk. But the Committee will keep the need for more standardised measures under review and may revisit its approach in this area at a later stage.

While the Committee currently has not proposed capital charges specifically for interest rate risk, it suggests that all banks should have enough capital to support the risks they incur, including those arising from interest rate risk.

But individual supervisory may decide to apply capital charges to their banking system in general or to individual banks that are more extensively exposed to interest rate risk or whose risk management processes are unsatisfactory, the Basle Committee adds.

Banks, the Basle Committee has said in its latest paper, should have a comprehensive risk management process in place that effectively identifies, measures, monitors and controls interest rate risk exposures, and is subject to appropriate board and senior management oversight.

The principles proposed (based on practices currently used by many international banks) are intended to be of general application - even though their specific application will depend to some extent on the complexity and range of activities undertaken by individual banks.

While the proposed supervisory principles are addressed to the member countries, the Basle Committee has also sent it to supervisory authorities worldwide in the view that the principles set out would provide a useful framework for prudent supervision of interest rate risk, and that sound risk management practices are essential to the prudent operation of banks and promoting the stability of the financial system as a whole.

Supervisory authorities should use them to reassess their own supervisory methods and procedures for monitoring how banks control interest rate risk. While the exact approach chosen by individual supervisors would depend on a host of factors, including their on-site and off-site supervisory techniques and the degree to which external auditors are used in supervisory functions, the Basle Committee members agree that the principles set out provide "the standards to be used by national supervisory authorities in evaluating the adequacy and effectiveness of a bank's interest rate risk management."

The proposals require:

* the board of directors of a bank to approve interest rate risk management policies and procedures, and be informed regularly of the interest rate risk exposure of the bank.

* senior management to ensure effective management of the structure of the bank's business and level of interest rate risks it assumes, with appropriate policies and procedures to control and limit such risks, and resources for evaluating and controlling the risks;

* banks to have risk management functions that are clearly defined, report risk exposures directly to senior management and board of directors, and sufficiently independent from the business lines of the bank;

* interest rate risk policies and procedures of banks should be clearly defined, consistent with the nature and complexity of the activities, and should address the bank's exposures on a consolidated basis, as also at level of individual affiliates;

* banks to clearly identify the risks inherent in new products and activities, and ensure their being subject to adequate procedures and controls, before introducing or undertaking such activities; major hedging or risk management initiatives should be approved in advance by the bank's board or an appropriate delegated committee;

* banks to have interest rate risk measurement systems that capture all material sources of such risk and assess the effect of interest risk changes in ways consistent with the scope of their activities;

* banks to establish and enforce operating limits and other practices that maintain exposures within levels consistent with internal policies;

* banks to measure their vulnerability to loss under stressful market conditions - including breakdown of key assumptions - and consider those risks when establishing and reviewing their policies and limits for interest rate risk;

* banks to have adequate internal controls for the interest rate risk management process, and periodically conduct an independent review of the adequacy and integrity of their risk management processes -- with such reviews available to relevant supervisory authorities;

* The G-10 supervisory authorities (addressed as a recommendation to other supervisory authorities) are charged with the task of obtaining from banks sufficient and timely information on these to evaluate the risks, and ensuring that the information take appropriate account of the range of maturities and currencies in each bank's portfolio, and other relevant factors like the distinction between trading and non-trading activities.