cuhk advd prog on basel iii sheng (final)
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Implications of Basel III on AsiaTRANSCRIPT
© Fung Global Institute
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Balance between Regulation and Growth- Implementation of Basel III in Asia
Andrew ShengPresident, Fung Global InstituteAdvanced Programme for Central Bankers and Regulators on Basel III17-19, January 2013The Chinese University of Hong KongInstitute of Global Economics and Finance
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Financial Reform Landscape remains Complex
Source: E&Y. Financial Regulatory Reform - What it means for bank business models, November 2012.
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4Asia Policy Forum on Financial Regulatory Reform
• Ensure that tighter standards, such as higher capital and liquidity requirements, do not choke off the global recovery.
• Support the development of a global mechanism for managing volatile short-term capital flows, and development of macroprudential surveillance and regulation at the national and regional levels.
• Establish an effective regulatory framework for macroprudential supervision and regulation at the national and regional levels.
Source: Asian Development Bank Institute, Policy Recommendations to Secure Balanced and Sustainable Growth in Asia, October 2010.
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Asia Policy Forum on Asian Voice and Interests• There needs to be an Asian voice on financial reform and regulation
rather than allowing the debate on issues to be dominated by a perceived choice between American and European approaches.
• A “one-size-fits-all” approach is inappropriate due to differences in financial systems, stages of development and banking industry practices, and may lead to excessive burdens in areas such as capital and liquidity adequacy requirements and leverage ratios.
• In addition, there is a risk of spillover effects from developed country regulatory changes and low-interest-rate policies that lead to migration of risky financial activities to Asia that could affect regional financial stability.
• Asian leaders should consider sponsoring their own research on the impacts of the new regulations on Asian financial institutions and markets.
Source: Asian Development Bank Institute, Policy Recommendations to Secure Balanced and Sustainable Growth in Asia, October 2010.
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Key Points
• We need to put the Implementation of Basel III in Asia within the proper context.• Post-2007 Global Financial Crisis, Basel III is an important standardization of
minimum capital and liquidity standards for global banking. • This is a NECESSARY, but NOT SUFFICIENT CONDITION for global financial
stability, because Financial Stability Board and national regulators have only just begun to address SHADOW BANKING, or non-bank financial intermediaries, risk issues. Although important, banks account for 43.1 percent of global financial assets as at the end of 2011, whereas stock market capitalization and bond markets (excluding derivative financial assets) account for more than half of financial sector risks.
• Hence, to obtain overall financial system stability, we need to look also at real sector imbalances, monetary and fiscal policies, and interconnectivity and feedback mechanisms between financial sectors (banks and shadow banks) as a systemic whole.
• We must never forget that Finance must serve the Real Sector, not the other way around.
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Key Questions
• What are Basel III’s main impact on (1) banking system and (2) growth and overall credit?
• While Basel III are Minimum conditions for capital and liquidity, do the complex calculations on risk weights impair or disadvantage EME banks?
• Which parts of Basel III should be priority for implementation? Should we move out of standard risk-based model towards Internal Risk-Based (IRB) models?
• What areas of structure (shadow banking), financial infrastructure and other issues should we consider ( Basel III included as part of package) for financial system stability?
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Contents
• Introduction
• What are the key issues and concerns?
• Role of Asia finance in rebalancing Asia’s Growth Model
• Conclusion
Appendix: Amendments to the Liquidity Coverage Ratio (LCR) and the new BCBS Charter; and CRR4
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IntroductionSection 1
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Asia finance must be there to serve the real sector
How should Asia position itself to generate sustainable growth, financial stability and
shared prosperity for its people?
Asia’s financial sector must serve the real
sector, not the other way around
Demographic dividends, demographic aging, rising
middle-class, growing urbanisation, and huge demand for education,
healthcare and insurance, pensions and social
infrastructure
Current advanced country model of financing the real economy through complex leverage is unsustainable.
Requires structural adjustment, technology and
innovation to compensate for negative effects of aging population & fiscal drag
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Asian banks are the primary providers of funding for private sector growth
Asia’s shift towards a domestic and regionally-driven engine of growth would require continuous funding from Asia’s bank-dominated financial system
However, Asia faces funding issue under Basel III rules that would reduce the incentive for banks to lend to trade finance and SMEs, and discourage long-term lending for infrastructure at a time when this is critical for Asia’s sustained growth
While Basel III requirements on higher capital adequacy, enhanced liquidity and an overall leverage cap are commendable, the detailed rules on liquidity and risk-weighting may restrain the funding capacity of Asian banks
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Banking sector has to adjust to unprecedented regulatory change
Source: Mc Kinsey. The Triple Transformation, October 2012.
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Global capital markets business also has to adjust to regulation
Source: Mc Kinsey. The Triple Transformation, October 2012.
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Need for adaptive business models to seize new growth trends
Source: Mc Kinsey, BCG.
UrbanisationRising class
of SME banking
Affluence
Doing business beyond home market
Innovation New trade corridors
Payments dynamism
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Going to where the new trade corridors are
Source: BCG. The Transaction Banking Advantage, October 2012.
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Revamping payments value chain
Source: BCG. The Transaction Banking Advantage, October 2012.
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Need true banking transformation to improve financial metrics
Source: Mc Kinsey. The Triple Transformation, October 2012.
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19Need to reverse declining ROE due to lack of performance improvement and rising capital ratios
Source: Mc Kinsey. The Triple Transformation, October 2012.
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Business model transformation – the basis for future growth• Capital markets business is most challenging due to regulatory
pressure, high funding costs, and shrinking revenues.
Source: Mc Kinsey. The Triple Transformation, October 2012.
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The need for a balanced view, with appropriate “fit” for EMEs1. Basel III was designed to address the causes of the 2007-2009
Financial Crisis in the advanced markets, aimed to resolve the issue of under-capitalisation and over-leverage in the advanced wholesale banking model.
2. Current Basel III on risk-taking governance requirements represent substantial improvement in quality, quantity and comparability of banks’ risk/reward profile. Asia needs that and supports Basel III.
3. However, there is substantial variation in quality of banks, supervisors and regulators between more retail-based systems (e.g., China, Canada, India, Australia) and wholesale systems (US, UK and some EU countries).
4. Need for clarity on WHAT is National discretion? WHAT fits local conditions and what is necessary to supplement Basel III implementation to ensure overall systemic stability.
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Agree that under-capitalisation and illiquidity of internationally-active banks need to be solved
Figure 1. Ratio of Debt to GDP Among Selected Advanced Economics(In percent, GDP-weighted, 1987=100)
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Do Basel III rules address the priority policy and real sector needs in Asia?
• While Asian banks can meet the current Basel III capital requirements, it is not clear as Asia grows faster with higher credit needs, whether there will capital constraints going forward.
• Asian banks are at different stages of development and Asian countries have different national imperatives.
• Capacity of Asian banks to implement Basel II/III vary hugely between banks, especially the smaller and non-internationally active banks.
• Europe is expected to have the largest shortfall of over €272 billion in meeting Basel III capital requirements, and the US may have a shortfall of $60 billion.
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Tighter financial conditions resulting in capital shortfalls, in turn worsening the real economy
Source: IIF. “The Cumulative Impact on the Global Economy of Changes in the Financial Regulatory Framework”. September 2011.
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Basel 2.5/III uses Risk Weighting and Models to assess Risks • Advanced country banks have high sovereign ratings and have
experience in Internal Risk Based (IRB) Models which assign lower risks, if banks can prove with data.
• Asian banks are less sophisticated and rely on standard model, and because sovereign credit ratings are lower, and Asian banks do not have good risk data, they automatically have higher capital costs relative to European banks (see next Slide).
• Example:For top ASEAN banks For top European banks For top American banks
• Basel III’s CET1 = average of 10.7%
• Basel II’s CT1 = average of 11.5%
• Basel II’s CT1 average = 10.2% (one bank has an average of below 7%)
• Basel III’s Tier 1 Common Ratio average = 8.4%
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Asian banks disadvantaged with the use of sovereign credit rating• Much more capital needed to support the same amount of
loans or bonds (based on S&P risk weights, ASEAN+3 banks will need 300% more capital).
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Asian banks have high RWA relative to total assets
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Top banks in Asia
CountryLargest
bankTotal
AssetsROA (%)
CAR(Tier 1 %)
CAR (Total %)
US J.P. Morgan 2265.79 0.84 12.30 15.40US Citibank 1873.88 0.59 13.60 16.99Germany Deutsche Bank 2805.29 0.20 12.90 14.50France BNP Paribas 2547.68 0.31 11.60 14.00Philippines Banco de Oro 26.84 0.95 10.00 15.80India ICICI Bank 94.73 1.61 12.70 18.50Singapore DBS 279.49 0.89 12.90 15.80South Korea Kookmin Bank 238.62 0.80 10.14 13.09Hong Kong HSBC 1333.03 0.28 9.10 14.40Indonesia Bank Mandiri 56.66 2.23 14.90 17.20Malaysia Maybank 135.96 1.08 11.84 15.36China ICBC 2476.30 1.35 10.07 13.17
JapanMitsubishi UFJ Financial Group 2603.95 0.19 12.31 14.91
Taiwan Bank of Taiwan 135.74 0.09 10.50 11.38Thailand Bangkok Bank 68.69 1.30 12.21 15.35
Source: The Asset, Volume 14 Number 11, December 2012.
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Whither Basel III for Asia?
• The US has postponed implementation of capital rules for the year 2013 and delayed implementation of liquidity rules. Pressure to delay the start date was due to concerns over the complexity of the rules and the cost to banks at a time of weak global economic growth.
• Europe is also re-considering and the Bank of England has expressed concerns on the complexity of the rules, especially since bank supervision is returning to the Bank of England.
“Rather than pushing through a flawed Basel III, we need to take the time to do it right so we do not have to do it over. … Basel III’s implementation has been postponed, and that offers a real chance to get it right. If we do, we won’t need Basel IV” – Thomas M. Hoenig, 2012*
As a result, Basel Committee announced agreement on Liquidity Rules with a delayed phase in period. * Get Basel III right and avoid Basel IV. http://www.ft.com/intl/cms/s/0/99ece1b0-3fa0-11e2-b2ce-
00144feabdc0.html#axzz2HRMF1qU1
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What are the key issues and concerns?
Section 2
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Emerging Market banks find it currently easier to meet Basel III requirements
Figure 2. International Comparison of the Financial Liabilities/Assets Ratio
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Asia has its own national banking development agenda and time frame• The extensiveness of the rules will have tremendous
implications on re-shaping and micro-managing the business models of banks locally, regionally and worldwide.
• This raises the question of whether national regulators should be given more discretion to adjust their regulatory and supervisory guidelines in line with the Basel principles in a manner that suit their national banking development agenda and time frame.
• BCBS has now created a small team to look at “simplifying Basel III”. This is the time to engage BCBS through Asian regulators which can influence the final outcome, especially those which are represented either at G20 or FSB/BCBS levels.
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Implementation of Basel III will have costs on all banks, global or local
Constrained credit provision by Emerging
Market banks
Retrenchment and deleveraging by global
banks
Risk of synchronised slowdown globally if Asian growth also
constrained by limits on credit
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Issue 1: Potential trap of synchronized recession• If the unintended consequences of implementing Basel III are
to slow Asian growth because of the limited capacity of the banking system to support the growth of the real economy, especially for SMEs, trade and infrastructure finance, then the whole world may be trapped in a policy-induced unintended synchronized recession.
• Solution: Each Asian country should study what are the credit needs projected to 2020 and see if addition capital would be required to meet the new credit needs.
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Issue 2: Risk-weightings biased against Asian banks• Basel capital rules favour banks that have developed
“advanced risk models” for determining risk-weighted assets (RWA). Asian banks are some 10 years behind in this respect. Hence, they will not be able to use efficient conversion factors even if they are given a transition period up to 2019.
• Solution: Each Asian country will have to develop better data-bases on credit history in order to re-calculate the risk weights; this will enable the larger banks to move toward Internal Risk-Based models with their own risk weights.
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Issue 3: Credit ratings biased against Asian banks• The Basel III risk-weightings are based on current sovereign
credit ratings.• Asian economies (and by definition, Asian banks) have lower
credit ratings, even though their sovereign debt has high foreign exchange backing (up to 50%) and Asian economies have higher savings and lower fiscal debt.
• Many Asian banks are state-owned, thus the urgency to raise large capital cushions is not as imperative as the European case.
• Solution: Asia should consider creating Mutual (owned by users and industry) not-for-profit Credit Rating Agencies that can give ratings that are more objectively based. This will provide competition to current top 3 that have become TBTF.
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Issue 4: Liquidity risk framework not directly relevant to Asian banks• The Basel liquidity risk framework aims to restrain the balance
sheets of banks which: (1) are highly leveraged; (2) have significant maturity mismatches; and (3) are funded mainly by the wholesale markets.
• However, Asian banks generally do not fall within any of these three categories because they have large deposit bases, the population has high savings rate, and the fiscal and balance of payments positions at the national level are much more robust.
Solution: Asian banks should work with central banks to examine how domestic liquidity can be provided in manner which would not create a ‘rush for funding’.
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Basel liquidity rules vs. Asian situation
Situations
targeted by
Basel liquidity
rules
Situation in Asia
• High loan-to-deposit ratios
• High leverage
• Flexible exchange rates
• Substantial liquid assets
• Low nominal leverage
With low fiscal debt and high foreign exchange, limits on loan-to-deposit ratio, Central Banks can easily provide liquidity to domestic banks.
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Issue 5: Asia has huge need for infrastructure funding• The detailed rules on liquidity, risk-weightings and leverage
may constrain the capacity of Asian banks to fund infrastructure since there is growing maturity mismatch risk.
• Furthermore, Basel III rules also make asset securitization more expensive.
• The ADB estimates that US$8 trillion will be required to finance infrastructure, creating massive potential for the development of Asian municipal and infrastructure bond markets.
• Solution: Develop Asia’s fixed income markets through asset securitization. This would help to lessen the maturity mismatch in bank balance sheets [e.g., Cagamas and HKMC].
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Large interest in infrastructure financing
• Asia is at the early stages of securitized debt markets.
• China also needs mortgage securitization to reduce maturity mismatch, particularly through bond market.
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Issue 6: Trade finance is Asia’s lifeblood
• Trade finance business is forecast to grow at 9% annually to 60% of all global trade by 2020, with one leg in Asia.
• Solution: Central banks should incentivise banks to promote trade finance and consider establishing a “Trade window” for real market transactions.
Trade finance underpins 30–40% of the lending SMEs received. It forms the most relevant part of working capital financing
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How to ringfence trade finance in times of crisis
• Central bank could offer low-cost liquidity to commercial banks, against “ringfenced” portfolios of trade assets.
• Public entity could purchase trade and hold trade assets directly.
• Public entity could “guarantee” specific trade obligations, to support a liquid market in trade assets.
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Basel III’s impact on trade
BAFT-IFSA: Basel III may raise trade finance
costs by 18-40%
Demand for trade finance rising rapidly
* BAFT-IFSA, Basel III-Impact on Trade, Tod Burwell, November 2011, Washington, D.C.
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Issue 7: Asia’s SME development drive and job creation• Asia is at the cusp of an SME development drive to promote job
creation, innovation and market competition. SMEs rely heavily on trade finance and short-term bank credit, they account for 80-90% of job creation to address employment and equity challenges.
• Both European Commission and UK recognize that lending to SMEs, though carrying higher credit risks, have large social benefits in terms of growth and employment generation.
• The net effect of higher risk-weights on SMEs and higher costs and lesser credit to SMEs may generate exactly the economic slowdown that creates higher risk for the banking system.
• Hence, policymakers have to weigh the positive spillover effects of SME health vs protecting banks against credit risk.
• Solution: Policy-makers should work alongside private sources of equity to meet SME financing needs.
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Lending to small enterprises still lower than medium and large enterprises
Figure 3. Growth Rate of Outstanding Loans Extended to Large Enterprises, MediumEnterprises, and Small Enterprises
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Access to finance is a major problem for SMEs
• A ECB survey shows that access to finance is perceived as the second most pressing problem for SMEs, after their order book.*
• Accordingly, the European Banking Authority (EBA) is examining a proposal by the European Parliament to adjust the risk-weights for lending to SMEs, and an increase in the threshold of EUR2 million for the Standardised Approach and EUR5 million for the Internal Ratings-Based (IRB) Approach.
* European Central Bank, Survey on the Access to Finance of SMEs in Euro Area, April 2012.
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We are in a self-fulfilling vicious cycle
SME have
high risks
We do not lend to SMEs
SMEs will not be able to grow
Economy will slow
down
Risk-weighting increases
risk
We have to distinguish the positive externalities of SMEs, trade finance, infrastructure, which creates jobs and future growth, from the negative externalities of fast trading, high leverage, things that will destroy the economy systemically
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Issue 8: Implementation cost on banking operations• Lastly, the implementation of complex Basel III rules will result in
Asian banks incurring disproportionately large costs.• Asian banks are still in the process of implementing Basel I and II
(and 2.5); and yet they are now burdened by Basel III.• Asian banks’ expertise and experience are scarce.
–Whether scarcity management and regulatory resources should be focused on developing a banking system that supports and fits Asian realities, rather than “one-size-fits-all” rules designed for implementation by advanced countries.
• Global banks have the capacity to absorb these costs but not the smaller national banks in Asia, which are at different stages of development.
• Solution: Asian banks should review their business models that can help generate new revenues to help fund these costs.
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49Non-Bank Assets (NBFI or shadow banking) more than Bank Assets
• Regulatory arbitrage from banks to shadow banks more than bank assets.
• Contagion can occur between banks and shadow banking. Risk are not just in banks.
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Basel Rules are not law and do not have legal force• Whilst national regulators need to use Basel III as standards,
the total national requirements and law are still paramount.
Source: BIS. Group of Governors and Heads of Supervision endorses revised liquidity standard for banks http://www.bis.org/speeches/sp130106.htm
“3. Legal Status. The BCBS does not possess any formal supranational authority. Its decisions do not have legal force. Rather, the BCBS relies on its members' commitments, as described in Section 5, to achieve its mandate.” - New Basel Committee on Banking Supervision (BCBS) Charter, January 2013
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Role of Asia finance in rebalancing Asia’s Growth Model
Section 3
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What do we mean by “Rebalancing”?
Rebalancing = reducing
concentration, risks and narrowing gaps
in the world as a whole
Address a system-wide balancing
problem at both the global and national
levels
Understand the complex network
effects of interconnectivity and
inter-dependency
Trade-off between efficiency, stability
and equity
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National rebalancing must address mismatches and gaps
NATIONAL REBALANCIN
G
Double Mismatches of Maturity and
Foreign Exchanges
Twin Gaps of Current Account and Fiscal Gaps
Social Gap between rich and poor in income
Wealth and Ownership Gaps
between state and private
sectors
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Impact of rebalancing on non-reserve currency countries
Region/Country Net Foreign Asset (+), Deficit
(-)US$ bn
GDP2008
US$ bn
NFA/GDP%
Exchange rate impact due to 10% change in
USD
Impact as % of GDP
Asian Surplus + 4,994 12,309 + 40.6 - 499 - 4.1Other Surplus + 2,863 3,706 + 77.3 - 286 - 7.7Total Surplus + 7,857 16,015 + 49.1 - 786 - 4.9
Euro Area - 2,584 13,631 - 16.9 +258 + 1.9USA - 3,690 14,441 - 25.6 +369 + 2.6Australia - 501 1,062 - 47.2 + 50 + 4.7Subtotal Deficit - 6,775 29,134 - 23.3 + 678 + 2.3Other Countries - 1,082 16,070 - 6.7 -108 +0.1Global Total 0 61,219
Table 2: Impact of Global Imbalances on Surplus Countries- Global Net Foreign Asset (NFA) and Liability Position, 2008
Source: Author’s calculations.
• For every 10% revaluation relative to G4 countries, the surplus holders of global FX reserves stand to lose roughly 5% of their GDP.
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ConclusionSection 4
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What should be Asia’s stance on Basel III?
• Basel III is now a complex rule book of over 600 pages and has become a “one-size-fits-all” rule-book.
• Risk that Basel rules have become too prescriptive, leaving little room for banks and regulators in developing countries to exercise judgment in conducting lending activities that support the national development agenda.
• The issue is trust between industry and regulators. Board of Directors have fiduciary duty and must be trusted to make their judgment on risks and rewards. Supervisory authorities should step in when there is supervisory judgment that the bank has not recognized the risks and may contribute to systemic risks.
• BCBS must trust national regulators to monitor their system risks and only step in (via FSAP/FSB/IMF) if the activities of D-SIFIs, G-SIFIs or national system contribute to global systemic risks.
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57Basel III is necessary, but not sufficient. Look at system as a whole (including shadow banking)
• We support Basel III’s capital adequacy and we are also fine with the compromise on liquidity requirements. The use of model – risk-weighting is still under dispute.
• The question is can we solve the banking problem by only looking at the banking system while ignoring the shadow banking, NBFI, and long-term funding issues?
• The banking problem is that it is too short-term. Basel III only concentrates on banking but not on shadow banking, capital markets, pension, insurance (the whole system). There is no proper pension or insurance system in place to take the long-term risks.
• It doesn’t mean that “if institutions are fixed, then everything will be fixed”. It’s the whole class of systemic assets and the linkages of systemic liabilities which cut across different institutions that will cause things to blow up if they become fragile. We need to focus on cross-cutting issues along with institutions. The current policy approach is an “either or” situation.
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An implementation time table, customized to domestic conditions and imperatives
• Asian policymakers should reconsider the practicality of the time frame in implementing Basel III, and the urgency of adopting broader financial infrastructure and national risk management framework that would help to enhance overall system resilience against endogenous and exogenous shocks.
• So long as local banks do not have systemic implications on global markets with negative spillovers, national regulators should reserve the discretion to draw up a timetable for implementation that is customized to domestic conditions and imperatives.
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Need to work together
• Emerging Asia needs practical implementable rules that best-fit Asian conditions.
• We seek to achieve the most effective OUTCOMES of Basel objectives AND systemic stability, including NBFIs.
Unless we coordinate, we are less likely to have impact in the global debate.
We need to rebalance between implementing rules and financial markets to serve the real economy.
We have to avoid rules that will fragilize the Asian economy.
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Amendments to the Liquidity Coverage Ratio (LCR) and the new BCBS Charter; andCRR4
Appendix
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61Amendments to LCR in four main areas – BCBS, 6 January 2013
High quality assets (HQLA) & net cash outflows
Definition of high quality assets for LCR (numerator of the ratio) and the factors that determine the net liquidity outflows that banks would face in stress (denominator of the ratio)
Revised timetable for introduction of the LCR – phase-in arrangements
• Same as that of capital requirements: coming fully into effect only in 2019• The LCR will be introduced as planned on 1 January 2015. But the minimum
requirement will begin at 60%, rising in equal annual steps of 10 percentage points to reach 100% on 1 January 2019
• This will ensure that the new liquidity standard will in no way hinder the ability of the global banking system to finance a recovery
Usability of stock of liquid assets in distress/transition
• During periods of stress, banks can use their stock of HQLA, thereby falling below the minimum. It is the responsibility of bank supervisors to give guidance on usability according to circumstances
• Countries with distressed banking systems have complete flexibility in their application of the LCR until the distress has passed
• Liquidity buffers defined by the LCR are to be used in times of stress• This is applicable both during the transition and in steady state
Further work on the interaction between LCR & the provision of central bank facilities
• Deposits with central banks are the most liquid asset, the interaction between the LCR and the provision of central bank facilities is important
• Ensure that banks hold sufficient liquid assets to prevent central banks becoming the "lender of first resort"
Source: BIS. Group of Governors and Heads of Supervision endorses revised liquidity standard for banks http://www.bis.org/speeches/sp130106.htm
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62LCR - Description
• To promote short-term resilience of a bank’s liquidity risk profile.
• To ensure that a bank has an adequate stock of unencumbered high quality liquid assets (HQLA).–Consists of cash or assets that can be converted into cash at little or no
loss of value in private markets, to meet liquidity needs for a 30 calendar day liquidity stress scenario.
• Two components:
• Absent a situation of financial stress, the value of the ratio be no lower than 100%1 (i.e. the stock of HQLA should at least equal total net cash outflows). Banks are expected to meet this requirement continuously and hold a stock of unencumbered HQLA as a defence against the potential onset of liquidity stress. During a period of financial stress, banks may use their stock of HQLA, thereby falling below 100%.
Source: BIS. Annex 1 - Summary description of the LCR.
Stock of HQLA Total net cash outflows over the next 30 calendar days
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63LCR – Detailed changes: HQLA (1/3)
Expand the definition of HQLA subject to a higher haircut and limit
• Corporate debt securities rated A+ to BBB– with a 50% haircut • Certain unencumbered equities subject to a 50% haircut • Certain residential mortgage-backed securities rated AA or higher with a
25% haircut
Aggregate of additional assets, after haircuts, subject to a 15% limit of the HQLA
Rating requirement on qualifying Level 2 assets
Use of local rating scales and inclusion of qualifying commercial paper
Usability of the liquidity pool
Incorporate language related to the expectation that banks will use their pool of HQLA during periods of stress
Operational requirements Refine and clarify the operational requirements for HQLA
Operation of the cap on Level 2 HQLA
Revise and improve the operation of the cap
Alternative liquid asset (ALA) framework
Develop the alternative treatments and include a fourth option for sharia-compliant banks
Central bank reserves Clarify language to confirm that supervisors have national discretion to include or exclude required central bank reserves (as well as overnight and certain term deposits) as HQLA as they consider appropriate
Source: BIS. Annex 2 - Complete set of agreed changes to the Liquidity Coverage Ratio.
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64LCR – Detailed changes: Inflows and Outflows (2/3)
Source: BIS. Annex 2. http://www.bis.org/press/p130106.htm
Insured deposits • Reduce outflow on certain fully insured retail deposits from 5% to 3% • Reduce outflow on fully insured non-operational deposits from non-financial corporates,
sovereigns, central banks and public sector entities (PSEs) from 40% to 20%
Non-financial corporate deposits
Reduce the outflow rate for “non-operational” deposits provided by non-financial corporates, sovereigns, central banks and PSEs from 75% to 40%
Committed liquidity facilities to non-financial corporates
Clarify the definition of liquidity facilities and reduce the drawdown rate on the unused portion of committed liquidity facilities to non-financial corporates, sovereigns, central banks and PSEs from 100% to 30%
Committed but unfunded inter-financial liquidity and credit facilities
Distinguish between interbank and inter-financial credit and liquidity facilities and reduce the outflow rate on the former from 100% to 40%
Derivatives • Additional derivatives risks included in the LCR with a 100% outflow (relates to collateral substitution, and excess collateral that the bank is contractually obligated to return/provide if required by a counterparty)
• Introduce a standardised approach for liquidity risk related to market value changes in derivatives positions
• Assume net outflow of 0% for derivatives (and commitments) that are contractually secured/collateralised by HQLA
Trade finance Guidance to indicate that a low outflow rate (0–5%) is expected to apply
Equivalence of central bank operations
Reduce the outflow rate on maturing secured funding transactions with central banks from 25% to 0%
Client servicing brokerage Clarify the treatment of activities related to client servicing brokerage (which generally lead to an increase in net outflows)
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65LCR – Detailed changes: Clarification to rule text and LCR phase-in (3/3)
Source: BIS. Annex 2. http://www.bis.org/press/p130106.htm
Rules text clarifications
• Clearer guidance on the usability of HQLA, and the appropriate supervisory response, has been developed to ensure that the stock of liquid assets is available to be used when needed
• A number of clarifications to the rules text to promote consistent application and reduce arbitrage opportunities (e.g., operational deposits from wholesale clients, derivatives cash flows, open maturity loans). Also incorporating previously agreed FAQ
Internationally agreed phase-in of the LCR
The minimum LCR in 2015 would be 60% and increase by 10 percentage points per year to reach 100% in 2019
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66Capital Requirements Regulation (CRR 4) – Overall impact on trade finance (TF)
• CRR 4 is the equivalent of Basel 3 and will be implemented in Europe across all 27 countries.
• Proposed changes under CRR4 in the treatment of TF products supportive of TF, which is a critical part to keep the economy ticking on an even keel.
• Recognition that TF is a low risk activity.–ICC study for 2011* shows on an industry-wide basis, there were fewer
than 3,000 defaults observed in a dataset comprising 11.4 million transactions collected for 2005-2010. Typical loss rates for 2008-2010: for TF products like L/Cs were 0.007%, export confirmed L/Cs 0.03%, Import loans 0.07%, export loans 0.017%.
–Strong case for arguing that Trade deserves a better treatment under the internal ratings based approach (IRB). A lower asset value correlation charge (AVC) for TF products would go some way to ensure that trade products get the appropriate capital treatment they deserve.
Source: International Chamber of Commerce (ICC). Global Risks ‒ Trade Finance, 2011.
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67Capital Requirements Regulation (CRR 4) – Proposed changes
Uniform rule book
Maturity Floor Waiver (MFW)
Credit Conversion Factor (CCF)
Asset Value Correlation
(AVC)
Leverage Ratio
Liquidity Ratios
• Under Basel 2, local regulators had to translate the European rules into local rules and regulations – this created scope for differences in the rules and regulations
• Basel left open the option to national discretion to extend the MFW to all TF products – CRR-4 proposes to extend the MFW to all TF products
• To reduce CCF applied to non-financial guarantees (i.e. bid bond, advance payment, performance and retention guarantees) from 50% to 20%
• Under Basel III and CRR 4, exposures to large financial institutions (assets > $100bn) will attract a 1.25 scaling factor to account for systemic risk
• While systemic risk is an important issue for banks, trade finance was not a contributor to the increased systemic risk within banks during the crisis and should not be penalised
• Important to note that increased linkages between banks, at least for trade finance, is a function of a bank’s primary role in facilitating payments within the financial system and not necessarily one of taking on increased counter party risk
• Hence, strong case for arguing that the scaling factor applied should be a range varying from anything greater than 1 to a max. of 1.25 instead of applying a flat scaling factor of 1.25 across all banks
• To apply more favourable CCF of 20% and 50% to TF products like L/Cs and guarantees. Basel III proposes to apply a 100% CCF to all contingent liabilities including TF products
• To recognise 100% of trade inflows in the calculation of the liquidity coverage ratio (LCR) in lieu of the Basel III proposed 50% of trade inflows
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