French banks were affected through several channels: •  First, through their direct exposures to American households in the subprime category or through indirect exposures in portfolios of structured financial instruments, such as residential mortgage backed securities (RMBS) and collateralised debt obligations (CDOs) that are in turn exposed to subprime risks. As was the case for the rest of the banking system in Europe, indirect exposures accounted for much greater amounts than direct exposures and therefore for the  BIS Review 82/2008  1  bulk of the losses; the lessons that this situation holds for more refined risk management need to be learned quickly. •  Secondly, through exposures to securitisation vehicles (conduits or structured investment vehicles) and particularly through liquidity lines, which need to be managed more rigorously going forward. •  Thirdly, through exposures to assets taken back from securitisation vehicles, or even collective investment schemes, that ran into liquidity problems; this type of reintermediation needs to be given more consideration in terms of capital requirements. •  Fourthly, through their exposures to monoline insurers, which insured some products and were themselves hard-hit by the crisis and thus epitomise “wrong-way” counterparty risks, which need to be assessed more carefully. •  Finally, though exposures to leveraged buy-outs, or more generally by credit-riskrelated costs on the most vulnerable companies, which are starting to rise. Consequently, French banks have not escaped the overall slowdown in net banking income growth affecting major international banking groups.
It will reduce the procyclicality of the financial sector. Higher capital requirements are an important component of the new framework. The capital requirements are set in relation to banks’ risk-weighted assets. The risk weights in the calculation are therefore also important for the system’s robustness. This may give rise to challenges, particularly with regard to housing loans. Under Basel III, a bank must set aside about NOK 2.50 for every NOK 100 they lend if the regulation’s standard risk weights for residential mortgages are applied. This is to cover the equity capital and conservation buffer requirements. If the countercyclical buffer has been turned on at maximum, the bank must provide one additional krone for each hundred kroner of loans. However, Basel III also provides banks with the option of full use of internal models for calculating their risk weights. When banks calculate risk weights using internal models, only institution-specific risk is taken into account and not system-wide risk. Norwegian banks that use such models arrive at risk weights that in some cases are a third of the standard weights, and for some Swedish banks that operate in Norway they are even lower. The capital requirements are then reduced correspondingly. In the case of full use of internal models,  4  BIS central bankers’ speeches  these banks will only have to set aside 1 krone for every NOK 100 in residential mortgage loans, even when the countercyclical buffer is fully turned on.