Basel III Leverage Ratio

Transcription

1 Basel III Leverage Ratio Prepared for Asia Risk Jakarta May 2018 by Mike Duncan

2 Agenda Overview of Basel III What is the Leverage Ratio? Basic principles and calculations Exposure Measure On-balance sheet exposures Off balance sheet exposures (OBS) Derivatives exposures Securities Financing Transactions (SFT) Exposures Leverage Ratio standard disclosure How does Leverage Ratio interplay with LCR and NSFR? Conclusion Q&A

3 Overview of Basel III What is Basel III? An extension of existing Basel II framework Builds on existing 3 Pillars concept Introduces new capital and liquidity standards (requirements) Why? A result of the Financial crisis of 2008 Governments requiring banks to be more robust, through additional levels of capital, regulation and supervision

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5 Overview of Basel III To get a better understanding of Basel III, need to know more about Basel II Accord Basel II result of substantial bank losses in the early 1990 s attributed to poor risk management Basel II made it mandatory for FI s to use Standardised measurements for credit, market risk and operational risk FI able to pursue advanced risk management approaches to free up capital Uses a 3 Pillars concept Pillar 1 Minimal capital requirements (addressing risk) Credit Risk calculated 3 ways, Standardised Approach (SA), Foundation Internal Rating based Approach (IRB) & advanced IRB Operational Risk Basic Indicator Approach (BIA), Standardised Approach (STA) & Internal Measurement Approach (AMA) Market Risk allows for Standardised and Internal approaches. Preferred is Value at Risk (VaR)

6 Overview of Basel III Uses a 3 Pillars concept Pillar 2 Supervisory review Regulatory response to the 1 st pillar, provides regulators better tools than previously Also provided framework for dealing with Pension Risk, Systemic Risk, Concentration Risk, Strategic Risk, Reputational Risk, Liquidity Risk and Legal Risk combined under the accord as Residual Risk Market Risk allows for Standardised and Internal approaches. Preferred is Value at Risk (VaR) Pillar 3 Market Discipline Designed to encourage market discipline by developing a set of disclosure requirements which allow market participants to assess key pieces of information on the scope of allocation, capital, risk exposure, risk assessment processes i.e. the capital adequacy of the FI MD supplements Pillar 2 as sharing of information facilitates assessments (i.e. comparisons) of the banks by others (investors, analysts, customers, clients, competitors and rating agencies) provides a common framework

7 Overview of Basel III Hence Basel III builds on the foundation of Basel II Focus on Pillar 1 Minimal Capital requirements (increased) Response to inadequate capital maintained by banks up to 2008 Banks required to hold more capital & higher quality capital under Basel II rules Explicit definitions of what Capital is - Tier 1 and Tier 2 Leverage Ratio (LR) introduced to supplement risk-based minimum capital requirements Liquidity Ratios to ensure adequate funding is maintained in the case of the next banking crisis But wait there is more

8 Overview of Basel III Created by the Basel Committee on Bank Supervision (BCBS) BCBS is a group of international banking authorities who work to strengthen the regulation, supervision and practices of banks and improve financial stability worldwide Members include; Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States Basel III regulations/policies have no legal authority. They have to be passed into law by the applicable authorities in each respective jurisdiction Hence applicable rules or applications will differ in various jurisdictions

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10 Leverage Ratio Basic principals and calculations What is it? Also known as the Supplementary Leverage Ratio (SLR) Non-risk-based backstop to the risk-based capital rules does not distinguish between safer or riskier assets Designed to be credible supplementary measure to risk-based capital requirements Limits excessive build-up in leverage Tier 1 capital of the bank must be at least 3% of the banks on & off balance sheet exposures (other jurisdictions it is higher e.g. US) LR applicable to all internationally active banks Public disclosure requirements allow for calibration and comparison across banks Basel III 2017 reforms at an additional buffer for Global Systematically Important Banks (G- SIBs)

11 LR Basic principals and calculations Calculation Leverage Ratio = Capital Measure Exposure Measure 3% Where Capital Measure = Tier 1 Capital (mostly Common Equity & some additional Tier 1 Capital Exposure Measure = Sum of on-balance sheet exposures, derivatives exposures, securities finance transactions (SFT) exposures & off-balance sheet exposures (OBS) For G-SIB LR buffer will be set at 50% of it s risk-based capital buffer. i.e. a G-SIB with a 2% risk-based buffer will have a 1% LR buffer so will have to maintain a total LR of 4%

12 LR basic principles & calculations Why is there a LR? An underlying cause of the GFC was the build up of excessive on- and off-balance sheet leverage in the banking system (e.g. Lehman Bros, RBS). In many case leveraged significantly while maintaining seemingly strong risk-based capital ratios. The deleveraging process at the height of the crisis created a vicious circle of losses and reduced the availability of credit in the real economy. Fears about bank solvency lead to wholesale funding markets freezing. BCBS introduced the LR in Basel III to reduce the risk of such period of deleveraging in the future. LR also intended to reinforce the risk-based capital requirements with a simple, non-risk based backstop

13 LR Exposure measurement The exposure measure should generally follow the account value subject to the following; 1. On-balance sheet, non-derivative exposures are included in the exposure measure net of specific provisions or accounting valuation adjustments (e.g. accounting credit valuation adjustments 2. Netting of loans and deposits is not allowed 3. Unless specified in the exposure types banks must not take account of physical or financial collateral, guarantees or other credit risk mitigation techniques to reduce the exposure measure Total exposure measure = On-balance sheet exposures + Derivative exposures +Securities financing transactions (SFT) + Off-balance sheet exposures (OBS)

14 LR Exposure measurement On-balance Sheet Exposures Banks must include all balance sheet assets in their exposure measure including on-balance sheet derivatives collateral Collateral for SFTs Exception is on-balance sheet derivative and SFT assets (covered in their specific sections) For consistency balance sheet assets deducted from Tier 1 Capital may be deducted from the exposure measure e.g. when an subsidiary entity is not included in the regulatory scope of consolidation Liability items (e.g. gains/losses on fair valued liabilities) must not be deducted from the exposure measure Balance sheet products cash, loans, securities, deposits, borrowing, equity

15 LR Exposure measurement Off-balance Sheet Exposures Incorporation OBS items as defined in Basel II framework into LR exposure measure OBS items defined as; Commitments (liquidity facilities) Direct credit substitutes - purchasing a subordinated cert of another bank's securitisation, guaranteeing mezzanine cert of another bank's securitization, providing a letter of credit to ABCP program Acceptances Standby letters of credit Trade letters of credit OBS items converted under the standardised approach (SA-CCR) into credit equivalents via use credit conversion factors (CCF) which are applied to the notional amount

16 LR Exposure measurement Derivative Exposures Banks required to calculate derivative exposures as a replacement cost (RC) for the current exposure (i.e. MTM) plus an add-on for potential future exposure (PFE) or the credit risk Includes when banks writes credit protection (sells CDS), which are subject to additional treatment In cases of bilateral netting contracts alternative treatments may be applied For single derivative exposure not covered by a bilateral netting agreement the amount of the exposure measure is as follows; Exposure measure = replacement cost (RC) + add-on where RC = replacement cost of contract (MTM), where the contract has a positive value Add-on = amount of PFE over remaining life of contract calculated by applying an add-on factor to notional principal of the derivative

17 LR Exposure measurement Derivative Exposures

18 LR Exposure measurement Derivative Exposures

19 LR Exposure measurement Derivative Exposures Bilateral Netting When a bilateral netting contract is used the RC for the set of derivatives covered by the contract will be the net replacement cost and the add-on will be Anet This is the sum of the net MTM replacement cost, if positive, plus an add-on based on the notional underlying principal. The add-on for the netted transactions (Anet) equals the weighted average of the gross add-on (AGross) and the gross add-on adjusted by the ratio of net current replacement cost to gross current replacement cost (NGR). Anet = 0.4 x Agross * NGR x Agross Where NGR = level of net replacement cost/level of gross replacement cost for transactions subject to legally enforceable netting agreements Agross = sum individual add-on amounts (multiplying notional amount by appropriate add-on factors) of all transactions subject to the netting agreement with one counterparty

20 LR Exposure measurement Derivative Exposures Collateral BCBS notes that collateral has two effects on leverage 1. Reduces counterparty exposure 2. Can increase economic resources available to the bank as bank can use the collateral for leverage (if no restriction on rehypothecation) Collateral received - may not be netted against underlying derivative exposures whether or not netting is permitted accounting or risk-based framework so banks cannot reduce the exposure amount by any collateral received from the counterparty Collateral provided banks must gross up their exposure measure by the amount of derivatives collateral provided where the provision of that capital has reduce the value of their balance sheet assets under their accounting framework Cash Variation margin cash portion of variation margin BCBS treating as form of presettlement payment

21 LR Exposure measurement Derivative Exposures Cash Variation margin (CVM) cash portion of variation margin BCBS treating as form of presettlement payment if following met: For trades not cleared through a QCCP cash received by recipient counterparty is not segregated CVM calculated and exchanged on a daily basis based on MTM valuation of derivative positions CVM is received in the same currency as the currency of settlement of the derivative contract CVM exchanged is the full amount that would be necessary to fully extinguish the MTM exposure of the derivative subject to the threshold and minimum transfer amounts applicable to the counterparty Derivatives transactions and variation margins are covered by a single master netting agreement (MNA) between the counterparties in the derivatives transaction If conditions above met; 1. cash portion of variation margin received can be used to reduce the RC portion of the LR exposure measure 2. receivables assets from CVM provided can be deducted from LR exposure measure as follows CVM received receiving bank can reduce RC (not the add-on portion)of the exposure amount by the amount of cash received if the positive MTM value has not already been reduced by the same amount CVM received under the banks accounting framework CVM provided to a counterparty, posting bank can deduct resulting receivable from its LR exposure measure where CVM has been recognized as an asset under the banks accounting framework CVM can not be used to reduce PFE amount,including calculation of NGR

22 LR Exposure measurement Derivative Exposures Treatment of clearing services bank acting as clearing member (CM) Where bank offers clearing services to clients, the CM trade exposures to the CCP that arise when the clearing member is obligated to cover the client for any losses suffered due to changes in value of transaction is CCP defaults must be captured as per usual treatment as other derivatives If CM based on contracts with client is not obligated to cover client for any losses suffered from default of CCP, CM need not recognize resulting trade exposures to CCP in LR exposure measure. Likewise when CM guarantees performance of a clients derivative trade exposures to a CCP must be included in LR exposure measure

23 LR Exposure measurement Derivative Exposures Additional treatment for written credit derivatives In addition to the CCR exposure arising from MTM value of the contracts, written credit derivatives (sold protection) create a notional credit exposure arising from the credit worthiness of the reference entity. Hence required to treat sold protection consistently with cash instruments (e.g. loans, bonds) for purposes of LR exposure measure. Effective notional amount of a written credit derivative can be reduced by any negative change in MTM value incorporated into calculation of Tier 1 capital with respect to the written credit derivative. The amount may be further reduced by the effective notional amount of a purchased credit derivative on the same reference name if 1. Credit protection purchased on the reference obligor which ranks pari passu with or is junior to the underlying reference obligor of the written credit derivative in case of singe name 2. Remaining maturity of credit protection purchased is equal to or greater than the remaining maturity of the written credit derivatives

24 LR Exposure measurement Securities Financing Transactions (SFT) Exposures Treatment designed to ensure consistent international implementation by providing a common measure for dealing main differences in operative accounting frameworks SFTs include following where transaction values depend on market valuations and transactions often subject to margin agreements; Repurchase agreements (repos) Reverse repurchase agreements (reverse repos) Security lending and borrowing(i.e. stock, borrowing & lending) Margin lending transactions

25 LR Exposure measurement Securities Financing Transactions (SFT) Exposures General Treatment (Bank Acting as principle) Gross SFT assets recognized for accounting purposes (i.e. no recognition of accounting netting) adjusted as follows Excluding from the exposure measure value of any securities received under an SFT, where the bank has recognized the securities as an asset on its balance sheet Cash payables and receivables in SFTs with same counterparty may be measured net: Transactions have same explicit final settlement date Right to set off amount owed to counterparty with the amount owed to the counterparty is legally enforceable currently in the normal course of business and in event of (i) default, (iii) insolvency and (iii) bankruptcy Counterparties intend to settle net and settle simultaneously (or transactions in system that has same effect)

26 LR Exposure measurement Securities Financing Transactions (SFT) Exposures General Treatment (Bank Acting as principle) A measure of CCR calculated as current exposure without an add-on for PFE, calculated as follows; With a qualifying master netting agreement (MNA), current exposure (E*) is greater of zero and total value of securities and cash lent to a counterparty included in the MNA ( Ei) less total value of cash and securities received from the counterparty for those transactions ( Cj) E = max 0, Ej Cj Where no MNA, current exposure for transactions with a counterparty must be calculated on a transaction basis (individual) i.e. each transaction treated as its own netting set E = max 0, Ei Cj

27 LR Exposure measurement Securities Financing Transactions (SFT) Exposures Bank Acting as agent prime broker, stock borrowing and lending Bank usually provides an indemnity or guarantee to only one of the parties involved, and only for the difference between the value of the security or cash its customer has lent and the value of the collateral the borrower as provided. Bank is only exposed to the counterparty of its customer for the difference in values, rather than the full exposure of the underlying security of the transaction When bank does not own/control the underlying cash or security resource that resource can t be leveraged by the bank i.e. no rehypothecation If bank provides an indemnity to a customer or counterparty as described above then bank has to use General Treatment without an MNA i.e. transactional basis, NO NETTING, NO OFFSET = OUCH!!! As doubling banks exposure to a relatively risk-free business

28 Disclosure Requirements Banks required to publicly disclose their LR on a consolidated basis from1 Jan 2015 Frequency concurrent with publication of the jurisdictions financial statements (i.e. halfyearly or quarterly), however Under basel II Pillar 3 (market discipline), large banks are subject to a minimum disclosure requirement to defined key capital ratios & elements on a quarterly basis regardless of frequency of publication of financial statements Disclosures must be either included in banks published financial statements or at a minimum provide a direct link to the completed disclosures on banks websites Banks must make available on their websites (or through publicly available regulatory reports) an ongoing archive of reconciliation & disclosure templates To enable participants to reconcile LR disclosures from period to period, to compare Capital Adequacy of banks across jurisdictions / accountancy frameworks necessitated a common consistency in formats of disclosures.

29 Disclosure Requirements Public disclosure requirements require internationally active banks to publish LR accounting to a common set of templates Summary comparison table provides comparison banks total accounting assets amounts & LR exposures Common disclosure template provide breakdown of main LR regulatory elements Reconciliation requirement details sources of material differences between banks total balance sheet assets in Financial Statements & on-balance sheet exposures in common disclosure template Other disclosures frequency of disclosure, location of disclosures, archives of disclosures

30 Disclosure Requirements Summary comparison table provides comparison banks total accounting assets amounts & LR exposures

31 Disclosure Requirements Common disclosure template provide breakdown of main LR regulatory elements

32 Disclosure Requirements Common disclosure template provide breakdown of main LR regulatory elements

33 Disclosure Requirements

34 Disclosure Requirements example JPM JP Morgan Chase & Co

35 Disclosure Requirements example JPM

36 How does LR interplay with CR, LCR & NSFR Capital Ratio Risk-based, increases in RWA require in Regulatory Capital Risk models used to calculate RWA can either incorrectly model the risk or misstate completely e.g. CDO Risk based Capital Ratio = Regulatory Capital Risk Weighted Assets LCR Liquidity coverage ratio minimum liquidity inventory level Requires banks to pass 30-day liquidity stress test to support expected liability run-offs over a 30 day period i.e. banks have to have sufficient cash or govt securities to survive stress conditions for 30 days LCR = High Quality Liquid Assets (HQLA) Net cash outflows (30 days) 100%

37 How does LR interplay with CR, LCR & NSFR NSFR Net stable funding ratio 1 year time horizon Assesses tenors of assets (loans etc) to liabilities (funding) Extends the maturity of the funding mix for banks Punitive to banks that are overly reliant to wholesale funding Concept of borrow short, lend long is restricted further NSFR = Available Stable Funding Required Stable Funding 100%

38 How does LR interplay with CR, LCR & NSFR Ultimately the regulators seek to prevent the chaos of GFC occurring in future via the banks Key aspects to the GFC were excessive leverage insufficient stable funding poor quality assets as collateral, poor assets in general insufficient capital reliance on short term funding Weaknesses in risk models and a result RWA, understated risk for numerous products (CDO, RBMS,CMBS, Leveraged Loans) e.g. CDO for risk purposes considered virtually riskless minimal RWA Poor underwriting standards e.g. NINJA loans, loan types with teasers, non-recourse loans CR - risk-based capital constraint risk-based leverage capital constraint weakness potentially with models, gaming the system etc LR - leverage constraint, used as a backstop to the capital constraint non-risk based simple ratio Avoids model risk and measurement error with CR

39 How does LR interplay with CR, LCR & NSFR LCR - minimum funding balance over stressed 30-day horizon NSFR mandates banks to have longer dated funding, relative to assets tenors Risk-weighted, lower quality assets discounted in formula Either > levels HQLA or extend tenors of funding The ratios work together to prevent excessive leverage in the banking sector outright leverage constraints International banks (DB, Deutsche, Citi bank etc) CR - key leverage constraint local and less sophisticated banks LR key leverage constraint on activity Liquidity constraints are LCR and NSFR working such that bank leverage levels are actively underpinned by solid liquidity (ability to fund assets) and quality assets/collateral. i.e. the ability support excessive is now curtailed significantly Lehman Bros scenario, LR and CR would have prevented them from having 40 times leverage Either CR or LR would have been exceeded requiring more regulatory capital, or a sell down in assets NSFR would have prevented the use of primarily ABCP to fund their growth (30 days of less maturity) LCR would have required switch to better quality assets and longer term funding (bond issuance)

40 Conclusion LR is a non risk-based measure designed to curtail excessive leverage Not as simple as it is implied devil is in the small print No model risk but exposure calculation is required for various product types there is model risk Has achieved objective of reducing leverage in banking system Also resulted in the withdrawal of players from business lines Clearing, Prime Services, bond market making etc Those that remain, margins eroded and costs increased Creation of bigger too big to fail institutions - US top 10 banks clear over 80% swaps - CCP s now systematically important (and consolidating) concentration of cleared derivatives in less hands This has let to less liquidity, more volatility, reduced ability to execute some trades. In a crises situation this will be exacerbated Initial versions extremely draconian toned down considerably, still improvements to be made Creates confusion where previously these was none clearing derivatives, collateral Makes trading more complicated in some cases Future focus of Basel on FRTB

41 Q&A Questions