Proportionality Principle: Its Application & Challenges Damodaran Krishnamurti Oct 2018
Caveat The contents of the presentation and the views expressed do not necessarily represent the views of the WBG or the IMF or the FED WB-IMF-FED - Oct 2018 - For Discussion 2
Outline Why proportionality What is proportionality How it is applied How it can be applied Challenges in applying proportionality What can help WB-IMF-FED - Oct 2018 - For Discussion 3
Why proportionality? Evolution of complex standards, despite attempt to strike a delicate balance Simplicity, Risk sensitivity and Comparability Widespread adoption of Basel (global) standards in EMDEs Peer (jurisdiction) pressure; Peer (correspondent banks) pressure Parent bank requirement; Home or Host supervisor requirement Investors, rating agencies, analysts and advisers Absence of key pre-requisites: External ratings, HQLA, developed and active markets... Unintended consequences: Diversion of supervisory resources Cost of operations & compliance costs Inclusive growth WB-IMF-FED - Oct 2018 - For Discussion 4
Outline Why proportionality What is proportionality How it is applied How it can be applied Challenges in applying proportionality What can help WB-IMF-FED - Oct 2018 - For Discussion 5
How do we understand Proportionality? ADAPT FOR COMPLEX/ RISKY/ SYSTEMIC BANKS ADAPT FOR SIMPLER BANKS BASEL STANDARD APPLY TO COMPLEX / RISKY/ SYSTEMIC BANKS NOT APPLY TO SIMPLER BANKS WB-IMF-FED - Oct 2018 - For Discussion 6
Outline Why proportionality What is proportionality How it is applied How it can be applied Challenges in applying proportionality What can help WB-IMF-FED - Oct 2018 - For Discussion 7
Broad approaches for applying proportionality Segmentation Standard specific Standard specific : Component level Standard component : Content level Mix and match WB-IMF-FED - Oct 2018 - For Discussion 8
How jurisdictions determine the segment(s) Balance sheet metrics Size; Size in relation to GDP; Materiality Islamic banks Foreign activity Business model Risk profile Supervisory judgment WB-IMF-FED - Oct 2018 - For Discussion 9
Size thresholds in practice Source: Financial Stability Institute WB-IMF-FED - Oct 2018 - For Discussion 10
Areas where proportionality has been applied Source: Financial Stability Institute WB-IMF-FED - Oct 2018 - For Discussion 11
Outline Why proportionality What is proportionality How it is applied How it can be applied Challenges in applying proportionality What can help WB-IMF-FED - Oct 2018 - For Discussion 12
Options for applying proportionality a % b % 100-x % 100-y % ADAPT FOR COMPLEX/ RISKY/ SYSTEMIC BANKS ADAPT FOR SIMPLER BANKS BASEL STANDARD APPLY TO TO MID-SIZE/ COMPLEX RISK / RISKY/ SYSTEMIC BANKS BANKS 100 % 100 % NOT APPLY TO SIMPLER BANKS x % y % 100-x % 100-y % % of Total Assets % of No. of banks WB-IMF-FED - Oct 2018 - For Discussion 13
How jurisdictions can apply proportionality Regulatory requirement Exempted Modified Higher Lower CAPITAL ADEQUACY Definition RWA calculation Buffer Capital adequacy ratio ICAAP Pillar 3 LEVERAGE MARKET RISK OPERATIONAL RISK IRRBB LCR NSFR INTRA-DAY LIQUIDITY Disclosures Supervisory reporting WB-IMF-FED - Oct 2018 - For Discussion 14
How jurisdictions can apply proportionality (2) Regulatory requirement Complex/ Risky/ Systemic Tier 1 banks Others Tier 2 banks Basel III Basel III Basel II Basel I Exempted CAPITAL ADEQUACY Definition RWA calculation Buffer Capital adequacy ratio ICAAP Pillar 3 LEVERAGE MARKET RISK OPERATIONAL RISK IRRBB LCR NSFR INTRA-DAY LIQUIDITY Disclosures Supervisory reporting WB-IMF-FED - Oct 2018 - For Discussion 15
Can we apply Proportionality as below? Zero % Zero % 45 % 95 % ADAPT FOR COMPLEX/ RISKY/ SYSTEMIC BANKS APPLY SIMPLER OPTIONS TO OTHER BANKS BASEL STANDARD APPLY LATEST TO COMPLEX/ RISKY/ SYSTEMIC BANKS 100 % 100 % NOT APPLY TO SIMPLER BANKS 55 % 5 % 45 % 95 % % of Total Assets % of No. of banks WB-IMF-FED - Oct 2018 - For Discussion 16
Outline Why proportionality What is proportionality How it is applied How it can be applied Challenges in applying proportionality What can help WB-IMF-FED - Oct 2018 - For Discussion 17
Challenges in applying proportionality Determination of segments Calibration Striking the balance simplicity, risk sensitivity, comparability Ongoing review and re-calibration of the proportionality regime Capacity challenges in supervisory agencies Implications for banks in EMDEs adopting proportionality Implications for investor assessments (rating agencies, analysts, advisors) WB-IMF-FED - Oct 2018 - For Discussion 18
Challenges in applying proportionality (2) Implications for systemic risks Can small institutions collectively be/ become systemic? Unintended opportunities for regulatory arbitrage Can have macroprudential implications for example, leading to potential creation of shadow banks, even within the banking system Implications for competition Implications for supervisory effectiveness Implications for standards assessments WB-IMF-FED - Oct 2018 - For Discussion 19
How to assess compliance with BCPs? Zero % Zero % 50 % 40 % ADAPT FOR COMPLEX/ RISKY/ SYSTEMIC BANKS ADAPT FOR SIMPLER BANKS BASEL STANDARD APPLY TO COMPLEX / RISKY/ SYSTEMIC BANKS NOT APPLY TO SIMPLER BANKS 25 % 5 % 25 % 55 % % of Total Assets % of No. of banks WB-IMF-FED - Oct 2018 - For Discussion 20
How to assess compliance with BCPs? (2) Regulatory requirement Exempted Modified Higher Lower CAPITAL ADEQUACY Definition RWA calculation Buffer Capital adequacy ratio ICAAP Pillar 3 LEVERAGE MARKET RISK OPERATIONAL RISK IRRBB LCR NSFR INTRA-DAY LIQUIDITY Disclosures Supervisory reporting WB-IMF-FED - Oct 2018 - For Discussion 21
Outline Why proportionality What is proportionality How it is applied How it can be applied Challenges in applying proportionality What can help WB-IMF-FED - Oct 2018 - For Discussion 22
What can help? Range of practices Country assessments of effectiveness of proportionate adoption of global standards Capacity building in EMDEs Global guidance or guiding principles Development of several simplified approaches WB-IMF-FED - Oct 2018 - For Discussion 23
Looking Ahead a principles based approach Adopt latest Basel standards in entirety for the Tier-1 banks; For example, D-SIBs Adopt the simpler options available under the Basel Standards for Tier-2 banks; For example, all banks that are not Tier-1 or Tier-3 banks Adopt the principles underlying the simpler options for Basel standards for Tier-3 banks; For example, Each bank that is less than x % of market share and Collectively less than y % of market share WB-IMF-FED - Oct 2018 - For Discussion 24
DISCUSSION
Thank You kdamodaran1@worldbank.org World Bank Group 1818 H Street Washington, DC 20433