Pre-commitment System And The Introduction Of China's Banking Supervision

With the wave of the financial globalization and integration, thecompetition in the financial field becomes more violent. The complexityand diversity of activities conducted by banking organizations and otherfinancial institutions have developed at a rapid pace in recent years,which make capital of bank unable to covered risk exposure of bankingactivities. It has become increasingly apparent to the financialinstitutions and increasingly recognized by bank regulators as well. Withregard to banking capital standard for market risks, the Basel supervisorsput this view by developing the internal model approach (For exampleVaR) as an alternative to the standardized model. The pre-commitmentapproach builds upon the logic of the internal model approach by havingeach banking organization develop its capital requirements in relation tothe organization's own activities. By relying on incentive compatibleinstead of on fixed rules, the pre-commitment approach stands at higherperspective for banking supervisory. In the first chapter, the paper gives a definition of thepre-commitment approach. It as follows: At first, the supervisoryinstitutions decided to take measurement periods based on economicconditions (A quarter or half a year), prior to commencing thepre-commitment approach, banks would specify the amount ofpre-commitment capital they wished to allocate to cover market riskexposures over a given period. The pre-commitment capital that iscalculated by risk-managing model of banks is prepared for cumulativetrading losses of banking activities and is also the minimum capitalstandards for supervising institutions. For the whole periods, if tradinglosses exceeded this pre-commitment amount, banks would subject topenalties. The penalties are made up of monetary and non-monetarymethods. Moreover, the first chapter differentiates the pre-commitmentapproach from VaR. In short, the pre-commitment approach has moreadvantages than VaR, from the measurement of market risk and thesupervisory cost or financial data, etc. At the end of the chapter, itintroduces the theoretical model of the pre-commitment approachdevised by Edward S. Prescott from Federal Reserve Bank (FRB). In the second chapter, the paper elaborates on the effectiveness ofthe pre-commitment approach, compared with previousbank-supervising ways, the pre-commitment approach gives a soft-linkof external restraints between risk exposures and capital commitments,so a variety of activities is free of constant capital preparation in banks.Banks structured risk management model based on risk managementabilities and experience respectively. For the consideration of safety andprofitability, banks make the initiative in proving the precision of modeland promoting the capacity of risk management. When it comes to theenforcement of the pre-commitment approach, it emphasizes the resultrather than the process, reducing interference to banking activities aspossible. As far as the supervisory institutions concerned, it causesdescent of supervisory cost. On the contrary, banks adopt thecost-minimized means for controlling risk, which spares the opportunitycost of banking capital and upgrades the technology of risk managementin the future. As a coin has two sides, the pre-commitment approach hasa few deficiencies when it is applied to banking supervisory. Forexample, bank's adverse selection, risk effect of guide's tenure, projectof penalty, etc. So there are still some points deserving further discussion.Then, the paper explicates the pilot exercise of the pre-commitmentapproach in America since 1996, from which the participating banksdraw the following conclusions: The pre-commitment approach providesstrong incentives for prudent risk management and more efficientallocation of capital as compared with other existing capital standards.Also, it in effect assigned to the participating banks the responsibility fordetermining an appropriate level of capital, free of any regulatorypreconceptions as to what that specific level should be. The third and fourth chapters are the most dif...