U.S. Banking Regulatory Update

Transcription

1 U.S. Banking Regulatory Update February 2013 kpmg.com

2 Change or Beware If we do not take change by the hand it will surely take us by the throat. Winston Churchill

3 Make Up of the Industry (2003 to 2012) $100 million to $1B 4,244 Institutions (58.6%) Source: FDIC. 2

4 Top 10 banks control > Half of industry s assets % 29% % 40% Combined Assets of All Others Combined Assets of Top 10 Banks % 52% Source: SNL, used with permission $0 $5,000 $10,000 $15,000 Dollar figures in Trillions 3

5 Net improving; Earnings under pressure (2 nd Q, 2012) Source: FDIC Quarterly Banking Profile, 2 nd Q, 2012 used with permission 4

6 ROA (2 nd Q, 2012) Source: FDIC Quarterly Banking Profile, 2 nd Q, 2012 used with permission 5

7 Problem institutions (2 nd Q, 2012) Source: FDIC Quarterly Banking Profile, 2 nd Q, 2012 used with permission 6

8 Growth in branches slows; Deposits increase Source: SNL Used with permission. 7

9 Preferred banking method All age groups Source: ABA used with permission. 8

10 Focus areas of U.S. Banks Regulation Basel II - III Durbin Amendment Volcker Cost Operational Efficiency Divesting non-core businesses Discretionary spend Growth Inorganic growth (e.g. M&A) New product /market development Re-pricing Change 9

11 The pessimist sees difficulty in every opportunity. The optimist sees the opportunity in every difficulty. Winston Churchill

12 The New U.S. Regulatory Landscape & Impacts 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. NDPPS

13 Dodd-Frank Act Financial Regulatory Reform: Areas of Focus Major Financial Legislation The Dodd-Frank Wall Street Reform and Consumer Protection Act ( The Dodd-Frank Act ) provided the most sweeping overhaul of the U.S. financial services industry and financial markets since the Great Depression Dodd-Frank (2010): 2,319 pgs Gramm Leach Bliley (1999): 145 pgs Sarbanes Oxley (2002): 66 pgs Glass Steagall (1933): 37 pgs Areas of Focus ,000 1,500 2,500 Number of Pages Systemic Risk Systemically important ( SIFI ) designation Financial Stability Oversight Counsel and Office of Federal Register oversight. Stress testing and living will requirements Financial Stability & Capital Requirements Liquidation authority Bank capital requirements Emergency stabilization Volcker Rule Proprietary trading restrictions Hedge fund and Private Equity fund restrictions Regulation of OTC Derivatives Swaps pushout rule Derivatives clearing and reporting requirements Consumer Protection & Mortgage Reform Broker/dealer and securities regulation Securitization risk retention Expanded mortgage documentation requirements Consumer Financial Protection Bureau Federal Bank Supervision Amendments to bank regulations Deposit insurance reforms Office of Thrift Supervision elimination Registration of Advisers SEC registration and exams Record keeping and reporting Private client disclosure Other Areas of Reform Conflict minerals disclosure requirements Interest on business deposits 12

14 The Dodd-Frank Act The New U.S. Regulatory Landscape New Agencies Changing Merging Unchanged Banks Insurance Securities Commodities/ Futures Consumers Federal Reserve Board Office of Thrift Supervision Office of the Comptroller of the Currency Federal Deposit Insurance Corporation Financial Stability Oversight Council Consumer Financial Protection Bureau State Bank Regulators State Insurance Regulators Federal Insurance Office Security and Exchange Commission Financial Industry Regulatory Authority State Securities Regulators Commodity Futures Trading Commission National Futures Assoc. Consumer Financial Protection Bureau Graphic updated/adapted from Financial Times article Regulatory reporting requirements can be expected to change further (increase) as the regulatory structure changes. 13

15 Impact on business and financial strategy Intensified regulatory pressure & risks Strategic Risk Fee revenue from ancillary and core products & services Increased risk management & compliance costs 14

16 Impact on infrastructure & operations Product innovation and marketing tactics Prioritization for operations & technology investment M&A due diligence 15

17 Impact on behaviors & culture Reputation Risk Customer Experience vs. Consumer Compliance Risks from affiliates and third parties 16

18 Implications and Challenges for US Banks Implications & Challenges 1. Enhanced Prudential Standards for key Safety & Soundness areas affecting U.S. banks: Enterprise risk management process and Board Risk Management oversight Capital adequacy - Basel III; stress-testing (CCAR & CaPR); enhanced capital plans Liquidity and Funding plans Legal entities oversight and rationalization; Resolution & Recovery Planning ( Living Will ) for large banks Enterprise Risk Management (*) Risk Appetite and enhanced Risk Dashboards (*) Credit exposures and concentrations (e.g., counterparties, CRE, sovereign debt) Internal Audit process (*) Transactions with affiliates (Reg W/23a &b) Information security Vendor risk management (including off-shoring) Executive incentive compensation process (* OCC Strong principles) 17

19 Implications and Challenges for US Banks (continued) Implications & Challenges 2. Increased Federal Reserve and OCC supervisory requirements for Enterprise-wide Governance, Risk Reporting, Risk Appetite and Internal Audit functions Especially for SIFIs but there is already a spillover effect on smaller firms Expectations for Strong Board oversight, Risk Management, Risk Appetite & Internal Audit processes Satisfactory is no longer acceptable 3. Systemic Risk oversight under the Federal Reserve, the FDIC and the Financial Services Oversight Council (FSOC) means a wider cross-section of U.S. financial institutions will come under federal scrutiny 4. Consumer Financial Protection Bureau (CFPB) has raised the bar on consumer protection laws, rules and requirements, including reporting 5. Increased regulatory scrutiny of Proprietary Trading and Derivatives Activities 6. Impact of regulatory reform requirements on bank product pricing and profitability, especially: Increased capital and liquidity requirements Loss of revenue due to potential Volcker and derivative push out provisions move activities into nonbank affiliates or outside the firm entirely More rigorous consumer protection requirements and associated costs and impact on profitability Increased regulatory reporting burden 18

20 Basel III Capital Requirements Basel III Regulatory Capital Ratios New ratio Common Equity Tier 1 Existing ratios with adjustments to calculations. Certain adjustments phased in Tier 1 Capital Tier 2 Capital Total Capital Leverage Impact on Equity Calculation Accumulated Other Comprehensive Income (AOCI) now flows through Tier 1 Capital Trust Preferred Securities Phased out of Tier 1 Capital and into Tier 2 Capital Other Deductions to be phased in between 2013 and 2018 Certain Deferred Tax Assets (DTAs), MSR Limits Gain on sale associated with securitization Defined pension benefit assets Sample Impacts on Risk Weighted Assets (RWA) Calculation Residential Loans 2 Groups Category 1 (35% - 100% RWA) and Category 2 (100% - 200% RWA) risk weighted based on LTV Commercial Loans New risk weight for High Volatility Commercial Real Estate (HVCRE) (150%) Investments Certain AFS securities receive new risk weighting (0% - 600%) Off-Balance Sheet and Derivatives Unfunded Commitments Original Maturity of one year or less now subject to risk weighting (20% Credit Conversion Factor (CCF)) Derivatives Removal of 50% Risk Weight cap for counterparty risk 19

21 Basel III Buffer Requirements Capital Conservation Buffer Counter-cyclical Buffer Comprised of Tier 1 components To be monitored and implemented by National Jurisdictions Minimum of 2.5% above the regulatory requirements Enforced by national authority as deemed necessary Banks build up capital buffers to draw down as losses are incurred Requirements between 0 and 2.5% of risk-weighted assets Ensures that banking sector capital requirements account for the macrofinancial environment 20

22 Basel III Liquidity Requirements Liquidity Coverage Ratio: Stock of high-quality liquid assets/total net cash outflows over the next 30 calendar days Minimum requirement = 100% Ensures that the bank has adequate level of assets to meet liquidity needs over the next 30 days Net Stable Funding Ratio: Available amount of stable funding/required amount of stable funding Minimum requirement = 100% Establishes minimum acceptable amount of stable funding based on asset and activity characteristics of an institution over a period of 1 year 21

23 Basel III Transition Planned to be implemented from Deadline of transposition into national law: 1st January 2013 BUT: the Agencies announced a delay in the Final Rule pending further review of industry comments During transition: the Basel Committee and US Regulators are expected to monitor economic effects 22

24 Implementation Timeline for New Regulatory Capital Minimums The US federal banking agencies are proposing to adopt an implementation timeline that is in line with the Basel III framework. Phase-in of Minimum Capital Ratios Phase-in of Capital Conservation Buffer As of January 1, Common Equity Tier % 4.000% 4.500% 4.500% 4.500% 4.500% 4.500% Capital Conservation Buffer 0.625% 1.250% 1.875% 2.500% Total Common Equity Tier % 4.000% 4.500% 5.125% 5.750% 6.375% 7.000% Tier 1 Capital 4.500% 5.500% 6.000% 6.625% 7.250% 7.875% 8.500% Total Capital 6.500% 7.500% 8.000% 8.625% 9.250% 9.875% % Phase-In of Certain CET1 0.0% 20.0% 40.0% 60.0% 80.0% 100.0% Deductions and AOCI Inclusion Leverage Ratio 3.000% Advanced Approaches Banks Only Reporting Begins 2015 Minimum Effective 2018 Importantly, certain deductions from Common Equity Tier 1 (DTAs from operating losses and credit carryforwards, gain-on-sale associated with securitization, defined pension benefit assets, excess of expected credit loss over allowance for loan and lease losses, and change in fair value arising from the bank s own creditworthiness) will be deducted in full from Tier 1 Capital on January 1, 2013, and transition to deductions from Common Equity Tier 1 according to the timeline above. Throughout the transition period, the balance of the deduction that has not yet transitioned to Common Equity Tier 1 will continue to be made to Tier 1 Capital. Goodwill will be fully deducted from Common Equity Tier 1 beginning January 1, Deductions for intangible assets other than goodwill and mortgage servicing rights ( MSRs ) will be deducted from Common Equity Tier 1 according to the transition timeline above for phase-in of Common Equity Tier 1 deductions. Threshold deductions relating to MSRs, certain DTAs arising from temporary differences, and significant investments in unconsolidated financial entities will be phased in according to the transition timeline above for phase-in of Common Equity Tier 1 deductions. Source: Interagency Notice of Proposed Rulemaking, Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, Transition Provisions, and Prompt Corrective Action, June 7,

25 What are Banks Doing? Can be separated into the 3 categories: 1. GSIFI (Global Systemically Financial Institutions) such as BofA, JPM, Citi etc. are responding to the NPRs while alerting shareholders of the additional capital that will be required. JPM calculated Basel III ratios based on the original Basel guidance in its 2011 Annual Report. 2. Medium sized banks are discussing internally what it means for them and those who have implemented Basel II or are a subsidiary of an overseas mandatory Basel II bank so report some Basel II requirements are probably more comfortable with the requirements. 3. Smaller banks are taking steps by completing the Basel 3 regulatory capital calculation spreadsheet and having a discussion with KPMG and other third parties. 24

26 The New U.S. Regulatory Landscape & Impacts 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. NDPPS

27 Step 1: Develop Macroeconomic View Economic Forecast Committee Meeting Macro- A Economic Forecast Report Functional Area : Consumer Loss Forecasting Assumptions Team Meeting IRE Loss Forecasting Assumptions Team Meeting Commercial Loss Forecasting Assumptions Team Meeting Loss Forecasting Results Analytics Management Review Meeting Monthly Quarterly Quarterly Monthly Monthly / Quarterly Monthly / Quarterly Macro- Economic Forecasting Report Step 2: Review and Confirm Loss Forecast Assumptions Consumer Loss Forecasting Assumptions IRE Loss Forecasting Assumptions Commercial Loss Forecasting Assumptions Step 3: Generate Loss Forecasts Loss Forecasting Committee Loss Forecasting Assumption Report Loss Forecasts, ALLL Analysis and NPLs Credit Risk Analytics Finance Treasury Review and approve assumptions at Loss Forecasting Committee Meeting C B Step 4: Review Financial Assumptions & Develop and Refine Financial Forecast NII Technical Meeting B/S & NII, & NIE/NIR Assumptions Review Meeting Financial Projections Interdependency: ABC Loss Forecasting Assumption Report D Step 5: Determine Capital Levels Working Group Capital Planning & Investment Committee E Capital Plan Report Step 6: Obtain Board Approval Capital Planning Team Leadership Meeting Executive Meeting Board Meeting Capital Planning, CCAR, and the Strategic Planning Process Sustainability is Key to Success Many banks struggle with converting CCAR submissions from a project compliance perspective into the fully integrated business planning cycle. Risk Appetite Statement Board of Directors set Risk Appetite Budget should reflect investment in acceptable business strategies Risk Appetite Statement CCAR can be built into the business planning cycle. To be sustainable, the following items need to be addressed: Defined governance structure Strategy and Capital Planning Other LOBS Consumer Business Budget BUDGET Derived from Year 1 Base Case of Capital plan Targets and metrics drilled down from Strategic Plan Business Planning Cycle + CCAR Other LOBs Consumer Business Strategic Plan Multi-Year Capital Plan Year 2 Year 3 CAPITAL PLAN and CCAR Collaborative process with cross functional participation Leverage process for both Regulatory Reporting and Strategic Planning STRATEGIC PLAN Business strategies refreshed New Initiatives identified Capital Plan informs investment priority BOD BOD Sponsored Committees Special Purpose Committees Working Groups Associates / Lines of Business / Geographies Documented processes, procedures, and tools Step 1: Develop Macroeconomic View Step 2: Review and Confirm Loss Forecast Assumptions A 1a 1b 1c Step 3: Generate Loss Forecasts Review & confirm Consumer assumptions with team Review & confirm Commercial assumptions with team Review and confirm IRE assumptions with team Step 4: Review Financial Assumptions & Develop and Refine Financial Forecast Step 5: Determine Capital Levels 2 3 Generate combined assumption set Step 6: Obtain Board Approval Clear understanding of roles, responsibilities, and staffing needs B 26

28 CCAR Framework Elements of a Robust Program All banking organizations should have the capacity to understand fully their risks and the potential impact of stressful events and circumstances on their financial condition SR Letter 12-7 The stress testing framework includes clearly defined objectives, well-designed scenarios, well-documented assumptions, ongoing review, and recommended actions. General Stress Testing Principles 1. Includes activities and exercises that are tailored to and sufficiently capture the banking organization s exposures, activities, and risks. 2. Employs multiple conceptually sound stress testing activities and approaches. Elements of a Robust Program Includes credit, market, operational, interest-rate, liquidity, country, strategic, and reputational risk. Aligned to Risk Appetite and part of regular risk identification and monitoring practices. Applied at various levels in the organization. Uses scenario, sensitivity, enterprise-wide, and reverse stress testing approaches. Relies on high-quality data. Documents assumptions, and degree of uncertainty. 3. Is forward-looking and flexible. Incorporates changes in the organizations activates, portfolio composition, asset quality, operating environment, business strategy, and other risks that arise over time. Ensures MIS are capable of incorporating changes. 4. Ensures results are clear, actionable, well supported, and inform decision making. Includes regular, documented communication to Board, management, and staff. Informs decisions related to strategies, limits, and risk profile. 5. Includes strong governance and effective internal controls. Requires critical review of key assumptions, uncertainties, and limitations. Integrated into business lines, capital and asset-liability committees, and other decision-making bodies; not isolated to risk management. 27

29 Common CCAR/Stress Testing Challenges Issue Description of Issue Process Sustainability Incomplete design and installation of suitable controls to fully integrate a sustainable, end-to-end capital planning process in the Company's financial, operational, and enterprise risk management framework, converting from a "project compliance" perspective to a fully integrated business process. Roles, Responsibilities, and Resources Data Quality and Data Management Risk Identification and Communication Board Review of Capital Forecast Lack of documentation (roles and responsibilities) needed to evaluate whether management has the appropriate management oversight, adequate staffing and proper segregation of duties for certain key departments involved in the capital planning process. Lack of quantitative resources to support capital reporting and analysis. Limited historical data availability (e.g. PD, LGD, EAD for specific portfolios) may impact ability to identify trends or back-test models. Data integrity concerns due to data handoffs between technology platforms and limited reporting between systems (e.g. loan system to GL) makes reconcilement and audit difficult. Changes in certain key assumptions may have a cascading effect in other areas not easily reconcilable across disparate systems. Limited processes to document whether the key stakeholders in the capital planning process are considering significant business decisions made by the Company that may have an impact on the forecasted information used in the capital planning process (e.g., Risk Appetite Statement, and New Initiatives Review). Senior leadership from certain groups may not be sufficiently involved in the capital planning forecasting process to determine if the impact of key business decisions are accurately reflected in the forecasted information used in capital planning. The bank s Board and executive management and board may not be provided with sufficient and consistent information to effectively conclude on necessary capital plan revisions, including dividend policy, share repurchases or suspension, capital raising or other funding strategies. Process and Model Imprecision Models may not be fully back tested and validated (specifically Risk Rating tools). Imprecision in models or data quality may need to be accounted for in a buffer (i.e. an additional amount of capital reserved for planning imprecision). 28

30 Example Successful Quarterly Capital Planning Overview of Key Steps The example capital planning process below is organized across six key steps that require significant cross functional coordination in order to develop the CCAR submission in a timely manner. The Fed requires each step in the process to be documented and repeatable making it crucial that sustainable processes are in places for each step. Example Quarterly Capital Planning Process Monthly Quarterly Quarterly Monthly Monthly / Quarterly Monthly / Quarterly Step 1: Develop Macroeconomic View Step 2: Review and Confirm Loss Forecast Assumptions Step 3: Generate Loss Forecasts Step 4: Review Financial Assumptions & Develop and Refine Financial Forecast Step 5: Determine Capital Levels Step 6: Obtain Board Approval Primary Functional Area(s) Treasury Risk Analytics Credit Risk Analytics Credit Finance Treasury Finance Treasury Finance Inputs Macroeconomic Data Regional Market Data Macroeconomic Forecast Report Macroeconomic Forecasting Report Loss Forecasting Assumptions Report Macroeconomic Forecasting Report Loss Forecasts, NPLs, and ALLL Analysis Financial Projections Economic Capital Output Results Capital Plan Report Completed CCAR Templates Outputs Macroeconomic Forecast Report Loss Forecasting Assumptions Report Loss Forecasts, NPLs, and ALLL Analysis Financial Projections (BS & Net Interest Income, & Non Interest Expense /Non Interest Revenue) Capital Plan Report n/a Update Frequency Monthly economic forecasting committee meeting Quarterly assumption meeting Quarterly run of all of the loss forecasting models based on the loss forecast assumptions and latest macroeconomic forecasts Monthly forecast development Monthly capital determination process Capital Planning Working Group (monthly) Capital Planning Investment Committee (quarterly) Executive review (monthly) Board review and approval (quarterly) Functiona Credit Risk Analytics Finance Treasury 2012 KPMG LLP, l a Area Delaware : limited liability partnership and the U.S. member firm of the KPMG network of independent 29

31 Model Governance and Validation Requirements The new guidance (OCC and FRB SR Letter 11-07) was issued on April 4, Its main objective is to broaden the scope of the existing model risk management guidance (i.e. OCC Bulletin ) to include all key aspects of model risk management. This guidance applies to national banks, bank holding companies, state member banks, and all other institutions for which the OCC or Fed is the primary supervisor. Previous guidance and other publications issued by the OCC and the Federal Reserve on the use of models pay particular attention to model validation Rigorous model validation plays a critical role in model risk management; however, sound development, implementation, and use of models are also vital elements. OCC , pp. 2 Model Cycle The term model is broadly referred to as a quantitative approach, method, framework, or system that applies statistical, economic, financial, mathematical, or computational / numerical theories, techniques, and assumptions to process input data into quantitative estimates. On-going Governance and Control Model Development Developer Model Testing Models are simplified representations of realworld relationships and dynamics among observed characteristics, values, and events. By design, they are not perfect and are meant to operate in a very specific environment. Model Implementation and Usage Independent Model Validation The Capital Planning Process is heavily reliant on modeling assumptions and output. Certain models may be used elsewhere consistency and suitability for use must be evaluated. Use of unvalidated models will conflict with the new guidance and increase risk. 30

32 KPMG CCAR Projection Process Projection Process Inputs Loss Data Market Data Position Data Scenarios Baseline and Stress Projections Analytical processes Models Preliminary Projections Balance Sheet Income Stmt Capital Sensitivity Analysis Professional Judgment Potential On-Top by Model/Process Owner Functional areas involved in projection process: Lines of Business Risk Analytics Treasury Financial Planning Challenge/Review Process Outcome Projections Challenged Includes On-Top and Sensitivity Analysis Challenge Results Projection and Sensitivity Analysis Pass 2 nd On Top for Projection, Sensitivity Analysis Pass Projection Pass, Sensitivity Analysis Not Pass Projection and Sensitivity Analysis Not Pass 14A schedules Final Projections are populated in 14A schedules and capital plan Sensitivity analysis included in capital plan Return to Sensitivity Analysis step Return to Inputs step 31