HSBC 2005 Annual Report Download - page 176

HSBC HOLDINGS PLC
Financial Review (continued)
174
• Under IFRSs, dividends are not recognised as a
liability on the balance sheet until they are
declared. This gives rise to an increase in
shareholders’ funds at the balance sheet date
compared with the previous accounting, which
is reversed when the relevant dividend is
subsequently declared. Banks reflect the benefit
of this increase in their regulatory capital until
the dividend declaration, in line with the
accounting treatment.
• Unrealised gains on available-for-sale equities
held are included as part of tier 2 capital;
previously these were not recognised.
The FSA plan to review certain elements of this
policy in mid-2007. In addition, in January 2006, the
FSA published a consultation paper, CP06/1, which
set out proposed amendments to the handbook, on
which comments are due in March 2006. These
proposals are not expected to have a significant
impact for HSBC.
Future developments
The Basel Committee on Banking Supervision (‘the
Basel Committee’) has published a new framework
for calculating minimum capital requirements.
Known as ‘Basel II’, it will replace the 1988 Basel
Capital Accord. Basel II is structured around three
‘pillars’: minimum capital requirements, supervisory
review process and market discipline. The
supervisory objectives for Basel II are to promote
safety and soundness in the financial system and
maintain at least the current overall level of capital
in the system; enhance competitive equality;
constitute a more comprehensive approach to
addressing risks; and focus on internationally active
banks.
With respect to pillar one minimum capital
requirements, Basel II provides three approaches, of
increasing sophistication, to the calculation of credit
risk regulatory capital. The most basic one, the
standardised approach, requires banks to use external
credit ratings to determine the risk weightings
applied to rated counterparties, and group other
counterparties into broad categories and apply
standardised risk weightings to these categories. In
the next level, the internal ratings-based foundation
approach allows banks to calculate their credit risk
regulatory capital requirement on the basis of their
internal assessment of the probability that a
counterparty will default, but with quantification of
exposure and loss estimates being subject to standard
supervisory formulae. Finally, the internal ratings-
based advanced approach will allow banks to use
their own internal assessment of not only the
probability of default but also the quantification of
exposure at default and loss given default.
Basel II also introduces capital requirements for
operational risk and, again, three levels of
sophistication are proposed. The capital required
under the basic indicator approach will be a simple
percentage of gross revenues: under the standardised
approach it will be one of three different percentages
of gross revenues applicable to each of eight
business lines, and under advanced measurement
approaches it will be an amount determined using
banks’ own statistical analysis of operational risk
data.
The EU Capital Requirements Directive
(‘CRD’) recast the Banking Consolidation Directive
and the Capital Adequacy Directive and will be the
means by which Basel II will be implemented in the
EU. The CRD was approved by the European
Parliament in September 2005 and the European
Parliament’s amendments were subsequently
endorsed by EU Finance Ministers on 12 October
2005. The CRD is expected to be published in its
final form in the spring of 2006. It requires EU
Member States to bring implementing provisions
into force on 1 January 2007, although in the case of
the provisions relating to the implementation of the
internal ratings-based advanced approach to credit
risk and the advanced measurement approach to
operational risk, implementation may be delayed
until 1 January 2008.
In January 2005, the FSA published a
consultation paper, CP05/3 ‘Strengthening capital
standards’, setting out proposals for implementing
the recast EU Directives. The FSA proposed that the
new requirements should take effect from 1 January
2007, except that firms may elect to continue
applying the existing capital adequacy framework
until 1 January 2008. A further FSA consultation
paper, CP06/3 ‘Strengthening Capital Standards 2’,
was published in February 2006 setting out the
FSA’s latest proposals for implementing the CRD in
the UK, together with the draft FSA Handbook text.
HSBC continues to participate actively in
industry consultations surrounding the development
and implementation of Basel II and the recast EU
Directives, and fully supports the more risk-sensitive
regulatory capital framework proposed to replace the
original 1988 Basel Capital Accord. The application
of Basel II across HSBC’s geographically diverse
businesses, which operate in a large number of
different regulatory environments, represents a
significant logistical and technological challenge,
and an extensive programme of implementation
projects is currently in progress. Basel II permits