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Basel warns banks to watch highly leveraged institutions Back  
The Basel Committee on Banking Supervision has called for banks to keep their risk management practices for Highly Leveraged Institutions (HLIs) under close scrutiny.

In a recent review of issues related to banks’ and securities’ firms dealings with highly leveraged institutions, Basel said it was particularly important that firms continue to enhance their methods of measuring exposure.

Previous work by the Basel Committee identified HLIs as being companies which were subject to very little or no direct regulatory oversight because of their structure (often as limited partnerships or high net worth individuals and the securities taking the form of private placements). Moreover a significant number of HLIS operate through offshore centres. Such institutions take on significant leverage and can sometimes expose the lending institutions to too much risk themselves.

In addressing the findings of the new report David Bowen, chairman of the IOSCO Technical Committee and chairman of the Ontario Securities Commission said it ‘emphasises the importance of keeping risk management practices in respect of HLIs under close scrutiny to ensure that they have in place a package of measures for monitoring and mitigating the risks involved.’
The report underlined the importance of keeping risk management systems up to date and that there was no room for complacency on the part of firms or supervisors.

An important aspect of the relationship between HLIs and authorised firms is the timely flow of relevant information between counterparties and the appropriate management of the exposure in the light of this information. Paul Wright, co-chairman of the HLI Working Group and chairman of the IOSCO Working Party on the Regulation of Financial Intermediaries explained: ‘While the availability of information from HLI counterparties has improved over the last two years progress has been inconsistent, particularly in the provision of quantitative information. Similarly, while firms have generally been able to strengthen contractual provisions with respect to the HLI sector, competitive pressure continue to affect firms’ ability to insist on the full range of risk mitigants, including initial margin.’

The report found that while firms have made significant progress in strengthening their measures of potential future exposure, efforts to conduct regular and comprehensive stress testing have progressed more slowly. It is important that firms devote the necessary resources to developing their stress testing capabilities for assessing the combined impact of large market moves, counterparty credit exposures and collateral values.’

The joint HLI working group said it was encouraged by institutions’ progress in implementing the previous recommendations and said that senior management had strengthened their oversight of HLIs activities through improved policies and a clearer definition of overall risk appetites.

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