Basel III and Liquidity Standard Status Quo and Next Steps

Dr. Georg von Pfstl PRMIA Frankfurt Chapter, Sept. 2011

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Agenda

Basel III Status Quo Basel III Implications & Implementation Challenges Basel III Liquidity Standard

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Key topics of Basel III will be implemented through an EU Regulation no further translation into national law required
From Basel II to Basel III
Basel 2.5 Legal basis (EU) CRD (2009/111/EC) published in the Official Journal (Nov. 2009) (CRD II) transposed into national law CRD (2010/76/EU) published in the Official Journal (Dec. 2010) (CRD III) partially transposed into national law Basel III CRD IV (package of two legal instruments: Directive and Regulation)

Status European/ national implementation and coming into force

Basel III published by the BCBS in Dec. 2010 (rev. version of capital framework June 2011) Proposals of Directive and Regulation published by the European Commission in July 2011 Directive: to be translated into national law till 31 Dec. 2012; Regulation: no national translation required 01 Jan. 2013 (with transition periods till 2019) Regulation definition of capital liquidity risk leverage ratio counterparty credit risk single rule book (through Regulation) Directive capital buffers enhanced governance sanctions enhanced supervision
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Coming into force Topics

31 Dec., 2010 large exposures securitization hybrid capital instruments liquidity risk management cross border supervision

31 Dec. 2011 re-securitization disclosure securitization risks trading book Remuneration policies

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The new liquidity ratios are the key challenge for most banks as they influence liquidity and funding strategy, pricing and the business model
Accenture estimated impact of Basel III (1/2) Topic
Definition of capital

Brief description Impact

New definition of capital to increase quality, consistency and transparency of the capital base New leverage ratio as a supplementary measure to the risk-based Basel II framework Introduction of a short-term LCR and a longer-term NSFR High

Potential impact for banks* Explanation/remarks

New definition of capital leads to a significant reduction of the capital ratios build up of capital (quantitative/qualitative), e.g. by issuing capital instruments or retaining earnings Leverage Ratio (design: Tier 1 capital/total exposure; gross ratio calibration: 3%) might narrow the scope of action for banks given the existing capital Ratios require increase of high quality liquid assets and change of funding mix which leads to higher liquidity costs. Further banks are expected to adhere to the sound principles of liquidity risk management Enhanced risk coverage (CCR; CVA; wrong way risk; asset value correlation for large financial institutions; CCP) leads to an increase of capital requirements for the trading book and complex securitization exposures

Leverage ratio

Medium

Liquidity standards

High

Counterparty credit risk (CCR)

Higher capital requirements for CCR arising from derivatives, repos and securities financing activities

Medium to High**

* Rough assessment; impact depends on bank specifics ** Depending on trading book and investment bank activities

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The discussed measures for SIFIs might have a material impact on those institutions. The definition of SIFIs is currently in discussion
Accenture estimated impact of Basel III (2/2) Topic
Countercyclical measures

Brief description Impact

Introduction of capital conservation and countercyclical capital buffer In discussion: EL-approach for provisioning; TTC** parameters Approach could include combinations of capital surcharges, contingent capital and bail-in debt (in discussion) Capital surcharge of 1-2.5% is proposed (CET1 capital) Creation of consistent rules removal of national discretions Medium

Potential impact for banks* Explanation/remarks

When capital levels fall into conservation range constraints on capital distribution are imposed. Countercyclical buffer extends capital conservation buffer. Pressure from the market to fulfill ratios before regulatory deadline Different measures currently in discussion; capital surcharge of 1-2.5% of RWA (depending on bucket) is proposed (CET 1 capital); definition of SIFIs currently in discussion ( Indicator-based measurement approach)

Systemically important financial institutions

High

Single rule book (entire regulation)

Low

Regulation harmonizes divergent national supervisory approaches by removing options and discretions

* Rough assessment; impact depends on bank specifics ** through the cycle

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The liquidity standards will have a high functional, technical as well as organizational implementation effort
Accenture estimated implementation effort of Basel III Topic Functional Definition capital Leverage Ratio Liquidity standards Counterparty credit risk (CCR) Countercyclical measures SIFIs Single rule book High Low High High Medium Medium Low Implementation effort* Technical Medium Low High High Medium Medium Low Organizational Medium Low High Low Low High (depending on regulation evolution) Low

* Rough assessment; implementation effoert depends on bank specifics

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Basel III introduces two liquidity ratios to promote the short-term and the longer-term resilience of the liquidity risk profile of institutions
Global Liquidity Standard

LCR High quality liquid assets Total net cash outflows over 30-day time period 100%

NSFR Available stable funding > 100% Required stable funding Institutions are required to fund their activities with more stable sources of funding on an ongoing structural basis

Institutions have to ensure that they have sufficient high quality liquid assets to survive an acute stress scenario lasting for 30 days

Frequency of calculation and reporting: Banks are expected to meet the requirements of the standards continuously; first reporting to supervisors is expected by Jan 1, 2012
LCR: reported at least monthly, with the operational capacity to increase the frequency to weekly or even daily in stressed situations; introduced on Jan 1, 2015 NSFR: calculated and reported at least quarterly; introduced on Jan 1, 2018

Scope of application: Level of individual institution (with legal personality) Disclosure of LCR and NSFR under pillar 3
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The LCR aims to ensure that banks maintain an adequate level of high-quality liquid assets to survive a severe liquidity stress scenario lasting for 30 days
LCR: High quality liquid assets Conditions high quality liquid assets (e.g.): Not issued by the institution or parent/subsidiary Eligibility as collateral in normal times for intraday liquidity needs and overnight liquidity facilities of a CB Listed on a recognized exchange 100%
Total net liquidity outflows over 30-day time period

LCR

High quality liquid assets

Operational requirements (e.g.): Appropriate diversification Assets are legally and practically readily available at any time during the next 30 days Liquid assets are controlled by a liquidity management function High quality liquid assets items: Level 1 assets (cash; transferable assets of extremely high liquidity and credit quality): min. 60% of liquid assets; market value; no haircut Level 2 assets (transferable assets that are of high liquidity and credit quality): max. 40% of liquid assets; market value; haircut of min. 15%

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Total net cash outflows are defined as the total expected cash outflows minus total expected cash inflows in the specified stress scenario
LCR: Net liquidity outflows Net liquidity outflows = Liquidity outflows Min {Liquidity inflows; 75% of liquidity outflows)

LCR

High quality liquid assets

100%
Total net liquidity outflows over 30-day time period

Net liquidity outflows: Liquidity outflows minus liquidity inflows in the stress scenario. The scenario includes firm-specific and systemic factors Calculation liquidity outflows: Multiplication of the items with the respective run off factor Calculation liquidity inflows: Multiplication of the items with the specified inflow factor; inflows are capped with 75% of the outflows

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The definition of high quality liquid assets and the treatment of interbank funding are key discussion points
Liquidity Coverage Ratio High quality liquid assets
Level 1 assets: cash; transferable assets of extremely high liquidity and credit quality (min. 60% of liquid assets) Level 2 assets: transferable assets that are of high liquidity and credit quality): max. 40% of liquid assets; market value; haircut of min. 15%

LCR

100%

Liquidity outflows
Retail deposits (5-10%) Other liabilites coming due during next 30 days (0-100%) Collateral other than level 1 assets (15-20%) Credit and liquidity facilities (5100%)

Liquidity inflows
Monies due from non financial customer (50%) Secured lending and capital market driven transactions (0%-100%) Undrawn credit and liquidity facilities (0%) Specified payables and receivables expected over the 30 day horizon (100%) Liquid assets (0%) New issuance of obligations (0%)

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The NSFR should ensure that long term assets are funded with at least a minimum amount of stable liabilities in relation to their liquidity risk profiles
NSFR: Available stable funding Available stable funding*
Items Tier 1 & 2 capital Preferred stock not included in Tier 2 capital with maturity 1 year Secured and unsecured borrowings and liabilities with effective remaining maturities 1 year ASF factor** 100%

NSFR

Available stable funding > 100% Required stable funding

"Stable" non-maturity (demand) deposits and/or term deposits with residual maturity < 1 year "Less stable" non-maturity (demand) deposits and/or term deposits with residual maturities < 1 year Unsecured wholesale funding, non-maturity deposits and/or term deposits with a residual maturity < 1 year, provided by non-financial corporates, sovereigns, central banks, multilateral development banks and PSEs All other liabilities and equity categories not included in the above categories

90% 80%

50%

0%

* Stable funding is defined as the portion of those types and amounts of equity and liability financing expected to be reliable sources of funds over a one-year time horizon under conditions of extended stress. ** The proposed EU Regulation does not include any ASF- or RSF factor. Neither at this point in time it is stated whether the NSFR should be > or 100%.

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Funding provided by financial institutions and loans to such firms are assigned with a low ASF and a high RSF respectively
NSFR: Required stable funding
Required stable funding
Items RSF factor*

NSFR

Available stable funding > 100% Required stable funding

Cash Short-term unsecured actively-traded instruments (< 1 yr) Securities with exactly offsetting reverse repo Securities with remaining maturity < 1 yr Non-renewable loans to FI with remaining maturity < 1 yr Debt issued or guaranteed by sovereigns, CB, BIS, IMF, EC, noncentral government, MDB with a 0% STA risk weight Unencumbered non-financial senior unsecured corporate bonds and covered bonds rated at least AA-, and debt that is issued by sovereigns, CB, and PSEs with a risk-weighting of 20%; maturity 1 yr Unencumbered listed equity securities or non-financial senior unsecured corporate bonds (or covered bonds) rated from A+ to A-, maturity 1 yr Gold Loans to non-financial corporate clients, sovereigns, central banks, and PSEs with a maturity < 1 yr Unencumbered residential mortgages of any maturity and other unencumbered loans, excluding loans to financial institutions with a remaining maturity of one year or greater that would qualify for the 35% or lower risk weight under Basel II standardised approach for credit risk

0%

5% 20%

50%

65%

* The proposed EU Regulation does not include any ASF- or RSF factor. Neither at this point in time it is stated whether the NSFR should be > or 100%.

Other loans to retail clients and small businesses having a maturity < 1 yr All other assets

85% 100%
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Basel III introduces a common set of monitoring tools that should allow competent authorities to obtain a comprehensive view of the liquidity profile of institutions
Monitoring Tools Contractual maturity mismatch

Contractual cash and security inflows and outflows from all on- and off-balance sheet items, mapped to defined time bands based on their respective maturities Different ratios/figures which should help to identify those sources of wholesale funding that are of such significance that withdrawal of this funding could trigger liquidity problems Available unencumbered assets that are marketable as collateral in secondary markets and/or eligible for central banks standing facilities Foreign Currency LCR = Stock of high-quality liquid assets in each significant currency / Total net cash outflows over a 30-day time period in each significant currency Early warning indicators based on high frequency market data with little or no time lag (market wide information; information on the financial sector; bank-specific information)

Concentration of funding

Available unencumbered assets LCR by significant currency Market-related monitoring tools

The proposed EU Regulation does not include any concrete monitoring tools. Rather EBA shall develop draft implementing technical standards regarding liquidity monitoring metrics that allow competent authorities to obtain a comprehensive view of the liquidity profile of institutions.

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Copyright 2011 Accenture All Rights Reserved. Accenture, its logo, and High Performance Delivered are trademarks of Accenture.