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Basel III Handbook

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					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
5.1.2.1 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
5.1.2.2 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.




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