Basel IV and proportionality initiativesUpcoming changes to the Canadian capital and liquidity framework

IntroductionEnhancements to risk-based capital requirements and minimum liquidity and funding standards for Deposit-Taking Institutions (DTIs) are two foundational aspects of post-financial crisis reforms introduced by Basel III. In Canada, initial Basel III reforms dedicated to raising the quality and quantity of capital have already been implemented. The domestic implementation of Basel III liquidity and funding standards will be complete when DTIs begin reporting the Net Stable Funding Ratio (NSFR) in

Q1-2020. Attention is now focused on the implementation of final Basel III reforms, informally referred to as ‘Basel IV’, which introduces extensive revisions to the calculation of Risk-Weighted Assets (RWA) for Pillar 1 risks. OSFI’s proposed policy direction and implementation timelines for Basel IV are included in OSFI’s July 2018 discussion paper, Implementation of the final Basel III reforms in Canada.

While the Basel framework was originally designed to apply to large, internationally-active banks, domestic regulators including OSFI have applied Basel standards to a wider set of banks for pragmatic reasons. However, the complexity introduced by Basel III/ IV has led regulators to now consider how the framework can be better tailored to smaller, less complex banks. OSFI’s July 2019 discussion paper titled Advancing Proportionality: Tailoring Capital and Liquidity Requirements for Small and Medium-Sized Deposit Taking Institutions presents its proposals to tailor requirements for non-D-SIB banks. OSFI’s timelines for implementing the changes related to Pillar 1 capital and liquidity requirements conclude in Q1-2022,

which obligates DTIs to achieve compliance with updated standards in short order.

In this paper, we provide a consolidated overview of the scope and timelines for the upcoming revisions to capital and liquidity requirements for DTIs and outline the extent to which proportionality considerations affect the scope of changes affecting Small and Medium Sized Institutions (SMSBs). Foreign Bank Branches (FBBs) are subject to different standards and expectations with respect to capital and liquidity, and a brief outline of the current state and future changes is also provided. Finally, we conclude with a summary of KPMG’s perspective on key considerations and challenges for DTIs leading up to Q1-2022.

Figure 1: Summary of basel capital, leverage and liquidity requirements

Focus of Basel III:Raising the quality and quantity of capital

Capital LCR, NSFR

Risk positions

Leverage ratio

SA for measuring

counterparty credit risk

Operationalrisk

SA for credit risk

IRB for credit risk

Market risk(FRTB)

CVA risk Output floor

Securitisation

CET1ratio

Focus of Basel IV:Revising how risks are calculated

RWA

Source: Workshop Basel IV, KPMG International, 2018.

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2 Basel IV and proportionality initiatives

Overview of the current Canadian capital and liquidity framework 1. Current capital and liquidity requirements for SMSBs and D-SIBs

Capital requirements, leverage requirements and the output floor

The following table summarizes the minimum target levels for risk-based capital ratios for DTIs:

Table 1: SMSB and D-SIB Risk-based Capital Ratios

Common Equity Tier 1 (CET1) Tier 1 Total

Minimum Ratios 4.5% 6.0% 8.0%

Capital Conservation Buffer (CCB) 2.5% 2.5% 2.5%

Countercyclical Buffer (CCyB) Not activated Not activated Not activated

Minimum Target for SMSBs (including buffers) 7.0% 8.5% 10.5%

D-SIB Buffer 1.0% 1.0% 1.0%

Domestic Stability Buffer (DSB) 2.0% 2.0% 2.0%

Minimum Target for D-SIBs (including buffers) 10.0% 11.5% 13.5%

Sources: Capital Adequacy Requirements Guideline, OSFI, 2019 Industry Notice on Domestic Stability Buffer, OSFI, June 2019

DTIs are also expected to maintain a leverage ratio (LR) of at least 3%. Disclosure requirements for capital and the leverage ratio can be found in OSFI’s Capital Disclosure Requirements and D-12 Leverage Ratio Disclosure Requirements.

In addition to the above changes that raise the quality and quantity of capital, the implementation of updated Basel IV standards related to the calculation of RWAs has also begun. Revisions to the securitization framework, the capitalization of central counterparty exposures (for inclusion in the calculation of both risk-based capital and leverage requirements), and the standardized approach for counterparty credit risk (SA-CCR) were implemented in Q1-2019. Outstanding revisions to RWA calculations will be implemented by Q1-2022.

DTIs that have received OSFI’s approval to use advanced approaches to determine credit or operational risk capital requirements are required to calculate a capital floor which limits the extent that RWAs can be lowered relative to standardized approaches. Prior to Q2-2018, Canadian DTIs using internal models to calculate a Basel I capital floor as per OSFI’s now expired A-3 Guideline. Effective Q2-2018, Canadian DTIs using internal models, or Internal Models Approved Institutions (IMAIs), switched over to revised capital floor based on Basel II standardized approaches which will stay in place until Q4-2021 using a scaling factor of 72.5%.

Figure 2: Interim domestic Basel II output floor

Modelled RWA = Total RWA using OSFI-approved advanced approaches plus partial-use portfolios treated under non-modelled approaches

Floor RWA = Credit RWA, Market RWA, Other Credit RWA and CVA RWA using standardized approaches (with some advanced inputs for CVA and market risk depending on a DTI’s approval status).

Modelled RWA 75% x Floor RWALess 12.5 x deductions for allowances included in capital

Plus 12.5 x allowance for shortfall deductions

Modelledrequirement

Floorrequirement

Source: Capital Adequacy Requirements Guideline, Chapter 1.9.1., OSFI 2019

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Basel IV and proportionality initiatives 3

Liquidity requirements

As stated in the Liquidity Adequacy Requirements (LAR), OSFI’s assessment of an institution’s liquidity adequacy is informed by its minimum liquidity and funding standards, additional liquidity metrics and supervisory standards. All DTIs are currently required to maintain a Liquidity Coverage Ratio (LCR) of no lower than 100% and D-SIBs must provide public disclosures in accordance

with OSFI’s D-11 Guideline. DTIs are also required to report to OSFI the Net Cumulative Cash Flow (NCCF) metric for multiple time horizons up to one year as well as a suite of liquidity and intraday liquidity monitoring tools. Although NCCF and other monitoring tools do not have defined minimum thresholds, OSFI reserves the right to set regulatory requirements as needed.

Figure 3: Factors in the supervisory assessment of liquidity adequacy

Minimum liquidity and funding standards

LCR NSFREffective Q1-2020

Supervisory assessments

OSFI B-6Liquidity principles

BCBS 144Principles for

sound liquidity risk management and

supervision

Additional liquidity metrics

NCCF Monitoring tools

Intraday monitoring tools

2. Current capital and liquidity requirements for foreign bank branches (FBBs)

FBBs are subject to different capital and liquidity requirements than D-SIBs and SMSBs. Instead of risk-based capital requirements, FBBs hold a foreign bank branch deposit (FBBD) requirement that is met by unencumbered assets deposited with an approved financial institution in Canada. For a lending branch, the FBBD is $100,000, whereas for a full-service branch there is an initial FBBD requirement of $5 million with additional maintenance requirements to account for fluctuations in liabilities and supervisory concerns.

With respect to liquidity, OSFI’s draft B-6 guideline indicates that FBBs may require quantitative reporting pertaining to the liquidity of the branch in Canada and its degree of ongoing reliance on its head office.

Figure 4: FBBD maintenance requirements for full-service branches

Supervisory concerns (if required by OSFI)

Fluctuation in liabilities

Base requirement

Source: Draft Guideline A-10, OSFI, 2019

Source: Liquidity Adequacy Requirements Guideline, OSFI, 2019

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4 Basel IV and proportionality initiatives

Overview of the upcoming changes to the Canadian capital and liquidity frameworkIn this section, we begin by reviewing the upcoming changes to the Canadian capital and liquidity framework for D-SIBs, which are directly transcribed from Basel, with modifications to take into account the unique aspects of domestic implementation

in Canada. Next, we explore OSFI’s proposals for how the tailoring of base D-SIB requirements helps to better fit the unique characteristics of SMSBs. This section concludes with a brief synopsis of changes to FBB branch capital requirements.

1. Domestic systemically important banks (D-SIBs)

Capital requirements, output floor and leverage requirements

As mentioned in Section II, the implementation of updated standards related to Basel IV is currently underway. This section provides a summary of the changes for which implementation is not complete and outlines the details of OSFI’s proposals for domestic implementation.

Credit risk

Changes to the credit risk standards in Basel IV introduce a revised, more risk sensitive and granular Standardized Approach

(SA), and modifications to the Internal Ratings Based (IRB) – the removal of the IRB eligibility of some asset classes and the introduction of parameter floors. The Basel Committee on Banking Supervision (BCBS) has also indicated that the 1.06 scaling factor that currently applies to credit RWAs no longer applies in light of revisions to the risk-weighted framework and the revised output floor1. KPMG’s Basel IV: The Way Ahead series includes two articles that explore the changes to the SA and IRB approaches in further detail.

OSFI’s July 2018 discussion paper proposes additional changes intended to better reflect Canadian market characteristics:

Table 2: Proposed changes to the domestic credit risk capital framework – Applicability to SA and IRB approaches

Residential mortgages Credit card exposures Retail SBE /Corporate SME

Impacted approach

Maintaining a 10% LGD Floor

Separate risk weight function for ‘property generated cash flow dependent’ residential mortgages

� Risk weight for transactors and

� Risk weight for non-transactors

� CCF for unconditionally cancellable commitments

� PD floor for non-transactors

Apply Corporate SME risk weights to both Retail SBE and Corporate SME categories

Revised Standardized Approach (SA)

× × ×

Modifications to the IRB Approach

× × × ×

Source: Domestic Implementation of the Final Basel III reforms, OSFI, July 16, 2018.

Operational risk

Basel IV reforms remove the Advanced Measurement Approach (AMA) from the regulatory framework and streamlines the operational risk framework by replacing the existing standardized approaches (The Basic Indicator Approach and the Standardized Approach) with a single, approach named the Standardized Measurement Approach (SMA). The SMA for operational risk

capital is determined by using an income statement based proxy known as the Business Indicator Component (BIC) and applying a scaling factor known as the Internal Loss Multiplier (ILM) which accounts for a bank’s historical loss levels based on internal data. KPMG’s Basel IV: The Way Ahead series explains the mechanics of the SMA approach in further detail.

1 Footnote 3, Page 3, Basel III: Finalising post-crisis reforms. https://www.bis.org/bcbs/publ/d424.pdf

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Basel IV and proportionality initiatives 5

OSFI’s July 2018 discussion paper proposes exercising the national discretion permitted by the BCBS in relation to the inclusion and exclusion of internal loss data in the following ways:

1. Establish a minimum threshold of C$25,000 for including loss events in data collection and average annual loss calculations used in calculating the ILM.

2. Allow smaller FIs (with a business indicator, or BI < C$1.25B) to use historical losses if they are able to meet minimum requirements with respect to loss data collection. This would make smaller banks’ operational risk capital requirements sensitive to their internal loss experience.

OSFI is providing a transition period for DTIs currently using AMA for operational risk capital (‘AMA DTIs’) as illustrated below:

Figure 5: Transition period for Basel III SMA implementation

2019 2020 2022

Continue using AMA capital reporting for the remainder of

fiscal 2019 reporting.

Reporting using the current standardized approach (TSA) for fiscal 2020

Removal of requirement for using business environment and internal control factors (BEICF)

Implement SMA foroperational risk capital

After AMA is de-commissioned, OSFI expects AMA DTIs to continue conducting internal and external loss data and scenario analysis as part of their internal risk management practices.

Market risk and CVA risk

The new Fundamental Review of the Trading Book (FRTB) framework introduces essential structural changes to all processes and calculations involved in determining market risk capital requirements. KPMG’s Basel IV: The Way Ahead series includes an article that explains the mechanics of the FRTB in further detail.

In a July 2017 industry letter, OSFI communicated its commitment to implementing the revised market risk capital standards by Q1-2022, however uncertainty remains within the marketplace in relation of the scope and timing of implementation plans for the internal models approach (IMA).

The revised standards for CVA Risk consist of two new options: the Basic Approach (BA-CVA) and a new Standardized Approach (SA-CVA). KPMG’s Basel IV: The Way Ahead series includes an article that explains the mechanics of the BA-CVA and SA-CVA approaches in further detail. In its July 2018 discussion paper, OSFI indicated that it intends to implement the changes for the updated CVA risk framework without any modifications in Q1-2022.

Output floor

Basel reforms introduce an updated output floor based on Basel III standardized approaches. Basel will phase in the capital floor from January 1, 2022 to January 1, 2027 by increasing the scaling factor from 50% to 72.5% over a five year period. However, OSFI has proposed implementing the output floor at a level of 72.5% effective Q1-2022, as it believes the transition period on the output floor is not needed.

Figure 6: Basel IV Capital Floor

Post floor RWAs = Max (pre-floor RWAs, 72.5% x standardised RWAs)

Pre-floor RWA

RWA using banksapproved methods

Standardized RWAs

Hypotheticalstandardised RWA

Post floor RWA

Maximum of pre-floor RWA and 72.5% of the

standardised RWA

4.5% of RWAs as

CET1 capital to meet pillar 1

rquirements

72.5% of SA

if SA

= 2-1

Operational risk SA

Market risk SA

CVA SA

CCR SA

Credit risk SA

Credit risk SA(roll out)

Additional RWA due to floor

Step 1 RWA

Operational risk SA

Market risk IMA

CVA SA

CCR IMM

Credit risk IRB

Credit risk SA(roll out)

1

2

3

Source: Workshop Basel IV, KPMG International, 2018.

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6 Basel IV and proportionality initiatives

Leverage ratio

Basel III reforms to the leverage ratio (LR) include a new LR buffer for G-SIBs and technical refinements to the exposure measure in the denominator of the LR. In its July 2018 discussion paper, OSFI proposes conservatively treating D-SIBs as first bucket G-SIBs and applying a LR buffer of 50 bps to D-SIBs (i.e. 50% of the D-SIB capital buffer of 1%). This raises the minimum LR requirement for D-SIBs to 3.5% starting in Q1-2022. The LR exposure measure has already been updated in Q1-2019 to reflect

the new SA for counterparty credit risk, but additional technical refinements to the treatment of on-balance sheet exposures, securities financing transactions (SFTs) and off-balance sheet items will be considered as part of OSFI’s consultation process for annual changes to the LR framework prior to Q1-2022.

Liquidity

Net stable funding ratio

Effective Q1-2020, OSFI will incorporate the NSFR into the Liquidity Adequacy Requirements (LAR). NSFR Disclosure requirements become effective in January 2021. The NSFR is a long-term structural liquidity metric defined as the ratio of Available Stable Funding (ASF) to Required Stable Funding (RSF). Based on KPMG’s interpretation of OSFI’s discussion papers on Final Basel III reforms and Proportionality, OSFI proposes requiring D-SIBs and IRB approved SMSBs to calculate the NSFR and maintain a level of at least 100% on an ongoing basis.

2. Small and medium sized banks (SMSBs) According to OSFI’s July 2019 Discussion Paper, proportionality initiatives will follow a phased approach. Phase 1 will focus on the development and implementation of a final set of rules that apply to Pillar 1 capital and liquidity, while Phase 2 will address Pillar 2 and 3.

– Phase 1: Rules will be finalized by December 2020 and implemented effective Q1-2022.

– Phase 2: Consultations will begin mid-2020 and finalization timelines are TBD.

Segmentation approach – dividing SMSBs into four categories

The SMSB category is comprised of domestic banks and credit unions, foreign bank subsidiaries, and trust and loan companies that differ significantly with respect to their nature, size, complexity and business activities. OSFI has proposed

segmenting SMSBs using the following qualitative and quantitative criteria:

1. IRB approval status: IRB-approved DTIs demonstrate a high level of sophistication with respect to their use of ratings, corporate governance and internal controls.

2. Size of on-balance sheet assets: Used as a proxy for a DTI’s size.

3. Size of Assets Under Management (AUM) or Assets Under Administration (AUA): Used as an additional factor to segment DTIs for SMSBs with relatively small amounts of on-balance sheet assets.

4. Supervisory judgement: Retained as a final category in assessing the nature of a DTI’s business.

Based on these criteria, OSFI has proposed the segmentation of SMSBs into four categories, as seen in Table 3:

Table 3: Proposed segmentation scheme for SMSBs

Category 1 2 3 4

Criteria Approved to use IRB approach for credit risk

SMSBs > $10B in assets

SMSBs with Assets of $0.5B to $10B or >$20B in AUA/AUM

SMSBs with ≤ $0.5B in Assets and ≤ $20B in AUA/AUM

Characteristics Large, diverse SMSBs Large SMSBs (with varying complexity and diversification)

Smaller SMSBs (with less complexity and diversification)

Smallest,

least complex institutions

Source: Advancing Proportionality: Tailoring Capital and Liquidity Requirements for Small and Medium-Sized Deposit-Taking Institutions, OSFI, 2019.

Figure 7: D-SIB Leverage requirements

3.5% Leverage ratio buffer

3.0%

Leverage requirement

Source: Leverage Requirements Guideline, OSFI, 2019.

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Basel IV and proportionality initiatives 7

Tailoring capital requirements, output floor and leverage requirements for SMSBs

Credit risk Operational risk Output floor

Category 1 SMSBs with IRB approval will be subject to the revisions to the credit risk capital framework as described in the D-SIB section above: the removal of IRB eligibility of some asset classes, newly introduced parameter floors, and changes intended to reflect Canadian market characteristics. OSFI proposes tailoring requirements to reduce complexity and better capture risks for Category 2 – 4 SMSBs in the following way:

– Category 2 SMSBs: Fully implement the final Basel III SA with the option of using a simplified standardized approach (SSA).

– Category 3 SMSBs: Use a SSA with the option of fully implementing the final Basel III standardized approach.

– Category 4 SMSBs: Exempt from all risk-based capital requirements for Pillar 1 risks.

SMSBs will continue to use their current approach (either the BIA or TSA) for operational risk until Q1-2021. OSFI is considering the following approach for tailoring SMSB operational risk requirements:

– Category 1 and 2 SMSBs: Implement the SMA as outlined in the final Basel III reforms.

– Category 3 SMSBs: Continue to use a simple approach to calculate operational risk capital (e.g. a simple flat rate charge based on the current BIA or another measure such as assets, AUA/AUM).

– Category 4 SMSBs: Exempt from all risk-based capital requirements for Pillar 1 risks.

The output floor will only apply to SMSBs that are also Internal Models Approved Institutions (IMAIs).

SMSBs that do not use advanced approaches to determine Pillar 1 capital requirements do not have to take the output floor into consideration.

Leverage requirements

Under OSFI’s proposal, Category 4 SMSBs will no longer be required to calculate risk-based capital ratios. The leverage ratio would be used to assess capital adequacy against an exposure measure that does not require assets to be risk-weighted.

They would instead be held to a higher minimum leverage ratio. Instead of the current 3% minimum, a possible range of 8%-12% was proposed.

Liquidity requirements

SMSBs are currently required by OSFI to calculate the Liquidity Coverage Ratio (LCR), Net Cumulative Cash Flow (NCCF), and a suite of assessment tools for assessing liquidity adequacy. OSFI’s July 2019 Discussion Paper proposes tailoring liquidity requirements for SMSBs in the following way:

– Category 1 SMSBs will have similar reporting requirements as D-SIBs. In addition to calculating the LCR and the NCCF, Category 1 SMSBs will be required to calculate the NSFR.

– Category 2 SMSBs will continue calculating both the LCR and NCCF. However, they will not be required to calculate the NSFR.

– Category 3 SMSBs will be required to calculate the LCR and a series of simplified liquidity metrics that better reflect

the liquidity risks that they face. They will not be required to calculate the NCCF and NSFR.

– Category 4 SMSBs will only be required to calculate a series of simplified liquidity metrics. They will not be required to calculate the LCR, NCCF, and NSFR.

OSFI has indicated that they are looking into possible revisions to the NCCF with the objective of increasing risk capture and modifying cash flow assumptions. The simplified liquidity metrics mentioned above have not been finalized, but may take the form of a minimum liquid asset holding requirement and a simplified cash flow metric depending on the nature of the SMSBs activities.

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8 Basel IV and proportionality initiatives

Table 4: Summary of SMSB proportionality proposals for Pillar 1 capital and liquidity

Category

Criteria

1 2 3 4

Approved to use IRB approach for credit risk

SMSBs > $10B in assets

SMSBs with Assets of $0.5B to $10B or >$20B in AUA/AUM

SMSBs with ≤ $0.5B in Assets and ≤ $20B in AUA/AUM

Capital

Risk-based Capital Ratios

Credit Risk IRB approach SA Simplified SA N/A

Operational Risk

SMA SMA Flat add-on N/A

Leverage Ratio (LR) LR LR LR Increased LR requirement

Liquidity

LCR LCR LCR LCR N/A

NCCF NCCF NCCF Simplified Metrics* Simplified Metrics*

NSFR NSFR N/A N/A N/A

Source: Advancing Proportionality: Tailoring Capital and Liquidity Requirements for Small and Medium-Sized Deposit-Taking Institutions, OSFI, 2019.

3. Foreign bank branches (FBBs) On June 18, 2019, OSFI published its proposed changes to Guideline A-10 that are scheduled to be implemented in Q1 2020. Revisions include updates and simplifications to reflect current practices and changes to the deposit ratio calculation.

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Basel IV and proportionality initiatives 9

Key considerations and challenges There are four key issues faced by banks globally: higher capital requirements, upgrades to data, systems and reporting, managing increased RWAs (by adjusting their product mix, finding cost efficiencies, issuing new capital or reducing RWA) and consideration of the broader context of other regulatory reforms. Piecing the Jigsaw Together from KPMG’s Basel IV: The Way

Ahead series elaborates on these issues in further detail. In addition to the global concerns listed above, we provide KPMG’s perspective on the following considerations and challenges related to the domestic implementation of Basel IV: reforms and proportionality initiatives.

1. Implementation of operational risk reformsDTIs’ implementation of SMA for operational risk should take into account the following considerations:

– Before migrating to the SMA in fiscal 2022, DTIs currently using the AMA must first transition to the TSA approach for operational risk capital in fiscal 2020. The resulting changes in the derivation of the ORC charge requires banks to compile gross income data and quickly address any issues that may arise as a result of data requirements associated with the TSA (e.g. three years of gross income data by Basel-defined business line, proxy development to address missing data, and incorporating gross income data from recent acquisitions).

– SMSBs currently using the Basic Indicator Approach (BIA) or TSA face a degree of uncertainty regarding what to expect in relation to their future ORC requirements. OSFI has proposed requiring Category 1 and 2 SMSBs to use the SMA and having Category 3 SMSBs calculate a to-be-determined flat rate charge for ORC. Category 4 SMSBs are exempt from risk-based capital requirements.

– AMA DTIs and Category 1 and 2 SMSBs should consider investigating the potential scope of SMA implementation efforts, as calculating the ILM vastly increases the scope of a DTI’s implementation as they must meet minimum standards for loss data identification, collection, and treatment documented in sections 5 and 6 of BCBS D424.

2. Implications of proportionality for SMSBs with plans for growth and applying for IRB approvalAfter the implementation of Basel IV: and proportionality related reforms in Q1-2022, SMSBs will be held to capital and liquidity requirements that are tailored to their size and complexity. However, SMSBs with plans for growth or applying for IRB approval will have to take into account the broader implications on its capital and liquidity requirements.

– Under OSFI’s proposed proportionality initiatives, Category 3 and Category 4 SMSBs are subject to less complex Pillar 1 capital and liquidity requirements. However, any future plans for business growth that result in an increase in on-balance sheet assets, AUA, or AUM beyond the thresholds must take into consideration the impact of elevated capital and liquidity requirements. The impact on Category 4 SMSBs is

the greatest, as migration to Category 3 results in the re-introduction of risk-based capital requirements and elevated liquidity requirements (i.e. being subject to LCR standards).

– SMSBs interested in applying for IRB approval should prepare for the impact of OSFI’s proportionality proposals in their work plans. Under the proposed SMSB categorization scheme, a newly approved IRB SMSB would be re-classified as a Category 1 SMSB and this would trigger the requirement to report and meet minimum standards for the NSFR. By electing to use an advanced approach for credit risk capital, a SMSB would be faced with meeting increased liquidity adequacy requirements.

3. SMSBs with exposures to CVA riskSMSBs with non-centrally cleared derivatives will have capital requirements for both counterparty credit risk and CVA risk. The same rules for both D-SIBs and SMSBs apply, and therefore CVA risk is not addressed in OSFI’s discussion paper on proportionality.

However, given that SMSBs typically have smaller derivative portfolios, it is worthwhile to note that the general provisions of

the minimum capital requirements for CVA risk (see Page 109, Paragraph 7 of BCBS 424) permit DTIs below a materiality threshold of €100B have the option to be able to determine CVA capital with CCR capital (i.e. CVA capital = 100% of CCR capital) or through either of the prescribed CVA approaches (BA-CVA or SA-CVA with supervisory approval).

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10 Basel IV and proportionality initiatives

4. Areas of SMSB proportionality initiatives requiring further elaborationOSFI’s proposals for tailoring SMSB’s capital and liquidity requirements do not provide specific details with respect to the simplified SA for credit risk, and simplified liquidity metrics:

– Under OSFI’s proposed approach for credit risk, Category 2 and 3 SMSBs have the option of using either the SA or the SSA for credit risk. The exact format of the SSA has yet to be determined however we are aware of simplified approaches for credit risk that have been implemented for smaller banks in both the US (based on domestic standards), Hong Kong (based on Basel I), and Switzerland (for mutual fund exposures).

– According to OSFI’s proposal, Category 3 SMSBs would continue to use a simple approach for operational risk capital,

a simple flat charge based on the existing Basic Indicator Approach or another measure such as AUM or AUA.

– With respect to liquidity requirements, little has been said about the exact nature of the simplified liquidity metrics for Category 3 and 4 SMSBs, except that they could take the form of a minimum liquid asset holding requirement or a simplified cash flow metric.

– Category 4 SMSBs would be held to higher minimum standards for the leverage ratio, in the range of about 8% to 12%.

SMSBs can get involved in the consultation process to provide feedback and express opinions on the format of these aspects of the proposed proportionality related changes.

5. Model governance implications for changes to IRB eligibility IRB approved DTIs need to consider the model governance implications resulting from the removal of Banks and other FIs, Large/mid-sized corporates and Equities from the Advanced IRB (AIRB) approach in Q1-2022.

– Banks with separate parameter models for regulatory capital (RC) and economic capital (EC) purposes will need to decommission their RC parameter models for the above portfolios in accordance with documented policies and

procedures and in compliance with Section 5.6 of OSFI E-23 Guideline. DTIs should notify relevant stakeholders that models are being decommissioned and established standards regarding the retention of model information and model inventory documentation should be followed.

– Banks that use the same parameter models for RC and EC will have to update their model inventories to reflect the change in model usage for EC purposes only.

ConclusionThe Canadian implementation of the final Basel III reforms (Basel IV) has already begun and it is scheduled to be completed by Q1-2022. For individual DTIs, the nature and scope of Basel IV reforms will differ for D-SIBs and the different categories of SMSBs.

OSFI’s proportionality initiatives for SMSB’s Pillar 1 capital and liquidity requirements will be finalized in December 2020 and they will need to be ready to implement these initiatives as part of their Basel IV implementation in Q1-2022. Their implementation efforts will also be shaped by public consultations regarding Pillar 2 and Pillar 3 considerations that are scheduled to begin in mid-2020.

KPMG can help DTIs implement, interpret and perform gap analyses for the Basel IV regulations and identify synergies

and optimization initiatives on the institution’s required implementation efforts. KPMG can provide support across the end-to-end implementation efforts from rules interpretation, data and systems, model development to independent review, and regulatory reporting.

KPMG in Canada’s Financial Risk Management practice leverages risk and regulatory specialists to provide the latest insights regarding the issues that DTI’s face, and the customers they serve. Our dedicated teams have developed leading and innovative strategies and solutions which are tailored to individual client needs. Utilizing these insights and solutions, KPMG professionals use their deep Financial Services experience to help DTI’s achieve and maintain regulatory compliance in an optimal manner.

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Basel IV and proportionality initiatives 11

GlossaryAIRB Advanced Internal Ratings Based (Approach for Credit Risk)

AMA Advanced Measurement Approach (for Operational Risk)

ASF Available Stable Funding

AUA Assets under Administration

AUM Assets under Management

BA-CVA Basic Approach for CVA Capital

BCBS Basel Committee for Banking Supervision

BI Business Indicator

BIC Business Indicator Component

CCB Capital Conservation Buffer

CCF Credit Conversion Factor

CCR Counterparty Credit Risk

CCyB Countercyclical Buffer

CET1 Common Equity Tier 1 capital

CVA Credit Valuation Adjustment

D-SIB Domestic Systemically Important Bank

DTI Deposit-Taking Institution

G-SIB Global Systemically Important Bank

ILM Internal Loss Multiplier

IMAI Internal Models Approved Institution

IMM Internal Model Method (for Counterparty Credit Risk)

IRB Internal Ratings Based Approach – Credit Risk

FBB Foreign Bank Branch

FBBD Foreign Bank Branch Deposit

FRTB Fundamental Review of the Trading Book

LAR Liquidity Adequacy Requirements

LCR Liquidity Coverage Ratio

LGD Loss Given Default

LR Leverage Ratio

NCCF Net Cumulative Cash Flow

NSFR Net Stable Funding Ratio

OSFI Office of the Superintendent of Financial Institutions

RSF Required Stable Funding

RWA Risk-Weighted Assets

SA Standardized Approach

SA-CVA Standardized Approach for CVA Risk

SBE Small Business Entities

SFT Securities Financing Transaction

SMA Standardized Measurement Approach

SME Small and Medium Sized Entities

SMSB Small and Medium Sized Banks

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© 2019 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 25255 The KPMG name and logo are registered trademarks or trademarks of KPMG International. kpmg.ca

Contact usCraig DavisPartner, Risk Consulting416-777-8671craigdavis2@kpmg.ca

Jason AuDirector, Risk Consulting416-777-3037jasonau@kpmg.ca

Diana LowePartner, Risk Consulting416-777-3838kdlowe@kpmg.ca

Corina DeaconuExecutive Director, Risk Consulting 647-777-5254cdeaconu@kpmg.ca