eba report on basel iv iv eba report_sci.pdf · 1. introduction - crr ii and basel iv 2. the most...

EBA Report on Basel IVThe impact of Basel IV in the EU and the impact on pricing and capital optimization

October 17th, 20195th Annual Capital Relief Trades Seminar

PwC

1. Introduction - CRR II and Basel IV2. The most important contents of CRR II at a glance3. Basel IV - Contents and impacts4. EBA Report on Basel IV implementation in the EU5. Pricing and capital allocation

Agenda

2October 2019CRR II and Basel IV

PwC

The new requirements will come into force in stages from 2019C

RR

II

+ C

RD

V

2019 2020 2022

Securitisations

Adoption in the EU Parliament

16.04.19EBA RTS on Software Capital Deduction

+ 1 year

2021

Date of first application CRR II

June 28, 2021

2023 2024

MREL / TLAC

Market risk

Immo LGD estimation

Definitions

Editorial

Mandates RTS / ITS

Equity Deduction (Exceptions), Compliance Tool, MDBs

reporting

Bas

el

IV

SA-CCR, Investment funds, NSFR, LR, large exposures, IRRBB, step-in-risk, disclosure, CCPEM

RTSDA

+ 4 yearsOwn fundsrequirement Market risk

Output Floor, SA, IRBA, CVA, OpRisk

Own funds requirement A-SA / A-IMA

Floor: Transitional regulations until 2027

LR: G-SII buffer as of 2022

DA: Delegated act Transitional period publication until entry into force Date of application regulationsTransition period until date of application Date of application essential CRR II regulationsExpected date of application essential Basel IV regulations

Publication in the EU Official Journal

07.06.19Entry into force of the CRR II

27.06.19


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The central requirements of CRR II at a glance

Counterparty credit risk (SA-CCR)

• Introduction of a new standardised approach to counterparty credit risk (SA-CCR)

• Consideration of collateral agreements and netting

• Significant increase in risk sensitivity, data requirements and complexity

• Simplified procedures for institutions with small derivatives portfolios

Market risk (FRTB)

• No new rules for the boundary between banking book and trading book

• New standardised approach for highly complex market risks

• New internal models approach for market risks with new approval procedure

• Reporting requirements starting from 2020/21 for standardised approach

Own funds + consolidation

• Profit transfer agreement• New deduction positions• holding companies

MREL & TLAC

• Introduction of TLAC in the EU• Extensive harmonisation with MREL

regulations

OpRisk

• Consideration of depreciation on leased assets analogous to interest expense for loans

Net Stable Funding Ratio (NSFR)

• Transformation into a binding minimum ratio

• Simple alternative for small banks

Leverage ratio

• Introduction of mandatory minimum ratio (3%) and G-SII buffer

• New derogations

Large exposure

• Limits based on tier 1 capital• Changes in credit risk mitigation

Reporting

• Scope / frequency of reporting depending on size + complexity

• EBA develops granular data model

Disclosure

• Amendment / extension of disclosure in accordance with Basel requirements

• proportionality

NPL Backstop

• Implementation of the NPL Backstop through separate CRR Amendment

• Additional capital deduction for the portion of non-performing exposures not covered by risk provisions

• Increase over time, depending on available collateral

• Complex calculation methodology and extensive data requirements

Counterparty risk

• Expansion of the SME factor and introduction of infrastructure supporting factor

• Nomination of further MDBs and international organisations

• Monitoring RW for receivables secured by real estate

• New approaches to the treatment of shares in investment funds

capital requirements complexity capital requirements complexity capital requirements complexity capital requirements complexity

capital requirements complexity capital requirements complexity

capital requirements complexity capital requirements complexity capital requirements complexity capital requirements complexity



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Introduction of the capital floorImpact of the capital floor on RWA and capital ratios

Calculation of the capital floor Impact on capital ratios

Own funds

𝑴𝑴𝑴𝑴𝑴𝑴 𝐑𝐑𝐑𝐑𝐑𝐑𝐈𝐈𝐈𝐈;𝟕𝟕𝟕𝟕,𝟓𝟓𝟓𝟓𝟓𝐑𝐑𝐑𝐑𝐑𝐑𝐒𝐒𝐑𝐑

≥8% + Capital conservation buffer + Anti-cyclical capital buffer + G-SII buffer + O-SII buffer + Systemic risk buffer + Pillar 2 Requirement (P2R)

!

* PU: partial use

Further challenges

• Introduction under transitional arrangements (5 years, 25% increase p.a.)• The amount of the additional RWA due to the application of the capital floors

must be disclosed.• RWAIM and RWASA should be reported and disclosed at the level of the

exposure classes• The floor must be maintained at all levels (solo, subgroup, group).• No adjustment to floor calculation to take account of the different treatment of

credit risk adjustments in the CRSA and IRBA (analogous to Basel specification)

0

50

100

150

RWA (IRBA, before Floor) RWA (SA) RWA (after Floor)OpR MR Real Estate Retail Corp. Summe CR

Example 1: Increase in MR and CR

0

50

100

150

RWA (IRBA, before Floor) RWA (SA) RWA (after Floor)OpR MR CR

10072.5 (21% increase)

60

10072.5 (21% increase)

60

Example 2: No internal model for MR, only use IRBA


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The Credit Risk Standard Approach (CRSA)Exposure classes Banks and Corporates

Banks• Derivation of the risk weight from external rating - due diligence necessary • Derivation of the risk weight from external rating - due diligence necessary

Corporates

AAA to AA- A+ to A- BBB+ to BBB- BB+ to B- Below B-20% 30% 50% 100% 150%

20% 20% 20% 50% 150%

Grade A Grade B Grade C30%/40% 75% 150%

20% 50% 150%

• In the case of unrated banks, abandonment of the country of domicile principle and allocation to risk grades:


Implementation challenges

• Scope of the required Due Dilligence – Analysis „require institutions to design a rigorous internal process for challenging the credit assessments provided by ECAIs“

• Data origin - group vs. solo level

• Basis for allocation to risk levels

• Significant increase in capital requirements for unrated banks

external rating

AAA to AA-

A+ to A-

BBB+ to BBB-

BB+ to BB-

Below BB-

Unrated

Base RW 20% 50% 75% 100% 150% 100%

• Risk weight 85% for exposures to SMEs, but abandonment of the SME factor in the EU• New specialised lending sub-category with its own risk weights

Category RWObject financing 100%

Commodity financing 100%

Project financing (pre-operational phase) 130%

Project financing (operational phase) 80%/100%

• Abandonment of the infrastructure supporting factor in the EU

Implementation challenges

• Scope of the required due diligence

• Definition of specialised lending operations in the database


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The Credit Risk Standard Approach (CRSA)Exposures secured by real estate

Residential real estate Commercial real estate General requirements


Gen

eral

trea

tmen

t

If the operational requirements are met • RW = 20% for up to 55% of the real estate value• RW of the counterparty for the remaining part• No implementation of the LTV approach / Whole loan

approachIf the operational requirements are not met• Risk weight of an unsecured exposure to the borrower

• RW = 150%• RW = 100%, if the project risk has been reduced, e.g.

through advance sale / pre-letting contracts - to be interpreted further by EBA RTS

LTV ≤50% 50% < LTV ≤60% 60% < LTV ≤80%30% 35% 45%

If the operational requirements are met • RW = Min (60%; counterparty's RW) for up to 55% of

the real estate value• RW of the counterparty to the remaining portion• No implementation of the LTV approach / Whole loan

approachIf the operational requirements are not met• Risk weight of an unsecured exposure to the borrower

LTV ≤ 60% 60% < LTV ≤ 80% LTV > 80%70% 90% 110%

• RW = 150%

80% < LTV ≤90% 90% < LTV ≤100% LTV > 100%60% 75% 105%

IPR

EAD

C

• Valuation using an independently determined, sufficiently conservative value, not taking into account the potential for future increases in value.

• Abandonment of the use of market values and mortgage lending values in favour of uniform specifications

• Maintaining the CRR requirements for monitoring and adjusting the assessment

• Assess whether assignment to IPRE is based on the ability to service the loan from sources other than the property income. Other sources may also include other properties

• Hard test


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The Credit Risk Standard Approach (CRSA)Other exposure classes

Equity and subordinated liabilities Retail Other items

• RW = 250% for equity• RW = 150% for subordinated debt and capital

instruments and for liabilities meeting the definition of 'other TLAC liabilities’

• RW = 400% for speculative unlisted equity investments

• No adoption of the Basel exemption for equity entered into within the framework of national support programmes

• Debt/equity swaps from the restructuring of receivables are generally allocated to the exposure class and receive a risk weight of 250% or 400% respectively.

• Equity and subordinated liabilities currently classified as positions with a particularly high risk receive a risk weight of 250% or 400% respectively.

• RW = 75% for sufficiently granular portfolios (to be interpreted by EBA RTS)

• RW = 45% for "Transactor" exposures, e.g. from credit card receivables, if these have always been repaid in due time within the past 12 months.

• RW = 100% for exposures to an individual or persons who do not meet all criteria, unless they are secured by real estate.

• The standard risk weight for all other assets is 100%.

• A risk weight of 0% applies to holdings of cash and gold bars held at the bank (or at another bank, provided that they are kept in a safe place to avoid insolvency).

• 20% risk weight for cash receivables in the process of being collected

• Approximation of the definition of the residual value of leased assets in the CRSA and IRBA as the carrying amount at the end of the lease term, after deduction of minimum lease payments and purchase options (current distinction between exposure value and residual value).

capital requirements complexity capital requirements complexity capital requirements complexity


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The Credit Risk Standard Approach (CRSA)Further changes

Off-balance sheet items Credit risk mitigation Currency mismatches

• Revision of the structure and allocation criteria of off-balance sheet items to risk categories according to Annex I of the CRR under an RTS

• Adjustment of the credit conversion factors to be applied:

• Changes in the applicable haircuts in the comprehensive method

• New formula and new haircuts for the netting of securities financing transactions (SFTs)

• Changes to the list of eligible guarantors• Exclusion of basket credit derivatives as credit risk

mitigation technique in the CRSA• Adoption of the proposals for credit risk mitigation

from the EBA Report of March 2018 Balance sheet netting for currency

mismatches Eligibility of gold Classification into credit ratings based on

non-nominated ECAIs …

• Adjustment of the risk weight for exposures to natural persons in the exposure class Retail or secured by residential real estate

• Increase of the risk weight by application of an multiplier of 1.5 up to an upper limit of 150%.

• If there are currency mismatches between the currency in which the loan is denominated and the currency in which the borrower derives his income

• Exceptions are positions hedged against currency risks; if banks cannot identify these, the multiplier is used.

capital requirements complexity capital requirements complexity capital requirements complexity


0%

20%

40%

60%

80%

100%

120%

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The Internal Ratings Based Approach (IRBA)Overview of the Basel Committee's new requirements

Focus

• Complexity reduction of the regulatory framework and improvement of comparability

• Reduction of excessive variability of the capital requirements for credit risk

Essential contentsScope of Internal Models • Elimination of the IRB approach for equity exposure

• Elimination of the advanced IRB approach for banks/other financial institutions (including insurance) and corporates with a consolidated turnover exceeding EUR 500 million.

• Maintaining IRB approaches for specialised lending• Elimination of the IRB scaling factor of 1.06

Floors for model parameters Introduction of floors on PDs and LGDs • Corporates: PD 0.05%, LGD unsecured 25% and LGD secured 0%, 10% or 15%• Retail: PD 0.05% or 0.10%, LGD unsecured 30% or 50% and LGD secured 0%, 5%,

10% or 15%

Parameter estimation More information on estimation practices• Stability of ratings (through-the-cycle)• PD estimate based on historical one-year average default rates

Output floors for capital requirements

Implementation of a capital floor• 72.5% Standardised Approach (SA) risk-weighted assets (RWA)• Transitional arrangements: 50% in 2022 -> 72.5% in 2027

1

2

3

4

Capital requirements

complexity


complexity


complexity


complexity


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EBA Report on Basel IVResults of the quantitative impact study (QIS)

The full implementation of Basel IV has high quantitative impacts!

Impact on weighted average minimum capital requirements (RWA)

24,4% 11,3% 5,5%

Impact on aggregated capital Shortfall

€ 135.1 bn

€ 0.9 bn

€ 0.1 bn

Medium sizebanks

Smallbanks

Medium sizebanks

Smallbanks

Using the most conservative assumptions*.

Allbanks

Allbanks

*Assumptions:

• Banks' balance sheets were assumed to be static

• Given the uncertainty about the impact, the underlying data are likely to reflect conservative reporting by banks

• The analysis assumes that current EU-specific decisions and exemptions will be discontinued and that the impact will fully reflect existing global standards.

• This assessment includes the impact of Pillar 2 and the macro-prudential requirements assumed to be static in the analysis compared to the previously presented Basel impact analyses.

• Due to the late finalization of the FRTB, the effects were determined based on the calibration of the market risk regulations of 2016. The inclusion of the recently adopted FRTB reform would reduce the impact.


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TotalRWA

Strong influence of the capital floor on IRB banks, effects of the new CRSA

Revised credit risk SA

High impact on real estate, specialised lending and capital instruments

F-IRBA (New) pre Floor

F-IRBA partly benefits from Basel IV, no partial use as an opportunity for CRSA banks

A-IRBA (New) pre Floor

Impacts in particular from the LGD determination of collateralised exposures, No partial use as an opportunity for CRSA banks

FRTB (SA)Increase especially in the case of complex products, calculation of credit risk (junk bonds)

The impact of Basel IV on RWA is heavily dependent on the portfolio and business model

-10% 10% 50%

-10% 10% 30%

-5% 40%20%

10% 30% 100%

30%

Floor =50%

Floor =72,5%

-10%-5% 5%

0%


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The Internal Ratings Based Approach (IRBA)Impact of the new Partial Use

SA -

IRB

AIR

BA

-SA

Exemplary impact of IRBA implementation (EUR million)

72.5% floor

Decomposition of the portfolio

6.5398.356

3.8296.093

4.527

2.264

Under the standardised approach, Basel IV leads to an increase in RWA of 21-28%.For some portfolios, the exact increasecan only be estimated when additional information is collected(e.g. income-producing real estate).The new partial use allows the IRB approach to be implemented only for certain portfolios.

With the introduction of the IRBA for retail exposures and exposures secured by real estate, total RWA could fall 7% from current levels and remain above the output floor.RWA optimization could further improve the results, e.g. it helps to reduce the RWA for the standard approach.

12

34

43.000 45.500

63.500

RWA (original) RWA (after) CSA RWA

2.000

3.000

2.000

10.000

15.000

10.000

1.000

2.200

4.300

3.000

14.500

22.000

16.500

1.000

SovereignsBanks

Specialised lendingCorporates

RetailRetail Mortgages

Equity

RWA RWA (CSA)

2.200

4.300

3.000

10.000

15.000

10.000

1.000

2.200

4.300

3.000

14.500

22.000

16.500

1.000

SovereignsBanks

Specialised lendingCorporates

RetailRetail Mortgages

Equity

RWA RWA (CSA)

Output floor - 46 038

RWA increase for portfolios transferred to the SA

RWA(before)

RWA(afterwards)

RWA (SA)

Sovereigns

Banks

Specialised lending

Corporates

Retail

Real estate finance.

Equity exposure

Sovereigns

Banks

Specialised lending

Corporates

Retail

Real estate finance.

Equity exposure

RWA (SA)RWA (SA)


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The floor compensation effect - a sample calculationEUROPA BANK’s initial situation

Risk position EAD RWA (SA) RWA (IRBA/IM)

Sovereigns 500 50 50

Banks 500 150 100

Retail other 1.500 1.125 525

Retail mortgages 3.000 750 300

Retail revolving 500 250 175

Equity 200 540 540

Corporates SMEs 2.000 1.500 800

Corporates 2.000 2.000 900

Large corporates 500 250 175

Specialised lending 500 475 750

Total credit risk 11.200 7.090 4.315

Total market risk 1000 1000 500

Total OpRisk 500 500 500

Total 12.700 8.590 5.315

EUROPA BANK RWA overview (€ million)

It is recommended to define more granular subportfolios in order to approximate the floor compensation effect even more precisely.

912,75

6.227,75RWA based on capital floor

RWA increase through capital floor

Taking into account the capital floor, the cost of capital can only be calculated as a "marginal contribution to total RWA".

This is because the granting of credit does notlead to a proportional increase in the RWA compared with the loan amount (EAD).


EXAMPLE

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0,36

0,50

Calculation of the cost of capital for additional exposures must in future be carried out via “marginal contribution to total RWA”

Example 1:

New Sovereign exposure

EAD 5,00

RW Standardised approach 10%

RWA isolated 0,50

Total RWA (incl. new exposure) 6.228,11

RWA increase 0,36

The new exposure does not increase EUROPA BANK's total RWA by

but rather by the capital floor and the resulting

floor compensation effect, the RWA only increase by

!

1. Loan amount

2. Average RW (PD/LGD/EAD/KSA-RW) of the exposure class concerned

3. Share of partial-use exposure classes

4. Average RW (PD/LGD/EAD/KSA-RW) of all other exposure classes

The correct calculation of the cost of capital for lending is carried out by calculating the effects on the total

RWA.

Since the influencing factors on the floor compensation effect are subject to fluctuations over time, these factors must be simulated on the basis of the business/capital plan.

The level of the floor compensation effect is determined by:


EXAMPLE

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The actual cost of capital can be approximated by RWA sensitivities

CRR II and Basel IV October 201916

The RWA sensitivities express the sensitivity of the total RWA compared to the exposure increase.

Alternatively, the RWA sensitivities can also be described as "marginal risk weights" based on a given portfolio.

If the RWA sensitivities are known, it is easy to optimize the RWA/ capital costs.

Lending in the asset class sovereignsEAD 5.00

Total exposure 505.00

RWA increase 0.36

Total RWA after lending 6,228.11

Exposure class RWA sensitivity

RWA Floor Sensitivity

Sovereigns 0,07% -0,03%

Banks 0,22% 0,02%

Retail other 0,54% 0,19%

retail mortgages 0,18% 0,08%

Retail revolving 0,36% 0,01%

Equity 1,96% -0,74%

Corporates SMEs 0,54% 0,14%

Corporates 0,73% 0,28%

Large corporates 0,36% 0,01%

Specialised lending 0,69% -0,81%

Example 1:

505.00 x 0.07%

6,227.75 + 0.36

EXAMPLE

Based on the initial portfolio, the floor sensitivities for each exposure class are as follows

New equity exposureEAD 2.00

Total exposure 202.00

RWA increase 3.95

RWA total after new exposure 6,231.70

Example 2:

202.00 x 1.96%

6,227.75 + 3.95

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Therefore, a completely new form of capital allocation must be implemented, which can reflect the positive effects as well as the negative effects of the capital floor.

Capital allocation to individual portfolios taking into account the capital floor

CRR II and Basel IV October 201917

Capital allocation today is based on capital requirements / capital demands of individual portfolios / business units

Example EUROPA BANKThe Retail unit comprises the following asset classes

Retail other 525retail mortgages 300Retail revolving 175sum 1,000

The Corporate unit comprises the following asset classes

Corporate SMEs 800Corporate 900Large corporates 175Specialised lending 750Sum 2,625

The Treasury unit comprises the following asset classes

Sovereigns 50Banks 100Equity 540Sum 690

Trading unit corresponds to the market risks in the trading book 500OpRisk is applied based on an algorithm 500The sum of the RWA of the business units corresponds to the Total RWA 5,315

The future capital floor leads to compensation effects between the portfolios and risk types.

Positive effects are allocated to a floor RWA fund, negative effects to a floor add on. These can be allocated according to the polluter.

Total RWA RWA Floor Funds RWA Floor add on RWA by floor

5,315 -262.25 1,175 6,227.75

EXAMPLE

pwc.de

Thank you for your attention.

2019 PricewaterhouseCoopers GmbH Wirtschaftsprüfungsgesellschaft.All rights reserved. "PwC" in this document means PricewaterhouseCoopers GmbH Wirtschaftsprüfungsgesellschaft, which is a member firm of PricewaterhouseCoopers International Limited (PwCIL). Each of the member companies of PwCIL is a legally independent company.

Martin NeisenPartnerGlobal Basel IV Leader

Mobile:+49 151 5380 0865Phone: +49 69 9585 [email protected]

DE: digital.pwc-tools.de/basel-ivyoutube.com/PwCBaselIVChannelEN: pwc.com/baselivwww

DE: blogs.pwc.de/regulatory

eba report on basel iv iv eba report_sci.pdf · 1. introduction - crr ii and basel iv 2. the most...

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