Basel III Handbook Table of Contents Figures 4 Tables 4 Abbreviations 5 1 Introduction 6 2 Definition of capital and capital buffers 12 2.1 New definition of capital 14 2.2 Components of capital 16 2.2.1 Common Equity Tier 1 capital 16 2.2.2 Additional Tier 1 capital 18 2.2.3 Tier 2 capital 19 2.3 Prudential filters and deductions 20 2.3.1 Prudential filters 20 2.3.2 Deductions from CET 1 capital 21 2.3.3 Exemptions from and alternatives to deduction from CET 1 items 22 2.3.4 Deductions from Additional Tier 1 capital 22 2.3.5 Deductions from Tier 2 items 23 2.4 Minority interests 24 2.4.1 Minority interests that qualify for inclusion in consolidated CET 1 capital 24 2.4.2 Qualifying Additional Tier 1, Tier 1, Tier 2 capital and qualifying own funds 24 2.5 Institutional networks 24 2.6 Capital buffers 25 2.6.1 Capital conservation buffer 25 2.6.2 Countercyclical capital buffer 25 2.7 Enhanced disclosure requirements 25 3 Counterparty Credit Risk 26 3.1 Effective Expected Positive Exposure 28 3.2 Credit valuation adjustment 28 3.3 Wrong way risk 29 3.4 Asset value correlation 29 3.5 Central counterparties 29 3.6 Enhanced CCR management requirements 29 2 4 Leverage ratio 30 4.1 Definition and calibration 32 5 Global liquidity standard 34 5.1 Liquidity Coverage Ratio 37 5.1.1. Definition of high quality liquid assets 38 5.1.2. Definition of net liquidity outflows 40 5.2 Net Stable Funding Ratio 42 5.3 Monitoring tools 45 5.4 Institutional networks 45 6 Enhanced governance and sanctions 46 6.1 Enhanced governance 48 6.2 Sanctions 48 7 Other topics 50 7.1 Systemically Important Financial Institutions 52 7.2 Overreliance on external ratings 53 7.3 Small and Medium-Sized Entity 53 7.4 Basel I limit 53 8 Conclusion 54 Bibliography 57 Appendix 58 3 Figures Figure 1: From Basel 2.5 to Basel III 9 Figure 2: Capital requirements Basel II/Basel 2.5 vs. Basel III 15 Figure 3: Phase-in arrangements Basel III capital requirements 15 Figure 4: Leverage Ratio within Basel III 32 Figure 5: Liquidity risk management (LRM) framework 36 Figure 6: Liquidity Coverage Ratio 37 Figure 7: LCR: High quality liquid assets 39 Figure 8: LCR: Net liquidity outflows 40 Figure 9: LCR: High quality liquid assets and net liquidity outflows 41 Figure 10: Net Stable Funding Ratio 43 Figure 11: NSFR: Available stable funding 43 Figure 12: NSFR: Required stable funding 44 Figure 13: AVC: Risk-Weights for large financial institutions – Basel II vs. Basel III 60 Tables Table 1: Flexibility of member states within the single rule book 10 Table 2: Prudential filters Basel III 20 Table 3: Deduction from CET 1 capital in Basel III 21 Table 4: Deduction from Additional Tier 1 capital in Basel III 22 Table 5: Deductions from Additional Tier 2 capital in Basel III 23 Table 6: Options on corporate governance 49 Table 7: Basel III Summary Table 58 Table 8: AVC: Risk-Weights for large financial institutions – Basel II vs. Basel III 60 Table 9: Indicator-based measurement approach G-SIBS 61 Table 10: Ancillary indicators for assessment G-SIBS 61 4 Abbreviations ASF Available Stable Funding BCBS Basel Committee on Banking Supervision CIU Collective Investment Undertaking CCP Central Counterparty CCR Counterparty Credit Risk CEM Current Exposure Method CET1 Common Equity Tier 1 CRD Capital Requirements Directive CVA Credit Valuation Adjustment EBA European Banking Authority EPE Expected Positive Exposure FSB Financial Stability Board FY Financial Year G-SIBs Global Systemically Important Banks IMM Internal Model Method LCR Liquidity Coverage Ratio MDA Maximum Distributable Amount NSFR Net Stable Funding Ratio OTC Over-the-Counter PD Probability of Default PSE Public Sector Entity RSF Required Stable Funding RW Risk-Weight SIBs Systemically Important Banks SIFIs Systemically Important Financial Institutions SM Standardized Method SME Small and Medium-Size Entity SSPE Securitization Special Purpose Entity VaR Value-at-Risk 5 1 Introduction 6 7 Recent financial crises have demonstrated numerous weaknesses in the global regulatory framework and in banks’ risk management practices. In response, regulatory authorities have considered various measures to increase the stability of the financial markets and prevent future negative impact on the economy. One major focus is on strengthening global capital and liquidity rules. Basel III addresses this, with the goal Definition of capital Enhanced risk coverage/ of improving the banking sector’s Counterparty Credit Risk Introduction of a new definition ability to absorb shocks arising from of capital to increase the quality, The reforms to the Basel II framework financial and economic stress. In consistency and transparency of by the BCBS in 2009 and the December 2010 the Basel Committee the capital base. As the recent crisis amendments made in the European on Banking Supervision (BCBS) demonstrated that credit losses and Capital Requirements Directive published the Basel III documents write-downs come out of retained III (CRD III)2 increased capital “Basel III: A global regulatory earnings, which is part of banks’ requirements for the trading book framework for more resilient banks and tangible common equity base, under and complex securitization positions banking systems” (a revised version Basel III common equity (i.e., common and introduced stressed value-at-risk was published in June 2011) and “Basel shares and retained earnings) must be capital requirements and higher capital III: International framework for liquidity the predominant form of Tier 1 capital. requirements for re-securitizations risk measurement, standards and Further, the reform package removes for both in the banking and trading monitoring.” the existing inconsistency in the book. Basel III now adds the following With this reform package, the BCBS definition of capital by harmonizing reforms: calculation of the capital aims to improve risk management deductions of capital and by increasing requirements for counterparty credit and governance as well as strengthen transparency through disclosure risk (CCR) based on stressed inputs; banks’ transparency and disclosure. requirements. introduction of a capital charge for Basel III is also designed to strengthen potential mark-to-market losses (i.e., the resolution of systemically credit valuation risk); strengthening significant cross-border banks. standards for collateral management It covers primarily the following and initial margining; higher capital aspects1: requirements for OTC derivatives exposures; raising CCR management standards. 8 Leverage ratio Global liquidity standard This handbook provides a detailed overview of the major changes of Introduction of a leverage ratio as A new liquidity standard is introduced Basel III corresponding to the EU rules. a supplementary measure to the to achieve two objectives. The first It focuses on aspects related to banks. risk-based framework of Basel II. The objective, pursued by the Liquidity Amendments regarding supervisory objective is to constrain the build-up Coverage Ratio (LCR), is to promote authorities in the context of enhanced of leverage and avoid destabilizing short-term resilience of a bank’s supervision are not covered in detail. deleveraging processes. liquidity risk profile by ensuring that The status of topics currently under it has sufficient high quality liquid discussion is included here, as are Reducing procyclicality and assets to survive a stress scenario differences between the EU rules lasting one month. The second promoting countercyclical buffers and the Basel III documents from objective is to promote resilience over the BCBS. Introduction of measures to make the longer term by creating additional banks more resilient to procyclical incentives for a bank to fund its The enhancements of the capital dynamics and avoid the destabilizing activities with more stable sources framework within “Basel 2.5” (CRD effects experienced in the last crisis. of funding. The Net Stable Funding II and CRD III in the EU), which are The main objectives of these measures Ratio (NSFR), with a time horizon of already in force or become applicable are: dampen any excess cyclicality one year, should provide a sustainable beginning in 2012 are not within of the minimum capital requirement; maturity structure of assets and the scope of this manual. Nor are promote more forward-looking liabilities. Basel III also introduces a the challenges banks face with provisions; conserve capital to build common set of monitoring tools. The the implementation of the Basel III buffers at individual banks and in new requirements complement the requirements.5 the banking sector that can be used “Principles for Sound Liquidity Risk in periods of stress testing; achieve Management and Supervision”3 which the broader macro-prudential goal of are included in the CRD II.4 The CRD protecting the banking sector from II requirements, implemented into periods of excess credit growth. national law by the EU Member States, became effective December 31, 2010. Figure 1: From Basel 2.5 to Basel III “Basel 2.5” “Basel III” Legal basis (EU) • CRD (2009/111/ • CRD (2010/76/ • "CRD IV“ (package of two legal instruments: directive EC) published in the EU) published in the and regulation) Official Journal (Nov. Official Journal (Dec. 2009) (CRD II) 2010) (CRD III) Status • Transposed into • Partially • "Basel III“ published by the BCBS in Dec. 2010 (rev. European/ national law transposed into version of capital framework June 2011) national national law • Directive and Regulation published by the European implementation Commission in July 2011; discussed by Parliament and Council in autumn 2011/beginning of 2012 • Directive: to be translated into national law till Dec. 31, 2012; Regulation: no national translation required Coming into • Dec. 31, 2010 • Dec. 31, 2011 • Jan. 1, 2013 (with transition periods till 2019) force Topics • Large exposures • Re-securitization Regulation c ri vD eti • Securitization • Disclosure • Definition of capital • Capital buffers • Hybrid capital securitization risks • Enhanced governance • Liquidity risk instruments • Trading book • Sanctions • Counterparty credit risk • Liquidity risk • Remuneration • Enhanced supervision • Leverage ratio management policies • Single rule book • Cross border (through Regulation) supervision Source: Accenture 9 Basel II and the reform packages of are implemented through a Directive. “Basel 2.5” are implemented through Following the European legislative directives in the EU (CRD, CRD II, process, the next step is for the legal CRD III). That is, the rules need to documents published by the European be transposed into national law Commission (the proposed Regulations with several options and discretions and Directives) to be discussed within at the national level. Basel III is the European Parliament and Council. introduced through two different legal instruments.6 Most of the key Despite the single rule book, Member topics, such as the new definition of States will retain some flexibility in capital and the new liquidity ratios, specific areas which are summarized are implemented through a Regulation in Table 1: (a directly applicable legal act, with no further national implementation needed). The objective is to create a level playing field (single rule book). Other aspects, including capital buffers and enhanced governance, Table 1: Flexibility of Member States within the single rule book Type of Measure Compatible with Single Rule Book? EU Macro-prudential Measures Pillar 1 Does not preclude the measure Power for the Commission to tighten Measure is embedded in the Single being specifically targeted to certain the requirements temporarily across Rule Book. It uniformly applies to all regional exposures the board for specific activities and institutions across Europe that have exposures. Special urgency procedure the type of exposure concerned. is possible for swift response to macro-prudential developments. National Measures Capital requirements for real estate Special procedure in the Regulation Measure is embedded in the Single lending under which Member States can both Rule Book. The requirements set by raise capital requirements and tighten country A apply also to institutions in loan-to-value limits for loans secured country B that do business in A. by commercial and/or residential property. Countercyclical buffer Member States can set an additional Measure is embedded in the Single buffer requirement to dampen excess Rule Book. The requirements set by lending growth more generally. This is country A apply also to institutions in to protect the economy/banking sector country B that do business in A. This from any other structural variables "reciprocity" is mandatory only up to and from the exposure of the banking 2.5%. sector to risk factors related to financial stability. Pillar 2 "Pillar 2" measures National supervisors can impose a Measures are included in the Directive. wide range of measures, including They must be justified in terms of additional capital requirements, on particular risks of a given institution individual institutions or groups of or group of institutions, including risks institutions to address higher-than- pertaining to a particular region or normal risk. sector. Further convergence of such measures will be sought over time. Source: CRD IV – Frequently Asked questions (July 2011), European Commission found at EUROPA - Press Releases - CRD IV – Frequently Asked Questions 10 11 2 Definition of capital and capital buffers 12 13 2.1 New definition of capital The financial crisis showed that not The own funds requirements under instruments that are currently used all institutions did hold sufficient Basel III are the following (as a but do not meet the new rules. They capital and that the capital was percentage of risk-weighted assets, are phased out over a 10-year period sometimes of poor quality and not RWA): beginning in 2013 (10% a year). While available to absorb losses as they the proposals of the BCBS require that materialized. Basel III introduces • CET 1 capital ratio of 4.5%; these instruments were issued prior – based on the amendments made • Tier 1 capital ratio of 6%; to the date of agreement of the new under the CRD II with regard to hybrid rules by Basel (September 12, 2010), capital instruments – a new definition • Total capital ratio of 8%. instruments issued after this cut off of capital to increase the quality, Total capital ratio will remain 8% of date would need to comply with the consistency and transparency of the RWA. CET 1 capital ratio increases new rules or would not be recognized capital base. It also requires higher from 2% to 4.5%. Additional Tier 1 as capital as of January 1, 2013. The capital ratios. Key elements of the capital ratio is 1.5%, leading to a Tier proposals of the EU Regulation set the revision include7: 1 capital ratio of 6%. The importance cut off date "as the date of adoption of Tier 2 capital decreases by reducing of the proposal by the Commission, • Raise quality and quantity of Tier 1 when the Commission as a College the ratio to 2% of RWA. capital; agreed to legally implement Basel • Simplification and reduction of Tier Apart from these changes, Basel III III in the EU. Setting a cut off date 2 capital; will introduce two new capital buffers: prior to this policy decision would a capital conservation buffer of neither be legitimate nor legally • Elimination of Tier 3 capital; 2.5% and a countercyclical buffer of sound, as it would apply the new rules • More stringent criteria for each 0-2.5% depending on macroeconomic retroactively.”8 instrument; circumstances (see section 2.6 for a detailed description of the buffers). For The latest proposals from the BCBS • Harmonization of regulatory both buffers, an extra cushion of CET follow a principles-based approach adjustments; 1 capital needs to be held leading to a in regard to capital, with the focus • Enhanced disclosure requirements; CET 1 capital ratio of up to 9.5%. on the substance of the capital instruments. They also ensure that the • Introduction of a new limit system Additional capital surcharges between new rules are capable of being applied for the capital elements. 1% and 2.5% (extra cushion of CET to the highest-quality capital items 1 capital) for systemically important of non-joint stock companies, such as According to the new definition, financial institutions (SIFIs) – cooperative banks. Through a set of capital comprises the following depending on the systemic importance principles, the EU standard specifies elements: of the institution – are currently in in greater detail the application discussion. of the new definition of capital to • Going-concern capital (Tier 1 instruments issued by non-joint capital); On top of these own funds stock companies to ensure they hold - Common Equity Tier 1 capital (CET 1 requirements, supervisory authorities comparable levels of high quality Tier capital): Common equity (i.e., common may require extra capital to cover 1 capital. Like the BCBS proposals, shares and retained earnings) must be other risks following Pillar 2 (as it is it imposes 14 strict criteria that the predominant form of Tier 1 capital also under the current framework). instruments need to meet. - Additional Tier 1 capital Basel III foresees a transition period before the new capital requirements • Gone-concern capital (Tier 2 capital). apply in full. The going concern (Tier 1) capital requirements will While going-concern capital (Tier be implemented gradually between 1) should allow an institution to 2013 and 2015; the capital buffers continue its activities and help prevent between 2016 and 2019. The new insolvency, gone-concern capital (Tier prudential adjustments will be 2) would help ensure that depositors introduced gradually, 20% a year and senior creditors can be repaid if from 2014, reaching 100% in 2018. the institution fails. Grandfathering provisions over 10 years would also apply to capital 14 Figure 2: Capital requirements Basel II/Basel 2.5 vs. Basel III 16% SIBs capital surcharge 14% (in discussion) 12% Countercyclical capital buffer– extra cushion of CET 1 10% Capital conservation buffer– extra cushion of CET 1 8% Tier 3 capital Lower Tier 2 capital– Tier 2 capital– 6% max. 50% Tier 1 capital max. 100% of Tier 1 capital Upper Tier 2 capital 4% Total capital Max. 50% of Tier 1 capital innovative Tier 1 capital hybrid capital max. 15% of Tier 1 capital 2% 0% Basel ll/Basel 2.5 Basel III CET 1 capital (certain Tier 1 items) SIBs surcharge (in discussion 1-2.5%) Countercyclical capital buffer (0-2.5%) Tier 2 capital Additional Tier 1 capital (hybrid capital) Capital conservation buffer Tier 3 capital Source: Accenture, based on Basel III – Leitfaden zu den neuen Eigenkapital- und Liquidititätsregeln für Banken (2011), Bundesbank and CRD IV – Frequently Asked Questions (2011), European Commission. Note: The treatment of hybrid capital instruments was amended within the CRD II (harmonization of the eligibility criteria and limits of hybrid capital instruments); further amendments follow within Basel III. Figure 3: Phase-in arrangements Basel III capital requirements 14% 12% 2.5% 1.875% 10% 1.25% 0.625% 1.875% 2.5% 0.625% 1.25% 8% 2.5% 2.0% 2.0% 2.0% 2.0% 2.0% 4.0% 3.5% 6% 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% 4% 1.0% 2.0% 2% 4.0% 4.5% 4.5% 4.5% 4.5% 4.5% 3.5% 2.0% 0% Until 2012 2013 2014 2015 2016 2017 2018 From 2019 CET 1 capital Additional Tier 1 capital Tier 2 capital Capital conservation buffer Countercyclical capital buffer Source: New proposals on capital requirements (July 2011), European Commission. 15 2.2 Components of capital 2.2.1 Common Equity The European Banking Authority f) The principal amount of the (EBA) has the mandate to develop instruments may not be reduced Tier 1 capital draft regulatory technical standards or repaid, except in either of the A key aspect of the stricter definition to specify the points previously following cases: of capital is that Common Equity mentioned. These include features that could cause the condition of an i) The liquidation of the institution; Tier 1 (CET 1) instruments – mainly common shares (or comparable institution to be weakened as a going ii) Discretionary repurchases of the instruments) and retained earnings concern during periods of market instruments or other discretionary – must be the predominant form stress. means of reducing capital, where of Tier 1 capital. According to the the institution has received the prior According to Article 26 of the proposed EU Regulation, CET 1 items consent of the competent authority proposed EU Regulation, capital consist of the following:9 in accordance with Article 72 of the instruments need to meet all of the proposed EU Regulation; a) Capital instruments, provided the following conditions to qualify as conditions laid down in Article 26 of CET 1 items:10 g) The provisions governing the the proposed EU Regulation are met; instruments do not indicate expressly a) The instruments are issued or implicitly that the principal amount b) Share premium accounts related to directly by the institution with the of the instruments would or might the instruments referred to in point a; prior approval of the owners of be reduced or repaid other than in the institution or, where permitted the liquidation of the institution, and c) Retained earnings; under applicable national law, the the institution does not otherwise management body of the institution; provide such an indication prior to or d) Accumulated other comprehensive at issuance of the instruments, except income; b) The instruments are paid up and in the case of instruments referred their purchase is not funded directly or to in Article 25 of the proposed EU e) Other reserves; indirectly by the institution; Regulation, where the refusal by the f) Funds for general banking risk. institution to redeem such instruments c) The instruments meet all the is prohibited under applicable CET 1 items of mutuals, cooperative following conditions as regards their national law; societies or similar institutions classification: include capital instruments by an h) The instruments meet the following i) They qualify as capital within the institution under its statutory terms conditions as regards distributions: meaning of Article 22 of Directive provided the following conditions are 86/635/EEC; i) There are no preferential met: ii) They are classified as equity distributions, including in relation a) The institution is of a type that to other Common Equity Tier 1 within the meaning of the applicable is defined under applicable national instruments, and the terms governing accounting standard; law and which competent authorities the instruments do not provide consider to qualify as a mutual, iii) They are classified as equity capital preferential rights to payment of cooperative society or a similar for the purposes of determining distributions; institution; balance sheet insolvency, where applicable under national insolvency ii) Distributions to holders of the b) The conditions laid down in law; instruments may be paid only out of Articles 26 and 27 of the proposed EU distributable items; d) The instruments are clearly and Regulation are met; iii) The conditions governing the separately disclosed on the balance sheet in the financial statements of instruments do not include a cap or c) The instrument does not possess the institution; other restriction on the maximum level features that could cause the of distributions, except in the case condition of the institution to be e) The instruments are perpetual; of the instruments referred to in weakened as a going concern during Article 25 of the proposed EU periods of market stress. Regulation; 16 iv) The level of distributions is not m) The instruments are not subject determined on the basis of the amount to any arrangement, contractual or for which the instruments were otherwise, that enhances the seniority purchased at issuance, and is not of claims under the instruments in otherwise determined on this basis, insolvency or liquidation. except in the case of the instruments referred to in Article 25 of the Capital instruments issued by proposed EU Regulation; mutuals, cooperative societies and similar institutions need to meet v) The conditions governing the the conditions mentioned in Article instruments do not include any 26 of the proposed EU Regulation obligation for the institution to make (see above) as well as the following distributions to their holders and the conditions as with respect to the institution is not otherwise subject to redemption of the capital instruments such an obligation; to qualify as CET 1 instruments: vi) Non-payment of distributions does not constitute an event of default of a) Except where prohibited under the institution; applicable national law, the institution shall be able to refuse the redemption i) Compared to all the capital of the instruments; instruments issued by the institution, the instruments absorb the first b) Where the refusal by the institution and proportionately greatest share of the redemption of instruments is of losses as they occur, and each prohibited under applicable national instrument absorbs losses to the same law, the provisions governing the degree as all other Common Equity Tier instruments shall give the institution 1 instruments; the ability to limit their redemption; j) The instruments rank below all other c) Refusal to redeem the instruments, claims in the event of insolvency or or the limitation of the redemption of liquidation of the institution; the instruments where applicable, may not constitute an event of default of k) The instruments entitle their owners the institution. to a claim on the residual assets of the institution, which, in the event of The EU also addresses the topic of its liquidation and after the payment “silent partnership,” pointing out that of all senior claims, is proportionate it is a generic term covering capital to the amount of such instruments instruments with widely varying issued and is not fixed or subject to a characteristics (e.g., in terms of ability cap, except in the case of the capital to absorb losses). Whether or not silent instruments referred to in Article 25 of partnership would qualify as a CET 1 the proposed EU Regulation; item depends on the characteristics of the instrument. The items must be l) The instruments are not secured, or of extremely high quality and able to guaranteed by any of the following: absorb losses fully as they occur.11 i) The institution or its subsidiaries; The CET 1 capital should include ii) The parent institution or its CET 1 items after the application of subsidiaries; regulatory adjustments, deductions iii) The parent financial holding and exemptions and alternatives. company or its subsidiaries; iv) The mixed activity holding company or its subsidiaries; v) The mixed financial holding company and its subsidiaries; vi) Any undertaking that has close links with the entities referred to in points (i) to (v); 17 2.2.2 Additional Tier 1 g) The instruments are perpetual and m) The instruments do not contribute the provisions governing them include to a determination that the liabilities capital no incentive for the institution to of an institution exceed its assets, Additional Tier 1 instruments include: redeem them; where such a determination a) instruments where the below- constitutes a test of insolvency under h) Where the provisions governing applicable national law; mentioned conditions of Article 49 of the instruments include one or more the proposed EU Regulation are met; call options, the option to call may be n) The provisions governing the and b) the share premium accounts exercised at the sole discretion of the instruments require the principal related to these instruments. issuer; amount of the instruments to be According to Article 49 of the written down, or the instruments to be i) The instruments may be called, converted to CET 1 instruments, upon proposed EU Regulation, capital redeemed or repurchased only where the occurrence of a trigger event; instruments need to meet all of the the conditions laid down in Article following conditions to qualify as 72 of the proposed EU Regulation are o) The provisions governing the additional Tier 1 capital items: met, and not before five years after instruments include no feature that a) The instruments are issued and the date of issuance; could hinder the recapitalization of the paid up; institution; j) The provisions governing the b) The instruments are not purchased instruments do not indicate explicitly p) Where the instruments are not by any of the following: or implicitly that the instruments issued directly by the institution or would or might be called, redeemed by an operating entity within the i) The institution or its subsidiaries; or repurchased and the institution consolidation pursuant to prudent does not otherwise provide such an consolidation (Chapter 2 of Title II of ii) An undertaking in which the indication; Part One), the parent institution, the institution has participation in the parent financial holding company, or form of ownership, direct or by way of k) The institution does not indicate the mixed activity holding company, control, of 20% or more of the voting explicitly or implicitly that the the proceeds are immediately available rights or capital of that undertaking; competent authority would consent to without limitation in a form that c) The purchase of the instruments is a request to call, redeem or repurchase satisfies the conditions laid down in not funded directly or indirectly by the the instruments; this paragraph to any of the following: institution; l) Distributions under the instruments i) The institution; d) The instruments rank below Tier meet the following conditions: 2 instruments in the event of the ii) An operating entity within the insolvency of the institution; i) They are paid out of distributable consolidation pursuant to Chapter 2 of items; Title II of Part One; e) The instruments are not secured, or ii) The level of distributions made on guaranteed by any of the following: iii) The parent institution; the instruments will not be modified based on the credit standing of the iv) The parent financial holding i) The institution or its subsidiaries; institution, its parent institution or company; ii) The parent institution or its parent financial holding company or v) The mixed activity holding company. subsidiaries; mixed activity holding company; The EU standard12 requires that all iii) The parent financial holding iii) The provisions governing the capital instruments recognized in the company or its subsidiaries; instruments give the institution full Additional Tier 1 capital are written discretion at all times to cancel the iv) The mixed activity holding down or converted into Common distributions on the instruments for company or its subsidiaries; Equity Tier 1 instruments when the an unlimited period and on a non- CET 1 capital ratio falls below 5.125% v) The mixed financial holding cumulative basis, and the institution (contingent capital). Contingent capital company and its subsidiaries; may use such cancelled payments not fulfilling these requirements without restriction to meet its vi) Any undertaking that has close will not be recognized as obligations as they fall due; links with entities referred to in points regulatory capital. (i) to (v); iv) Cancellation of distributions does not constitute an event of default of f) The instruments are not subject the institution; to any arrangement, contractual or otherwise, that enhances the seniority v) The cancellation of distributions of the claim under the instruments in imposes no restrictions on the insolvency or liquidation; institution; 18 Regarding hybrid capital instruments, According to Article 60 of the j) The instruments may be called, the EU standard builds upon the proposed EU Regulation, instruments redeemed or repurchased only where amendments made under the CRD need to fulfill the following conditions the conditions laid down in Article II concerning the quality of such to qualify as Tier 2 capital: 72 of the proposed EU Regulation are instruments, introducing stricter met, and not before five years after eligibility criteria for inclusion in a) The instruments are issued and fully the date of issuance; Additional Tier 1 capital. Hybrid capital paid-up; k) The provisions governing the instruments need to absorb losses by b) The instruments are not purchased instruments do not indicate or suggest being written down or converted into by any of the following: that the instruments would or might CET 1 instruments when CET 1 capital be redeemed or repurchased other ratio falls below 5.125%. Hybrid i) The institution or its subsidiaries; than at maturity and the institution capital instruments with an incentive does not otherwise provide such an to redeem, which are currently limited ii) An undertaking in which the indication or suggestion; to 15% of the Tier 1 capital base (see institution has participation in the CRD II), will be phased out under form of ownership, direct or by way of l) The provisions governing the Basel III. control, of 20% or more of the voting instruments do not give the holder rights or capital of that undertaking; the right to accelerate the future The Additional Tier 1 capital base scheduled payment of interest or consists of the corresponding c) The purchase of the instruments is principal, other than in the insolvency instruments after deductions. not funded directly or indirectly by the or liquidation of the institution; institution; m) The level of interest or dividend d) The claim on the principal amount 2.2.3 Tier 2 capital of the instruments under the payments due on the instruments will not be modified based on the credit The new definition of capital provisions governing the instruments standing of the institution, its parent rationalizes Tier 2 capital by is wholly subordinated to claims of all institution or parent financial holding eliminating Upper Tier 2 from the non-subordinated creditors; company or mixed activity holding capital structure. It also introduces e) The instruments are not secured, or company; harmonized and strict eligibility guaranteed by any of the following: criteria. Under Basel III, Tier 2 capital n) Where the instruments are not ensures loss absorption in case of i) The institution or its subsidiaries; issued directly by the institution or liquidation (gone-concern). by an operating entity within the ii) The parent institution or its consolidation pursuant to prudent subsidiaries; Tier 2 capital includes the following consolidation (Chapter 2 of Title II of items: iii) The parent financial holding Part One), the parent institution, the company or its subsidiaries; parent financial holding company, or a) Capital instruments, where the the mixed activity holding company, iv) The mixed activity holding conditions laid down in Article 60 are the proceeds are immediately available company or its subsidiaries; met; without limitation in a form that v) The mixed financial holding satisfies the conditions laid down in b) The share premium accounts related company and its subsidiaries; this paragraph to any of the following: to the instruments referred to in point (a); vi) Any undertaking that has close i) The institution; links with entities referred to in points c) For institutions calculating risk- (i) to (v); ii) An operating entity within the weighted exposure amounts in consolidation pursuant to Chapter 2 of f) The instruments are not subject accordance with the Standardized Title II of Part One; to any arrangement that otherwise Approach, general credit risk enhances the seniority of the claim adjustments, gross-of-tax effects, of iii) The parent institution; under the instruments; up to 1.25% of risk-weighted exposure g) The instruments have an original iv) The parent financial holding amounts calculated in accordance maturity of at least five years; company; with the Standardized Approach; h) The provisions governing the v) The mixed activity holding company. d) For institutions calculating risk- instruments do not include any weighted exposure amounts under incentive for them to be redeemed by The Tier 2 capital base consists of the Internal Ratings Based approach the institution; the corresponding instruments after (IRB), positive amounts, gross-of-tax deductions. effects, resulting from the calculation i) Where the instruments include one laid down in Article 154 and 155 up or more call options, the options are to 0.6% of risk-weighted exposure exercisable at the sole discretion of amounts calculated under the IRB the issuer; approach. 19 2.3 Prudential filters and deductions 2.3.1 Prudential filters The Basel III standard harmonizes regulatory adjustments (i.e., deductions from capital and prudential filters) which will generally be applied at the level of CET 1 capital or its equivalent in the case of non-joint stock companies in the future. Table 2: Prudential filters Basel III Regulatory Adjustments Item Description Prudential filters Securitized assets An institution shall exclude from any element of own funds any increase in its equity under the applicable accounting standard that results from securitized assets. Cash flow hedges and changes in the The fair value reserves related to gains or losses on cash flow hedges of value of own liabilities financial instruments that are not valued at fair value, including projected cash flows; and gains or losses on liabilities of the institution that are valued at fair value that result from changes in the credit standing of the institution should not be included in any element of own funds. Additional value adjustments Institutions shall apply the requirements for prudent valuation specified in the proposed Regulation to all their assets measured at fair value when calculating the amount of their own funds and shall deduct from CET 1 capital the amount of any additional value adjustments necessary. Unrealized gains and losses measured Institutions shall generally not make adjustments to remove from their own at fair value funds unrealized gains or losses on their assets or liabilities measured at fair value. Source: New proposals on capital requirements (July 2011), European Commission found at http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm 20 2.3.2 Deductions from CET 1 capital Table 3: Deduction from CET 1 capital in Basel III Regulatory Adjustments Item Description Deductions from CET 1 capital Losses for current fiscal year Intangible assets Institutions shall determine the intangible assets to be deducted in accordance with the following: (a) the amount to be deducted shall be reduced by the amount of associated deferred tax liabilities that would be extinguished if the intangible assets became impaired or were derecognized under the relevant accounting standard; (b) the amount to be deducted shall include goodwill included in the valuation of significant investments of the institution. Deferred tax assets Deferred tax assets that rely on future profitability according to Article 35 of the proposed EU Regulation. Deferred tax assets that do not rely on future profitability according to Article 36 of the proposed EU Regulation. Negative expected losses IRB banks should deduct negative amounts resulting from the calculation of expected loss (see Article 37 of the EU proposed Regulation). Benefit pension fund assets Benefit pension fund assets should be deducted according to Article 38 of the proposed EU Regulation. Direct and indirect holding of CET 1 Direct and indirect holdings by an institution of own CET1 instruments, including items own CET 1 instruments that an institution is under an actual or contingent obligation to purchase by virtue of an existing contractual obligation (see Article 39 of the proposed EU Regulation). Holdings of CET 1 items of entities Holdings of the CET 1 instruments of relevant entities where those entities have with reciprocal cross holding a reciprocal cross holding with the institution that the competent authority considers to have been designed to inflate artificially the own funds of the institution (see Article 41 of the proposed EU Regulation). Not-significant investments in relevant The applicable amount of direct and indirect holdings by the institution of CET 1 entities instruments of relevant entities where the institution does not have a significant investment in those entities (see Article 43 of the proposed EU Regulation). Significant investments in relevant The applicable amount of direct and indirect holdings by the institution of the entities CET 1 instruments of relevant entities where the institution has a significant investment (e.g., the institution owns more than 10% of the CET 1 instruments issued by that entity) in those entities (see Article 40 of the proposed EU Regulation). Amount that exceed Additional Tier 1 The amount of items required to be deducted from Additional Tier 1 items that capital exceed the Additional Tier 1 capital of the institution. Alternative to risk-weight of 1.250% The exposure amount of the specified items (e.g., qualifying holdings outside the financial sector) which qualify for a risk-weight of 1.250%, where the institution deducts that exposure amount from CET 1 capital as an alternative to applying a risk-weight of 1.250%. Tax charge Any tax charge relating to CET 1 items foreseeable at the moment of its calculation, except where the institution suitably adjusts the amount of CET 1 items insofar as such tax charges reduce the amount up to which those items may be applied to cover risks or losses. Source: New proposals on capital requirements (July 2011), European Commission found at http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm 21 2.3.3 Exemptions from 2.3.4 Deductions from Additional Tier 1 capital and alternatives to Table 4: Deduction from Additional Tier 1 capital in Basel III deduction from CET 1 Regulatory Adjustments items Item Description The following items, which in aggregate are equal to or less than Deductions from Additional 15% of the CET 1 capital of the Tier 1 capital institution (after adjustments), may Direct and indirect holding Direct and indirect holdings by an institution of not be deducted from CET 1 capital: of Additional Tier 1 items own Additional Tier 1 instruments, including own Additional Tier 1 instruments that an institution • Deferred tax assets that are could be obliged to purchase as a result of dependent on future profitability and existing contractual obligations (see Article 54 of arise from temporary differences, the proposed EU Regulation). and in aggregate are equal to or less than 10% of the CET 1 items of the Holdings of Additional Tier Holdings of the Additional Tier 1 instruments of institution (after adjustments); 1 items of entities with relevant entities with which the institution has reciprocal cross holding reciprocal cross holdings that the competent • Significant investments in a relevant authority considers to have been designed to entity,13 the direct and indirect inflate artificially the own funds of the institution holdings of that institution of the (see Article 55 of the proposed EU Regulation). CET 1 instruments of those entities that in aggregate are equal to or less Not-significant investments Direct and indirect holdings of the Additional than 10% of the CET 1 items of the in relevant entities Tier 1 instruments of relevant entities, where an institution (after adjustments). institution does not have a significant investment in those entities (see Article 57 of the proposed Instruments that are not deducted EU Regulation). shall be assigned a risk-weight of Significant investments in Direct and indirect holdings by the institution 250%. relevant entities of the Additional Tier 1 instruments of relevant The EU standard allows alternatives to entities where the institution has a significant the deduction of significant holdings investment in those entities, excluding of institutions in the CET 1 instruments underwriting positions held for five working days of other financial entities like or fewer. insurance undertakings, reinsurance Amount that exceeds Tier The amount of items required to be deducted undertakings and insurance holding 2 capital from Tier 2 items that exceed the Tier 2 capital of companies included in the scope of the institution. consolidated supervision (Article 46 of the proposed EU Regulation). Tax charge Any tax charge relating to Additional Tier 1 items The European Commission justifies foreseeable at the moment of its calculation, this aspect with the so-called except where the institution suitably adjusts the “bancassurance” business model amount of Additional Tier 1 items insofar as such which is a key feature of the EU tax charges reduce the amount up to which those banking landscape, i.e., groups that items may be applied to cover risks or losses. contain significant banking/investment Source: New proposals on capital requirements (July 2011), European Commission found at http://ec.europa.eu/ businesses and insurance businesses.14 internal_market/bank/regcapital/index_en.htm Further, the standard permits mutuals, cooperative societies or similar institutions not to deduct significant and not-significant holdings in another such institution or in its central or regional credit institution if the specified conditions are met (see chapter 2.5). 22 2.3.5 Deductions from Tier 2 items Table 5: Deduction from Additional Tier 2 capital in Basel III Regulatory Adjustments Item Description Deductions from Tier 2 capital Direct and indirect holding of Tier 2 Direct and indirect holdings by an institution of own Tier 2 instruments, including items own Tier 2 instruments that an institution could be obliged to purchase as a result of existing contractual obligations. Holdings of Additional Tier 2 items of Holdings of the Tier 2 instruments of relevant entities with which the institution entities with reciprocal cross holding has reciprocal cross holdings that the competent authority considers to have been designed to inflate artificially the own funds of the institution (see Article 65 of the proposed EU Regulation). Not-significant investments in relevant The applicable amount determined in accordance with Article 67 of direct and entities indirect holdings of the Tier 2 instruments of relevant entities, where an institution does not have a significant investment in those entities. Significant investments in relevant Direct and indirect holdings by the institution of the Tier 2 instruments of relevant entities entities where the institution has a significant investment in those entities, excluding underwriting positions held for fewer than 5 working days. Source: New proposals on capital requirements (July 2011), European Commission found at http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm 23 2.4 Minority interests 2.5 2.4.1 Minority interests that qualify for inclusion 2.4.2 Qualifying Additional Tier 1, Tier Institutional in consolidated CET 1 capital 1, Tier 2 capital and qualifying own funds networks Minority interest includes CET 1 Qualifying Additional Tier 1, Tier 1, The EU standard allows mutuals, instruments, the related retained Tier 2 capital and qualifying own cooperative societies or similar earnings and share premium accounts funds include the minority interest, institutions not to deduct significant of a subsidiary where the following Additional Tier 1, Tier 1 or Tier 2 and not-significant holdings in another conditions are met: instruments, as applicable, plus the such institution or in its central related retained earnings and share or regional credit institution if the a) The subsidiary is one of the premium accounts, of a subsidiary following conditions are met: following: where the following conditions i) An institution; are met: i) Where the holding is in a central or regional credit institution, the ii) An undertaking that is subject by a) The subsidiary is one of the institution with that holding is virtue of applicable national law to following: associated with that central or the requirements of the proposed EU regional credit institution in a i) An institution; Regulation and proposed Directive; network subject to legal or statutory ii) An undertaking that is subject by provisions and the central or regional b) The subsidiary is included fully in virtue of applicable national law to credit institution is responsible, under the consolidation; the requirements of the proposed EU those provisions, for cash-clearing c) Those CET 1 instruments are owned Regulation and proposed Directive; operations within that network; by persons other than the undertakings b) The subsidiary is included fully in included in the consolidation. ii) The institutions fall within the same the consolidation; institutional protection scheme; Minority interests that are funded d) Those instruments are owned by directly or indirectly, through a iii) The competent authorities have persons other than the undertakings special-purpose entity or otherwise, by granted the permission referred to in included in the consolidation. the parent institution, parent financial Article 108(7);15 holding company, mixed activity Additional Tier 1 and Tier 2 capital holding company or their subsidiaries issued by special-purpose entities iv) The conditions laid down in Article shall not qualify as consolidated CET 1 may be included only if the conditions 108(7) are satisfied; capital. specified in Article 78 of the proposed EU Regulation are met. v) The institution draws up and Institutions should determine the reports to the competent authorities amount of minority interests of a Institutions should determine the the consolidated balance sheet subsidiary included in the consolidated amount of qualifying Tier 1 capital referred to in point (e) of Article CET 1 capital according to Article 79 of a subsidiary that is included in 108(7) no less frequently than own of the proposed EU Regulation. the consolidated Tier 1 capital and funds requirements are required to be consolidated Additional Tier 1 capital reported under Article 95. according to Articles 80-81 of the proposed EU Regulation. The amount A regional credit institution may of qualifying own funds of a subsidiary not deduct holdings in its central or that is included in consolidated own another regional credit institution funds and in consolidated Tier 2 if the conditions mentioned above capital shall be determined according are met. to Article 82 and 83 respectively of the proposed EU Regulation. 24 2.6 Capital buffers Basel III introduces two capital buffers calculate the MDA depends on how The designated authority that is in addition to the capital requirements: much an institution is dropping below responsible for setting the buffer a capital conservation buffer and a the requirement and ranges from 0% should calculate a buffer guide based countercyclical capital buffer. While (first/lowest quartile) to 60% (fourth/ on a deviation of the ratio of credit- the definition of capital is treated highest quartile).17 to-GDP from its long-term trend on in the proposed EU Regulation, the a quarterly basis. An increase of the capital buffers are discussed in the Further, the affected institutions countercyclical capital buffer should corresponding proposed Directive should prepare a capital conservation generally be communicated 12 months requiring national transposition.16 plan and submit it to the competent in advance. A decrease of the buffer authorities including the following: could be applicable immediately. The estimates of income and expenditure designated authority should give an 2.6.1 Capital and a forecast balance sheet; indicative (not binding) period during measures to increase the capital ratios conservation buffer of the institution; and a plan and which no increase in the buffer is expected. The capital conservation buffer, 2.5% timeframe for the increase of own of RWA and to be met with CET 1 funds with the objective of meeting International institutions need to capital, applies at all times and it is fully the combined buffer requirement. calculate the institution-specific intended to ensure that institutions countercyclical capital buffer which are able to absorb losses in stress The capital conservation buffer partly consists of the weighted average periods lasting for a number of solves the regulatory paradox after of the countercyclical buffer rates years. Considering the 4.5% CET 1 which higher minimum capital should that apply in the jurisdictions where capital ratio, institutions must hold not be used to absorb losses falling the relevant credit exposures of the 7.0% CET 1 capital on an individual below the minimum requirements, institution are located (based on the and consolidated basis at all times. leading to a withdrawal of the own funds requirements for credit Institutions are expected to build up banking license. With the introduced risk). the capital in good economic times. capital buffers and the associated 2.7 Enhanced distribution constraints falling below In case institutions fail to meet fully the requirements, a “softer” regulatory the “combined buffer requirement” tool is introduced.18 (i.e., the total CET 1 capital required to meet the requirement for the capital conservation buffer extended by an 2.6.2 Countercyclical disclosure institution-specific countercyclical capital buffer capital buffer), distribution constraints on CET 1 capital are imposed. CET The countercyclical capital buffer is requirements 1 capital should thereby include the introduced to “achieve the broader following items: macro-prudential goal of protecting The proposed EU Regulation includes the banking sector and the real improved disclosure requirements a) A payment of cash dividends; economy from the system-wide regarding the capital endowment risks stemming from the boom-bust and own funds of institutions. The b) A distribution of fully or partly evolution in aggregate credit growth purpose is to strengthen market paid bonus shares or other capital and more generally from any other discipline and enhance financial instruments; structural variables and from the stability. The corresponding technical exposure of the banking sector to standards to specify uniform formats, c) A redemption or purchase by an any other risk factors related to risks frequencies, etc., are to be developed institution of its own shares or other to financial stability.”19 The level of by the European Banking Authority specified capital instruments; this buffer is set by each Member and submitted to the European State, ranges between 0% and 2.5% Commission by January 1, 2013. d) A repayment of amounts paid up of RWA 20 and has to be met by CET 1 in connection with specified capital capital.21 The buffer is required during instruments; periods of excessive credit growth and e) A distribution of items referred to in it is released in an economic downturn. points (b) to (e) of Article 24(1) of that In cases where institutions fail to meet Regulation. fully the countercyclical capital buffer Falling below the combined buffer requirements, capital distribution requirement, institutions have to constraints are imposed (see above). calculate the “Maximum Distributable Amount” (MDA). The factor to 25 3 Counterparty Credit Risk 26 27 Basel III strengthens the requirements for the All other banks must calculate a standardized CVA risk capital charge. management and capitalization of counterparty credit Within this method – it is based on the risk (CCR). It includes an additional capital charge for bond equivalent approach – portfolio own funds requirements for CVA risk possible losses associated with deterioration in the for each counterparty have to be creditworthiness of counterparties or increased risk- calculated using the given formula. weights on exposures to large financial institutions. The The calculation of the aggregate CCR and CVA risk capital charges depends new framework also enhances incentives for clearing on the methods used by banks. over-the-counter (OTC) instruments through central • For banks with IMM approval and counterparties (CCP).22 market-risk internal-models approval for the specific interest-rate risk of 3.1 Effective 3.2 Credit bonds, the total CCR capital charge is the sum of the following components: i) The higher of (a) its IMM capital Expected valuation charge based on current parameter calibrations for EAD and (b) its IMM Positive adjustment capital charge based on stressed parameter calibrations for EAD; ii) The advanced CVA risk capital Exposure In addition to the default risk capital requirements for CCR, Basel III introduces an additional capital charge charge calculated with the internal models. For banks using an Internal Model to cover the risk of mark-to-market • For banks with IMM approval and Method (IMM) to calculate CCR losses on the expected counterparty without Specific-Risk VaR approval for regulatory capital, Basel III requires risk (Credit Valuation Adjustment, CVA) bonds, the total CCR capital charge is determining the default risk capital to OTC derivatives. The calculation the sum of the following components: charge by using the greater of the of the CVA charge depends on the portfolio-level capital charge (not method banks use to determine the i) The higher of (a) its IMM capital including CVA charge) based on capital charge for CCR and specific- charge based on current parameter Effective Expected Positive Exposure interest rate risk. Transactions with calibrations for EAD and (b) its IMM (EEPE) using current market data a central counterparty (CCP) and capital charge based on stressed and the one based on EEPE using a securities financing transactions (SFT) parameter calibrations for EAD; stress calibration. The greater of the need not be considered. ii) The standardized CVA risk capital EEPEs should not be applied on a charge. counterparty-by-counterparty basis, Banks with IMM approval for CCR but on a total portfolio level. • For all other banks, the total CCR risk and approval to use the market capital charge is the sum of the risk internal models approach for the following components: specific-interest rate risk of bonds must calculate the additional capital charge i) The sum over all counterparties of by modeling the impact of changes in the Current Exposure Method (CEM) the counterparty’s credit spread on or Standardized Method (SM)-based the CVAs of all OTC derivatives using capital charge (depending on the the internal VaR model for bonds. This bank’s CCR approach); VaR model is restricted to changes in the counterparties’ credit spreads and ii) The standardized CVA risk capital does not model the sensitivity of CVA charge. to changes in other market factors such as changes in the value of the reference asset, commodity, currency or interest rate of a derivative. The CVA risk capital charge consists of both general and specific credit spread risks, including Stressed VaR but excluding incremental risk charge (IRC). 28 3.3 Wrong Regulation consider institutions as “large” if the total assets, on the level of that individual firm or on the 3.6 Enhanced way risk consolidated level of the group, are greater than or equal to EUR 70 billion threshold. The Basel III document by CCR In addition to the consideration of general wrong way risk – stress testing and scenario analysis must the BCBS includes a threshold of US $100 billion. management be designed to identify such risks – Basel III introduces an explicit Pillar 1 capital charge for specific Depending on the probability of default of the institution, the introduction of this multiplier requirements wrong way risk. Banks are exposed increases the risk-weight by Basel III strengthens not only the to specific wrong way risk if future approximately 20% to 35%. A detailed CCR measurement but also the CCR exposure to a specific counterparty calculation is provided in the appendix management by requiring institutions is highly, positively correlated with of this handbook. to establish and maintain a CCR the counterparty’s probability of management framework consisting of: default. Banks must “have procedures a) Policies, processes and systems 3.5 Central in place to identify, monitor and control cases of specific wrong way to ensure the identification, risk, beginning at the inception of a measurement, management, approval counter- trade and continuing through the life and internal reporting of the trade. To calculate the CCR of CCR; capital charge, the instruments for b) Procedures for ensuring that those parties which there exists a legal connection between the counterparty and the policies, processes and systems are underlying issuer, and for which complied with. specific wrong way risk has been The new capital framework also The framework should ensure that identified, are not considered to enhances incentives for clearing institutions comply with the following be in the same netting set as other instruments through central principles: transactions with the counterparty. counterparties (CCP) by applying lower Furthermore, for single-name own funds requirements relative to a) It does not undertake business with credit default swaps where a legal OTC transactions. Also, the additional a counterparty without assessing its connection exists between the CVA capital charge does not apply creditworthiness; counterparty and the underlying issuer, to exposures towards eligible CCPs. and where specific wrong way risk b) It takes due account of settlement It should be noted that several has been identified, EAD counterparty and pre-settlement credit risk; conditions need to be fulfilled to exposure equals the full expected classify as CCP. c) It manages such risks as loss in the remaining fair value of the comprehensively and practicable at the underlying instruments assuming the While so far there is no capital counterparty level by aggregating CCR underlying issuer is in liquidation.”23 charge for derivatives with a CCP the exposures with other credit exposures proposed EU Regulation introduces and at the firm-wide level. own funds requirements for trade 3.4 Asset exposures. According to this an institution has to apply a risk-weight of 2% to the exposure values of all Basel III also includes new requirements for CCR back testing and stress testing. Banks must have value its trade exposures with CCPs. An exposure value of zero can be used in cases where the posted collaterals to a a comprehensive stress testing program including regular execution, single- and multi-factor tests, trade correlation CCP or a clearing member bankruptcy are remote events, or if the CCP, the clearing member or one or more of the coverage and internal control. In addition, new requirements for collateral management and policies Basel III increases the risk-weights other clients of the clearing member are stipulated. The regulatory floor for (RW) on exposures to financial becomes insolvent. the margin period of risk will increase, institutions relative to the non- depending on the counterparty financial corporate sector in the IRB In addition to institutions acting as portfolio and historic margin approach. The correlation coefficient clearing members, they have to hold call failures. in the IRB formula is increased own funds to cover the exposures by 25% for all exposures to large arising from their contributions regulated financial entities and to to the default fund of a CCP, the all unregulated financial entities.24 corresponding methodology is In effect, a multiplier of 1.25 is specified in Article 298 of the introduced. The proposals of the EU proposed EU Regulation. 29 4 Leverage ratio 30 31 4.1 Definition and calibration To prevent an excessive build-up arithmetic mean of the monthly for various types of institutions. Based of leverage on institutions’ balance leverage ratios over a quarter.27 on the EBA report, final adjustments sheets, Basel III introduces a non-risk- of the ratio would be made in the first based leverage ratio to supplement For the numerator of the ratio (capital half of 2017. The EBA would develop the risk-based capital framework of measure), the Tier 1 capital should drafts of technical standards to Basel II. This new regulatory tool is not be considered. The denominator determine the contents and format of intended to be a binding instrument at (exposure measure) should be the the uniform reporting template. this stage but as an “additional feature sum of the exposure values of all that can be applied on individual assets and off-balance sheet items Within the disclosure requirements, banks at the discretion of supervisory not deducted from the calculation of the following information should be authorities with a view to migrating Tier 1 capital. For off-balance-sheet reported: to a binding ('Pillar one') measure in items, a specific credit risk adjustment 2018, based on appropriate review and of 10% generally applies for undrawn a) The leverage ratio; calibration.”25 Reporting requirements credit facilities, (this may be cancelled unconditionally at any time without b) A breakdown of the total exposure from January 1, 2013 would allow a notice), and 100% for all other off- measure; corresponding review and decision on its introduction as a binding balance-sheet items.28 c) A description of the processes requirement in 2018. Starting in 2015, used to manage the risk of excessive publication of the leverage ratio by the At this time a leverage ratio of 3% is proposed. By October 31, 2016, leverage; institutions is proposed.26 the EBA will report to the European d) A description of the factors that The leverage ratio should be calculated Commission among others on whether had an impact on the leverage ratio by dividing an institution’s capital 3% would be an appropriate level for a during the period to which the measure by the total exposure Tier 1 capital-based leverage ratio and disclosed leverage ratio refers. (expressed as a percentage). The ratio whether the leverage ratio should be should be calculated as the simple the same for all institutions or differ Figure 4: Leverage Ratio within Basel III Tier 1 capital • Exposure measure generally follows Leverage Ratio = ≥ 3% accounting measure Total exposure • Credit risk adjustement for off-balance-sheet items: - Generally 100% - 10% for unconditionally cancellable commitments Calculation Simple arithmetic mean of the monthly leverage ratio over the quarter Scope of application Solo, consolidated and sub-consolidated level Disclosure Disclosure of the key elements of the leverage ratio under Pillar 3 Introduction Planned for Jan. 1, 2018 Transition period • Jan. 1, 2011: Start supervisory monitoring period (development of templates) • Jan. 1, 2013 – Jan. 1, 2017: Parallel run (leverage ratio and its components will be tracked, including its behavior relative to the risk based requirement) • Jan. 1, 2015: Disclosure of the leverage ratio by banks • First half of 2017: Final adjustments • Jan. 1, 2018: Migration to Pillar 1 treatment Source: Accenture 32 33 5 Global liquidity standard 34 35 Basel III includes a new liquidity standard introducing two liquidity ratios. The Liquidity Coverage Ratio (LCR) is introduced to improve the short-term resilience of the liquidity risk profile of institutions, requiring them to hold a buffer of “high quality” liquid assets to match net liquidity outflows during a 30-day period of stress. The Net Stable Funding Ratio (NSFR) is designed to promote resilience over the longer term by requiring institutions to fund their activities with more stable sources of funding on an ongoing structural basis. Further, EBA will develop draft It should be noted that institutions implementation technical standards are not only expected to meet the regarding liquidity monitoring metrics new standards but also to adhere which should allow competent to the Principles for Sound Liquidity authorities to obtain a comprehensive Risk Management and Supervision.29 view of the liquidity risk profiles of These principles provide guidance on institutions. The Basel III document the risk management and supervision from the BCBS contains a number of of liquidity and funding risk and have monitoring tools which are presented been considered in the context of the in section 5.3. CRD II. The following figure gives an overview of the relevant topics. Figure 5: Liquidity risk management (LRM) framework Governance • Liquidity risk tolerance • Responsibility senior management Liquidity risk • Pricing of liquidity costs management framework Measurement and management • Liquidity risk management (LRM) process • Group-wide perspective • Funding strategy Governance Measurement • Intraday liquidity positions and management • Collateral positions • Stress testing • Contingency funding plan • High quality liquid assets Public disclosure • Disclosure Public disclosure Role of Role of supervisors supervisors • Assessment LRM framework • Monitoring • Effective/timely intervention • Communication with other supervisors Fundamental principle for the management Fundamental principle and supervision of liquidity risk • A bank should establish a robust liquidity risk management framework that ensures it maintains sufficient liquidity Source: Accenture 36 5.1 Liquidity Coverage Ratio The Liquidity Coverage Ratio (LCR) to stringent conditions – waive the competent authorities on a daily requires institutions to hold a the application to a consolidated basis. sufficient buffer of “high quality” requirement.31 liquid assets to cover net liquidity The LCR should be reported on a outflows during a 30-day period of To meet the requirement, institutions monthly basis. Competent authorities stress. The stock of high quality liquid shall “at all times hold liquid assets, may authorize a lower reporting assets (numerator) should include the sum of the values of which frequency on the basis of the assets of high credit and liquidity equals, or is greater than, the liquidity individual situation of an institution. quality. The stress scenario that is outflows less the liquidity inflows Competent authorities might also used to determine the net cash under stressed conditions so as to require institutions with significant outflows (denominator) reflects ensure that institutions maintain levels liquidity risk in a foreign currency to both institution-specific and of liquidity buffers which are adequate report these items separately. systemic shocks.30 to face any possible imbalance between liquidity inflows and outflows The LCR will be introduced by 2015 under stressed conditions over a short after an observation period to avoid period of time. Institutions shall not possible unintended consequences. count double liquidity inflows and From 2013 on, there is a general liquid assets.”32 requirement for banks to keep appropriate liquidity coverage. If an institution does not meet the requirements, it is asked to notify the According to the proposed EU competent authorities and submit Regulation, the LCR will in principle a plan for the timely restoration of apply at the level of every individual compliance with the LCR requirement. institution (with legal personality). Until the institution has restored Competent authorities may – subject compliance, it must report the items to Figure 6: Liquidity Coverage Ratio (LCR) High quality liquid assets Institutions have to ensure that they have LCR = ≥ 100% at all times sufficient high quality liquid Total net liquidity outflows assets to survive an acute stress scenario lasting for 30 days over 30-day time period Introduction Jan. 1, 2015; observation period starting Jan. 1, 2013 Scope of application Level of individual institution (with legal personality) Reporting Monthly with the operational capacity to increase the frequency to weekly or even daily in stressed situations Disclosure Disclosure of LCR under Pillar 3 Source: Accenture 37 5.1.1. Definition of high- a) assets that are issued by a credit c) Their price can be determined by a institution unless they fulfill one of the formula that is easy to calculate based quality liquid assets following conditions: on publicly available inputs and does The following items should qualify as not depend on strong assumptions as i) They are bonds eligible for treatment is typically the case for structured or liquid assets: as covered bonds; exotic products; a) Cash and deposits held with ii) They are bonds as defined in Article central banks to the extent that these d) They are listed on a recognized 52(4) of Directive 2009/65/EC33 other deposits can be withdrawn in times exchange; than those referred to in (i); of stress; iii) The credit institution has been e) They are tradable on active outright b) Transferable assets that are of set up and is sponsored by a Member sale or repurchase agreement markets extremely high liquidity and State central or regional government with a large and diverse number of credit quality; and the asset is guaranteed by market participants, a high trading that government and used to fund volume and market breadth and depth. c) Transferable assets representing promotional loans granted on a claims on or guaranteed by the central non-competitive, not-for-profit basis Items have to fulfill several operational government of a Member State or a in order to promote its public policy requirements to be considered as high- third country if the institution incurs a objectives; quality liquid assets: liquidity risk in that Member State or b) Assets issued by any of a) They are appropriately diversified; third country that it covers by holding the following: those liquid assets; b) “Level 1 assets” should not be less i) An investment firm; than 60% of the liquid assets (see d) Transferable assets that are of high above); liquidity and credit quality. ii) An insurance undertaking; iii) A financial holding company; c) They are legally and practically As an operational requirement, items readily available at any time during listed in points a, b and c (also called iv) A mixed-activity holding company; the next 30 days to be liquidated via “level 1 assets”) should not be less v) Any other entity that performs outright sale or repurchase agreements than 60% of the liquid assets of an one or more of the activities listed in order to meet obligations institution. Such items owed and due in Annex I of the Directive as its coming due; or callable within 30 calendar days main business (e.g., financial leasing; d) The liquid assets are controlled by a shall not count towards 60% unless acceptance of deposits and other liquidity management function; the assets have been obtained against mutual recognition). collateral that qualifies under points e) A portion of the liquid assets is a, b or c. The items shall fulfill the following periodically and at least annually conditions to qualify as high quality liquidated via outright sale or Regarding the definition of “high” liquid assets: repurchase agreements for the and “extremely high” liquidity and following purposes: credit quality of transferable assets, a) They are not issued by the institution itself or its parent or i) To test the access to the market for EBA will work on a uniform definition subsidiary institutions or another these assets, until December 31, 2013, considering the following criteria: minimum trade subsidiary of its parent institutions or parent financial holding company; ii) To test the effectiveness of its volume of the assets; credit quality processes for the liquidation of assets, steps; average volume traded and b) They are eligible collateral in normal average trade size; remaining time iii) To test the usability of the assets, times for intraday liquidity needs to maturity. Until then, institutions and overnight liquidity facilities of a iv) To minimize the risk of negative themselves should identify the central bank in a Member State or, signaling during a period of stress; corresponding transferable assets that if the liquid assets are held to meet are of high or extremely high liquidity liquidity outflows in the currency of and credit quality. a third country, of the central bank of Institutions should not consider the that third country; following items as high quality liquid assets: 38 f) Price risks associated with the The value of the liquid assets shall assets may be hedged but the liquid be the market value, subject to assets are subject to appropriate appropriate haircuts. For level 2 assets internal arrangements that ensure that the haircut shall not be less than 15%. they will not be used in other ongoing If institutions hedge the price risk, operations, including: they should take into account the cash flow resulting from the potential i) Hedging or other trading strategies; close-out of the hedge. Shares or units ii) Providing credit enhancements in in CIUs should be subject to haircuts, structured transactions; looking through to the underlying assets. The haircuts range from 0% iii) To cover operational costs; to 20%. g) The denomination of the liquid assets is consistent with the distribution by currency of liquidity outflows after the deduction of capped inflows. Figure 7: LCR: High quality liquid assets High quality liquid assets LCR = ≥ 100% Total net liquidity outflows over 30-day time period 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 Central Bank • Listed on a recognized exchange 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% Source: Accenture 39 5.1.2. Definition of net ii) held in a transactional account, sector entity of the Member State including accounts to which salaries in which the credit institution was liquidity outflows are regularly credited; authorized. The denominator of the LCR consists of the net liquidity outflows over 10% of other retail deposits;34 iv) For liabilities resulting from a 30-day period of stress. They are b) For other liabilities that come due, deposits that have to be maintained: calculated as the liquidity inflows can be called for payout, or entail an minus the outflows, whereas the implicit expectation of the provider of (a) By the depositor in order to obtain inflows are limited to 75% of liquidity the funding that the institution would clearing, custody or cash management outflows. repay the liability during the next 30 services from the institution; days, the following percentages should (b) In the context of common task The liquidity outflows are calculated be used to calculate liquidity outflows: sharing within an institutional by multiplying the assets with the i) 0% of the liabilities resulting protection scheme or as a legal or specified “run off” factors; the inflows, from the institution’s own operating statutory minimum deposit by another by multiplying the assets with the expenses; entity being a member of the same specified inflow factor. institutional protection scheme; ii) 0% of liabilities resulting from 5% in case of point a) to the extent to 220.127.116.11 Liquidity outflows secured lending and capital- Liquidity outflows are calculated as which they are covered by a Deposit market-driven transactions which Guarantee Scheme or an equivalent the sum of the following items: are collateralized with high quality deposit guarantee scheme in a third liquid assets (up to the value of the country, and by 25% otherwise; a) 5% of retail deposits that are liquid assets); 100% of the remaining covered by a Deposit Guarantee v) 75% of liabilities resulting from liabilities; Scheme and the depositor is either: deposits by clients that are not iii) 25% of liabilities resulting from financial customers i) Part of an established relationship secured lending and capital-market- making withdrawal highly unlikely; vi) 100% of payables and receivables driven transactions if the assets would not qualify as liquid assets, the lender expected over the 30-day horizon is the central bank or another public from the contracts listed in Annex II into account on a net basis across counterparties; Figure 8: LCR: Net liquidity outflows vii) 100% of other liabilities. High quality liquid assets c) Collateral other than “level 1” assets LCR = ≥ 100% which is posted by the institution for Total net liquidity outflows contracts listed in Annex II shall be over 30-day time period subject to an additional outflow of 15% of the market value of assets for “level 2” assets and 20% of the market Net liquidity outflows = value of other assets; Liquidity outflows – Min (Liquidity inflows; 75% of liquidity outflows) d) Outflows from credit and liquidity Net liquidity outflows facilities that qualify as medium or Liquidity outflows minus liquidity inflows in the stress scenario medium-to-low risk, which shall be The scenario includes firm-specific and systemic factors determined as a percentage of the Calculation liquidity outflows maximum amount that can be drawn Multiplication of the items with the respective “run off“ factor during the next 30 days. The maximum amount should be multiplied by: Calculation liquidity inflows Multiplication of the items with the specified inflow factor; i) 5% if the facilities qualify for inflows are capped at 75% of the outflows the retail exposure class under the Source: Accenture standardized or IRB approaches for credit risk; 40 ii) 10% if they do not qualify for inflows should be taken into account counterparties and shall be multiplied retail exposure; have been provided in full with the following exceptions: by 100% of a net amount receivable. to clients that are not financial customers; have not been provided for a) Monies due from customers that Institutions should not consider the purpose of replacing funding of the are not financial customers shall be inflows from any of the liquid client in situations when the client is reduced by 50% (this does not apply assets (as specified in the proposed unable to obtain funding requirements to monies due from secured lending Regulation) other than payments due in the financial markets; and capital-market-driven transactions on the assets that are not reflected in that are collateralized by “level 1” and the market value of the asset. iii) 100% applies in particular to (a) “level 2” assets); liquidity facilities that the institution Further inflows from new issuance of has granted to securitization special b) Monies due from secured any obligations should not be taken purpose entity (SSPEs); and (b) lending and capital-market-driven into account. arrangements under which the transactions, if they are collateralized institution is required to buy or swap by liquid assets, shall not be taken into Institutions shall take into account assets from an SSPE. account up to the value net of haircuts liquidity inflows which are to be of the liquid assets but shall be taken received in third countries where e) Additional outflows in period of into account in full for the remaining there are transfer restrictions or which stress.35 monies due; are denominated in non-convertible currencies only to the extent that they 18.104.22.168 Liquidity inflows c) Monies due that the institution correspond to outflows in the third Institutions should measure liquidity owing those monies treats, any country or currency in question. inflows over the next 30 days. They undrawn credit or liquidity facilities are limited to 75% of the liquidity and any other commitments received outflows and should include only shall not be taken into account. contractual inflows from exposures that are not past due and for which Payables and receivables expected the bank has no reason to expect non- over the 30-day horizon from the performance within 30 days. Liquidity contracts listed in Annex II shall be reflected on a net basis across Figure 9: LCR: High quality liquid assets and net liquidity outflows Liquidity Coverage Ratio High quality liquid assets LCR = ≥ 100% Total net liquidity outflows over 30-day time period 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% ≥ 100% Liquidity outflows Liquidity inflows • Retail deposits (5-10%) • Monies due from non financial customer (50%) • Other liabilities coming due during next • Secured lending and capital market driven 30 days (0-100%) transactions (0%-100%) • Collateral other than “level 1” assets • Undrawn credit and liquidity facilities (0%) (15-20%) • Specified payables and receivables expected over • Credit and liquidity facilities (5-100%) the 30 day horizon (100%) • Liquid assets (0%) • New issuance of obligations (0%) Source: Accenture 41 5.2 Net Stable Funding Ratio The Net Stable Funding Ratio (NSFR) The items shall be presented in the i) Any other assets; requires institutions to maintain a following five time blocks according to j) Undrawn credit facilities that qualify sound funding structure over one year maturity date or the earliest date they as 'medium risk' or 'medium/low risk'. in an extended firm-specific stress can be contractually called: scenario. Assets currently funded and Where applicable, all items shall any contingent obligations to fund a) Within 3 months; be reported in the five time blocks must be matched to a certain extent b) Between 3 and 6 months; described above. by sources of stable funding. The minimum requirement described in c) Between 6 and 9 months; The proposed EU Regulation does not more detail below is to be introduced include any “available stable funding d) Between 9 and 12 months; by January 1, 2018. There is an factors” (ASF factors) or “required observation period until then. e) After 12 months. stable funding factors” (RSF factors), The denominator of the NSFR includes i.e., factors by which the available The reporting frequency for the LCR the items requiring stable funding. or required stable funding items should not be less than monthly. The Institutions shall report the following must be multiplied to calculate the NSFR should be reported not less items to competent authorities in corresponding value. Neither at this than quarterly. Competent authorities order to allow an assessment of the time is it stated whether the NSFR are allowed to authorize a lower need for stable funding: should be “>” or “≥” 100%.36 reporting frequency on the basis of the individual situation of an institution. a) Liquid assets, broken down by To give an overview of the current asset type; discussion regarding ASF and RSF The numerator of the NSFR includes factors, the following figures represent the stable sources of funding. The b) Securities and money market the proposals from the Basel III following items shall be reported to instruments not included in (a); document of the BCBS.37 competent authorities separately in c) Equity securities of non-financial order to allow an assessment of the entities listed on a major index in a availability of stable funding: recognized exchange; a) Own funds; d) Other equity securities; b) The following items not included in e) Gold; the own funds: f) Other precious metals; i) Retail deposits as defined in the g) Non-renewable loans and Regulation; receivables, and separately, those the ii) Deposits that fulfill certain borrowers of which are: conditions; i) Natural persons other than commercial sole proprietor and iii) All funding obtained from financial partnerships and deposits placed by customers; small and medium-size enterprises where the aggregate deposit placed iv) Funding from secured lending as by that client or group of connected specified in the Regulation; clients is less than 1 million EUR; v) Liabilities resulting from covered ii) Sovereigns, central banks and PSEs; bonds; iii) Clients not referred to in (i) and (ii) vi) Other liabilities resulting from other than financial customers; securities issued; iv) Any other borrowers; vii) Any other liabilities. h) Derivatives receivables; 42 Figure 10: Net Stable Funding Ratio Available stable funding Institutions are required to maintain a NSFR = ≥ 100% sound funding structure over one year Required stable funding in an extended firm-specific stress scenario Introduction Jan. 1, 2018; under observation until then Scope of application Level of individual institution (with legal personality) Reporting Quarterly Disclosure Disclosure of NSFR under Pillar 3 Source: Accenture Figure 11: NSFR: Available stable funding Source: Accenture Note: Based on Basel III document from Basel Committee on Banking Supervision 43 Figure 12: NSFR: Required stable funding Available stable funding NSFR = ≥ 100% Required stable funding Required stable funding Items - RSF factor 0% • Cash • Unencumbered short-term unsecured instruments and transactions with outstanding maturities < 1 year • Unencumbered securities with stated remaining maturities < 1 year with no embedded options • Unencumbered securities held where the institution has an offsetting reverse repurchase transaction • Unencumbered loans to financial entities with effective remaining maturities < 1 year that are not renewable and for which the lender has an irrevocable right to call Items - RSF factor 5% • Unencumbered marketable securities with residual maturities of one year or greater representing claims on or claims guaranteed by sovereigns, central banks, BIS, IMF, EC, non-central government PSEs or multilateral development banks that are assigned a 0% risk-weight under the Basel II standardized approach, provided that active repo or sale-markets exist for these securities Items - RSF factor 20% • Unencumbered corporate bonds or covered bonds rated AA- or higher with residual maturities ≥ 1 year satisfying all of the conditions for Level 2 assets in the LCR • Unencumbered marketable securities with residual maturities ≥ 1 year representing claims on or claims guaranteed by sovereigns, central banks, non-central government PSEs that are assigned a 20% risk-weight under the Basel II standardized approach, provided that they meet all of the conditions for Level 2 assets in the LCR Items - RSF factor 50% • Gold • Unencumbered equity securities, not issued by financial institutions or their affiliates, listed on a recognized exchange and included in a large cap market index • Unencumbered corporate bonds and covered bonds that are central bank eligible and are not issued by financial institutions Items - RSF factor 65% • Unencumbered residential mortgages of any maturity that would qualify for the 35% or lower risk-weight under Basel II Standardized Approach • 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 Standardized Approach for credit risk Items - RSF factor 85% • Unencumbered loans to retail customers and SME (as defined in the LCR) having a remaining maturity < 1 year Items - RSF factor 100% • All other assets not included in the above categories Source: Accenture Note: Based on Basel III document from Basel Committee on Banking Supervision 44 5.3 Monitoring tools A further objective of Basel III Concentration of funding Market-related monitoring is to strengthen and promote global consistency in liquidity Different ratios/figures 39 to help tools identify sources of wholesale funding Early warning indicators based risk supervision. According to the that are of such significance that their on high-frequency market data proposed EU Regulation, EBA shall withdrawal could trigger liquidity with little or no time lag (market develop draft implementing technical problems. wide information; information on standards regarding additional liquidity monitoring metrics that allow the financial sector; bank-specific competent authorities to obtain a Available unencumbered information). comprehensive view of the liquidity assets profile of institutions. Available unencumbered assets In the Basel III document of the BCBS, that are marketable as collateral in the following monitoring tools or secondary markets and/or eligible for metrics are proposed.38 central banks’ standing facilities. Contractual maturity LCR by significant currency mismatch Foreign Currency LCR = Stock of high- quality liquid assets in each significant Contractual cash and security inflows currency/total net cash outflows and outflows from all on-and off- over a 30-day time period in each balance sheet items, mapped to significant currency.40 defined time bands based on their respective maturities. 5.4 Institutional networks For institutional networks, the Basel b) NSFR: As previously mentioned, III framework includes the following the proposed EU Regulation does special treatments relating to the not include any specific ASF and calculation of the LCR and NSFR. RSF factors. According to the BCBS document for liabilities versus financial a) LCR: For calculating liquidity institutions there should generally outflows, generally a “run off” be applied an ASF factor of 0% factor of 100% should be applied for when calculating the available stable unsecured wholesale funding. In case funding. These are not recognized as of common task sharing within an stable sources of funding. A possible institutional protection scheme or as a exception to this treatment is for legal or statutory minimum deposit by stable deposits from cooperative another entity being a member of the banks that are required by law to be same institutional protection scheme, placed at the central organization a factor of 25% can be used by the and are legally constrained within centralized institution. the cooperative bank network as “minimum deposit requirements.” For deposits held at the centralized These deposits shall be assigned an institution in a cooperative banking ASF factor of 75% or 50% depending network that are assumed to stay on whether the depositor is a retail at the centralized institution, the or SME client or a non-financial depositing bank should not count corporate client. any inflow for these funds. They will receive a 0% inflow rate (by the depositing bank). 45 6 Enhanced governance and sanctions 46 47 6.1 Enhanced 6.2 Sanctions governance With the proposed Directive, the divergent and not-always-appropriate national sanctioning regimes for Among other deficiencies, the key violations of the CRD would recent financial crisis demonstrated be harmonized. At this point, in shortcomings in corporate governance some Member States the levels of arrangements in the financial services administrative pecuniary sanctions are industry, contributing to excessive too low and thus are an insufficient risk-taking. According to the Basel deterrent, or the actual application of Committee on Banking Supervision sanctions differs in Member States.43 and the EU Commission in many cases risk oversight by boards was With the new rules, effective, inadequate, often due to insufficient proportionate and deterrent sanctions time commitment, inadequate would be imposed to ensure technical knowledge or insufficient compliance with the CRD rules. For diversity in board composition. Boards the European Commission, the most were often not sufficiently involved appropriate options to achieve that in the overall risk strategy or did objective would be a combination of not spend sufficient time discussing the following: risk issues, as risk management was considered a low priority compared • Minimum common rules on the type to other concerns. In addition, the of administrative sanctions available risk management function has not to competent authorities; been given appropriate weight in the • Minimum common rules on decision-making process.41 maximum level of pecuniary administrative sanctions; With the proposed Directive,42 the non-binding nature of most of the • List of key factors to be taken corporate governance principles which into account when determining the contributed to the lack of compliance administrative sanctions; with these principles should be • Obligation to provide for the transformed into binding regulations. application of administrative sanctions This should help avoid excessive risk to both individuals and credit taking. The strengthening of the institutions; corporate governance framework requires: • Publication of sanctions as a general rule. • Increasing the effectiveness of risk oversight by boards; • Improving the status of the risk management function; and • Ensuring effective monitoring by supervisors of risk governance. The table on page 49 provides a summarized overview of the options on corporate governance. 48 Table 6: Options on corporate governance Improve time commitment of board • Require credit institutions to disclose the number of mandates of board members members • Require board members to spend sufficient time exercizing their duties • Limit the maximum number of mandates a board member may hold at the same time Improve expertise of board members • Require disclosure of the recruitment policy and the actual expertise and skills of board members • Specify skills and expertise that board members must possess individually and collectively • Require that board members receive appropriate induction and continuous training • Mandatory nomination committee Counterbalance management • Prohibit cumulating mandates of chairman and chief executive officer in the dominance same credit institution Improve diversity in boards' • Require disclosure of internal policy on diversity composition • Benchmarking different practices at national and European level • Require diversity as one of the criteria of boards' composition • Require credit institutions to establish a diversity policy Improve ownership by boards of risk • Require a declaration on the adequacy of risk management systems strategy • Require a risk statement stating credit institution's approach to risk Improve priority given by boards to • Require disclosure of policy and practice with regard to discussion and analysis risk issues of risk issues during board meetings • Require that boards devote sufficient time to risk issues • Mandatory risk committee at board level Improve the information flow to • Require disclosure of policy and practice with regard to the information flow on boards on risk risk to the board • Require boards to determine the content, format and frequency of risk information it should receive • Require that the risk management function report directly to the board Improve the standing and the • Require disclosure of the standing and authority of risk management function authority of the risk management • Require an independent risk management function function • Require an independent chief risk officer • Require that chief risk officer have appropriate status and authority • Require that removal of the chief risk officer is subject to prior approval by the board Ensure efficient monitoring of risk • Require that corporate governance is part of supervisory review governance by supervisors • Require that the suitability of board members is subject to specific supervisory review • Require supervisors to review agendas and supporting documents for meetings of the board Source: Executive Summary of the Impact Assessment. Accompanying the document Directive of the European Parliament and the Council (July 2011), European Commission. 49 7 Other topics 50 51 7.1 Systemically Important Financial Institutions The treatment of systemically indicators are chosen to reflect The BCBS is of the view that the important financial institutions (SIFIs) the different aspects of what magnitude of the discussed additional – systemically important banks (SIBs) generates negative externalities loss absorbency depends on the are a part of them – is currently under and makes a bank critical for the assessment and the bucket where it discussion at the Financial Stability stability of the financial system.”46 resides. A capital surcharge between Board (FSB) and the Basel Committee The indicators reflect the size, the 1% and 2.5% - to be met with CET1 on Banking Supervision (BCBS). The interconnectedness, lack of readily capital – is currently proposed and it objective is to reduce the probability available substitutes for the service should be implemented through an of failure of G-SIBs44 by increasing provided, global (cross jurisdictional) extension of the capital conservation their going-concern loss absorbency activity and the complexity of banks buffer. It should be phased in along and reducing the extent or impact of and should be assigned with an with the capital conservation and failure of G-SIBs, by improving global equal weight of 20% (see Appendix). countercyclical buffer, i.e., between recovery and resolution frameworks. The assessment is conducted with 2016 and year-end 2018, becoming In July 2011 a consultation paper consolidated group data.47 fully effective on January 1, 2019. was published by the BCBS dealing with the assessment methodology The indicator-based measurement and additional loss absorbency approach can be supported by requirements for such institutions.45 supervisory judgment based on certain principles. The BCBS also identified For assessing which banks should be several ancillary indicators which can considered as G-SIB, an indicator- support the supervisory judgment based measurement approach (see Appendix). is proposed where the “selected 52 7.2 Overreliance 7.3 Small on external and Medium- 7.4 Basel I ratings Sized Entity limit A further objective of the proposed Basel II allows a preferential risk- With Basel II a limit was introduced Directive is to reduce the overreliance weight for SMEs compared to other requiring that institutions have capital of institutions and investors on corporates. This beneficial treatment no lower than 80% of the capital external credit ratings, i.e., on ratings will continue under Basel III. that would have been required under issued by credit rating agencies. This Basel I. This limit expired at the end of goal can be reached by: A more preferential treatment, 2009 but was reinstated until the end i.e., lower risk-weights for small of 2011 by the Directive 2010/76/EC a) Requiring that all banks' investment and medium-sized entities (SMEs) (CRD III). The proposed EU Regulation decisions are based not only on compared to the current status as concerning Basel III reinstates it until external ratings but also on their own suggested from different countries 2015.50 internal credit opinion; and with a SME-based economy, would require a revision to the international b) That banks with a material number Basel framework. According to the of exposures in a given portfolio proposed EU Regulation, EBA should develop internal ratings for that analyze and report by September 2012 portfolio instead of relying on external on the current risk-weights, taking into ratings for the calculation of their consideration a scenario for a possible capital requirements.48 reduction by one-third compared to the current situation.49 53 8 Conclusion 54 55 In response to the serious nature of the recent financial crisis, several measures at the micro and macro level are being considered to increase the stability of the financial markets. One major focus is strengthening global capital and liquidity rules through Basel III. In December 2010, the BCBS published the corresponding Basel III documents (a revised version of the capital framework was published in June 2011). In the EU, Basel III will be implemented NSFR). Also included are increased mainly through a Regulation, i.e., requirements for systemically the rules are directly applicable at important financial institutions and the national level. The European strengthening corporate governance. Commission published the proposed Regulation as well as the Even though some of the requirements supplementary Directive in July 2011. are still under discussion and need to These legal instruments are now be specified (e.g., the concrete ASF- being discussed within the European and RSF-factors within the NSFR) and Parliament and Council. The new rules others might be recalibrated based would apply as of January 1, 2013, on the quantitative impact analysis with varying transition periods. (e.g., leverage ratio), banks at this time clearly must deal with wide- Key aspects of Basel III are: a stricter ranging regulatory changes that will definition of capital to increase the impact their business models and quality, consistency and transparency funding strategies as well as capital of the capital base; introduction of and liquidity costs. At the same time, capital buffers; increased capital pressure continues to mount from a requirements for CCR; introduction market expecting banks to fulfill or of a leverage ratio to supplement even exceed the new requirements the risk-based framework of Basel II; before the regulatory deadline. and a new global liquidity standard introducing two new ratios which banks need to fulfill (LCR and 56 Bibliography Basel III and Its Consequences. http://www.bundesbank.de/download/ Confronting a New Regulatory bankenaufsicht/pdf/basel3_leitfaden. Environment; (2011), Accenture pdf found at http://www.accenture. com/SiteCollectionDocuments/ New proposals on capital requirements PDF/Accenture_Basel_III_and_its_ (July 2010), European Commission Consequences.pdf found at http://ec.europa.eu/internal_ market/bank/regcapital/index_en.htm Principles for Sound Liquidity Risk Management and Supervision Directive 2010/76/EU of the European (September 2008), Basel Committee Parliament and of the Council of on Banking Supervision (hereafter November 24, 2010 amending BCBS) of the Bank for International Directives 2006/48/EC and 2006/49/ Settlements (hereafter ‘BIS’) found at EC as regards capital requirements http://www.bis.org/publ/bcbs144.pdf for the trading book and for re- securitisations, and the supervisory Basel III: A global regulatory review of remuneration policies framework for more resilient banks (November 2010), European Parliament and banking systems (December 2010; and Council, found at http://eur-lex. rev. June 2011), BCBS found at http:// europa.eu/LexUriServ/LexUriServ.do?ur www.bis.org/publ/bcbs189.pdf i=OJ:L:2010:329:0003:0035:EN:PDF Basel International framework for Directive 2010/76/EU of the European liquidity risk measurement, standards Parliament and of the Council of and monitoring. (December 2010), September 16, 2009 amending BCBS found at http://www.bis.org/ Directives 2006/48/EC, 2006/49/ publ/bcbs188.pdf EC and 2007/64/EC as regards banks affiliated to central institutions, Global systemically important banks: certain own funds items, large Assessment methodology and the exposures, supervisory arrangements, additional loss absorbency requirement and crisis management (September (July 2011), BCBS, Consultative 2009), European Parliament and Document found at http://www.bis. Council found at http://eur-lex.europa. org/publ/bcbs201.pdf eu/LexUriServ/LexUriServ.do?uri=OJ:L: 2009:302:0097:0119:EN:PDF Basel III – Leitfaden zu den neuen Eigenkapital- und Liquiditätsregeln für Banken (2011), Deutsche Bundesbank; 57 Appendix Basel III Summary Table Table 7: Basel III Summary Table Basel Committee on Banking Supervision reforms - Basel III Strengthens micro-prudential regulation and supervision, and adds a macro-prudential overlay that includes capital buffers. Capital Framework Pillar 1 Capital Risk coverage Containing leverage All Banks Quality and level of capital Securitisations Leverage ratio Greater focus on common equity. The Strengthens the capital treatment for A non-risk-based leverage ratio that minimum will be raised to 4.5% of certain complex securitisations. Requires includes off-balance sheet exposures risk-weighted assets, after deductions. banks to conduct more rigorous credit will serve as a backstop to the analyses of externally rated securitisation risk-based capital requirement. Also Capital conservation buffer exposures. helps contain system wide build up of Comprising common equity of 2.5% of leverage. risk-weighted assets, bringing the total Trading book common equity standard to 7%. Constraint Significantly higher capital for trading and on a bank’s discretionary distributions will derivatives activities, as well as complex be imposed when banks fall into the buffer securitisations held in the trading book. range. Introduction of a stressed value-at-risk framework to help mitigate procyclicality. Countercyclical buffer Imposed within a range of 0-2.5% compris- Counterparty credit risk ing common equity, when authorities judge Substantial strengthening of the counter- credit growth is resulting in an unaccept- party credit risk framework. Includes: more able build up of systematic risk. stringent requirements for measuring exposure; capital incentives for banks to use central counterparties for derivatives; and higher capital for inter-financial sector exposures. SIFIs In addition to meeting the Basel III requirements, global systemically important financial institutions (SIFIs) must have higher loss absorbency capacity to reflect the greater risks that they pose to the financial system. The Committee has developed a methodology that includes both quantitative indicators and qualitative elements to identify global SIFIs. The additional loss absorbency requirements are to be met with a progressive Common Equity Tier 1 (CET1) capital requirement ranging from 1% to 2.5%, depending on a bank’s systemic importance. A consultative document was submitted to the Financial Stability Board, which is coordinating the overall set of measures to reduce the moral hazard posed by global SIFIs. Source: BCBS (2011): http://www.bis.org/bcbs/basel3/b3summarytable.pdf 58 Liquidity Pillar 2 Pillar 3 Risk management Market Global liquidity standard and and supervision discipline supervisory monitoring Supplemental Pillar 2 requirements. Revised Pillar 3 disclosures requirements Liquidity coverage ratio Address firm-wide governance and risk The requirements introduced relate to The liquidity coverage ratio (LCR) will management; capturing the risk of securitisation exposures and sponsorship require banks to have sufficient high- off-balance sheet exposures and of off-balance sheet vehicles. Enhanced quality liquid assets to withstand a securitisation activities; managing risk disclosures on the detail of the 30-day stressed funding scenario that is concentrations; providing incentives for components of regulatory capital and specified by supervisors. banks to better manage risk and returns their reconciliation to the reported Net stable funding ratio over the long term; sound compensation accounts will be required, including a The net stable funding ratio (NSFR) is a practices; valuation practices; stress comprehensive explanation of how a longer-term structural ratio designed to testing; accounting standards for bank calculates its regulatory capital address liquidity mismatches. It covers the financial instruments; corporate ratios. entire balance sheet and provides governance; and supervisory colleges. incentives for banks to use stable sources of funding. Principles for Sound Liquidity Risk Management and Supervision The Committee’s 2008 guidance entitled Principles for Sound Liquidity Risk Management and Supervision takes account of lessons learned during the crisis and is based on a fundamental review of sound practices for managing liquidity risk in banking organisations. Supervisory monitoring The liquidity framework includes a common set of monitoring metrics to assist supervisors in identifying and analysing liquidity risk trends at both the bank and system-wide level. 59 Asset Value Correlation: Risk-Weight for large financial institutions Basel II vs. Basel III Figure 13: AVC: Risk-Weights for large financial institutions – Basel II vs. Basel III Risk-weight 180% 160% 140% Basel III 120% Basel II 100% 80% 60% 40% 20% 0% 0.03% 0.2% 0.4% 0.6% 0.8% 1% 1.2% 1.4% 1.6% 1.8% 2% 2.2% 2.4% 0.1% 0.3% 0.5% 0.7% 0.9% 1.1% 1.3% 1.5% 1.7% 1.9% 2.1% 2.3% 2.5% Source: Accenture Table 8: AVC: Risk-Weights for large financial institutions – Basel II vs. Basel III PD RW Basel II RW Basel III Increase RW 0.03% 15.31% 20.84% 36.09% 0.10% 31.43% 42.47% 35.12% 0.20% 46.53% 62.22% 33.74% 0.30% 57.64% 76.44% 32.60% 0.40% 66.48% 87.52% 31.64% 0.50% 73.79% 96.52% 30.81% 0.60% 79.98% 104.03% 30.07% 0.70% 85.33% 110.43% 29.41% 0.80% 90.01% 115.94% 28.81% 0.90% 94.15% 120.77% 28.27% 1.00% 97.86% 125.03% 27.77% 1.10% 101.19% 128.82% 27.30% 1.20% 104.23% 132.24% 26.88% 1.30% 107.00% 135.34% 26.48% 1.40% 109.56% 138.16% 26.10% 1.50% 111.93% 140.76% 25.76% 1.60% 114.14% 143.16% 25.43% 1.70% 116.20% 145.39% 25.12% 1.80% 118.15% 147.49% 24.83% 1.90% 119.99% 149.46% 24.55% 2.00% 121.75% 151.32% 24.29% 2.10% 123.42% 153.09% 24.04% 2.20% 125.02% 154.78% 23.81% 2.30% 126.56% 156.40% 23.58% 2.40% 128.05% 157.97% 23.37% 2.50% 129.48% 159.48% 23.16% Source: Accenture 60 Indicator-based measurement approach G-SIBS Table 9: Indicator-based measurement approach G-SIBS Indicator-based Measurement Approach Category (and weighting) Individual Indicator Indicator Weighting Cross-jurisdictional activity (20%) Cross-jurisdictional claims 10% Cross-jurisdictional liabilities 10% Size (20%) Total exposures as defined for use in the Basel III leverage 20% ratio Interconnectedness (20%) Intra-financial system assets 6.67% Intra-financial system liabilities 6.67% Wholesale funding ratio 6.67% Substitutability (20%) Assets under custody 6.67% Payments cleared and settled through payment systems 6.67% Values of underwritten transactions in debt and equity 6.67% markets Complexity (20%) OTC derivatives notional value 6.67% Level 3 assets 6.67% Trading book value and available for sale value 6.67% Source: Global systemically important banks: Assessment methodology and the additional loss absorbency requirement (July 2011), BCBS, Consultative Document Table 10: Ancillary indicators for assessment G-SIBS List of Standardized Ancillary Indicators Category Individual Indicator Cross-jurisdictional activity (20%) Non-domestic revenue as a proportion of total revenue Cross-jurisdictional claims and liabilities as a proportion of total assets and liabilities Size Gross or net revenue Equity market capitalization Substitutability Degree of market participation: 1. Gross mark-to-market value of repo, reverse repo and securities lending transactions 2. Gross mark-to-market OTC derivatives transactions Complexity Number of jurisdictions Source: Global systemically important banks: Assessment methodology and the additional loss absorbency requirement (July 2011), BCBS, Consultative Document. 61 Footnotes 1. Basel III: A global regulatory framework 12. Proposed EU Regulation [Proposal for a credit institutions, insurance undertakings for more resilient banks and banking Regulation of the European Parliament and and investment firms in a financial systems (December 2010; rev. June 2011), of the Council on prudential requirements conglomerate; p. 12. Basel Committee on Banking Supervision for credit institutions and investment (hereafter “BCBS”) of the Bank for firms] (European Commission, July 2011). 20. Calibrated in increments of 0.25 International Settlements (hereafter percentage points, or multiples of .25. “BIS”) found at http://www.bis.org/bcbs/ 13. Relevant entities according to the EU proposed Regulation are: (a) another 21. The directive allows also a buffer basel3/compilation.htm and International institution; (b) a financial institution; (c) an beyond 2.5 if justified. framework for liquidity risk measurement, standards and monitoring (December insurance undertaking; (d) a third country 22. Basel III: A global regulatory 2010), BCBS. The appendix of this insurance undertaking; (e) a reinsurance framework for more resilient banks and handbook contains a Basel III summary undertaking; (f) a third country banking systems (December 2010; rev. table from BCBS. reinsurance undertaking; (g) a financial June 2011), BCBS as well as New proposals undertaking; (h) a mixed activity insurance on capital requirements (July 2011), 2. European Capital Requirements holding company; (i) an undertaking European Commission found at http:// Directive III (2010/76/EU). excluded from the scope of Directive. See ec.europa.eu/internal_market/bank/ New proposals on capital requirements 3. Principles for Sound Liquidity Risk regcapital/index_en.htm. (July 2011), European Commission found at Management and Supervision (June 2008), http://ec.europa.eu/internal_market/bank/ 23. Basel III: A global regulatory BCBS. regcapital/index_en.htm. framework for more resilient banks and 4. European Capital Requirements banking systems (December 2010; rev. 14. See European Commission (2011): CRD Directive III (2009/111/EC). June 2011), BCBS, p. 38. IV – Frequently Asked Questions (http:// europa.eu/rapid/pressReleasesAction.do?re 24. According to the proposed EU 5. For Basel III implementation challenges ference=MEMO/11/527&format=HTML&ag Regulation [Proposal for a Regulation see: Basel III and Its Consequences. ed=0&language=EN&guiLanguage=en). of the European Parliament and of the Confronting a New Regulatory Environment (2011), Accenture Council on prudential requirements for 15. Article 108(7) of the proposed EU found at http://www.accenture.com/ credit institutions and investment firms] Regulation [Proposal for a Regulation SiteCollectionDocuments/PDF/Accenture_ unregulated financial entity means any of the European Parliament and of the Basel_III_and_its_Consequences.pdf. other entity that is not a regulated entity Council on prudential requirements for but performs one or more of the listed credit institutions and investment firms] 6. New proposals on capital requirements activities. deals with the calculation of risk-weighted (July 2011), European Commission found at exposure amounts with regard to 25. European Commission (2011): http://ec.europa.eu/internal_market/bank/ counterparties with which the institution Proposal for a Directive of the European regcapital/index_en.htm. has entered into an institutional protection Parliament and of the Council on the 7. New proposals on capital requirements scheme that is a contractual or statutory access to the activity of credit institutions (July 2011), European Commission found at liability arrangement which protects those and the prudential supervision of credit http://ec.europa.eu/internal_market/bank/ institutions and in particular ensures their institutions and investment firms and regcapital/index_en.htm. liquidity and solvency to avoid bankruptcy amending Directive 2002/87/EC of the in case it becomes necessary. European Parliament and of the Council 8. European Commission (2011): CRD IV – on the supplementary supervision of Frequently Asked Questions, p. 15 (http:// 16. For the following explanations see credit institutions, insurance undertakings europa.eu/rapid/pressReleasesAction.do?re New proposals on capital requirements and investment firms in a financial ference=MEMO/11/527&format=HTML&ag (July 2011), European Commission found at conglomerate; p. 15. ed=0&language=EN&guiLanguage=en). http://ec.europa.eu/internal_market/bank/ regcapital/index_en.htm. 26. For the following descriptions see New 9. For the following descriptions see New proposals on capital requirements (July proposals on capital requirements (July 17. For more details about the calculation 2011), European Commission found at 2011), European Commission found at see Article 131 of the proposed EU http://ec.europa.eu/internal_market/bank/ ;http://ec.europa.eu/internal_market/bank/ Directive. regcapital/index_en.htm. regcapital/index_en.htm 18. See also Bundesbank (May 2011): Basel 27. During the period from Jan. 1, 2013 10. Article 26 of the proposed EU III – Leitfaden zu den neuen Eigenkapital- to Dec. 31, 2017 competent authorities Regulation [Proposal for a Regulation und Liquidititätsregeln für Banken. may permit institutions to calculate the of the European Parliament and of the end-of-quarter leverage ratio where 19. European Commission (2011): Proposal Council on prudential requirements for they consider that institutions may not for a Directive of the European Parliament credit institutions and investment firms] have data of sufficiently good quality and of the Council on the access to (European Commission, July 2011). to calculate a leverage ratio that is an the activity of credit institutions and the prudential supervision of credit arithmetic mean of the monthly leverage 11. European Commission (2011): CRD IV – institutions and investment firms and ratios over a quarter. Frequently Asked Questions. amending Directive 2002/87/EC of the 28. For explicitly mentioned off-balance- European Parliament and of the Council sheet items, there are exceptions to this on the supplementary supervision of treatment. 62 29. Principles for Sound Liquidity Risk 41. For the following descriptions 49. New proposals on capital requirements Management and Supervision (September see European Commission (2011) – (July 2011), European Commission found at 2008), BCBS. Commission Staff Working Paper: http://ec.europa.eu/internal_market/bank/ Executive Summary of the Impact regcapital/index_en.htm. 30. For the following descriptions see New Assessment. Accompanying the document proposals on capital requirements (July Directive of the European Parliament and 50. See European Commission (July 2011), European Commission found at the Council on the access to the activity 2011): New proposals on capital http://ec.europa.eu/internal_market/bank/ of credit institutions and the prudential requirements;http://ec.europa.eu/internal_ regcapital/index_en.htm supervision of credit institutions and market/bank/regcapital/index_en.htm. investment firms and amending Directive 31. See Article 7(1) of the proposed 2002/87/EC of the European Parliament Regulation; for cross border institutions and of the Council on the supplementary also Article 7(2). supervision of credit institutions, insurance 32. Article 401 of the proposed Regulation. undertakings and investment firms in a financial conglomerate (http://ec.europa. 33. Bonds are issued by a credit institution eu/internal_market/bank/docs/regcapital/ which has its registered office in a CRD4_reform/executive_summary_IA_ Member State and is subject by law to directive_en.pdf). special public supervision designed to protect bond-holders [Directive 2009/65/ 42. See New proposals on capital EC of the European Parliament and requirements (July 2011), European the Council, http://eur-lex.europa.eu/ Commission found at http://ec.europa. LexUriServ/LexUriServ.do?uri=OJ:L:2009:3 eu/internal_market/bank/regcapital/ 02:0032:0096:en:PDF). index_en.htm. 34. According to the proposed EU 43. For the following descriptions Regulation [Proposal for a Regulation see European Commission (2011) – of the European Parliament and of the Commission Staff Working Paper: Council on prudential requirements for Executive Summary of the Impact credit institutions and investment firms] Assessment. Accompanying the document retail deposit means a liability to a natural Directive of the European Parliament and person or to a small and medium sized the Council on the access to the activity enterprise where the aggregate liability to of credit institutions and the prudential such clients or group of connected clients supervision of credit institutions and is less than 1 million EUR. investment firms and amending Directive 2002/87/EC of the European Parliament 35. See Article 408(2) of the proposed and of the Council on the supplementary EU Regulation [Proposal for a Regulation supervision of credit institutions, insurance of the European Parliament and of the undertakings and investment firms in a Council on prudential requirements for financial conglomerate (http://ec.europa. credit institutions and investment firms]. eu/internal_market/bank/docs/regcapital/ CRD4_reform/executive_summary_IA_ 36. In the Basel III document from the directive_en.pdf). Basel Committee on Banking Supervision “> 100%" is proposed. 44. Global systemically important banks. 37. Basel III: International framework for 45. See hereto and for the following liquidity risk measurement, standards and descriptions Global systemically important monitoring (December 2010), BCBS. banks: Assessment methodology and the additional loss absorbency requirement 38. Basel III: International framework for (July 2011), BCBS, Consultative Document. liquidity risk measurement, standards and monitoring (December 2010), BCBS. 46. Global systemically important banks: Assessment methodology and the 39. Metrics suggested: a) Funding additional loss absorbency requirement liabilities sourced from each significant (July 2011), BCBS, Consultative Document, counterparty/ the bank's balance sheet p. 3. total; b) Funding liabilities sourced from each significant product/instrument/ 47. For more details see Global the bank's balance sheet total; c) List of systemically important banks: Assessment asset and liability amounts by significant methodology and the additional loss currency. absorbency requirement (July 2011), BCBS, Consultative Document. 40. Note: Amount of total net foreign exchange cash outflows should be net of 48. See CRD IV – Frequently Asked foreign exchange hedges. Questions (2011), European Commission. 63 Contact Michael Auer Georg von Pfoestl Michael is executive principal – Georg is senior manager – Accenture Accenture Risk Management, Munich, Risk Management. Based in Vienna, responsible for German-speaking Georg has 8 years of experience in the markets. Michael has 18 years of area of risk management with a focus industry and consulting experience on credit and liquidity risk, regulatory in financial services and risk matters and Risk-Weighted Assets management across Europe working optimization. With his experience as with global institutions to transform a banking inspector at the Austrian their business and risk capabilities. National Bank, his pragmatic His extensive experience in risk knowledge from working with regional management – mainly in the areas of and international financial institutions market, credit and operational risk, risk across German-speaking markets and regulatory matters and operating and his technical skills pertaining models helps executives and their to Basel II and Basel III regulatory multinational firms become high- requirements, he guides companies on performance businesses. their journey to high performance. Copyright © 2012 Accenture About Accenture Risk About Accenture All rights reserved. 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