Speaking to Moody’s Second Annual Canadian Structured Finance Conference, Julie Dickson, assistant superintendent from the Office of the Superintendent of Financial Institutions, spoke in defence of the latest version of the Basel Capital Accord.

The Accord is often criticized as too complex, Dickson noted. “The problem may not lie so much in the Accord itself as with the way people are treating it. Indeed, the Accord has been considered — for a long time at least — a ‘technical’ file, both in banks’ and in regulators’ offices. Consequently, regulators may not be spending the time to consider the ramifications for their supervisory processes. And CEOs may not be spending the time to understand its strategic implications,” she said. “In other words, people may be missing the big picture. This is unfortunate, because I think the Accord will result in some very important changes.”

Dickson suggested that the latest version of the Accord will require both regulators and bankers to gain a better understanding of their businesses. For example, in order to get a capital reduction under Basel 2, banks will have to back test credit risk models and have more detailed information on the loans made using the model. They have to formally calculate a probability of default for loans with various scores under the model, as well as a loss given default measure and exposure at default. “This requires the bank to really understand the collateral it holds as well as the credit worthiness of the borrower — what we all understand is the business of banking!” she said.

She suggested that the complexity of the Accord has meant that less attention has been given to it at more senior levels. “Yet the Accord is all about having more information so that you know what is going on and the associated risks, so you can better manage that risk and hold appropriate capital — and earn good returns while you are at it.”

“The new Accord will not run on autopilot like the ’88 Accord did. Banks can’t blindly rely on models. And banks have to ‘walk the talk’ — they can’t just buy a model and point to it when the regulator asks. They actually have to use the model in their everyday decision-making. The models have to perform. CEOs and boards of directors have to understand what is going on,” she says. “Regulators like OSFI have been moving away from autopilot as well. The job used to be comprised of ticking boxes and checking for compliance. The problem with such a system is over-reliance on rules and a failure of the regulator to really understand the bank. Now we are required to think — to focus on areas of most risk and to use judgement regarding people, systems and processes, so as to better understand the bank.”