Basel iii capital adequacy accord

Basel III Capital Adequacy AccordBasel Committee on Banking Supervision09th Sep, 2012

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a. 2008 Financial Crisis & the Evolution of Basel Norms

b. Basel III Guidelines

c. Basel II vs. Basel III – Points of Difference

d. Capital Conservation Buffer & Countercyclical Buffer

e. Leverage Ratio

f. Liquidity Standards

• Liquidity Coverage Ratio

• Net Stable Funding Ratio

Contents

A. 2008 Financial Crisis & the Evolution of Basel Norms

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The 2008 Financial Crisis in a Nutshell

Financial leverage overrides capital (equity) & financial markets tend to dominate over the traditional industrial economy & agricultural economies

Deregulation of financial services sector in the US from the 1980s

Large inflow of foreign funds

Easy credit conditions in US Debt-financed consumption (▲)

(US Credit Bubble) (US Housing Bubble)

Financial Innovation (▲)

○ Mortgage Backed Securities○ Collateralized Debt Obligations

Financialization

Shadow Banking System (▲)

○ Financing of mortgages though off-balance sheet securitizations

○ Hedging of risks through off-balance sheet Credit Default Swaps

○ Synthetic CDOs

Mispricing of risk

Weak & fraudulent underwriting practice

○ Vulnerable to Maturity Mismatch – borrowed short-term liquid assets to purchase long-term, illiquid & risky assets

2008 Credit Market Crisis

An increase in TED spread to a region of 150-200 bps as opposed to long-term average of around 30 bps ► indicating an increase of counterparty risk (default of interbank loans)

Underestimation of risk concentration

Insufficient Risk CoverageRisk sensitivity of financial products such as OTC derivatives was incorrectly estimated under Basel II and Counterparty Credit Risk, Liquidity Risk, Concentration Risk, Wrong-Way Risk, etc. were not adequately addressed

Definition of Risk-Weighted AssetsBasel II presumed that the level of capital in the system was sufficient based on its categorization of assets and risk-weights, however new financial products spawned out of securitization were highly vulnerable to systemic risk which was not taken in to account while assigning risk-weights

Failure to capture off-balance sheet exposures

Basel II failed to regulate key exposures such as complex trading activities, resecuritizations and exposures to off-balance sheet vehicles

LeverageBasel II did not regulate the amount of financial leverage that banks and institutions could take leading to excessively leveraged positions of banks prior to the crisis

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What’s wrong with Basel II…?

Insufficient high-quality capitalprevented banks to absorb losses as a going concern

Insufficient risk coverageThe financial crisis highlighted the need to revisit some of the risk sensitivity assumptions underlying financial instruments such as OTC derivatives – Counterparty Risk, Wrong-Way Risk and Liquidity Risk

Failure to capture key exposures (such as complex trading activities, resecuritisations and exposures to off-balance sheet vehicles )

Basel IIAccentuates Procyclicality Financial

Instability

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Basel III intends to…

• Basel III intends to improve the quality of capital with the ultimate aim of improving loss-absorption capacity in both going concern & liquidity scenarios

Increase quality of capital

• Basel III aims at increasing the level of capital held by banks

Increase quantity of capital

• Liquidity Coverage Ratio promotes short-term resilience to potential liquidity disruptions

Increase short-term liquidity coverage

• Net Stable Funding Ratio encourages banks to use stable sources to fund their activities

Increase stable long-term balance sheet funding

• Basel III enhances risk coverage by modifying the treatment of exposures to financial institutions & the counterparty risk on derivative exposures

Strengthen risk capture, notably counterparty risk

• Leverage Ratio is aimed at reducing the risk of a build-up of excessive leverage at the bank level as well as the systemic level

Reduce leverage through introduction of backstop leverage ratio

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Basel II Basel IIICommon

EquityTier 1

CapitalTier 2

CapitalCommon

EquityTier 1

CapitalTier 2

Capital

Minimum Requirements 2% 4% 8% 4.5% 6% 8%

Capital Conservation Buffer Not applicable 2.5%

Countercyclical Capital Buffer Not applicable 0% to 2.5%

Leverage Ratio Not applicable Tier 1 Leverage Ratio ≥ 3% #

Liquidity Coverage Ratio

Not applicable≥ 100%

Net Stable Funding Ratio

Not applicable≥ 100%

So does Basel III replace Basel II?

Basel III guidelines are not meant to be a replacement for the Basel II guidelines. For banks to be Basel III compliant, Basel II guidelines need to be first implemented across all the pillars and then substituted with specific recommendations of the Basel III framework.

# The minimum level of 3% will be tested by BCBS during the parallel run period from 01 Jan 2013 to 01 Jan 2017

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Basel Framework Today

Pillar I Capital Ratios

Liquidity Ratio

Leverage Ratio

Pillar II Supervisory

Review process

Pillar III Market

Discipline

Standard IRB-F IRB-A

CCR Derivative Exposure

CEM EPE

Standard

CVA

IMA

WWR

VAR

Stressed VAR

IRC

BIA Standardized AMA

Tier 1

Tier 2

Capital

RWA

Credit

Market

Operational

LCR

NSFR

Updated with Basel III Added in Basel III No change from Basel II

Updated with Basel 2.5

CCB

CB

B. Basel III Guidelines

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Building Blocks of Basel III

Basel III

Regulatory Capital

Risk Management

Countercyclical Measures

■ Improvement of quality of Tier 1 Capital■ Harmonized & simplified Tier 2 Capital■ Tier 3 Capital eliminated

■ Introduction of “stressed VaR” into capital requirements■ Capital requirements for an “Incremental Risk Charge”■ Additional capital requirements for Counterparty Credit Risk (CVA, AVC, Wrong-Way Risk)■ Strengthen internal credit risk processes & decrease reliance on external credit ratings

Leverage Ratio Liquidity Risk Management

Systemic Risk

■ Additional capital surcharges between 1-3.5% for systemically important financial institutions

■ Unified minimum liquidity criteria to cover liquidity risk:■ Liquidity Coverage Ratio■ Net Stable Funding Ratio

■ Reinforces risk-based requirements with a simple, non-risk based “backstop” measure based on gross exposure

■ Introduces an additional Capital Conservation Buffer that can be drawn down in periods of financial stress■ Introduces a Countercyclical Capital Buffer that ensures financial resilience of the banking sector in periods of excessive credit growth■ Promotes more forward looking measures

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Basel III – Quantitative Impact

Capital Ratio =Risk-weighted Assets

Eligible Capital

Leverage Ratio =Total Exposure

Tier 1 Capital≥ 3%

High-quality liquid assets

Total net cash outflows over the next 30 calendar days

≥ 100% Liquidity Coverage Ratio =

Available stable funding

Required stable funding≥ 100%Net Stable Funding Ratio =

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Basel III – Qualitative Impact

Impact on Individual Banks Impact on Financial System

Pressure on profitability & ROE

The most important implication of Basel III is an increase in cost of lending due to increased capital requirements possibly translating in to decreased profit margins and diminishing ROE

Reduced risk of a systemic banking crisis

Enhanced capital & liquidity buffers along with enhanced risk management standards & capability should reduce the risk of a systemic banking crisis in the future

Weaker banks crowded out

With downward pressure on profit margins and increasing costs of compliance, weaker banks would find it difficult to compete under the updated Basel framework

Reduced lending capacity

With increased capital requirements the lending capacity of banks will be diminished across the system possibly leading to a slowdown in economic growth

Change in demand from short-term to long-term funding

With the introduction of additional liquidity ratios – LCR & NSFR – there would be a qualitative shift in the demand from short-term to long-term funding with the consequent impact on the pricing & margins that are achievable

Reduced investor appetite for bank debt and equity

Should profitability margins & ROE decrease, investors would be less attracted by bank debt or equity issuance given that dividends are likely to be reduced to allow firms to rebuild capital bases

Legal entity reorganization

Increased supervisory focus on proprietary trading, matched with the treatment of minority investments and investments in financial institutions may lead to group reorganizations, including M&A & portfolio liquidation

International Arbitrage

If national authorities implement Basel III guidelines differently, it may lead to international regulatory arbitrage as was observed under Basel I and Basel II implementations

Source: Basel III: Issues and Implications – KPMG (2011)

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The Basel III minimum capital requirement reduces the available capital with banks, bringing about a leftward shift in the bank’s credit supply curve from S1 to S2.

In the medium term, this would result in reduced lending by banks along with in an increase in lending rates causing a decrease in demand for credit in the economy.

The interest elasticity of demand would determine the extent of decrease in demand for credit across national jurisdictions.

Overall, increased capital requirements and cost of funding would impact growth and ROE of banks and financial institutions.

Basel III’s Impact on Bank’s ROE – The Curves

S2

S1

D

Lending Rate

Credit

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2011 2012 2013 2014 2015 2016 2017 2018 01 Jan 2019

Min. CE Capital Ratio 3.5% 4.0% 4.5% 4.5% 4.5% 4.5% 4.5%

Capital Conservation Buffer (CCB)

0.625% 1.25% 1.875% 2.5%

Min. CE + CCB 3.5% 4.0% 4.5% 5.125% 5.75% 6.375% 7.0%

Phase-in of deductions from CET1 (including amounts exceeding the limit for DTAs, MSRs & financials)

20% 40% 60% 80% 100% 100%

Min. Tier 1 Capital 4.5% 5.5% 6.0% 6.0% 6.0% 6.0% 6.0%

Min. Total Capital 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0%

Min. Total Capital + CCB

8.0% 8.0% 8.0% 8.625% 9.125% 9.875% 10.5%

Capital instruments that no longer qualify as non-core Tier 1 or Tier 2 Capital

Phased out over 10 year horizon beginning 2013

Leverage Ratio Supervisory Monitoring Parallel run: 01 Jan 2013 to 01 Jan 2017Disclosure starts 01 Jan 2015

Migration to Pillar 1


Observation period begins

Introduce min. std.


Observation period begins

Introduce min. std.

Basel III Timeline

Source: Basel III – Design and Potential Impact – Deloitte (2010)

C. Basel II vs. Basel III – Points of Difference

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Basel II vs. Basel III – Tier 1 Capital Components

Basel II Basel III

Common Stock & other forms of Tier 1 Common Equity issued by the bank that meets the criteria for inclusion

Innovative instruments (limited to max 15%) net of goodwill

Stock surplus (share premium) resulting from the issue of instruments included in Common Equity Tier 1

-- Retained earnings (including interim profit or loss)

Disclosed reserves (including from minority interests)

Other comprehensive income & other disclosed reserves

-- Regulatory Adjustments

Source: bcbs189 – BIS (2011) and bcbs128 – BIS (2006)

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Basel II vs. Basel III – Tier 1 Capital (Deductions)

Basel II Basel III

Deduction: goodwill & increase in equity from a securitization exposure - “gain-on-sale”

Deduction: goodwill & all other intangibles (except mortgage servicing rights). Subject to prior supervisory approval, banks that report under local GAAP may use IFRS definition of intangible assets.

Deduction: 50% of investments in other financial institutions; 50% of securitization exposure

Deduction: Investments in the capital of institutions outside the regulatory scope of consolidation – 100% deduction of reciprocal cross-holding of capital; deduction of holdings exceeding 10% of bank’s common equity: “corresponding deduction approach”

Deduction: Following items can be either be deducted 50% from Tier 1 and 50% from Tier 2 or be risk weighted:• Certain securitization exposures• Certain equity exposures under the PG/LGD approach• Non-payment/ delivery on non-DvP and non-PvP transactions• Significant investments in commercial entities

Deduction: Items eligible to be deducted 50% from Tier 1 and 50% from Tier 2 or be risk weighted, now have a risk weight of 1250%.


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Basel II vs. Basel III – Additional Tier 1 Capital Components

Basel II Basel III

-- Instruments issued by the bank meeting the criteria for inclusion in AT 1

-- Stock surplus (share premium) resulting from instruments included in AT 1

-- Instruments issued by consolidated subsidiaries of the bank & held by third parties (i.e minority interest) that meet criteria for AT 1

-- Regulatory Adjustments

Additional Tier 1 Capital was not available under Basel II


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Basel II Basel III

( Limited to a max of 100% of Tier 1 ) ( No max limit on Tier 2 capital )

Undisclosed reserves Instruments issued by the bank meeting the criteria for inclusion in Tier 2

Asset revaluation reserves (latent gains on unrealized securities are subject to a discount of 50%)

Stock surplus (share premium) resulting from the issue of instruments

General provisions / loan-loss reserves (limited to max of 1.25% of RWA)

General provisions / loan-loss reserves held against future, presently unidentified losses (limited to a max 1.25% of credit RWA calculated under standardized approach)

Hybrid capital instruments (unsecured, subordinated, fully paid-up, not redeemable)

Total eligible provisions minus total expected loss amount (limited to max 0.6% of credit RWA calculated under IRB approach)

Subordinated debt (limited to a max of 50% of Tier 1 capital)

Instruments issued by consolidated subsidiaries of the bank & held by third parties (i.e minority interests) that meet the criteria for Tier 2

Deduction: 50% of investments in other financial institutions; 50% of securitization exposure

Regulatory adjustments

Hybrid capital instruments have been removed from Tier 2 Capital definition under Basel III


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Basel II Basel III

( Limited to a max of 250% of Tier 1 ) --

Short-term subordinated debt (at the discretion of the national authority for the sole purpose of meeting capital requirements for market risks)

--

Tier 3 Capital has been removed from the regulatory capital under Basel III


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Common Equity Tier 1 Additional Tier 1 Tier 2

ISSUER

1. General • Bank• Fully-consolidated subsidiary of bank meeting conditions below

• Bank• Consolidated subsidiary of bank meeting conditions below• Special purpose vehicle (SPV) meeting conditions below

• Bank• Consolidated subsidiary of bank meeting conditions below• Special purpose vehicle (SPV) meeting conditions below

2. Subsidiary Issuers

• Held by third parties• Common equity, if issued by bank, would qualify as Tier 1 Common Equity in all respects• Subsidiary is itself a bank• Amount recognized limited to total amount of common equity of subsidiary minus surplus attributable to minority shareholders (if any) (surplus calculated as lower of (i) minimum Tier 1 Common Equity requirement of subsidiary plus capital buffer (i.e., 7.0% of risk weighted assets) and (ii) portion of consolidated minimum Tier 1 requirement plus capital buffer relating to subsidiary)

• Held by third parties• Instrument, if issued by bank, would qualify as Tier 1 capital in all respects• Amount recognized limited to total amount of Tier 1 capital of subsidiary minus surplus attributable to third party investors (if any) (surplus calculated as lower of (i) minimum Tier 1 requirement of subsidiary plus capital buffer (i.e., 8.5% of risk weighted assets) and (ii) portion of consolidated minimum Tier 1 requirement plus capital buffer relating to subsidiary) • Excludes any instrument recognized as Tier 1 CE

• Held by third parties• Instrument, if issued by bank, would qualify as Tier 1 or Tier 2 capital in all respects• Amount recognized limited to total amount of total capital of subsidiary minus surplus attributable to third party investors (if any) (surplus calculated as lower of (i) minimum total capital requirement of subsidiary plus capital buffer (i.e., 10.5% of risk weighted assets) and (ii) portion of consolidated minimum Tier 1 requirement plus capital buffer relating to subsidiary) • Excludes any instruments recognized as Tier 1 CE or Tier 1 Additional Capital

Criteria for Inclusion – Key Aspects

Source: Regulatory Capital Reform under Basel III – Latham & Watkins (2011)

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ISSUER

3. SPV Issuers • Proceeds of instrument issued by SPV must be immediately available without limitation to operating entity or holding company in form meeting or exceeding all other criteria for inclusion in Tier 1 Additional Capital

• Proceeds of instrument issued by SPV must be immediately available without limitation to operating entity or holding company in form meeting or exceeding all other criteria for inclusion in Tier 2 Capital

4. Source of funds

• Neither bank nor related party over which bank exercises control or significant influence can have purchased instrument, nor can bank directly or indirectly have funded purchase of instrument

• Neither bank nor related party over which bank exercises control or significant influence can have purchased instrument, nor can bank directly or indirectly have funded purchase of instrument

Criteria for Inclusion – Key Aspects (Cont’d)


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TERM

1. In general Perpetual • Perpetual• No step-ups or other incentives to redeem

• Minimum original maturity of at least 5 years• Recognition in regulatory capital in remaining 5 years before maturity amortized on straight-line basis• No step-ups or other incentives to redeem (an option to call after 5 years but prior to start of amortization period, without creating expectation of call, is not incentive to redeem)

2. Redemption / Repayment

• Principal perpetual & never repaid outside of liquidation• Discretionary repurchases & other discretionary means of effectively reducing capital permitted if allowable under national law

• Repayment of principal (e.g. through repurchase or redemption) only with prior supervisory approval• Instrument cannot have features hindering recapitalization, such as provisions requiring issuer to compensate investors if new instrument issued at lower price during specified time frame

• Investor must have no rights to accelerate repayment of future scheduled payments (coupon or principal), except in bankruptcy and liquidation



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TERM

3. Call • Callable at initiative of issuer only after minimum of five years: a. To exercise call option bank must receive prior supervisory approval; and b. Bank must not do anything creating expectation that call will be exercised; and c. Bank must not exercise call unless: i. bank replaces called instrument with capital of same or better quality and replacement done at conditions sustainable for income capacity of bank (replacement must be concurrent with call, not after); or ii. bank demonstrates that capital position well above minimum capital requirement after call exercised (“minimum” requirement refers to national law not Basel III rules)

• Callable at initiative of issuer only after minimum of five years: a. To exercise call option bank must receive prior supervisory approval; and b. Bank must not do anything creating expectation that call will be exercised; and c. Bank must not exercise call unless: i. bank replaces called instrument with capital of same or better quality and replacement done at conditions sustainable for income capacity of bank (replacement must be concurrent with call, not after); or ii. bank demonstrates that capital position well above minimum capital requirement after call exercised (“minimum” requirement refers to national law not Basel III rules)



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TERM

4. No Expectation

• Bank does nothing to create expectation at issuance that instrument will be bought back, redeemed or cancelled nor do statutory or contractual terms provide any feature which might give rise to such expectation

• Bank should not assume or create market expectation that supervisory approval for repayment of principal will be given

• Bank must not do anything creating expectation that call will be exercised

DISTRIBUTIONS / COUPONS

1. Source • Distributions paid out of distributable items• Level of distributions not in any way tied or linked to amount paid in at issuance and not subject to cap (except to extent bank unable to pay distributions exceeding level of distributable items)

• Dividends/ coupons paid out of distributable items



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2. No Obligation

• No circumstances under which distributions obligatory• Non-payment not event of default

• Dividends/ coupons discretion:

a) Bank must have full discretion at all times to cancel distributions/ payments

b) Cancellation of discretionary payments must not be event of default

c) Banks must have full access to cancelled payments to meet obligations as they fall due

d) Cancellation of distributions/ payments must not impose restrictions on bank except in relation to distributions to common stockholders

• Investor must have no rights to accelerate repayment of future scheduled payments (coupon or principal), except in bankruptcy and liquidation



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3. Priority • Distributions paid only after all legal and contractual obligations met and payments on more senior capital instruments made• No preferential distributions, including in respect of other elements classified as highest quality issued capital

4. Margin adjustment

• Instrument may not have a credit sensitive dividend feature, i.e., dividend/ coupon reset periodically based in whole or part on bank’s current credit standing

• Instrument may not have a credit sensitive dividend feature, i.e., dividend/ coupon reset periodically based in whole or part on bank’s current credit standing

SUBORDINATION

1. Priority • Most subordinated claim in liquidation of bank• Entitled to claim of residual assets proportional with share of issued capital after all senior claims repaid in liquidation

• Subordinated to depositors , general creditors and subordinated debt of bank

• Subordinated to depositors , general creditors of bank



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SUBORDINATION

2. Loss Absorbency

• Takes first and proportionately greatest share of any losses as occur• Within highest quality capital; absorbs losses on going-concern basis proportionately and pari passu with all others

• Instruments classified as liabilities must have principal loss absorption through eithera) conversion to common shares at

objective pre-specified trigger point or

b) Write-down mechanism allocating losses to instrument at pre-specified trigger point

Write-down will have the following effects

c) reduce claim of instrument in liquidation,

d) Reduce amount re-paid when call is exercised, and

e) Partially or fully reduce coupon/ dividend payments on instrument

3. Equity-like nature

• Paid-in amount recognized as equity capital for determining balance sheet insolvency• Paid-in amount classified as equity under relevant accounting standards

• Instrument can’t contribute to liabilities exceeding assets if balance sheet test forms part of national insolvency law



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SUBORDINATION

4. Security • Neither secured nor covered by guarantee of issuer or related entity or subject to other arrangement legally or economically enhancing seniority of claim

• Neither secured nor covered by guarantee of issuer or related entity or other arrangement legally or economically enhancing seniority of claim vis-à-vis bank creditors

• Neither secured nor covered by guarantee of issuer or related entity or other arrangement legally or economically enhancing seniority of claim vis-à-vis depositors and general bank creditors



D. Capital Conservation Buffer & Countercyclical Buffer

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Capital Conservation Buffer Countercyclical Capital Buffer

2.5% of RWA 0% - 2.5% of RWA

Fixed Variable

Objective is to build capital buffers outside periods of stress which can be drawn down as losses are

incurred

Objective is to dampen excessive credit growth in the economy to ensure capital levels in the

banking sector

Non-discretionary – disclosed buffer requirements

Discretionary – buffer requirement is decided by national authorities

Pre-determined set of consequences for banks that do not meet the buffer requirements

Pre-determined set of consequences for banks that do not meet the buffer requirements similar to

that of Capital Conservation Buffer

Implemented as it is and sits on top of the Common Equity Tier 1 capital requirements

Implemented as an extension to the Capital Conservation Buffer

-- National authorities pre-announce the decision to raise the buffer requirements by up to 12 months

Buffers Comparison

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The Capital Conservation Buffer is intended to ‘promote the conservation of capital and the build-up of adequate buffers above the minimum that can be drawn down in periods of stress.’

Outside of period of stress, banks should hold buffers of capital above the regulatory minimum.

When buffers have been drawn down, banks should rebuild them through:

Reducing discretionary distribution of earnings (reducing dividend payouts, share-backs, staff nous payments)

Raising ne w capital from the private sector

In the absence of raising capital in the private sector, the share of earnings retained by banks for the purpose of rebuilding their capital buffers should increase the nearer their capital levels are to the minimum capital requirement.

The framework reduces the discretion of banks which have depleted their capital buffers to engage in ‘unacceptable’ practices like:

Using future predictions of recovery as justification for maintaining generous distribution to shareholders, other capital providers and employees

Using the distribution of capital as a way to signal their financial strength

Capital Conservation Buffer – Objective

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A capital conservation buffer of 2.5%, comprised of Common Equity Tier 1, is established above the regulatory minimum capital requirement. Capital distribution constraints will be imposed on a bank when capital levels fall within this range.

Banks will be able to conduct business as normal when their capital levels fall in to the conservation range as they experience losses. The constraints imposed only relate to distributions, not the operation of the bank.

The distribution constraints imposed on banks when their capital levels fall into the range increases as the banks’ capital levels approach the minimum requirements.

The Basel Committee does not wish to impose the constraints for entering the range that would be so restrictive as to result in the range being viewed as establishing a new capital requirement.

Capital Conservation Buffer – The Framework

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Individual bank minimum capital conservation standards

Common Equity Tier 1 Ratio Minimum Capital Conservation Ratios(expressed as a percentage of earnings)

Within 1st quartile of buffer (4.5% - 5.125%) 100%

Within 2nd quartile of buffer (> 5.125% - 5.75%) 80%

Within 3rd quartile of buffer (> 5.75% - 6.375%) 60%

Within 4th quartile of buffer (> 6.375% - 7%) 40%

Above top of buffer (> 7%) 0%

Capital Conservation Buffer – Mechanics

For example, a bank with a CET 1 capital ratio in the range of 5.125% to 5.75% is required to conserve 80% of its earnings in the subsequent financial year (i.e payout no more than 20% in terms of dividends, share buybacks and discretionary bonus payments).

Source: bcbs189 – BIS (2011)

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Items considered to be distributions include dividends and share buybacks, discretionary payments on other Tier 1 capital instruments and discretionary bonus payments to staff.

Earnings are defined as distributable profits calculated prior to the deduction of elements subject to the restriction on distributions. Earnings are calculated after the tax which would have been reported had none of the distributable items been paid.

The Capital Conservation Buffer framework should be applied at the consolidated level, i.e restrictions would be imposed on distributions out of the consolidated group. National supervisors would have the option of applying the regime at the solo level to conserve resources in specific parts of the group.

Banks should not choose in normal times to compete with other banks and win market share. To ensure that this does not happen, supervisors have the additional discretion to impose time limits on banks operating within the buffer range on a case-by-case basis.

The Capital Conservation Buffer will be phased in between 01 Jan 2016 and year end 2018 becoming fully effective on 01 Jan 2019. It will begin at 0.625% of RWAs on 01 Jan 2016 and increase each subsequent year by an additional 0.625 percentage points, to reach its final level of 2.5% of RWAs on 01 Jan 2019.

Capital Conservation Buffer – Other Key Aspects & Timeline

2016 2017 2018 2019

Capital Conservation Buffer 0.625% 1.25% 1.875% 2.5%

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Basel II Basel III0%

2%

4%

6%

8%

10%

12%

Regulatory Capital

Tier 2Other Tier 1CET1 + CCB

Capital Conservation Buffer – Impact on Regulatory Capital

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The countercyclical buffer aims to ‘ensure that the banking sector in aggregate has the capital on hand to help maintain the flow of credit in the economy without its solvency being questioned’.

‘It will be deployed by national jurisdictions when excess aggregate credit growth is judged to be associated with a build-up of system-wide risk to ensure the banking system has a buffer of capital to protect it against future potential losses.’ The objective behind countercyclical buffer is to dampen excessive credit growth when national regulatory authorities judge the credit-to-GDP ratio is deviating from the trend.

The buffer for internationally active banks will be a weighted average of the buffers deployed across all national jurisdictions to which they have credit exposures.

Banks would be subject to restrictions on distributions if they do not meet the buffer requirements as mandated by the regulatory authority.

The buffer will vary between zero and 2.5% of risk weighted assets, depending on the judgment of the relevant national authority.

Countercyclical Buffer – Objective

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Individual bank minimum capital conservation charges, when a bank is subject to a 2% Countercyclical Buffer requirement

Common Equity Tier 1 Minimum Capital Conservation Ratios(expressed as a percentage of earnings)

Within 1st quartile of buffer (4.5% - 5.625%) 100%

Within 2nd quartile of buffer (>5.625% - 6.75%) 80%

Within 3rd quartile of buffer (>6.75% - 7.875%) 60%

Within 4th quartile of buffer (>7.875% – 9%) 40%

Above top of buffer (> 9%) 0%

Countercyclical Buffer – Mechanics

Since the Countercyclical Buffer is implemented as an extension of the Capital Conservation Buffer (2.5%), a hypothetical Countercyclical Buffer requirement of 2% implies that the bank would need to maintain a capital ratio of 9% failing which restriction on distribution of earnings would be applicable.

4.5% (CE Tier 1) + 4.5% (Conservation Buffer + Countercyclical Buffer) = 9%

Source: bcbs189 – BIS (2011)

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The BIS document titled ‘Guidance for national authorities operating the countercyclical capital buffer’, delineates the principles that national regulatory authorities have agreed to follow in making buffer decisions.

To give banks time to adjust to a new buffer level, a period of up to 12 months would be given after the announcement of the decision by the concerned regulatory authority. Decision to reduce the buffer level would take effect immediately post-announcement.

The countercyclical buffer regime will be phased-in in parallel with the capital conservation buffer between 01 Jan 2016 and year end 2018 becoming fully effective on 01 Jan 2019.

The maximum countercyclical buffer requirement will begin at 0.625% of RWAs on 01 Jan 2016 and increase each subsequent year by an additional 0.625 percentage points, to reach its final maximum of 2.5% of RWAs on 01 Jan 2019.

Countries that experience excessive credit growth should consider accelerating the build up of the capital conservation buffer and the countercyclical buffer. National authorities have the discretion to impose shorter transition periods and should do so where appropriate.

In addition, jurisdictions may choose to implement larger countercyclical buffer requirements. In such cases the reciprocity provisions of the regime will not apply to the additional amounts or earlier time-frames.

Countercyclical Buffer – Timeline & Transitional Agreements

2016 2017 2018 2019

Countercyclical Buffer 0.625% 1.25% 1.875% 2.5%

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Guidance for national authorities operating the Countercyclical Capital Buffer

National authorities are urged to take countercyclical capital buffer decisions on a quarterly or more frequent basis.

Basel Committee believes that national authorities should implement a communication strategy that provides regular updates on their assessment of macro financial situation and the prospects for potential buffer actions. This would promote accountability and sound decision-making while allowing banks and their stakeholders to prepare for buffer decisions.

The capital surplus created when the countercyclical buffer is returned to zero should be unfettered. i.e there are no restrictions on distributions when the buffer is turned off.

Credit-to-GDP Guide

National authorities can determine the buffer add-on by the following 3 steps:

1. Calculate the aggregate private sector credit-to-GDP ratio

2. Calculate the credit-to-GDP gap (the gap between the ratio and its trend)

3. Transform the credit-to-GDP gap in to the guide buffer add-on

Credit-to-GDP Guide to determine Countercyclical Buffer

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1. Calculating the credit-to-GDP ratio

The credit-to-GDP ratio in period t for each country is calculated as:

RATIOt = CREDITt / GDPt Х 100%

GDPt is domestic GDP and CREDITt is a broad measure of credit to the private, non-financial sector in period t. Both GDP and CREDIT are in nominal terms and on a quarterly frequency.

2. Calculating the credit-to-GDP gap

The credit-to-GDP ratio is compared to its long term trend. If the credit-to-GDP ratio is significantly above its trend (i.e there is a large positive gap) then this is an indication that credit may have grown to excessive levels relative to GDP.

The gap (GAP) in period t for each country is calculated as the actual credit-to-GDP ratio minus its long-term trend (TREND):

GAPt = RATIOt – TRENDt

TREND is a simple way of approximating something that can be seen as a sustainable average of ratio of credit-to-GDP based on the historical experience of the given economy. It is established using the Hodrick-Prescott filter which tends to give higher weights to more recent observations.

Credit-to-GDP Guide to determine Countercyclical Buffer (cont’d)

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3. Transforming the credit-to-GDP gap into the guide buffer add-on

The size of the buffer add-on (VBt) (in percent of risk-weighted assets) is zero when GAP t is below a certain threshold (L). It then increases with the GAP t until the buffer reaches its maximum level (VBmax) when the GAP exceeds an upper threshold H.

Basel Committee on Banking Supervision’s analysis has found that an adjustment factor based on L=2 and H=10 provides a reasonable and robust specification based on historical banking crises.

For example, when the credit-to-GDP ratio is 2 percentage points or less above its long term trend, the buffer add-on (VBt) will be 0%. Similarly, when the credit-to-GDP ratio exceeds its long term trend by 10 percentage points or more, the buffer add-on will be 2.5% of risk weighted assets.

Credit-to-GDP Guide to determine Countercyclical Buffer (cont’d)

E. Leverage Ratio

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Prior to the financial crisis of 2007, many financial institutions and banks had built up excessive on- and off-balance sheet leverage which were not accurately accounted for in the risk-based capital ratios.

LR is a secondary measure that is to be used alongside Basel II risk-based capital ratios.

LR would ‘…constrain the build-up of leverage in the banking sector, helping to avoid destabilizing deleveraging processes which can damage the broader financial system and the economy ’

Leverage Ratio

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 01 Jan 2018

Transition period • 01 Jan 2011: Start supervisory monitoring period (development of templates)• 01 Jan 2013-2017: Parallel run (leverage ratio & its components will be tracked, including its behavior relative to the risk based requirement)• 01 Jan 2015: Disclosure of the leverage ratio by banks• First half of 2017: Final adjustments• 01 Jan 2018: Migration to Pillar 1 treatment

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LR is not intended to be a binding instrument at this stage but as an “additional feature that can be applied on individual banks at the discretion of supervisory authorities with a view to migrating to a binding (Pillar 1) measure in 2018, based on appropriate review and calibration.”

Leverage Ratio

Leverage Ratio =Total Exposure

Tier 1 Capital≥ 3%

Sum of the exposure values of all assets and off-balance sheet items not deducted from the calculation of Tier 1 capital. Exposure measure generally follows accounting measure. For off-balance sheet items, a specific credit risk adjustment of 10% generally applies for undrawn credit facilities (this may be cancelled unconditionally at any time without notice), and 100% for all other off-balance sheet items.

Within the disclosure requirements, the following information should be reported:

Leverage Ratio

A breakdown of the total exposure method

A description of the processes used to manage the risk of excessive leverage

A description of the factors that had an impact on the leverage ratio during the period to which the disclosed leverage ratio refers

F. Liquidity Standards

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Liquidity Standards – A Comparison

Liquidity Coverage Ratio Net Stable Funding Ratio

Introduction 01 Jan 2015; observation period starting 01 Jan 2013

01 Jan 2018; under observation until then

Goal To promote short-term resilience of a bank’s liquidity profile such that it survives a “significant stress scenario” lasting for 30 days

To promote long-term resilience of banks by requiring a sustainable maturity structure for assets and liabilities by creating incentives to use more stable funding sources

Horizon 30 days 1 year

Scope of Application

Level of individual institution (with legal personality)

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

Quarterly

Disclosure Disclosure of LCR under Pillar 3 Disclosure of NSFR under Pillar 3

Source: Basel III Handbook – Accenture

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LCR is aimed at ensuring that banks have adequate, high-quality liquid assets to survive a short-term stress scenario and is defined as:

Stock of high-quality liquid assets


LCR has two components:

Value of the stock of high-quality liquid assets in stressed conditions; and

Total net cash outflows over the next 30 calendar days = Outflows - Min [Inflows; 75% of Outflows]


≥ 100%

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High-quality liquid assets


“Level 1” assetsCash; transferrable assets of extremely high liquidity & credit quality (Min. of 60% of liquid assets)

“Level 2” assetsTransferrable assets that are of high liquidity & credit quality (Max. 40% of liquid assets; market value; haircut of min. 15%)

Liquidity outflows• Retail deposits (5-10%)• Other liabilities coming

due during next 30 days (0-100%)

• Collateral other than “level 1 assets” (15-20%)

• Credit & liquidity facilities (5-100%)

Liquidity inflows• Monies due from non-financial

customer (5-10%)• Secured lending & capital market

driven transactions (0-100%)• Undrawn credit & liquidity facilities

(0%)• Specified payables & receivables

expected over the 30 day horizon (100%)

• Liquid assets (0%)• New issuance of obligations (0%)

≥ 100%

Liquidity outflows are calculated by multiplying the assets with the specified “run-off” factors Liquidity inflows are calculated by multiplying

the assets with the specified inflow factor


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What is a liquid asset?

Liquid Asset #

Cash and deposits held with central banks which can be withdrawn in times of stress

Transferrable assets that are of extremely high liquidity and credit quality

Transferrable assets representing claims on or guaranteed by the central govt. of a Member State or a third country if the institution incurs a liquidity risk in that Member State or third country that covers by holding those liquid assets

Transferrable assets that are of high liquidity and credit quality

Level 1 Asset

Level 2 Asset

Level 1 assets can comprise an unlimited share of the pool, are

held at market value and are not subject to a haircut under the

LCR. ≥ 60% of the liquid assets.

Level 2 assets are subject to a cap of 40% of all liquid assets and

subject to 15% haircut.

Fundamental Characteristic Market CharacteristicLow credit and market risk Active and sizable market

Ease and certainty of valuation Presence of committed market matters

Low correlation with risky assets Low market concentration

Listed on developed and recognized exchange market Investors show tendency to move into asset during systemic crisis

# Source: Basel III Handbook – Accenture

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High quality liquid assets

High Quality Liquid Asset Not High Quality Liquid Asset

Not issued by the institution itself or its parent or subsidiary institutions or another subsidiary of its parent financial holding company

Assets issued by a credit institution unless they fulfill one of the following conditions:

a) They are bonds eligible for treatment as covered bonds

b) The credit institution has been set up and is sponsored by a Member State central or regional govt. and the asset is guaranteed by that govt. and used to fund promotional loans granted on a non-competitive, not-for-profit basis in order to promote its public policy objectives

Eligible collateral in normal times for intraday liquidity needs & overnight liquidity facilities of a central bank in a Member State or if, the liquid assets are held to meet liquidity outflows in the currency of a third country, or of the central bank of that third country

The price can be determined by a formula that is easy to calculate based on publicly available inputs and doesn’t depend on strong assumptions as is typically the case for structured or exotic products

Assets issued by any of the following:a) An investment firmb) An insurance undertakingc) A financial holding companyd) A mixed-activity holding companye) Any other entity that performs one or more of

the activities listed in Annex I of the Directive as its main business (eg. financial leasing; acceptance of deposits and other mutual recognition)

Listed on a recognized exchange

Tradable on active outright sale or repurchase agreement with a large and diverse number of market participants, a high trading volume and market depth and breadth


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To be considered as high quality liquid assets items have to fulfill several operational requirements:

They are appropriately diversified

“Level 1 assets” should not be less than 60% of the liquid assets

They are legally and practically readily available at any time during the next 30 days to be liquidated via outright sale or repurchase agreements in order to meet obligations coming due

The liquid assets are controlled by a liquidity management function

A portion of the liquid assets is periodically and at least annually liquidated via outright sale or repurchase agreements for the following purposes:

o To test the access to the market for these assets

o To test the effectiveness of its processes for the liquidation of assets

o To test the usability of the assets

o To minimize the risk of negative signaling during a period of stress

Price risks associated with the assets may be hedged but the liquid assets are subject to appropriate internal arrangements that ensure that they will not be used in other ongoing operations, including hedging or other trading strategies; providing credit enhancements in structured transactions; to cover the operational costs

The denomination of the liquid assets is consistent with the distribution by currency of liquidity outflows after the deduction of capped inflows

High quality liquid assets – operational requirements

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The stress scenarios envisaged for LCR incorporates many of the shocks experienced during the 2008 financial crisis at a systemic level as well as the idiosyncratic level (institution specific level):

The run off of a proportion of retail deposits

A partial loss of unsecured wholesale funding capacity

A partial loss of secured, short-term financing with certain collateral and counterparties

Contractual outflows that would arise from a downgrade in the bank’s public credit rating by up to and including 3 notches, including collateral posting requirements

Increase in market volatilities that impact the quality of collateral or potential future exposure of derivative positions

Unscheduled draws on committed but unused credit and liquidity facilities

The potential need to buy back debt or honor non-contractual obligations in the interest of mitigating reputational risk

Liquidity Coverage Ratio – Stress Conditions Scenarios

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The objective of NSFR is to promote more medium and long-term funding of the assets and activities of banking organizations.

Institutions are required to maintain a sound funding structure over one year in an extended firm-specific stress scenario.

Assets currently funded and any contingent obligations to fund must be matched to a certain extent by sources of stable funding.

NSFR is designed to act as a minimum enforcement mechanism to complement the LCR and reinforce other supervisory efforts by promoting structural changes in the liquidity risk profiles of institutions away from short-term funding mismatches and toward more stable, longer-term funding of assets and business activities.

It aims to limit over-reliance on short-term wholesale funding during times of buoyant market liquidity and encourage better assessment of liquidity risk across all on- and off-balance sheet items.




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ASF Factor Items

100% • Tier 1 & 2 capital• Preferred stock not included in Tier 2 capital with maturity ≥ 1 year• Secured & unsecured borrowings & liabilities with effective remaining maturities ≥ 1 year

90% • “Stable” non-maturity (demand) deposits and/or term deposits with residual maturity < 1 year

80% • “Less stable” non-maturity (demand) deposits and/or term deposits with residual maturity < 1 year

50% * Unsecured wholesale funding, non-maturity deposits and/or term deposits with a residual maturity < 1 year, provided by non-financial corporates, sovereigns, central banks, MDBs and PSEs

0% • All other liabilities and equity categories not included in the above categories


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Required stable funding

RSF Factor Items

0% • Cash• Unencumbered short-term unsecured instruments & transactions with outstanding maturities < 1 yr• 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

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

20% • Unencumbered corporate bonds or covered bonds rated AA- or higher with residual maturities 1 yr 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




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Required stable funding (cont’d)

RSF Factor Items

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

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 ≥ 1 yr, that would qualify for the 35% or lower risk-weight under Basel II Standardized Approach for credit risk

85% • Unencumbered loans to retail customers and SME (as defined in the LCR) having a remaining maturity < 1 year

100% • All other assets not included in the above categories




Thank You

Documents

Basel iii capital adequacy accord