basel iii new rules, new game - treasury alliance …©2015 – treasury alliance group llc – all...

©2015 – Treasury Alliance Group LLC – All Rights Reserved

BASEL III New Rules, New Game

Daniel L. Blumen, CTP Partner, Treasury Alliance Group LLC


New Rules, New Game

•  Basel III, the BCBS response to the financial crash of 2008 –  Builds on systemic risk reduction efforts of Basel I and II –  Adds liquidity and leverage standards to capital adequacy

•  Directly affects banks, the banks will shift the impact to key treasury services such as: –  Cash pooling and concentration –  Short term funding and investment

•  The effect is magnified for global treasuries because of the G-SIB designation of large providers –  Will be felt unevenly due to varying bucket assessments

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Today’s Session

•  New rules •  New game •  Taking action •  Questions and discussions

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NEW RULES


The Basel Accords

Accord Lever 1 – Capital

Basel I Published: 1988

•  Capital •  Flat rate 8% of exposure

•  Rules across international banks •  Minimum base of own funds in every bank

Basel II Published: 2004

•  More capital •  8% of Risk Weighted

Assets

•  Risk differentiation – more capital for higher risk •  Added operational risk, besides credit and market

Lever 1 - Capital Lever 2 - Liquidity Lever 3 - Leverage

Basel III Published: 2010-13

More and better capital •  Minimum Capital

Standards (2013-2019) •  Basel III strengthens

capital adequacy in all three components – capital resources, risk weighted assets and capital ratios

•  More liquidity/better long term funding

•  Liquidity Coverage Ratio (2015-2019)

•  Net Stable Funding Ratio (2018)

•  Basel III introduces a regime that promotes resilience to liquidity shocks

•  Prevents excessive build up of leverage

•  Leverage Ratio (2018)

•  Basel III introduces a regime that constrains leverage in the banking sector and mitigates model risk through non risk based measures

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Lever 1 - Capital

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•  Common Equity Tier 1: 4.5% • Minimum Tier 1 Capital ratio: 6%

Minimum Risk Based Capital Ratio: 8%

•  Capital Conservation Buffer: >2.5% •  Countercyclical Buffer: 0%-2.5% •  G-SIB Surcharge: 1% - 2.5%

Additional Capital Requirements

Total Potential Capital Requirement: 15.5% …or higher


Levers 2 and 3

•  Lever 2 - Liquidity –  Liquidity coverage ratio (LCR)

•  Stock of high quality liquid assets divided by net cash outflows over a 30 day time period

–  Net stable funding ratio (NSFR) •  Available amount of stable funding divided by required amount of stable

funding, must be at least 100%

•  Lever 3 – Leverage –  Leverage ratio

•  Qualifying tier 1 capital divided by total assets plus off balance sheet items, must be at least 3%

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Global Systemically Important Banks

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November 2014


NEW GAME


Product View of the Balance Sheet

•  Higher equity translates to higher cost of credit products

•  Specific liquidity requirements translate to new pricing of depository services

•  Leverage requirements translate to new pricing of other services

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•  Client value to bank –  Operational deposits under 30 days –  Deposits over 30 days –  Non-operational deposits under 30 days –  Potential threat to hub and spoke cash management structures

•  Impact on liquidity management products –  Gross values of pooling participant accounts may be required –  Potential universal requirement for cross-guarantees in pooling

structures –  Impact on use of indigenous/global bank model is unclear –  Unknown impact on global banks leveraging priority or strategic

banking partners –  Too early to answer many of these questions

Liquidity Management – Deposits

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•  Costs will change –  More direct link between risk rating and cost –  Long term lending will become more challenging given

need for stable deposits

•  Capital and liability requirements will reduce ability to create assets (loans) l

•  Overdraft finance will become more expensive •  Backup/undrawn lines will become more

expensive

Liquidity Management – Borrowing

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Risk Management

•  Hedging and the credit value adjustment (CVA) –  The CVA is the difference between the value of a derivative

assuming the counterparty is default risk-free and the value of a derivative reflecting the default risk of the counterparty

–  The US interpretation of CVA differs from the EU interpretation of CVA

–  Hedging costs will change and vary by domicile of contract

•  Basel III piles onto EMIR and Dodd Frank for OTC derivatives –  Highly complex in terms of calculations and interactions –  Net result is that OTC derivatives will cost more

•  Basel III impact –  Risk matters more –  New calculations apply

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Trade Finance

•  Trade finance instruments (LCs and BAs)have not been a source of leverage for banks –  Risk profile is much lower –  Fully collateralized –  Lower leverage and run-off requirements

•  Basel III treats trade finance products as regular loans –  Will be included in calculating a bank’s leverage ratio –  Will also impact liquidity ratios but level of impact is still unclear

•  Trade finance instruments will incur higher capital and funding costs –  May have a negative impact on trade for developing countries as

indigenous banks could pull back –  Non-bank products may become an alternative

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Relationship Management

•  Compliance costs –  Diminish as a share of total revenue for large relationships

•  Type and usage of bank products and services –  Retailers using multiple collection banks may experience higher costs,

incentive for electronic payments –  Credit facilities will be sized more carefully and monitored by both

sides –  Credit ratings of bank and client will matter more

•  Total relationship matters –  Banks incented to focus on fewer, lower risk and more profitable

customers –  Poorly performing relationships are at risk given regulatory focus on

capital –  Treasury management business will become even more valuable for

banks

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TAKING ACTION


Four Steps

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Basel III Readiness

3) RAROC Analysis

1) Impact Assessment

2) Counterparty Review

4) Banking Continuity Plan


Impact Assessment

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Use rating agencies or banks, validate

assumptions and input

Include transactions by entity, currency, type

and bank

Funding needs for short and medium term,

same for deposits and investments

Leverage TMS, bank portals and field

accountants

Validate credit rating

Assess transaction flows

Determine liquidity requirements

Ensure visibility of all corporate liquidity


Counterparty Review

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Include banks, other financial institutions,

customers and suppliers

Formal process to ensure continued

accuracy and appropriateness

Bank ratings, customer concentration,

investment instruments

Identify counterparty exposure

Review and update

Validate compliance with internal policies


RAROC Analysis

•  RAROC = Risk Adjusted Return On Capital •  Developed as a profitability tool for banks

–  Includes all elements of the relationship, not just those managed by treasury

–  Assigns risk rating to each of these elements –  Compares total risk to total return

•  The formula: risk adjusted return divided by risk-adjusted capital required for the return –  Accounts for the capital needed to support relationship

•  Used in one form or another by virtually all banks

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Banking Continuity Plan

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Who can do it, who do you want, do they want

you

Systems vendors, third party applications,

consultants

Planned actions under various scenarios

Critical, core and desirable

Bank Selection

Non-bank Partners

If/Then Analysis

Banking Activities


Key Lessons

•  Basel III is aimed at financial institutions –  Will have follow on impact for corporates –  Exact nature is still unclear but EU/US divergence shows the

potential for adventure

•  There will be confusion •  Basic housekeeping

–  Develop accurate picture of current treasury management practices –  Eliminate unnecessary excess lines, OD protections and hedging

operations –  Communicate your intentions and needs to counterparties –  Perform bank spend analysis

•  Further action –  RAROC analysis –  Banking continuity plan

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