basel iii and impact analysis

8/3/2019 Basel III and Impact Analysis

1/33


2/33


3/33


4/33

Comprehensive set of reform measures, developed by

the Basel Committee on Banking Supervision, tostrengthen the regulation, supervision and riskmanagement of the banking sector.

Aim:

Improve the banking sector's ability to absorb shocks fromfinancial and economic stress.

Improve risk management and governance

Strengthen banks' transparency and disclosures.

Micro prudential regulation - Raise the resilience of individual banking institutions in periods of stress

Macro prudential regulation ensure system wideresilience against risks/ shocks and counter

procyclicality.


5/33

Strengthening the resilience of the bankingsector International framework for liquidity riskmeasurement, standards and monitoring.


6/33

Strengthening the capital framework .

Redefining Capital and Minimum Capital Requirement.

Reducing Procyclicality & Promoting countercyclical buffers.

Capital Conservation & Countercyclical Buffers.

Forward looking provisioning.

Enhancing Risk Coverage .

Enhancing counterparty Credit Risk Management Systems, incentivesfor moving towards CCPs and Collateral Management.

Reducing reliance on ECAI ratings.

Pillar-2 and 3 measures for better governance and disclosures.

Supplementing Risk Based Capital requirement with Leverageratio.

Introducing Global Liquidity standard.

LCR & NSFR.


7/33


8/33

Flaws in existing definition of capital Regulatory adjustment (deductions) not applied

to common equity

No harmonized list of regulatoryadjustments/deductions. Weak transparency in disclosure of regulatory

capital.

Subordinated instruments turned out to be lessloss absorbent during crisis.


9/33

Raising quality, consistency and

transparency of capital baseImproving/enhancing risk coverage onaccount of counterparty credit risk

Supplementing risk based capitalrequirement with leverage ratioReducing pro-cyclicality and introducingcountercyclical capital buffer


10/33

Redefining Capital Predominant form of Tier 1 capital must be the common

equity CE(common shares and retained earnings). Increased minimum requirement for CE -from 2% to 3.5%

by Jan, 2013,4% by 2014 and 4.5% from Jan, 2015. The Tier 1 capital - increased from 4% to 6% over the same

period. Capital instruments that do not meet the criteria for

inclusion in common equity Tier 1 will be excluded fromcommon equity Tier 1 as of 1 January 2013.

Abolished Tier III capital.


11/33

Countercyclical buffer & Capital Buffers

Countercyclical Buffer Range of 0% 2.5% of CE or other fullyloss absorbing capital (Influenced by national circumstances)linked with excessive credit growth (when credit to GDP ratio isabove its long term trend by certain percentage) .

Capital conservation buffer 2.5%, is designed to :

Ensure that banks build up capital buffers outside periods of

stress which can be drawn down as losses are incurred.

Invoke capital distribution constraints on a bank when capitallevels fall within the following ranges.


12/33

Minimum Required 1st Jan,

2013

1 st Jan,

2014

1 st Jan,

2015

1 st Jan,

2016

1 st Jan,

2017

1 st Jan,2018

1st, Jan,20

19Common EquityCapital Ratio

3.5% 4% 4.5% 4.5% 4.5% 4.5% 4.5%

CapitalConservationBuffer

0% 0% 0% 0.625%

1.25% 1.875%

2.5%

CE Capital Ratio

Plus Capital Buffer

3.5% 4% 4.5% 5.125

%

5.75

%

6.375

%

7%

Phase-indeductions fromCET1(DTA, Significant Investments) subject to Thresholds)

20% 40% 60% 80% 100% 100%

Tier-1 capital 4.5% 5.5% 6% 6% 6% 6% 6%Total capital 8% 8% 8% 8% 8% 8% 8%Total capital PlusconservationBuffer

8% 8% 8% 8.625%

9.25% 9.875%

10.5%

Discretionarycountercyclicalbuffer(Common Equity)

0% 0% 0% 0.625%

1.25% 1.875%

2.5%

Phasing out non -eligible capital instruments (as per new definition )from CET1, T1 or T2 capital To be phased out by 10 years from 2013


13/33

Raise the capital buffers for counterparty credit exposures arising from

derivatives, repo and securities financing transactions.Banks with large and illiquid derivative exposures to counterparty willhave to apply longer margining periods for determining the regulatorycapital.

A stressed value-at-risk (VaR) capital requirement based on a 12-monthperiod of significant financial stress & higher capital requirements forresecuritisations .

Incentives to move OTC derivative contracts to central counterpartiesthrough relatively lower capital requirements.

Incentives to strengthen the risk management of counterpartycredit exposures & collateral management.

Banks will be subject to a capital charge for MTM losses ( ie creditvaluation adjustment CVA risk ) associated with deterioration inthe credit worthiness of counterparty.

Asset value correlation of 1.25 for Systemically importantfinancial firms and unregulated financial firms


14/33

2011 2012

2013 2014 2015 2016 2017 2018 1st Jan,2019

Leverage Ratio SupervisoryMonitoring

Parallel Run 1st Jan,2013- 1st Jan,2017.

Disclosure from 1st Jan, 2015

Migrationto Pillar 1

Liquidity Coverage Ratio Observation Period IntroduceMinimum Standard

Net Stable FundingRatio

Observation Period IntroduceMinimumStandard


15/33

Help in to mitigate the risk of high leverage &destabilizing deleveraging processes which can damagethe financial system and the economyAdditional safeguard against model risk andmeasurement error by supplementing the risk-basedmeasure with a simple, transparent, independentmeasure of risk . Minimum should be 3%.Reinforce the risk based requirements with a simple, non-risk based backstop measure

Numerator Tier 1 capitalDenominator On and off balance sheet exposure creditequivalent


16/33

Key characteristic of the financial crisis wasinaccurate and ineffective management of liquidity risk

Two standards/ratios proposed Liquidity coverage ratio (LCR) for short term (30

days) liquidity risk management Net Stable Funding Ratio (NSFR) for longer term

structural liquidity mismatches


17/33


18/33

Ensuring enough liquid assets to survive an

acute stress scenario lasting for 30 days


19/33

Banks must hold unencumbered high quality liquid assets tocover total net cash outflows over a 30 day period under astressed scenarioUnencumbered means not pledged to secure, collateralize orcredit enhance any transaction

Assets are considered high quality liquid assets if they canbe easily and immediately converted into cash at little or noloss of valueHigh quality liquid assets should also ideally be eligible atcentral banks for intraday and overnight liquidity needs

In certain jurisdictions where central bank eligibility is limitedto a narrow list of assets, a supervisor may allowunencumbered, non-central bank eligible assets to be used2 categories of assets Level 1 and Level 2 asset


20/33

cashCentral bank reserves;

Marketable securities representing claims on/ claimsguaranteed by sovereigns, central banks, non-centralgovernment PSEs, BIS, IMF, EC or multilateraldevelopment banks which have a 0% risk weightunder Basel 2 Standardized Approach; have a deepand active repo or cash markets; is a proven source

of liquidity in markets; and is not a financialobligation

Non-0% risk-weighted sovereigns/ central bank debtsecurities issued in domestic currency or foreign

currency; AA- and better


21/33

Subject to a minimum 15% haircut and capped at 40% (post haircut)marketable securities representing claims on/ claims guaranteed bysovereigns, central banks, non-central government PSEs, or multilateraldevelopment banks.

The conditions are the same as Level 1 except these will have a 20% riskweight under Basel 2 Standardized Approach

corporate bonds and covered bonds satisfying the followingconditions :-

i) not issued by a financial institution/ its affiliates (for corp. bonds)

ii) not issued by bank itself/ its affiliates (for covered bonds)

iii) have a credit rating from a recognized credit institution of at least AA-

ratingiv) traded in large, deep and active cash or repo markets

v) proven record as a reliable source of liquidity (max. decline of

price/ increase in haircut over 30 day period does not exceed 10%)


22/33

Run-off of a proportion of retail deposits;

Partial loss of unsecured wholesale funding capacity;

Additional contract outflows that arises from a banksdowngrade in its public credit rating by up to and including 3notches, including collateral posting requirements;

Increase in market volatilities that impact quality of collateral/ potential future derivatives exposure that mayrequire larger collateral haircuts/additional collateral or leadsto other liquidity needs;

Unscheduled draws on committed but unused credit and

liquidity facilities that a bank provides to its clients;Potential need for a bank to buy back debt/ honor non-contractual obligations to mitigate reputational risk


23/33

To promote medium to long term structural funding of assets andactivities

Available amount of stable funding

Defined as the total amount of a banks:

a) Capital

b) Preferred stock with a maturity of equal or >1 yr

c) Liabilities with effective maturity equal or >1 yeard) Portion of non-maturity and/or term deposits with maturities of


24/33

Amount of stable funding measured usingsupervisory assumptions on the liquidityprofiles of an institutions assets, off-balancesheet exposures etc.

Required amount of stable funding = Sumof the value of the assets held multiplied by therelevant RSF factor, added to the amount of off-balance sheet activity multiplied by itsassociated RSF factor.

Assets that are more liquid and more readilyavailable as a source of extended liquidity in

the stressed environment, receive a lower RSF


25/33


26/33

Shortfall in capital = Almost 60 % of Tier 1 capitaloutstanding,Liquidity gap = Approx 50 % of all O/s short-term liquidity.Estimated Decline in ROE -4% Europe -3% US

Estimated Shortfalls by 2019(Source McKinsey Report, Nov, 2010)


27/33

Retail banks - Affected least, unless with very low capitalratios.Corporate banks Increase in cost for specialized lending,trade finance and capital market exposures & OTC Derivatives.Investment banks - Core businesses profoundly affected,particularly trading, OTC derivatives and securitization

businesses.

Cutting costs ,adjusting prices, Balance-sheet restructuring -Improve the quality of capital and Business-model adjustments

Create capital/ RWA light- and liquidity-efficient businessmodels and products.

Rethink the scope and even the viability of specific businesslines and exit certain lines ,if found unviable through above


28/33


29/33

Lending between financial institutions & LCs- An essential element of tradefinance & Basel III Increases RW for financial institutions by some 20 % to30 %.

Leverage ratio - Trade finance now count in full Vs 20%-50% now, afivefold increase over todays capital ratio requirements.

Liquidity rules More reserves against off-balance-sheet liquidity linessuch as LCs and trade guarantees.

Increase in Product Costs - Structured finance, unsecured loans,specialized lending. Estimated increase of about 60 basis points.

OTC derivatives - Stressed value at risk, incremental risk charge (IRC),credit valuation adjustments (CVAs) increase capital for counterparty creditrisk and market risk, along with increased liquidity costs and reducedliquidity benefits trades.

Trades with lower-rated counterparties /trades with counterparties withlimited netting ability- to be more costly Eg: sales of risk-managementproducts to corporates


30/33


31/33

SOME EXAMPLES

Offering transaction a/cs with investment capabilities. For NSFR, such a/cshave beneficial treatment of stable funding.Ensure all short-term investment funds are held in accounts classified asstable.Attract more stable funding - Retail and small and midsize enterprise (SME)deposits.Substitute factoring for receivables financing which reduce RWAs by nearlyhalf.Convert corporate lending into corporate bond issuance for large, high-quality clients,. Substitute RWA-free fee income for RWA heavy net interestincome.

Increase the proportion of short-maturity lending to reduce funding costs.Use risk-adjusted pricing to accurately account for costs for risk, capital,and liquidity.

REDESIGNING CUSTOMER MIX & ACQUISITION

STRATEGIESExit customers with big share of the banks RWAs without returning the


32/33

BIS, Macroeconomic Assessment Group (MAG)- April ,2011 studyreleased in Oct, 10,2011.

Fall in GDP by 0.34% from baseline forecast, followed bya recovery.

Due to Higher capital requirements on the top 30 potential G-

SIBs (globally systemically important banks) over 8 yrs. Roughly 0.04 % reduction from annual growth, while lending

spreads rise by around 0.31%.Benefits Outweigh Costs

Estimatedthe benefitsof Basel III

= The degree to which reduction inthe exposure of the financialsystem to systemic crisesreduces the annual probability of a systemic crisis.

Estimate of overall cost of atypical crisis interms of lostoutput

Estimated annual benefit -Up to 2.5% of GDP.

Benefits many times the costs of the reforms by temporarily slower


33/33

Risk Governance

Balancing Growth with capital.

Pillar-2 enhancements for risk coverage.

Risk Based pricing and remuneration.

Strengthening Liquidity management & reporting.

Enhancing counterparty credit risk and collateralmanagement standards.Infrastructure- Addressing Gaps in MIS & Skillsets forBasel-II & III compliance.

basel iii and impact analysis

Documents