Effects of Basel II Accord on Qatar’s Banking Sector

Effects of Basel II associate on Qatars curseing SectorChapter 1 creation supra republical bounding is increasingly resilient for e genuinely country in point to create an image for itself in the world(prenominal)istic pay market. Alongside, the increase in globalisation and the deal in breaksourcing by multi raceal companies in the west guard created a lot of opportunities for proceeds in the eye eastbound and Far Eastern countries. This on the face of it requires a strong transnationalistly stable fiscal organization to conduct executions denyways the globe without each errors (i.e.) ampere-second% accuracy. This includes reli talent and stability of the blaspheme under extreme situations (like emergency for example), which is highly important to conduct supranational traffics. Also the po hug drugtial to meet monetary demands during crisis situations is a vital criterion that is considered sm e really(prenominal)-arm presenting themselves in the glob al market.In addition to the globalisation, outsourcing and export/import growth, there is also a tremendous growth in cross-b companionshiping finance among the countries in the centre of attention East and Far East. Along with all these factors the developing nations in the Middle East face a unavoidable indispensability of a sable global imprecateing system in order to attract foreign enthronization.The increase in cross reverberate finance activeness among the middle eastern countries is also a critical element to be considered for establishing a stable transnational aver within the nation in order to represent the country in the supranational finance market. The countries in the Middle East atomic number 18 progressively dynamic in cross- smother finance since the dawn of the twenty-first century. Being a producer of crude which is a vital ingredient at all levels of life right from day-to-day driving up to violence generation for the nation in order to run in dustries and serve domestic purposes, makes it critical for the nations in the Middle East to have a strong multinational briming system to conduct transactions across the globe accurately and hard-hittingly. Qatar is a growing nation in the Middle East with primary operations in oil and gas export as well increasing its potential in cranial orbits of development in technology focusing on IT and communication. The nation has effective international operations and conducts monetary transactions amongst western nations as well as with eastern nations. Since the take over of the government by H.H. dandy Hamad Bin Khalifa in 1995, the country is make tremendous progress in deploying its hydrocarbon resources in order to penetrate in the international market and present itself as a financially stable nation in the international market.Further to the increase in the international operations by the countries in the Middle East and the Far East, the stick for world large Settle ments substantial a poser to co-ordinate the international financial operations as well as create a portfolio for the pileus standard and great shopworns which every nation involving in international stranding operations is evaluate to adopt in order to stabilise and mystify in order the international transactions between countries. The Basel II distribute produced by Basel perpetration on Banking Supervision aims at achieving foreign Convergence of ceiling amount and Capital Standards. The arrangement aims to set a minimal standard to be met by its participating nations in order to achieve working cap enough by the participating nations in the international market.This story aims at analysing the effects of Basel II affiliate on Qatars swearing sector. The objectives of this report are say belowTo analyse the Basel II accord and its manikin for measuring seat of government adequacy in the nations participating in the international banking transaction.To inv estigate the banking sector of Qatar and the effect of Basel II accord on its international operations and detonator adequacy.To analyse the effect of Basel II accord on the nations twain study banks having international operations in Qatar namely, Qatar Industrial learning Bank (QIDB) and Commercial Bank of Qatar (CBQ) and to analyse the impact of Basel II shell out on the Banking Sector of Qatar.Report lineThe report comprises of the by-line chapters. Chapter 1 Introduction This chapter introduces the endorser to the objectives of the report and presents a broad picture of the report to the indorser.Chapter 2 Overview of Basel II accord This chapter presents with an overview of the Basel II accord. The leash pillars of Basel II accord namely token(prenominal) Capital Requirements, supervisory programy Review transition and Market Discipline are analysed in detail to add the subscriber with a expand understanding of the apply of Basel Committee on Banking Supervisi on.Chapter 3 Implications and Critical Analysis of Basel II AccordThe literature retread on the Basel II Accord in chapter 2 is followed by the critical analysis and its implications on nations ( disdain and political) are presented to the reader before proceeding to present the overview of the Qatar Banking sector. Chapter 4 Overview of Qatar and its Banking SectorThis chapter presents the reader with an overview of Qatar as a nation and its business operations in the International market. Alongside, the chapter analyses the countrys growth in the banking sector and its internationally active banks.Chapter 5 Case StudyThis chapter conducts a nerve study analysis on Qatars two internationally active banks namely Qatar Industrial Development Bank (QIDB) and Commercial Bank of Qatar (CBQ). The effect of Basel II accord on the banks along with an overview of the bank is presented to the reader. The data practised to present the eccentric person study is primarily obtained from a lternative sources like journals, reports and white papers. This is apparently ascribable the fact that the analysis is conducted on a foreign nation as well as the data acquirable from the secondary sources are also legitimate as they are published by legitimate organizations and popular journals.Chapter 6 Results and DiscussionsThe results of the incase study analysis and passwords are carried out in this chapter. This chapter aims to present a clearer picture to the reader on the effects of the Basel II accord on the banks analysed.Chapter 7 Conclusion and Recommendations The end points derived from the case results and discussions on the case study and the boilers suit conclusion on the effect of Basel I accord on the Qatar Banking Sector is presented in this chapter. Alongside, this chapter presents a few constructive recommendations found on the results and discussion on the case study.Chapter 2 Overview of Basel II AccordThis chapter begins with an overview of the Ba nk for International Settlements followed by a detailed analysis of the Basel II accord. The Basel II delegacy is also analysed alongside in order to provide a deeper insight to the readers.2.1 Bank for International Settlements Overview and its OperationsThe Bank for International Settlements (Bank for International Settlements) is an international organization carriageing subsequently international monetary and financial co-operation across the globe. This organization acts as the bank for all the telephone exchange banks of countries participating in the international finance and banking.The Bank for International Settlements profile states that the bank achieves the aforementioned statement through acting asA forum to promote discussion and facilitate decision-making operatees among central banks and within the international financial and supervisory community.A centre for frugal and monetary researchA prime counter society for central banks in their financial transaction s andAgent or trustee in connection with international financial operations.Established in 17th M each 1930, it is the oldest financial organization at the international level.The Bank for International Settlements has three major decision making bodies within the bank to achieve its mission. They areThe public concourse of process central banksThis meeting is held before the end of four months of the end of the banks one-year financial year. The meeting tradees all the issues related to business and the fragment central banks gather to approve the annual financial statement released by the bank.The Board of DirectorsThe board of directors comprise the central bank governors elected from various participating countries. They monitoring device the overall operation of the bank and take responsibility for actions to be taken and address issues related to disputes and some other major international financial cross border problems.The Management CommitteeThe centering deputati on is the first line representative of the Bank for International Settlements and addresses the day-to-day activities of the bank. This delegacy primarily manages the monetary and financial co-operation services. The services includeMeetings Apart from the yearly general meeting the Bank for International Settlements organizes meetings on a bimonthly basis. This meeting brings the member central banks together with the aim of monitor the global economic and financial development and discusses issues on its policies in relation to the monetary and financial stability.Committees and SecretariatsBank for International Settlements has several military commissions to monitor limited problems and issues in the international finance and cross border loans. Alongside, several other committees and organizations focusing on international financial systems have their secretariats in the Bank for International Settlements and work closely with the bank in order to enhance the overall intern ational banking and cross border finance.Basel committee of the Bank for International Settlements is the committee that laid the preciseations for superior measurement and crown standard of the central banks participating in the international banking.Research and StatisticsIn order to support its meetings and the activities of the organizations Basel found committees the Bank for International Settlements carries out regular research on economic, monetary, financial and legal areas of the international banking and cross border finance.Investment services for central banks Bank for International Settlements also provides security, liquidity and re bending for its central bank members. The three primary points with respect to this identified by the organization areTo provide security, the Bank has built up a sizeable equity superior and ample reserves. It pursues an investment strategy foc utilize on combining diversification benefits with intensifier credit and market seek analysis.To date liquidity, the Bank stands ready to repurchase its tradable instruments at little cost to its customers and thus respond quickly and flexibly to their needs.The BIS offers an engaging and competitive arrest on the specie deposited by central banks and international organisationsThe Bank for International Settlements focuses on serving the financial needs of central banks of the member countries. Alongside, it also acts as a banker managing the monetary resource for legion(predicate) international financial institutions.2.2 Basel committee OverviewThe Basel committee was established the member central banks of the Bank for International Settlements in order to create a standard for the international banking and capital modeling for crass border finance and lending. The committee was initially set up in 1970 and meets regularly four times a year to discuss the progress in international banking and address issues related to business in this context.The member na tions of the committee include Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, unify Kingdom and United States. The countrys central bank and financial institutions that are not active in banking commercially provided monitor the financial operations of the nation both(prenominal) at national and international levels represent the nations. The committee does no possess any authority over its member nations banking systems and the decisions of the committee are neer intended to have a legal force on its member nations.The Central bank governors of the grouping ten countries endorse the committees major initiatives. Also the committee reports to the aggroup ten countries central bank governors. The committee first proposed he capital measurement system in 1988 commonly referred to as Basel Capital Accord. The committee aims in supervising the international banking operations of the nations across the globe. The decisions o f the committee endorsed by the group ten countries address various financial issues in the international market outside the groups as well.The major aim of the committee is the close the gaps in international supervisory coverage and to ensure that no foreign banking systems escapes the supervision in order to establish a accord among the member nations of the Bank for International Settlements as well as in the international market.The committee has promoted supervisory standards in the past few years. Some of its major milestones include the pursuit1997 Cover Principles for effective banking supervision 1999 Core Principles regularityologyThe committee also presented the Basel II accord with revision on international capital framework. This aims to standardise the capital framework of every bank participating in the international banking as well as sets slabs for negligible capital retentions to be met by the banks in order to qualify for international operations.The committ ee has numerous subgroups to perform specific tasks of the committee in order to achieve the overall motto of the committee. They are listed belowAccord Implementation conclaveAccounting Task ForceCapital companyCapital Task ForceCore Principles Liaison Group (with 16 non-G10 countries)Cross-Border Banking GroupElectronic Banking GroupJoint Forum (with IAIS and IOSCO)Joint IOSCO BCBS workings Group on Trading BookResearch Task ForceRisk Management GroupSecuritisation GroupTransparency GroupThe next theatrical role provides a detailed analysis of the Basel II accord and its various implications on international banking is discussed in chapter 3.2.3 The Basel II AccordThe Basel II accord was released in June 2004 come along to the release of the Basel Accord in 2003. The Basel II is a revised edition of the initial Basel capital accord. It is a framework designed to derive the capital holdings of internationally active banks to meet the international standards and sets a minimum level of capital holding which is a primary criteria for the banks. The Basel II framework is aimed to be applied on a consolidated basis over internationally active banks in order to preserve the integrity of capital in the banks with subsidiaries. Also the framework eliminates the pronged gearing through this salute.The Basel II accords framework is also applied on a in full consolidated basis on any parent holding company which acts as a parent entity within a banking group in order to capture the insecurity on a consolidated basis without missing any element that contributes considerably to the find of the overall banking system.Alongside, the framework is also applicable to all internationally active banks at every tier of the banking group.Apart from the aforementioned statements one of the principal objectives of the Basel II Accord is to protect the interest of the depositors essentially to ensure that capital recognised capital adequacy measures is readily available for the depositors. Apparently, these measures are aimed to establish a common platform for international banking and cross border finance across the globe.The scope of activity extends to the following segments of the international banking and finance entities.Banking, securities and other financial subsidiariesSignificant minority investments in banking securitiesInsurance entitiesSignificant investment in commercial entities.Deduction of investment pursuant to this partThe aforementioned entities are obtained from the Basel Committee report on International Convergence of Capital step and Capital Standards, published in June 2004. The Basel II accord overview is based on this report. The illustration in the fig 1 gives a clear picture of the overall scope of application of the Basel II accord.The Basel II accord is split into three pillars.The first editorial Minimum Capital RequirementsThis is the very important pillar of the Basel II Accord. This pillar has very clear defini tions of the Accords application on the credit seeks and operational chance along with the Trading Book issues that are vital for international banking establishment. The layout in fig 2 reproduced from the Basel II report provides the inner picture of the First Pillar.The following subsections provide a detailed analysis on the elements shown in fig 2.2.4 The First PillarThe First pillar lays down the minimum capital requirements that every internationally active bank should incorporate. It is split into the following subsection.2.4.1 Calculation of Minimum capital requirementsThe minimum capital requirement is mastermindd as a measure of the capital ration. The capital ratio in turn is calculated using the regulative capital and risk- weight pluss. The requirement of this criterion is that the capital ration must be a minimum of 8% or to a greater extent in order to be suitable for the international activities. Also, in case of a two tier system the capital in tier 2 must not be great than the tier 1 capital (i.e.) the tier 2 capital can be a maximum of 100% of the tier 1 capital. The capital is accounted from the following sources Regulatory capital The minimum accounting capital requirements for the financial institution encompasses the regulatory capital. The Basel II accord has draw back the provision to include general aliment in tire 2 capital, which was in effect in the 1988 Accord under the inbred Ratings- base (IRB) preliminary. Furthermore the accord has lain down that the banks using the Internal Ratings base approach to their other assets must compare the amount of total eligible provision with the total expected losings amount to the bank. This eventually increases the capital holding of the bank in order to meet the criteria.Risk Weighted Assets The Basel II Accord calculates the total risk-weighted assets by multiplying the capital requirement for market risk and operational risk by the reciprocal of the minimum capital ratio o f 8% and adding the resulting value to the sum of risk weighted assets for credit risk. Even though this is reconcile to review the approach lays enormous burden on the bank to increase its minimum capital holdings. Apparently the Basel II Accord is aiming to establish that the internationally active banks must have enough capital to meet its short comings without depending on loans and cross border finance to address its immediate requirements and short comings. The idea though being novel is very intense for the banks to maintain the required minimum capital.Transitional Arrangements The Accord has also stated that the banks following the Internal Ratings-Based approach or the Advanced measurements come along (AMA) that there will be a capital floor after the carry outation of the Basel II framework. The adjustment factors used in both the cozy ratings-based approach and the advanced measurements approach for calculate the capital floor as per the definition of the Basel II framework is shown in fig 3 below.2.4.2 consultation Risk-The Standardised ApproachUnder this method the Basel committee provides the internationally active banks a choice for calculating their capital requirements for credit risk. The first approach is the exchangeable method of measuring the credit risk through support from external credit assessments. This method is approved by the Basel committee while the other method is yet to explicitly approved by the committee. Under the alternate method of calculating the credit risk, the bank supervisor can allow banks to use their inner(a) rating systems for calculating the credit risk.Under both the methodologies one should not oversee the fact that the Basel committee is very keen in assessing the credit risk on the capital holdings of the internationally active banks. Even though this is appreciated, the rules are very stringent making it very difficult for the banks for adopt easily.2.4.3 Credit Risk- Internal Ratings Based Approa chThe Basel II committee has precondition supervisory compliment for banks to use the Internal Ratings-Based approach to chequer their capital requirement for a given up scene subject to certain minimum conditions and disclosure requirements. The risk components considered includeMeasures of the probability of remissness (PD),Loss given default (LGD),The word-painting at default (EAD),Effective maturity (M)The Basel II accord states that The Internal Ratings Based Approach is based on the measure of out of the blue(predicate) loses (UL) and Expected Loses (EL).Under the Internal Ratings Based Approach, the committee expects the bank to categories their motion pictures in order to identify the different underlie risk characteristics. The categories include corporate, sovereign, bank, sell and equity. These are identified as the corporate asset disunitees and the approach further expects the bank to identify the subclasses associated with the asset classes in order to mea sure the credit risk associated with the exposure. The detailed analysis of every corporate class and its associated subclasses is beyond the scope of this report.In essence the Internal Ratings Based Approach gives the bank more liberty to calculate its credit-risk on the minimum capital requirement for a given exposure. But the producers laid by the Basel II Accord is very tedious to adopt and implement for every corporate class exposure and identifying the subclasses associated.2.4.4 Credit Risk- Securitisation FrameworkThe Basel Committee in its revised accord, has made it mandatory for the banks to apply the Securitisation Framework for determining regulatory capital requirements on exposure arising from tralatitious and synthetic Securitisation or similar structures that contain features common to both. The Basel II accord also states that the capital treatment of the Securitisation exposure must be determined on the basis of the economic substance rather than the legal form of the structure. It is apparent that the securities can be structured in many different ways and the committee has approved the use of either the traditional Securitisation or the synthetic Securitisation framework. Also the Basel II accord expects the supervisor to look at the economic substance of transaction in order to determine whether it should be subject to Securitisation framework or not. This gives the discretionary power to the supervisor to square off on a specific transaction whether to include it in the framework or to eliminate it from the framework towards determining the regulatory capital framework. The traditional Securitisation and the synthetic Securitisation framework are discussed below.Traditional SecuritisationThe Basel II Accord defines the traditional framework as a structure where the cash flow from an underlying pool of exposures is used to service at least(prenominal) two different stratified risk positions or tranches reflecting different degrees of credit risk. The advantage with this approach is that the payment to the investors is based on the performance of the specified underlying exposures rather than a derivation from an obligation of the entity originating those exposures.Synthetic SecuritisationA synthetic Securitisation is a structure with at least two different stratified risk positions or tranches that reflect different degrees of credit risk where credit risk of an underlying pool of exposures is transferred, in self-coloured or in part, through the use of funded (e.g. credit-linked notes) or un-funded (e.g. credit default swaps) credit derivatives or guarantees that serve to hedge the credit risk of the portfolio. This approach leaves the return to the investors in the hands of the performance of the underlying pool. Apparently, the risk associated is higher since the performance can be affected by numerous causes.From the above-mentioned approaches the Basel II accords stand for evaluating the capital and minim um capital requirements are evident.2.4.5 Operational RiskThe operational risk is defined by the Basel Committee as the risk associated with the loss resulting from inadequate or failed internal processes, people, systems or external events. This includes the legal risk with the exclusion of strategic and reputational risk.The Basel II Accord has approved three methods for calculating the operational risk and risk esthesia with the implications on minimum capital requirements. They are (i) The prefatory indicator approach, (ii) the Standardised Approach and (iii) Advanced Measurement Approach.Basic Indicator ApproachIn this case the banks should hold capital for the operational risk equal to the average over the past three years of a fixed percentage. This is expressed as a formula below KBIA = (GI1n x )/n Where KBIA = the capital charge under the Basic Indicator Approach GI = annual gross income, where positive, over the previous three years n = number of the previous three years for which gross income is positive = 15%, which is set by the Committee, relating the industry wide level of required capital to the industry wide level of the indicator. This formula is obtained from the Basel II accord for the purpose of reader understanding.Standardised ApproachThe standardised approach divides the banks activities into eight-business lines namely corporate finance, traffic sales, retail banking, commercial banking, payment settlement, agency services, asset management, and retail brokerage. The likelihood of operational risk exposure is calculated from the gross income associated with each business line that serves as an indicator for the scale of business operations by the bank in that specific area of business or business line. This approach is very clumsy since the gross income associated with the business line varies due to numerous reasons both internal and external.Advanced Measurement ApproachThe Advanced Measurement Approach equates the regul atory capital requirement with the risk measure generated by the banks internal operational risk measurement system using quantitative and qualitative criteria. The banks can use this method only after the approval by the Committee.The Basel II Accord sets the approach for the banks based on their international activity and significant operational risk exposures. Also, when a bank agrees to use a more sophisticated method, it cannot revert hindquarters to the easier method without approval from the supervisor. This eventually increases the burden on the banks to choose a sophisticated method.2.4.6 Trading Book IssuesThe utmost segment of the first pillar is the trading book. Basel Committee defines the trading book as a container of both the financial instruments and commodities held either with trading intent or in order to hedge other elements of the trading book. The trading book forms a vital element for the bank since it is the record of the banks financial instruments as we ll as commodities. The Basel II Accord identifies four key principles for the supervisory process. They are listed below.The basic requirements for the eligibility to trading book capital treatment put forth by the Basel II Accord are as followsClearly documented trading strategy for the position/instrument or portfolios, approved by senior management (which would include expected holding horizon).Clearly defined policies and procedures for the active management of the positionClearly defined policy and procedures to monitor the positions against the banks trading strategy including the monitoring of turnover and stale positions in the banks trading book2.3 The Second Pillar- Supervisory Review ProcessBasel committee was initially set up for the supervising the internationally active banks and produce a common platform for the smooth transactions and cross border finance. The Basel II Accord has established Supervisory Process as one of the three pillars in order to emphasise its s tand on supervisory process. The richness of supervisory process is described below.2.3.1 splendour of Supervisory ProcessThe supervisory review process of the Basel II Accord aims not only to ensure that banks have adequate capital to support all the risks in their business but also intends to encourage the banks to develop and use better risk management techniques in monitoring and managing risks. Alongside, the supervisory process by developing internal capital assessment process and setting capital targets that are commensurate with the banks risk profile recognises the importance for bank management in order to modify the atmosphere in the international banking and cross border finance.The Supervisory process evaluates the relationship between the amount of capital held by the bank against the risk, strength and effectiveness of the banks risk management eventually guiding the bank and supervising its activities in order to improve the performance of the banks in the intern ational business market and cross border finance.2.3.2 Four Key Principles of the supervisory reviewThe four key principles identified by the Basel II Accord on the supervisory process is listed below. These principles emphasise on the committees focus on supervision and its aim to maintain harmony in the international banking and cross border finance.Principle 1 Banks should have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital levels.Principle 2 Supervisors should review and evaluate banks internal capital adequacy assessments and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital ratios. Supervisors should take appropriate supervisory action if they are not satisfied with the result of this process.Principle 3 Supervisors should expect banks to operate above the minimum regulatory capital ratios and should have the ability to require banks to hold capital in excess of the minimum.Principle 4 Supervisors should seek to intervene at an early stage to prevent capital from falling below the minimum levels required to support the risk characteristics of a particular bank and should require rapid remedial action if capital is not maintained or restored.2.3.3 Issues to be turn toThere are two specific issues to be addressed by the Supervisory-Review Process. They areInterest Rate Risk in the Banking bookSince it is clear that the Basel Committees primary focus is on identifying and preventing risk in the international bEffects of Basel II Accord on Qatars Banking SectorEffects of Basel II Accord on Qatars Banking SectorChapter 1 IntroductionInternational banking is increasingly vital for every country in order to create an image for itself in the international finance market. Alongside, the increase in globalisation and the upsurge in outsourcing by multinational companies in the west have created a lot of opportunities for growth in the Middle East and Far Eastern countries. This apparently requires a strong internationally stable financial organization to conduct transactions across the globe without any errors (i.e.) 100% accuracy. This includes reliability and stability of the bank under extreme situations (like emergency for example), which is highly important to conduct international transactions. Also the potential to meet financial demands during crisis situations is a vital criterion that is considered while presenting themselves in the international market.In addition to the globalisation, outsourcing and export/import growth, there is also a tremendous growth in cross-border finance among the countries in the Middle East and Far East. Along with all these factors the developing nations in the Middle East face a mandatory requirement of a sable international banking system in order to attract foreign investment.The increase in cross border finance activity among the middle eastern countries is also a critical element to be considered for establishing a stable international bank within the nation in order to represent the country in the international finance market. The countries in the Middle East are actively participating in cross-border finance since the dawn of the 21st century. Being a producer of Oil which is a vital ingredient at all levels of life right from day-to-day driving up to power generation for the nation in order to run industries and serve domestic purposes, makes it critical for the nations in the Middle East to have a strong international banking system to conduct transactions across the globe accurately and effectively. Qatar is a growing nation in the Middle East with primary operations in oil and gas export as well increasing its potential in areas of development in technology focusing on IT and communication. The nation has efficient international operations and conducts financial transactions between western nations as well as with eastern nations. S ince the take over of the government by H.H. Sheikh Hamad Bin Khalifa in 1995, the country is making tremendous progress in deploying its hydrocarbon resources in order to penetrate in the international market and present itself as a financially stable nation in the international market.Further to the increase in the international operations by the countries in the Middle East and the Far East, the Bank for International Settlements developed a framework to co-ordinate the international financial operations as well as create a portfolio for the capital measurement and capital standards which every nation involving in international banking operations is expected to adopt in order to stabilise and put in order the international transactions between countries. The Basel II accord produced by Basel Committee on Banking Supervision aims at achieving International Convergence of Capital Measurement and Capital Standards. The arrangement aims to set a minimum standard to be met by its part icipating nations in order to achieve capital adequacy by the participating nations in the international market.This report aims at analysing the effects of Basel II accord on Qatars banking sector. The objectives of this report are stated belowTo analyse the Basel II accord and its framework for measuring capital adequacy in the nations participating in the international banking transaction.To investigate the banking sector of Qatar and the effect of Basel II accord on its international operations and capital adequacy.To analyse the effect of Basel II accord on the nations two major banks having international operations in Qatar namely, Qatar Industrial Development Bank (QIDB) and Commercial Bank of Qatar (CBQ) and to analyse the impact of Basel II Accord on the Banking Sector of Qatar.Report OutlineThe report comprises of the following chapters. Chapter 1 Introduction This chapter introduces the reader to the objectives of the report and presents a broad picture of the report to t he reader.Chapter 2 Overview of Basel II Accord This chapter presents with an overview of the Basel II accord. The three pillars of Basel II accord namely Minimum Capital Requirements, Supervisory Review Process and Market Discipline are analysed in detail to provide the reader with a detailed understanding of the consent of Basel Committee on Banking Supervision.Chapter 3 Implications and Critical Analysis of Basel II AccordThe literature review on the Basel II Accord in chapter 2 is followed by the critical analysis and its implications on nations (business and political) are presented to the reader before proceeding to present the overview of the Qatar Banking sector. Chapter 4 Overview of Qatar and its Banking SectorThis chapter presents the reader with an overview of Qatar as a nation and its business operations in the International market. Alongside, the chapter analyses the countrys growth in the banking sector and its internationally active banks.Chapter 5 Case StudyThis c hapter conducts a case study analysis on Qatars two internationally active banks namely Qatar Industrial Development Bank (QIDB) and Commercial Bank of Qatar (CBQ). The effect of Basel II accord on the banks along with an overview of the bank is presented to the reader. The data used to present the case study is primarily obtained from secondary sources like journals, reports and white papers. This is apparently due the fact that the analysis is conducted on a foreign nation as well as the data available from the secondary sources are also reliable as they are published by legitimate organizations and popular journals.Chapter 6 Results and DiscussionsThe results of the case study analysis and discussions are carried out in this chapter. This chapter aims to present a clearer picture to the reader on the effects of the Basel II accord on the banks analysed.Chapter 7 Conclusion and Recommendations The conclusions derived from the case results and discussions on the case study and the overall conclusion on the effect of Basel I accord on the Qatar Banking Sector is presented in this chapter. Alongside, this chapter presents a few constructive recommendations based on the results and discussion on the case study.Chapter 2 Overview of Basel II AccordThis chapter begins with an overview of the Bank for International Settlements followed by a detailed analysis of the Basel II accord. The Basel II committee is also analysed alongside in order to provide a deeper insight to the readers.2.1 Bank for International Settlements Overview and its OperationsThe Bank for International Settlements (Bank for International Settlements) is an international organization looking after international monetary and financial co-operation across the globe. This organization acts as the bank for all the central banks of countries participating in the international finance and banking.The Bank for International Settlements profile states that the bank achieves the aforementioned statement through acting asA forum to promote discussion and facilitate decision-making processes among central banks and within the international financial and supervisory community.A centre for economic and monetary researchA prime counter party for central banks in their financial transactions andAgent or trustee in connection with international financial operations.Established in 17th many a(prenominal) 1930, it is the oldest financial organization at the international level.The Bank for International Settlements has three major decision making bodies within the bank to achieve its mission. They areThe general meeting of member central banksThis meeting is held before the end of four months of the end of the banks annual financial year. The meeting addresses all the issues related to business and the member central banks gather to approve the annual financial statement released by the bank.The Board of DirectorsThe board of directors comprise the central bank governors elected from vari ous participating countries. They monitor the overall operation of the bank and take responsibility for actions to be taken and address issues related to disputes and other major international financial cross border problems.The Management CommitteeThe management committee is the first line representative of the Bank for International Settlements and addresses the day-to-day activities of the bank. This committee primarily manages the monetary and financial co-operation services. The services includeMeetings Apart from the Annual general meeting the Bank for International Settlements organizes meetings on a bimonthly basis. This meeting brings the member central banks together with the aim of monitoring the global economic and financial development and discusses issues on its policies in relation to the monetary and financial stability.Committees and SecretariatsBank for International Settlements has several committees to monitor specific problems and issues in the international fin ance and cross border loans. Alongside, several other committees and organizations focusing on international financial systems have their secretariats in the Bank for International Settlements and work closely with the bank in order to enhance the overall international banking and cross border finance.Basel committee of the Bank for International Settlements is the committee that laid the specifications for capital measurement and capital standard of the central banks participating in the international banking.Research and StatisticsIn order to support its meetings and the activities of the organizations Basel based committees the Bank for International Settlements carries out regular research on economic, monetary, financial and legal areas of the international banking and cross border finance.Investment services for central banks Bank for International Settlements also provides security, liquidity and return for its central bank members. The three primary points with respect to t his identified by the organization areTo provide security, the Bank has built up a sizeable equity capital and ample reserves. It pursues an investment strategy focused on combining diversification benefits with intensive credit and market risk analysis.To ensure liquidity, the Bank stands ready to repurchase its tradable instruments at little cost to its customers and thus respond quickly and flexibly to their needs.The BIS offers an attractive and competitive return on the funds deposited by central banks and international organisationsThe Bank for International Settlements focuses on serving the financial needs of central banks of the member countries. Alongside, it also acts as a banker managing the funds for numerous international financial institutions.2.2 Basel committee OverviewThe Basel committee was established the member central banks of the Bank for International Settlements in order to create a standard for the international banking and capital framework for crass borde r finance and lending. The committee was initially set up in 1970 and meets regularly four times a year to discuss the progress in international banking and address issues related to business in this context.The member nations of the committee include Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, United Kingdom and United States. The countrys central bank and financial institutions that are not active in banking commercially but monitor the financial operations of the nation both at national and international levels represent the nations. The committee does no possess any authority over its member nations banking systems and the decisions of the committee are never intended to have a legal force on its member nations.The Central bank governors of the Group ten countries endorse the committees major initiatives. Also the committee reports to the group ten countries central bank governors. The committee first proposed he capit al measurement system in 1988 commonly referred to as Basel Capital Accord. The committee aims in supervising the international banking operations of the nations across the globe. The decisions of the committee endorsed by the group ten countries address various financial issues in the international market outside the groups as well.The major aim of the committee is the close the gaps in international supervisory coverage and to ensure that no foreign banking systems escapes the supervision in order to establish a harmony among the member nations of the Bank for International Settlements as well as in the international market.The committee has promoted supervisory standards in the past few years. Some of its major milestones include the following1997 Cover Principles for effective banking supervision 1999 Core Principles methodologyThe committee also presented the Basel II accord with revision on international capital framework. This aims to standardise the capital framework of ever y bank participating in the international banking as well as sets slabs for minimum capital holdings to be met by the banks in order to qualify for international operations.The committee has numerous subgroups to perform specific tasks of the committee in order to achieve the overall motto of the committee. They are listed belowAccord Implementation GroupAccounting Task ForceCapital GroupCapital Task ForceCore Principles Liaison Group (with 16 non-G10 countries)Cross-Border Banking GroupElectronic Banking GroupJoint Forum (with IAIS and IOSCO)Joint IOSCO BCBS Working Group on Trading BookResearch Task ForceRisk Management GroupSecuritisation GroupTransparency GroupThe next section provides a detailed analysis of the Basel II accord and its various implications on international banking is discussed in chapter 3.2.3 The Basel II AccordThe Basel II accord was released in June 2004 further to the release of the Basel Accord in 2003. The Basel II is a revised edition of the initial Base l capital accord. It is a framework designed to derive the capital holdings of internationally active banks to meet the international standards and sets a minimum level of capital holding which is a primary criteria for the banks. The Basel II framework is aimed to be applied on a consolidated basis over internationally active banks in order to preserve the integrity of capital in the banks with subsidiaries. Also the framework eliminates the double gearing through this approach.The Basel II accords framework is also applied on a fully consolidated basis on any parent holding company which acts as a parent entity within a banking group in order to capture the risk on a consolidated basis without missing any element that contributes considerably to the risk of the overall banking system.Alongside, the framework is also applicable to all internationally active banks at every tier of the banking group.Apart from the aforementioned statements one of the principal objectives of the Basel II Accord is to protect the interest of the depositors essentially to ensure that capital recognised capital adequacy measures is readily available for the depositors. Apparently, these measures are aimed to establish a common platform for international banking and cross border finance across the globe.The scope of application extends to the following segments of the international banking and finance entities.Banking, securities and other financial subsidiariesSignificant minority investments in banking securitiesInsurance entitiesSignificant investment in commercial entities.Deduction of investment pursuant to this partThe aforementioned entities are obtained from the Basel Committee report on International Convergence of Capital Measurement and Capital Standards, published in June 2004. The Basel II accord overview is based on this report. The illustration in the fig 1 gives a clear picture of the overall scope of application of the Basel II accord.The Basel II accord is split in to three pillars.The first Pillar Minimum Capital RequirementsThis is the very important pillar of the Basel II Accord. This pillar has very clear definitions of the Accords application on the credit risks and operational risk along with the Trading Book issues that are vital for international banking establishment. The layout in fig 2 reproduced from the Basel II report provides the inner picture of the First Pillar.The following subsections provide a detailed analysis on the elements shown in fig 2.2.4 The First PillarThe First pillar lays down the minimum capital requirements that every internationally active bank should incorporate. It is split into the following subsection.2.4.1 Calculation of Minimum capital requirementsThe minimum capital requirement is calculated as a measure of the capital ration. The capital ratio in turn is calculated using the regulatory capital and risk-weighted assets. The requirement of this criterion is that the capital ration must be a minimum of 8 % or more in order to be eligible for the international activities. Also, in case of a two tier system the capital in tier 2 must not be greater than the tier 1 capital (i.e.) the tier 2 capital can be a maximum of 100% of the tier 1 capital. The capital is accounted from the following sources Regulatory capital The minimum accounting capital requirements for the financial institution encompasses the regulatory capital. The Basel II accord has withdrawn the provision to include general provisions in tire 2 capital, which was in effect in the 1988 Accord under the Internal Ratings-Based (IRB) approach. Furthermore the accord has lain down that the banks using the Internal Ratings Based approach to their other assets must compare the amount of total eligible provision with the total expected losses amount to the bank. This eventually increases the capital holding of the bank in order to meet the criteria.Risk Weighted Assets The Basel II Accord calculates the total risk-weighted ass ets by multiplying the capital requirement for market risk and operational risk by the reciprocal of the minimum capital ratio of 8% and adding the resulting value to the sum of risk weighted assets for credit risk. Even though this is subject to review the approach lays enormous burden on the bank to increase its minimum capital holdings. Apparently the Basel II Accord is aiming to establish that the internationally active banks must have enough capital to meet its short comings without depending on loans and cross border finance to address its immediate requirements and short comings. The idea though being novel is very intense for the banks to maintain the required minimum capital.Transitional Arrangements The Accord has also stated that the banks following the Internal Ratings-Based approach or the Advanced Measurements Approach (AMA) that there will be a capital floor after the implementation of the Basel II framework. The adjustment factors used in both the internal ratings-ba sed approach and the advanced measurements approach for calculating the capital floor as per the definition of the Basel II framework is shown in fig 3 below.2.4.2 Credit Risk-The Standardised ApproachUnder this method the Basel committee provides the internationally active banks a choice for calculating their capital requirements for credit risk. The first approach is the standardised method of measuring the credit risk through support from external credit assessments. This method is approved by the Basel committee while the other method is yet to explicitly approved by the committee. Under the alternate method of calculating the credit risk, the bank supervisor can allow banks to use their internal rating systems for calculating the credit risk.Under both the methodologies one should not oversee the fact that the Basel committee is very keen in assessing the credit risk on the capital holdings of the internationally active banks. Even though this is appreciated, the rules are very stringent making it very difficult for the banks for adopt easily.2.4.3 Credit Risk- Internal Ratings Based ApproachThe Basel II committee has given supervisory approval for banks to use the Internal Ratings-Based approach to determine their capital requirement for a given exposure subject to certain minimum conditions and disclosure requirements. The risk components considered includeMeasures of the probability of default (PD),Loss given default (LGD),The exposure at default (EAD),Effective maturity (M)The Basel II accord states that The Internal Ratings Based Approach is based on the measure of unexpected loses (UL) and Expected Loses (EL).Under the Internal Ratings Based Approach, the committee expects the bank to categories their exposures in order to identify the different underlying risk characteristics. The categories include corporate, sovereign, bank, retail and equity. These are identified as the corporate asset classes and the approach further expects the bank to identif y the subclasses associated with the asset classes in order to measure the credit risk associated with the exposure. The detailed analysis of every corporate class and its associated subclasses is beyond the scope of this report.In essence the Internal Ratings Based Approach gives the bank more liberty to calculate its credit-risk on the minimum capital requirement for a given exposure. But the producers laid by the Basel II Accord is very tedious to adopt and implement for every corporate class exposure and identifying the subclasses associated.2.4.4 Credit Risk- Securitisation FrameworkThe Basel Committee in its revised accord, has made it mandatory for the banks to apply the Securitisation Framework for determining regulatory capital requirements on exposure arising from traditional and synthetic Securitisation or similar structures that contain features common to both. The Basel II accord also states that the capital treatment of the Securitisation exposure must be determined on the basis of the economic substance rather than the legal form of the structure. It is apparent that the securities can be structured in many different ways and the committee has approved the use of either the traditional Securitisation or the synthetic Securitisation framework. Also the Basel II accord expects the supervisor to look at the economic substance of transaction in order to determine whether it should be subject to Securitisation framework or not. This gives the discretionary power to the supervisor to decide on a specific transaction whether to include it in the framework or to eliminate it from the framework towards determining the regulatory capital framework. The traditional Securitisation and the synthetic Securitisation framework are discussed below.Traditional SecuritisationThe Basel II Accord defines the traditional framework as a structure where the cash flow from an underlying pool of exposures is used to service at least two different stratified risk position s or tranches reflecting different degrees of credit risk. The advantage with this approach is that the payment to the investors is based on the performance of the specified underlying exposures rather than a derivation from an obligation of the entity originating those exposures.Synthetic SecuritisationA synthetic Securitisation is a structure with at least two different stratified risk positions or tranches that reflect different degrees of credit risk where credit risk of an underlying pool of exposures is transferred, in whole or in part, through the use of funded (e.g. credit-linked notes) or un-funded (e.g. credit default swaps) credit derivatives or guarantees that serve to hedge the credit risk of the portfolio. This approach leaves the return to the investors in the hands of the performance of the underlying pool. Apparently, the risk associated is higher since the performance can be affected by numerous causes.From the above-mentioned approaches the Basel II accords stand for evaluating the capital and minimum capital requirements are evident.2.4.5 Operational RiskThe operational risk is defined by the Basel Committee as the risk associated with the loss resulting from inadequate or failed internal processes, people, systems or external events. This includes the legal risk with the exclusion of strategic and reputational risk.The Basel II Accord has approved three methods for calculating the operational risk and risk sensitivity with the implications on minimum capital requirements. They are (i) The Basic indicator approach, (ii) the Standardised Approach and (iii) Advanced Measurement Approach.Basic Indicator ApproachIn this case the banks should hold capital for the operational risk equal to the average over the past three years of a fixed percentage. This is expressed as a formula below KBIA = (GI1n x )/n Where KBIA = the capital charge under the Basic Indicator Approach GI = annual gross income, where positive, over the previous three years n = number of the previous three years for which gross income is positive = 15%, which is set by the Committee, relating the industry wide level of required capital to the industry wide level of the indicator. This formula is obtained from the Basel II accord for the purpose of reader understanding.Standardised ApproachThe standardised approach divides the banks activities into eight-business lines namely corporate finance, trading sales, retail banking, commercial banking, payment settlement, agency services, asset management, and retail brokerage. The likelihood of operational risk exposure is calculated from the gross income associated with each business line that serves as an indicator for the scale of business operations by the bank in that specific area of business or business line. This approach is very clumsy since the gross income associated with the business line varies due to numerous reasons both internal and external.Advanced Measurement ApproachThe Advanced Measu rement Approach equates the regulatory capital requirement with the risk measure generated by the banks internal operational risk measurement system using quantitative and qualitative criteria. The banks can use this method only after the approval by the Committee.The Basel II Accord sets the approach for the banks based on their international activity and significant operational risk exposures. Also, when a bank agrees to use a more sophisticated method, it cannot revert back to the easier method without approval from the supervisor. This eventually increases the burden on the banks to choose a sophisticated method.2.4.6 Trading Book IssuesThe final segment of the first pillar is the trading book. Basel Committee defines the trading book as a container of both the financial instruments and commodities held either with trading intent or in order to hedge other elements of the trading book. The trading book forms a vital element for the bank since it is the record of the banks finan cial instruments as well as commodities. The Basel II Accord identifies four key principles for the supervisory process. They are listed below.The basic requirements for the eligibility to trading book capital treatment put forth by the Basel II Accord are as followsClearly documented trading strategy for the position/instrument or portfolios, approved by senior management (which would include expected holding horizon).Clearly defined policies and procedures for the active management of the positionClearly defined policy and procedures to monitor the positions against the banks trading strategy including the monitoring of turnover and stale positions in the banks trading book2.3 The Second Pillar- Supervisory Review ProcessBasel committee was initially set up for the supervising the internationally active banks and produce a common platform for the smooth transactions and cross border finance. The Basel II Accord has established Supervisory Process as one of the three pillars in or der to emphasise its stand on supervisory process. The importance of supervisory process is described below.2.3.1 Importance of Supervisory ProcessThe supervisory review process of the Basel II Accord aims not only to ensure that banks have adequate capital to support all the risks in their business but also intends to encourage the banks to develop and use better risk management techniques in monitoring and managing risks. Alongside, the supervisory process by developing internal capital assessment process and setting capital targets that are commensurate with the banks risk profile recognises the importance for bank management in order to improve the atmosphere in the international banking and cross border finance.The Supervisory process evaluates the relationship between the amount of capital held by the bank against the risk, strength and effectiveness of the banks risk management eventually guiding the bank and supervising its activities in order to improve the performance of the banks in the international business market and cross border finance.2.3.2 Four Key Principles of the supervisory reviewThe four key principles identified by the Basel II Accord on the supervisory process is listed below. These principles emphasise on the committees focus on supervision and its aim to maintain harmony in the international banking and cross border finance.Principle 1 Banks should have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital levels.Principle 2 Supervisors should review and evaluate banks internal capital adequacy assessments and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital ratios. Supervisors should take appropriate supervisory action if they are not satisfied with the result of this process.Principle 3 Supervisors should expect banks to operate above the minimum regulatory capital ratios and should have the ability to require banks to hold capital in excess of the minimum.Principle 4 Supervisors should seek to intervene at an early stage to prevent capital from falling below the minimum levels required to support the risk characteristics of a particular bank and should require rapid remedial action if capital is not maintained or restored.2.3.3 Issues to be addressedThere are two specific issues to be addressed by the Supervisory-Review Process. They areInterest Rate Risk in the Banking bookSince it is clear that the Basel Committees primary focus is on identifying and preventing risk in the international b