Basel III - Implementation issues facing the Industry. Patricia Jackson Head of Financial Regulation Advisory EMEIA

Transcription

1 Basel III - Implementation issues facing the Industry Patricia Jackson

2 Systemically Important Banks FSB paper on intensive supervision Other elements are under discussion Contains a number of components: National discretion will Intensive Large supervision exposures create unlevel playing field Higher Capital Bail - in/cocos SIFIs Mandatory recovery and resolution planning Resolution Early Action This will create pressures global strengthening of regulatory regimes. Global increase in focus on stress testing and governance. Page 2

3 Practical Implications - SIFIs, CoCo, Bail In, Resolution AA AA- A+ A A- Remedial actions CoCo Layer ~7% capital trigger Or Bail in linked to resolution Recovery Recovery actions Bank can no longer operate standalone below a level (eg A-) value unravels quickly due to loss of swap rating, counterparties step away, etc, bank run Bail in separate from resolution Recovery Resolution Bank unravels The shareholder dynamic: CoCo layer held by hedge funds, sovereign wealth funds, etc As bail in approaches so are bonds In the CoCo layer shareholder dynamic shifts authorities now dealing with hedge funds. Bail In issues and challenges: Equity holders are they wiped out when bail in is triggered Scope? All wholesale Senior bonds Derivatives How to execute recapitalisation determining haircuts for bail in, how to allocate to creditors. Can it be done over a weekend? Or is more time required? Contracts statutory classification issues Linking bail in with resolution? Page 3

4 Indicative Capital Buffers Basel III focusing on changing quality and quantity of bank capital Hybrid capital increased confidence effects Subordinated debt was debt Equity capital not high enough Additional requirement for markets over heating 9.5% 7% 0-2.5% Capital conservation buffer- stops profit being distributed Additional requirement for systemically important firms to be decided 2.5% 4.5% Minimum capital Boom Recession Boom But multiple buffers will add to complexity Too much capital will drive disintermediation Increase cost for industry - industry incentive to move to point in time models to offset buffers Page 4

5 Changes to trading book treatments New incremental risk and CVA charges Securitisation exposures in trading book Changes to the trading book Stressed VaR and EPE Counterparty risk changes magnify effect capital now rises 3 to 4 times particularly because of CVA Revised specific risk charges for equity exposure These changes increase capital in trading books by 100% Page 5

6 Basel Committee Quantitative Impact study capital impact relative to end Banks Across 23 countries 94 large/international ( Group 1) 169 others (Group2) CETI 11.1% (Group 1) Pre-Basel III 10.7% (Group 2) Reduction 5.4 Percentage points Reduction 2.9 Percentage points 5.7% Post-Basel III 7.8% Page 6

7 Overall additional capital required Basel QIS Sample CET1 4.5% CET1 7% (10%) Shortfall end 2009 Group 1 165bn 575bn ( 825bn) Group 2 8bn 25bn Overall private sector estimate for whole European banking industry up to 1 trillion more capital needed. 50% raised already- but 50% still to raise Over 400bn raised in past 2 years Page 7

8 QIS results liquid assets shortfall Shortfall 1.73tr end 2009 Contributions to the shortfall- liability structure/shocks Group 1 Group 2 Retail/ SME 10% 18% Corporate 16% 21% Financial Institution 28% 26% Collateral 25% 11% Derivative payables Stock of high quality liquid assets Net cash outflows over a 30-day time period 7% 13% 100% Page 8

9 Strategic Issues Business focus will have to change. Spreads will need to rise percentage points. Proprietary trading much less profitable trading book capital 3-4 times higher. Large corporate lending will be difficult to remunerate. Markets will have to change increased collateralised faster close out swaps. Three way constraint on strategy Leverage constraint Cost of more capital 40% to 100% more equity Cost of the liquid assets buffer Page 9

10 Source: McKinsey, Basel III and European banking: Its impact, how banks might respond, and the challenges of implementation, Philipp Härle et al. ROE Pre-Crisis 15% Estimates of cut pre-mitigating actions reduction around 4 percentage points Components of the reduction Capital quality 0.8 percentage points Capital increase 1.3 Leverage ratio 0.1 Liquid assets 0.6 Strategic issue for the banks how much disclosure needed to convince equity investors they are safer Page 10

11 Basel III will change the shape of markets UK US Unsecured inter bank Secured inter bank Derivatives exposures uncollateralised Pressure under Basel to: i) increase term of wholesale funding ii) collateralise exposures Page 11

12 Liquidity- challenges /improvements needed Intra-day liquidity tracking New data hubs needed Contingen t commitments Better consolidat -ed/ group wide data Systems/ processes governance Funds transfer pricing Collateral tracking systems Enhanced analytic capability Key concern -regulatory uncertainty Page 12

13 Systems challenge General ledger Large number of systems involved and multiplies across jurisdictions Finance Treasury Front office 5 to 6 sub systems Regulatory reporting 2-3 data warehouses Collateral Management Resource constraints: -Limited number of IT experts - Other pressures on resources eg improving risk systems Cost : $200m ($30m per annum) or more for large banks Time: 5 years+ Page 13

14 New Capital instruments Uncertainty re allowable instruments Bank equity price impacted by uncertainty Issues Large volume ( 250bn) of hybrid maturing by 2018 Uncertainty about bail-in Size of market for Cocos depends on clarity of triggers Could take 4-5 years for market to build Page 14

15 Costs of regulatory compliance Not including the large systems change Regulatory compliance alone = 45m - 70m per bank Excluding enhancement of risk and finance capabilities, capital, funding and balance sheet management Equivalent to 30%-50% of Basel II costs Page 15

16 At the same time banks are running programmes to improve risk management Page 16

17 EY survey of risk management improvements/challenges Areas of greatest progress 83% 89% 65% 92% 93% Increased board oversight of risk Areas where more progress still needs to be made 78% Strengthened the role of the CRO 92% Made adjustments to allocating capital across business units 96% Changed approaches to liquidity risk management, and 82% instituted more rigorous internal pricing Implemented new stress testing, but most firms continue to see significant challenges Stress testing 59% Counterparty risk Risks not in VaR Stress VaR Illiquidity Valuation of uncertainty Notional or gross positions Revised compensation schemes but only 40% are close to completion of initial changes Increased attention on risk culture, but only 23% report a significant shift Increased focus on risk appetite, but only 25% report a link to business decisions Enhanced risk transparency, but only 26% have yet made significant changes 41% 48% 59% 65% 65% 76% 87% Areas of increased transparency Page 17