Basel 3 May 2012


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Basel 3 May 2012

  1. 1. Basel iii Compliance ProfessionalsAssociation (BiiiCPA)1200G Street NW Suite800Washington, DC 20005-6705USA Tel:202-449-9750Web: www.basel-iii-association.comDear Member,Crying is not a sign of weakness. You may let out your tears!Assuming full implementationof the Basel III requirementsasof 30June2011, includingchangestothe definitionof capital andrisk-weightedassets, and ignoringphase-in arrangements,Group 1bankswouldhavean overall shortfall of €38.8 billion for the CET1minimum capital requirement of 4.5%, whichrisesto€485.6billion for aCET1target level of 7.0% (ie including thecapital conservation buffer);the latter shortfall already includesthe G-SIB surchargewhereapplicable.As a point of reference, the sum of profitsafter tax prior to distributionsacross the same sample of Group 1banksin the second half of 2010 andthefirst half of 2011was€356.6billion.Under the same assumptions, thecapital shortfall for Group 2 banksincludedin the Basel III monitoring sample is estimated at €8.6 billionfor the CET1minimum of 4.5% and €32.4 billion for a CET1 target levelof 7.0%.Thesum of Group 2bank profitsafter tax prior todistributionsin thesecond half of 2010and the first half of 2011was€35.6 billion.Quantitative impact study results published by the BaselCommittee, 12April 2012TheBasel Committeepublished theresultsofitsBasel III monitoring exercise.Thestudyis based on rigorousreportingprocessesset up by the Committee toperiodicallyreview theimplicationsof theBasel III standardsfor financial markets.Atotal of 212banksparticipated in the study,including103Group1banks(ie thosethat haveTier 1capital in excessof €3 billion and areinternationallyactive) and 109Group 2banks(ie all other banks).
  2. 2. While the Basel III frameworksetsout transitional arrangementstoimplement thenew standards, themonitoring exerciseresultsassumefull implementationof thefinal Basel III packagebasedondata asof 30June2011(ie theydonot take account of thetransitional arrangementssuch asthephasein of deductions).No assumptionsweremade about bank profitabilityor behaviouralresponses,suchaschangesin bank capital or balance sheetcomposition.For that reason the resultsof thestudyare not comparable to industryestimates.Basedon data asof 30June 2011and applying the changestothedefinitionof capital and risk-weightedassets,the averagecommonequityTier 1capital ratio(CET1) of Group 1bankswas7.1%, ascomparedwith theBasel III minimum requirement of 4.5%.In orderforall Group1bankstoreachthe4.5%minimum, anincreaseof€38.8 bi llion CET1 wou ld be requ ired .Th e ove rall sh ortfall inc reases t o €485.6 billion toachieveaCET1 target level of 7.0% (ie including thecapital conservationbuffer);this amount includesthe surchargefor global systemically importantbankswhereapplicable.As a point of reference, thesum of profitsafter tax and prior todistributionsacrossthesamesampleof Group 1banks in thesecondhalf of 2010and the first half of 2011was €35 6.6 billion .For Group 2banks, the averageCET1ratio stood at 8.3%.In order for all Group 2banksin thesampletomeet thenew 4.5% CET1ratio, the additional capital needed is estimatedtobe €8.6 billion.Theywouldhave required an additional €32.4 billion toreach a CET1target 7.0%; the sum of these banks profitsafter tax and prior todistributionsin thesecondhalf of2010andthefirsthalf of2011was€35.6billion.TheCommitteealsoassessedthe estimatedimpact of the liquiditystandards.Assuming banksweretomake nochangestotheir liquidityrisk profileor fundingstructure, asof June2011, theweightedaverage LiquidityCoverageRatio(LCR) forGroup 1bankswouldhavebeen90% whiletheweightedaverage LCR for Group 2bankswas83%.Theaggregate LCR shortfall is €1.76trillion whichrepresents
  3. 3. sampleof institutionsin each jurisdiction.approximately3% of the €58.5 trilliontotal assetsof the aggregatesample.TheweightedaverageNet StableFundingRatio(NSFR) is94%forbothGroup 1and Group 2 banks.Th e aggregate sh ortfall of req u ired st ab le fu nd in g is €2 .78trillion.Banks haveuntil 2015tomeet the LCR standard and until 2018to meettheNSFR standard, whichwill reflect anyrevisionsfollowingeachstandards observation period.As noted in a January 2012pressstatement issuedby theGroup ofGovernorsand Headsof Supervision, the Basel Committees oversightbody, modificationstoa few keyaspectsof the LCR arecurrentlyunderinvestigationbut will not materiallychange the frameworksunderlyingapproach.TheCommitteewill finaliseand subsequentlypublish itsrecommendationsin theseareasby the end of 2012.Banks that are below the 100% required minimum thresholds can meetthese standards by, for example, lengthening the term of their fundingor restructuring business models which are most vulnerable to liquidityrisk in periodsof stress.It should be noted that the shortfallsin the LCR and the NSFR are notadditive, as reducing the shortfall in one standard may also reduce theshortfall in theother standard.Resultsof the Basel III monitoring exercise asof 30 June 2011April 2012Executive summaryIn 2010,the Basel Committeeon BankingSupervision conducted acomprehensivequantitativeimpact study(C-QIS) using data asof 31December2009toascertainthe impact on banks of the Basel IIIframework,published in December 2010.TheCommitteeintendsto continuemonitoring the impact of theBaselIII frameworkin order togather full evidenceon itsdynamics.Toservethispurpose, a semi-annual monitoring frameworkhasbeen setup on therisk-basedcapital ratio, theleverageratio and theliquiditymetricsusingdata collectedby national supervisorson a representative
  4. 4. Basel III requirementsbased on data asof 30 June 2011.This report summarisesthe aggregate resultsof the latest Basel IIImonitoringexercise,using data asof 30June 2011.TheCommitteebelievesthat theinformation contained in the reportwill providethe relevant stakeholderswitha useful benchmark foranalysis.Information for thisreport wassubmitted by individual banksto theirnational supervisorson a voluntary and confidential basis.Atotal of 212 banksparticipated in thestudy, including103Group 1banksand 109Group 2 banks.Members‘coverageof their banking sector is very high for Group 1banks,reaching 100% coveragefor some jurisdictions,whilecoverageiscomparatively lowerfor Group 2banksand varied acrossjurisdictions.TheCommitteeappreciatesthesignificant effortscontributed by bothbanksand national supervisorsto this ongoingdata collection exercise.Thereport focuseson thefollowingitems:- Changesto bank capital ratiosunder thenew requirements,andestimatesof any capital deficienciesrelativetofullyphased-inminimum and target capital requirements(toincludecapitalchargesfor global systemically important banks– G-SIBs);- Changesto thedefinitionof capital that result from the new capitalstandard, referred toascommon equityTier 1(CET1), includingareallocationof deductionstoCET1, and changestothe eligibilitycriteria forAdditional Tier 1and Tier 2 capital;- Increasesin risk-weightedassetsresultingfrom changesto thedefinitionof capital, securitisation, tradingbook and counterpartycredit risk requirements;- Theinternational leverageratio; and- Twointernational liquiditystandards– the liquiditycoverageratio(LCR) and thenet stablefunding ratio(NSFR).With the exception of the transitional arrangementsfor non-correlationtradingsecuritisationpositionsin the tradingbook, this report doesnottake intoaccount any transitionalarrangementssuchasphase-in ofdeductionsand grandfatheringarrangements.Rather, the estimatespresented assume full implementationof the final
  5. 5. No assumptionshave been made about banks‘profitabilityorbehaviouralresponses,such aschangesin bank capital or balancesheetcomposition, sincethis date or in the future.For thisreason theresultsare not comparable tocurrent industryestimates,whichtend to be based on forecastsand considermanagement actionsto mitigatethe impact, and incorporateestimateswhereinformation is not publicly available.Theresultspresented in thisreport arealsonot comparabletothepriorC-QIS,whichevaluatedthe impact of policy questionsthat differ incertainkeyrespectsfrom the finalisedBasel III framework.As one example, theC-QIS did not consider the impact of capitalsurchargesfor global systemicallyimportant banks.Capital shortfallsAssuming full implementationof the Basel III requirementsasof 30June2011, includingchangestothe definitionof capital andrisk-weightedassets, and ignoringphase-in arrangements,Group 1bankswouldhavean overall shortfall of €38.8 billion for the CET1minimum capital requirement of 4.5%, which rises to €485.6 billion for aCET1 target level of 7.0% (ie including the capital conservation buffer);thelatter shortfall already includesthe G-SIB surchargewhereapplicable.As a point of reference, the sum of profitsafter tax prior to distributionsacross the same sample of Group 1banksin the second half of 2010 andthefirst half of 2011was€356.6billion.Under the same assumptions, thecapital shortfall for Group 2 banksincludedin the Basel III monitoring sample is estimated at €8.6 billionfor the CET1minimum of 4.5% and €32.4 billion for a CET1 target levelof 7.0%.Thesum of Group 2bank profitsafter tax prior todistributionsin thesecond half of 2010and the first half of 2011was€35.6 billion.Further detailson additional capital needsto meet theBasel IIIrequirementsare included in Section 2.Capital ratiosTheaverageCET1 ratiounder the Basel III frameworkwould declinefrom 10.2% to7.1%for Group 1banks and from 10.1%to8.3% for Group2banks.
  6. 6. LCR and 1January 2018for the NSFR.TheTier 1capital ratiosof Group 1bankswoulddecline, on averagefrom 11.5% to 7.4% and total capital ratioswoulddecline from 14.2% to8.6%.As withtheCET1ratios, thedeclinein other capital ratiosiscomparatively lesspronouncedfor Group 2banks; Tier 1capital ratioswoulddecline on averagefrom 10.9% to8.6% and total capital ratioswoulddecline on averagefrom 14.3% to10.6%.Changesin risk-weighted assetsAs compared tocurrent risk-weightedassets,total risk-weightedassetsincreaseon averageby 19.4% for Group 1banksunder the BaselIIIframework.This increaseis driven largely by chargesagainst counterpartycreditrisk and tradingbook exposures.Securitisation exposures, principally those risk-weighted at 1250% underthe Basel III framework (which were previously 50/ 50 deductions underBaselII), are alsoa significant contributor totheincrease.Banks that have significant exposures in theseareasinfluencetheaverageincreasein risk-weightedassetsheavily.As Group 2 banks are lessaffected bythe revised counterpartycredit riskand trading book rules, these banks experience a comparatively smallerincreasein risk-weightedassetsof only 6.3%.Even within thissample, higher risk-weightedassetsare attributedlargelytoGroup 2bankswithcounterparty and securitisationexposures(ie thosesubject toa 1250%riskweighting).Leverage ratioTheweightedaveragecurrent Tier 1leverageratiofor all banks is 4.5%.For Group 1banks,it is somewhat lowerat 4.4% while it is 5.0% forGroup 2banks.TheaverageBasel III Tier 1leverageratiofor all banks is 3.5%. TheBaselIII averagefor Group 1banksis3.4%, and theaverageforGroup 2banksis 4.2%.Liquidity standardsBoth liquiditystandards are currentlysubject toan observation periodwhichincludesareview clausetoaddressanyunintendedconsequencesprior totheir respectiveimplementation datesof 1January 2015for the
  7. 7. calculationof risk-weightedassets(RWA), the calculationof a leverageBasel III monitoring resultsfor the end-June2011reportingperiod givean indicationof theimpact of the calibration of thestandardsandhighlight several keyobservations:Atotal of103Group1and102Group2banksparticipatedin theliquiditymonitoringexercisefor the end-June 2011reference period.TheweightedaverageLCR forGroup 1banksis90% whiletheweightedaverageLCR for Group 2banksis 83%.Theaggregate LCR shortfall is €1.76trillion whichrepresentsapproximately3% of the €58.5 trilliontotal assetsof the aggregatesample.TheweightedaverageNSFR is 94% for both Group 1and Group 2banks.Theaggregate shortfall of required stablefunding is€2.78trillion.General remarksAt its12September 2010meeting, theGroup of Governors and HeadsofSupervision(GHOS), theCommittee‘soversight body, announcedasubstantial strengtheningof existingcapital requirementsand fullyendorsedthe agreementsit reached on 26July2010.Thesecapital reformstogether withtheintroduction of twointernational liquiditystandards, delivered on thecore of theglobalfinancial reform agendapresentedtotheSeoul G20 Leaderssummit inNovember 2010.Subsequent to the initial comprehensivequantitativeimpact studypublishedin December 2010,the Committeecontinuestomonitor andevaluatetheimpact of thesecapital and liquidityrequirements(collectivelyreferredto as―Basel III‖) on a semi-annual basis.This report summarisesresultsof the latestBaselIII monitoringexerciseusing 30June 2011data.Scope of the impact studyAll but one of the 27 Committeemember jurisdictionsparticipatedinBasel III monitoring exerciseasof 30June 2011.Theestimatespresented are based ondata submitted by theparticipatingbankstonational supervisorsin reportingquestionnairesin accordancewiththe instructionspreparedby the CommitteeinSeptember 2011.Thequestionnaire covered componentsof eligiblecapital, the
  8. 8. ratio, and componentsof theliquiditymetrics. The resultswereinitiallysubmittedtothe Secretariat of the Committeein October 2011.Thepurposeof the exerciseis toprovidethe Committeewithanongoing assessment of the impact on participatingbanksof the capitaland liquidityproposalsset out in thefollowingdocuments:- Revisionsto the Basel II market risk frameworkand Guidelinesforcomputing capital for incremental risk in the tradingbook;- EnhancementstotheBasel II framework whichincludetherevisedrisk weightsfor re-securitisationsheld in the banking book;- Basel III: Aglobal framework for more resilient banksand thebankingsystem aswell asthe Committee‘s13January2011pressreleaseon lossabsorbencyat the point of non-viability;- International frameworkfor liquidityrisk measurement, standardsandmonitoring; and- Global systemicallyimportant banks:Assessment methodology andtheadditional lossabsorbency requirement.Sample of participating banksAtotal of 212 banksparticipated in thestudy, including103Group 1banksand 109Group 2 banks. Group 1banksarethosethat haveTier 1capital in excessof €3 billion and are internationallyactive.All other banksare considered Group 2banks.Banks wereasked toprovidedata asof 30June 2011at theconsolidatedlevel.Subsidiariesof other banksare not includedin the analysestoavoiddoublecounting.Table1showsthe distributionof participationby jurisdiction.For Group 1banksmembers‘coverageof their banking sector wasveryhigh reaching100% coveragefor some jurisdictions.Coverage for Group 2 bankswascomparatively lowerand varied acrossjurisdictions.
  9. 9. Not all banks provideddata relatingto all parts of the BaselIIIframework.Accordingly, a small number of banksare excluded from individualsectionsof the BaselIII monitoring analysisdue toincompletedata.MethodologyTheimpact assessment wascarried out by comparing banks‘ capitalpositionsunder Basel III tothe current regulatory frameworkimplemented by thenational supervisor.With the exception of transitional arrangementsfor non-correlationtradingsecuritisationpositionsin thetradingbook, Basel III resultsarecalculatedwithout consideringtransitional arrangementspertainingto
  10. 10. positionscould be attributedtodifferinginterpretationsof the rules,thephase-in of deductionsand grandfatheringarrangements.Reported averageamountsin this document havebeen calculatedbycreatinga composite bank at a total sample level, whicheffectivelymeansthat thetotal sample averagesare weighted.For example, the averagecommon equityTier 1capital ratio is thesumof all banks‘common equityTier 1capital for the total sample dividedbythe sum of all banks‘risk-weightedassetsfor the total sample.Tomaintainconfidentiality, many of theresultsshownin thisreport arepresentedusing box plots charts.Thesechartsshowthedistributionof resultsasdescribedbythemedianvalues(thethin red horizontal line) and the75th and 25th percentilevalues(definedby the blue box).Theupper and lower end pointsof the thin bluevertical linesshow thevalueswhich are1.5timesthe rangebetweenthe 25th and the75thpercentile abovethe75th percentile or belowthe25thpercentile, respectively.Thiswouldcorrespondtoapproximately99.3%coverageif thedatawerenormallydistributed.Thered crossesindicateoutliers.Toestimatethe impact of implementingthe Basel III frameworkoncapital, comparisonsaremadebetweenthoseelementsof Tier 1capitalwhicharenot subject to a limit under thenational implementationofBasel I or Basel II, and CET1 under Basel III.Data qualityFor thismonitoring exercise, participatingbanks submittedcomprehensiveand detailed non-publicdata on a voluntary andbest-effortsbasis.As withthe C-QIS, national supervisorsworked extensivelywith bankstoensuredataquality, completenessandconsistencywiththepublishedreporting instructions.Banks are included in the variousanalysesthat followonlyto the extenttheywereable to providesufficient qualitydata tocompletetheanalyses.For theliquidityelements,data qualityhasimproved significantlythroughout the iterationsof the BaselIII monitoring exercise, althoughit is still thecasethat some differencesin banks‘reported liquidityrisk
  11. 11. common equitydeductionsare fullyphasedin and all non-qualifyingrather than underlying differencesin risk.Most notablyindividual banks appear tobe usingdifferentmethodologiestoidentifyoperationalwholesaledepositsandexclusionsof liquid assetsdue tofailure to meet theoperational requirements.Interpretation of resultsThefollowingcaveatsapplytotheinterpretationof resultsshownin thisreport:Theseresultsare not comparable to thoseshown in the C-QIS, whichevaluated theimpact of policy questionsthat differ in certain keyrespectsfrom the finalisedBaselIII framework.As one example, theC-QIS did not consider the impact of capitalsurchargesfor G-SIBsbasedon the initial list of G-SIBs announced bytheFinancial StabilityBoard in November 2011.Onemember country, Switzerland, hasalready implementedcertainelementsof the Basel III frameworkpertainingto new rulesfor marketrisk and enhancementstothe treatment of securitisationsheld in thebankingbook (often referred to collectivelyas―Basel 2.5‖).For banks in this country, the resultsincluded in this report reflect theimpact of adopting the BaselIII requirementsrelativeto theBasel IIand Basel2.5frameworksalreadyin place.Thenew rules for counterparty credit risk are not fullyaccounted for inthereport, asdata for capital chargesfor exposurestocentralcounterparties(CCPs) andstressedeffectiveexpectedpositiveexposure(EEPE) could not be collected.Theactual impact of thenew requirementswill likely be lower thanshownin this report giventhe phased-inimplementation of therulesand interim adjustmentsmade by thebanking sectorto changingeconomicconditionsand the regulatory environment.For example, theresultsdo not consider bank profitability, changesincapital or portfoliocomposition, or other management responsesto thepolicy changessince30June 2011or in the future.For thisreason, theresultsare not comparable toindustryestimates,which tend to bebasedon forecastsand considermanagement actionstomitigatethe impact, aswell asincorporateestimateswhereinformation is not publicly available.TheBaselIII capital amountsshownin thisreport assume that all
  12. 12. capital instrumentsare fully phasedout.As such, theseamountsunderestimatetheamount of Tier 1capital andTier 2 capital held bya bank astheydonot give any recognitionfor non-qualifying instrumentsthat are actuallyphased out over nineyears.Thetreatment of deductionsand non-qualifying capital instrumentsalsoaffects figuresreportedin the leverageratiosection.Theunderestimationof Tier 1capital will becomelessof an issueastheimplementationdateof theleveragerationears.In particular, in 2013, the capital amountsbased on the capitalrequirementsin placeon the Basel III monitoring reportingdate willreflect the amount of non-qualifying capital instrumentsincludedincapital at that time.Theseamountswill thereforebe more representativeof the capital heldbybanks at the implementation dateof the leverageratio.Capital shortfallsand overall changesin regulatory capitalratiosTable2 showsthe aggregate capital ratiosunder the current and BaselIII frameworksand the capital shortfallsif Basel III werefullyimplemented, both for thedefinitionof capital and the calculationofrisk-weightedassetsasof 30 June 2011.
  13. 13. Ascomparedtocurrent CET1,theaverageCET1capitalratio ofGroup1bankswouldhavefallenby nearlyone-third from 10.2% to 7.1% (adeclineof 3.1percentage points) whenBasel III deductionsandrisk-weightedassetsaretaken intoaccount.Thereduction in theCET1 capital ratio of Group 2banksis smaller(from 10.1%to 8.3%), whichindicatesthat the new frameworkhasgreater impact on larger banks.Resultsshow significant variation acrossbanksasshown in Chart 1.Thereduction in CET1ratios is driven by thenew definition of eligiblecapital, by deductionsthat werenot previouslyapplied at the commonequitylevel of Tier 1capital in most jurisdictions(numerator) and byincreasesin risk-weightedassets(denominator).Banks engagedheavily in trading or counterparty credit activitiestendtoshowthe largest denominator effectsastheseactivitiesattractsubstantivelyhigher capital chargesunder the new framework.Tier 1capital ratiosof Group 1banks wouldon averagedecline4.1percentagepointsfrom 11.5% to 7.4%, and total capital ratiosof thissamegroup woulddeclineon averageby 5.6percentagepointsfrom14.2% to 8.6%.As withCET1, Group 2 banks show a more moderatedecline in Tier 1capital ratiosfrom 10.9% to8.6%, and a declinein total capital ratiosfrom 14.3% to10.6%.
  14. 14. TheBasel III frameworkincludesthefollowingphase-in provisionsforcapital ratios:For CET1,thehighest form of lossabsorbing capital, theminimumrequirement will be raisedto4.5% and will be phased-in by 1January2015;For Tier 1capital, the minimum requirement will be raised to6.0% andwill be phased-in by1January2015;For total capital, theminimum requirement remainsat 8.0%;Regulatoryadjustments(ie possiblystrictersetsof deductionsthatapplyunder Basel III) will be fullyphased-inby 1January 2018;An additional 2.5% capital conservation buffer abovethe regulatoryminimum capital ratios, whichmust be met with CET1, will bephased-in by 1January 2019;andTheadditional lossabsorbencyrequirement for G-SIBs, which rangesfrom 1.0% to 2.5%, will be phased in by 1January2019.It will be applied asthe extension of thecapital conservation buffer andmust be met with CET1.TheAnnex includesa detailed overview of all relevant phase-inarrangements.Chart 2 and Table2 provideestimatesof the amount of capital thatGroup 1and Group 2 bankswouldneed between 30June 2011and 1January 2019in addition to the capital theyalreadyheld at thereportingdate, in order tomeet the target CET1, Tier 1,and total capital ratiosunder Basel III assuming fullyphased-in target requirementsanddeductionsasof 30June 2011.Under theseassumptions,the CET1capital shortfall for Group 1bankswith respect to the 4.5% CET1 minimum requirement is€38.8billion.TheCET1shortfall withrespect to the 4.5% requirement for Group 2banks,wherecoverageofthesectorisconsiderablysmaller,isestimatedat €8.6 billion.For a CET1 target of 7.0% (ie the 4.5% CET1 minimum plusthe 2.5%capital conservation buffer, plusany capital surcharge for G-SIBsasapplicable),Group 1banks‘shortfall is€485.6billionandGroup2banks‘shortfall is €32.4 billion.Thesurchargesfor G-SIBs are a bindingconstraint on 24 of the28G-SIBs included in this Basel III monitoring exercise.As a point of reference, the aggregatesum of after-taxprofitsprior todistributionsfor Group 1and Group 2banks in the same samplewas
  15. 15. €356.6billion and €35.6 billion, respectively in thesecond half of 2010andthe first half of 2011.Assuming the4.5% CET1minimum capitalrequirementswerefullymet(ie, there wereno CET1 shortfall), Group 1bankswouldneed anadditional €66.6 billion to meet the minimum Tier 1capital ratiorequirement of 6.0%.Assuming banks alreadyhold 7.0% CET1capital, Group 1banks wouldneed and an additional €221.4billionto meet the Tier 1capital targetratio of 8.5% (ie the6.0% Tier 1minimum plusthe 2.5% CET1capitalconservation buffer), respectively.Group 2banks wouldneed an additional €7.3billion and an additional€16.6billion tomeet theserespectiveTier 1capital minimum and targetratio requirements.AssumingCET1andTier1capitalrequirementswerefullymet(ie,therewerenoshortfallsin eitherCET1orTier 1capital), Group 1bankswouldneedan additional€119.3billion tomeet theminimum total capital ratiorequirement of 8.0% and an additional €223.2billionto meet the totalcapital target ratio of 10.5% (ie the8.0% Tier 1minimum plusthe 2.5%CET1capital conservationbuffer), respectively.Group 2banks wouldneed an additional €5.5billion and an additional€11.6billion to meet theserespectivetotal capital minimum and targetratio requirements.As indicatedabove, no assumptionshavebeen madeabout bank profitsor behavioural responses, such aschangesbalancesheetcomposition, that will serve to ameliorate the impact of capital shortfallsover time.
  16. 16. reduction in Group 2 bank grossCET1.Impact of the definition of capital on Common Equity Tier 1capitalAs noted above, reductionsin capital ratios under theBasel IIIframeworkare attributed in part tocapital deductionsnot previouslyappliedat the common equitylevel of Tier 1capital in mostjurisdictions.Table3 showsthe impact of variousdeduction categorieson the grossCET1capital (ie, CET1beforedeductions) of Group 1and Group 2banks.In the aggregate, deductionsreducethegrossCET1of Group 1banksunder the Basel III frameworkby 32.0%.Thelargest driver of Group 1bank deductionsisgoodwill, followedbycombineddeferred tax assets(DTAs) deductions, and intangiblesotherthan mortgage servicingrights.ThesedeductionsreduceGroup 1bank grossCET1by15.4%, 4.9%, and3.6%, respectively.Thecategorydescribedasother deductionsreducesGroup 1bank grossCET1by 3.0% and pertain mainlyto deductionsfor provision shortfallsrelativetoexpectedcredit lossesand deductionsrelatedtodefinedbenefit pension fund schemes.Holdingsof capital of other financial companiesreducethe CET1ofGroup 1banksby 2.9%.Thecategory―Excessabove15%‖ referstothedeductionof theamountbywhichtheaggregate of the three itemssubjecttothe 10% limit forinclusionin CET1 capital exceeds15%of a bank‘sCET1, calculatedafter all deductionsfrom CET1.These15% threshold bucket deductionsreduce Group 1bank grossCET1by 2.1%. Deductionsfor MSRsexceedingthe 10% limit have aminor impact on Group 1CET1.DeductionsreducetheCET1 ofGroup 2banksby26.9%. Goodwillisthelargest driver of deductionsfor Group 2 banks, followedby holdingsofthecapital of other financial companies, and combined DTAsdeductions.ThesedeductionsreduceGroup 2bank CET1by10.5%, 4.4%, and4.3%, respectively.Other deductions,whichare driven significantlyby deductionsforprovision shortfallsrelative to expectedcredit losses, result in a 3.5%
  17. 17. Deductions for intangibles other than mortgage servicing rights anddeductions for itemsin excess of the aggregate 15% threshold basketreduceGroup 2 bank grossCET1by 2.5% and 1.8%, respectively.Deductionsfor mortgage servicingrightsabovethe 10% limit have noimpact on Group 2 banks.Changesin risk-weighted assetsOverall resultsReductionsin capital ratiosunder the BaselIII frameworkare alsoattributedto increasesin risk-weightedassets.Table4providesadditionaldetail on thecontributorstotheseincreases,toincludethefollowingcategories:Definition of capital:Thesecolumns measurethe change in risk-weighted assetsasa result of proposedchangesto the definition of capital.Thecolumn heading ―other‖includesthe effectsof lowerrisk-weightedassetsfor exposuresthat arecurrentlyincludedin risk-weightedassetsbut receivea deduction treatment under Basel III.Thecolumn heading―50/50‖ measuresthe increasein risk-weightedassetsapplied to securitisation exposurescurrentlydeducted under theBasel II framework that are risk-weightedat 1250% under Basel III.Thecolumn heading―threshold‖ measuresthe increaseinrisk-weightedassetsforexposuresthat fall belowthe10%and15%limitsfor CET1 deduction;
  18. 18. Counterparty credit risk (CCR):This column measurestheincreasedcapital chargefor counterpartycredit risk and thehigher capital charge that resultsfrom applying ahigher asset valuecorrelationparameter againstexposurestofinancialinstitutionsunder the IRB approachestocredit risk.Not included in CCR are risk-weightedasset effectsof capital chargesfor exposuresto central counterparties (CCPs) or anyimpact ofincorporatingstressedparameters for effectiveexpectedpositiveexposure (EEPE);Securitisation in the banking book:This column measurestheincreasein the capital chargesfor certaintypesof securitisations(eg, resecuritisations)in the banking book;andTrading book:This column measurestheincreasedcapital chargesfor exposuresheldin thetrading book toincludecapital requirementsagainst stressedvalue-at-risk,incrementaldefault risk, and securitisationexposuresinthetradingbook.Risk-weightedassetsfor Group 1banks increaseoverall by 19.4% forGroup 1banks.This increaseis toa largeextent attributedto higher risk-weightedassetsfor counterparty credit risk exposures,whichresult in an overallincreasein total Group 1bank risk-weightedassetsof 6.6%.Thepredominant driver behind this figure is capital chargesforcounterpartycredit risk asthehigher asset value correlation parameterresultsin an increasein overall risk-weightedassetsof only 1.0%.Tradingbook exposuresand securitisationexposurescurrentlysubjecttodeduction under Basel II, alsocontribute significantlytohigherrisk-weightedassetsat Group 1banksat 5.2% for each category.
  19. 19. Securitisationexposurescurrentlysubject to deduction, counterpartycredit risk exposures, and exposuresthat fall below the10% and 15%CET1eligibility limitsare significant contributorstochangesinrisk-weightedassetsfor Group 2 banks.Changesin risk-weightedassetsshowsignificant variationacrossbanksasshownin Chart 3.Again, these differencesare explainedin largepart by theextent ofbanks‘counterpartycredit risk and trading book exposures, whichattract significantlyhigher capital chargesunder Basel III ascomparedtocurrent rules.Impact of the revisions to the Basel II market risk frameworkTable5 showsfurther detail on theimpact of the revised tradingbookcapital chargeson overall risk-weightedassetsfor Group 1banks.Thesample analysed here issmallerthan theone in Table4asnot alltheGroup 1banksprovided data on market risk exposures.For thisreduced sample of banks, tradingbook exposures resultedin a6.1% increasein total risk-weightedassets.Themain contributorsto this increaseare stressed value-at-risk(stressedVaR), non-correlationtrading securitisationexposuressubjectthestandardisedmeasurement method (column heading―SMM
  20. 20. non-CTP‖), and theincremental risk capital charge(IRC), whichcontribute2.2%, 1.7%, and 1.4%.Lesssignificant contributors totheincreasein overall risk-weightedassetsare capital chargesfor correlation tradingexposures.Increasesin risk-weightedassetsare partiallyoffset by effectsrelated topreviouscapital charges24 and changestothe standardisedmeasurement method (SMM).Impact of the ruleson counterparty credit risk (CVA only)Credit valuation adjustment (CVA) risk capital chargeslead to a 7.3%increasein total RWAfor thesubsampleof 77bankswhichprovidedtherelevant data (6.6% on thefull Group 1sample).Alargerfractionofthetotaleffect isattributabletotheapplicationof thestandardisedmethod thantotheadvanced method.Theimpactson Group 2banksare smallerbut still significant, addingup toan overall 2.9% increasein RWAover a subsample of 63banks(2.2% for the full Group 2 sample), totallyattributableto thestandardisedmethod. Further detailed are provided in Table6.
  21. 21. Findingsregarding the leverage ratioTheresultsregarding theleverageratioare provided using twoalternativemeasuresof Tier 1capital in the numerator:BaselIII Tier 1,whichisthefullyphased-inBaselIII definition ofTier 1capital, and Current Tier 1, whichisTier 1capital eligibleunder theBasel II agreement (thephase-inperiod of Basel III begins in 2013).Total exposures of Group 1banks accordingtothedefinition of thedenominatorof theleverageratio were€59.2 trillion while totalexposuresfor Group 2 bankswere€5.6 trillion.Oneimportant element in understandingtheresultsof theleverageratiosection istheterminologyused to describea bank‘sleverage.Generally, when a bank is referred to ashaving more leverage, or beingmore leveraged, this refers toa multiple(eg 33times) asopposed toaratio (eg 3%).Therefore,a bank witha high level of leveragewill have a low leverageratio.Chart 4presentsleverageratiosbased on Basel III Tier 1and currentTier 1capital.Thechart providesthis information for all banks, Group 1banks andGroup 2banks.
  22. 22. Theweightedaveragecurrent Tier 1leverageratiofor all banks is 4.5%.For Group 1banks,it is somewhat lowerat 4.4% while it is 5.0% forGroup 2banks.TheaverageBasel III Tier 1leverageratiofor all banks is 3.5%. TheBaselIII averagefor Group 1banksis3.4%, and theaverageforGroup 2banksis 4.2%.Theanalysisshowsthat Group 2banksare generallylessleveragedthanGroup 1banks, and thisdifferenceincreasesunder Basel III when therequirementsare fullyphased in.It is likely that a portion of thiseffectis due tothe changesin thedefinitionof capital, which, asseen in Section 2, are likely toaffectGroup 1banksto a greater extent than Group 2 banks.Under the current Tier 1leverageratio, 17 bankswouldnot meet the 3%Tier 1leverageratiolevel, includingsix Group 1banks and 11Group 2banks.Under the Basel III Tier 1leverageratio, 63 bankswouldnot meet the3% Tier 1leverageratiolevel, including36 Group 1banksand 27Group2banks.LiquidityLiquidity coverage ratioOneof thetwostandardsintroduced bythe Committeeisa 30-dayliquiditycoverageratio (LCR) whichis intendedtopromoteshort-termresiliencetopotential liquiditydisruptions.TheLCR hasbeen designedtorequire global banks tohave sufficienthigh-qualityliquid assetsto withstanda stressed 30-dayfundingscenario specifiedby supervisors.TheLCR numerator consistsof a stock of unencumbered, high qualityliquidassetsthat must be availabletocover any net outflow, whilethedenominatoris comprised of cash outflowslesscashinflows(subject toa cap at 75% of outflows) that are expectedto occur in a severe stressscenario.103Group 1and 102Group 2banks providedsufficient data in the 30June2011Basel III monitoring exercisetocalculatethe LCR accordingtothe BaselIII liquidityframework.TheweightedaverageLCR was90% for Group 1banks and 83% forGroup 2banks. Theseaggregate numbersdo not speak totherangeofresultsacrossthe banks.
  23. 23. Chart 5below givesan indicationof thedistribution of bank results;thethick red lineindicatesthe 100% minimum requirement, the thin redhorizontal linesindicatethemedian for the respectivebank group.45% of thebanksin the BaselIII monitoring samplealreadymeet orexceedthe minimum LCR requirement and 60% have LCRs that are ator above75%.For thebanks in thesample, Basel III monitoringresultsshow ashortfall ofliquidassetsof €1.76trillion(whichrepresentsapproximately3%of the€58.5trilliontotal assetsof theaggregate sample) asof 30June2011, if banksweretomake nochangeswhatsoevertotheir liquidityriskprofile.This number isonlyreflectiveof the aggregate shortfall for banks thatare below the 100% requirement and doesnot reflect surplusliquidassetsat banks above the100% requirement.Banks that are below the 100% required minimum have until 2015tomeet the standard by scalingback businessactivitieswhichare mostvulnerable toa significant short-term liquidityshock or by lengtheningtheterm of their fundingbeyond 30days.Banks may alsoincreasetheir holdingsof liquid assets.Thekey componentsof outflowsand inflowsare shownin Table7.Group 1banksshow a notablylarger percentageof total outflows, whencomparedtobalancesheet liabilities,than Group 2 banks.Thiscanbeexplainedbytherelativelygreatercontribution of wholesalefundingactivitiesand commitmentswithin theGroup 1sample,whereas,for Group 2 banks, retail activities, which attract much lower
  24. 24. stressfactors,comprise a greater share of funding activities.Cap on inflowsThecomposition of high qualityassetscurrentlyheld at banks isdepictedin Chart 6.Themajorityof Group 1and Group 2banks‘holdings, in aggregate, arecomprised of Level 1assets;howeverthe sample, on whole, showsdiversityin their holdingsof eligibleliquid assets.WithinLevel 1assets,0% risk-weightedsecuritiesissuedor guaranteedbysovereigns,central banks and PSEs, and cash and central bankreservescomprisingsignificant portionsof thequalifying pool.Comparatively, within theLevel 2assetclass, themajorityof holdingsiscomprised of 20% risk-weightedsecuritiesissued or guaranteed bysovereigns, central banksor PSEs, and qualifying coveredbonds.
  25. 25. Cap on Level 2 assets€121billion of Level 2 liquid assetswereexcluded becausereportedLevel 2assetswereinexcessofthe40% capascurrentlyoperationalised.34banks currentlyreported assetsexcluded, of which24 (11% of thetotal sample) had LCRs below 100%.Chart 7 combinestheaboveLCR componentsby comparing liquidityresources(buffer assetsand inflows) to outflows.Note that the€800billiondifferencebetweentheamount ofliquidassetsandinflowsand theamount of outflowsandimpact of thecapdisplayedin the chart issmaller than the€1.76trilliongrossshortfall noted aboveasit is assumed here that surplusesat onebank can offset shortfallsatother banks.In practice the aggregate shortfall in theindustry is likelytoliesomewherebetweenthesetwonumbersdependingon how efficientlybanksredistributeliquidityaround thesystem.
  26. 26. Net stable funding ratioThesecond standard is thenet stablefunding ratio(NSFR), alonger-term structural ratio toaddressliquiditymismatchesand provideincentivesfor bankstouse stablesourcesto fund their activities.103Group 1and 102Group 2banks providedsufficient data in the30June2011BaselIII monitoringexercisetocalculatetheNSFR accordingtothe BaselIII liquidityframework.46% of thesebanksalready meet or exceedtheminimum NSFRrequirement, withthree-quartersat an NSFR of 85% or higher.TheweightedaverageNSFR for each of the Group 1bank and Group 2samplesis 94%.Chart 8 shows the distribution of resultsfor Group 1and Group 2 banks;the thick red line indicatesthe 100% minimum requirement, the thin redhorizontal linesindicatethemedian for the respectivebank group.
  27. 27. Theresultsshowthat banks in the samplehad a shortfall of stablefundingof€2.78trillionat theendofJune2011, if banksweretomakenochangeswhatsoevertotheir fundingstructure.This number isonlyreflectiveof the aggregate shortfall for banks thatare below the 100% NSFR requirement and doesnot reflect anysurplusstablefunding at banks above the 100% requirement.Banks that are below the 100% required minimum have until 2018tomeet thestandard and can takea number of measurestodoso,includingby lengtheningtheterm of their fundingor reducingmaturitymismatch.It should be noted that the shortfallsin the LCR and the NSFR are notnecessarilyadditive,asdecreasingtheshortfall in onestandard mayresult in a similar decreasein the shortfall of the otherstandard, dependingon thestepstaken to decreasetheshortfall.
  28. 28. EBA, ESMA and EIOPA publish tworeportson MoneyLaunderingTheJoint Committeeof thethree European SupervisoryAuthorities(EBA, ESMA and EIOPA) haspublishedtworeportson theimplementationofthethirdMoneyLaunderingDirective[2005/ 60/ EC](3MLD).The―Report on the legal, regulatory and supervisoryimplementationacrossEU MemberStatesinrelationtotheBeneficialOwnersCustomerDueDiligencerequirements‖analysesEU MemberStates‘currentlegal, regulatory and supervisoryimplementationof the anti - moneylaundering/ counterterrorist financing(AML/CTF) frameworksrelatedtothe application bydifferent credit and financial institutionsofCustomer Due Diligence(CDD) measureson their customers‘beneficial owners.Thereport sought to identify differencesin the implementation of theDirectiveand to determine whethersuch differencescreatea gap in theEU AML/ CTF regime that could be exploited by criminalsfor moneylaunderingand terrorist financingpurposes.The―Report on the legal and regulatory provisionsand supervisoryexpectationsacrossEU Member Statesof Simplified Due Diligencerequirementswherethe customersare credit and financial institutions‖providesan overview of EU Member States‘legal and regulatoryprovisionsand supervisoryexpectationsin relationto the applicationofSimplifiedDue Diligence(SDD) requirementsof the 3MLD.Thereport focusesexclusivelyon oneparticularsituationof lowriskwhereSDD is applicable,namely wherethe customer isa credit orfinancial institutionsituated in a EU/ EEA state or in a country thatimposesequivalent AML/CFT requirements.Both reportscome totheconclusionthat there are significantdifferencesin the implementationacrosstheEU MemberStates,andthat some of thesedifferencescould createundesirableeffectson thecommon EuropeanAnti MoneyLaundering Regime.Thereportsfind that some of thesedifferencesare not duetotheDirective‘sminimum harmonisation approach, but insteadappear tostem from different national interpretationsof the Directive‘srequirements.
  29. 29. EIOPA - European Insuranceand Occupational PensionsAuthorityBoth reportsalsocall on theEuropean Union to consider addressingtheseproblems.The Joint CommitteeTheJoint Committeeis a forum for cooperationthat wasestablished on1stJanuary2011, withthegoal of strengtheningcooperationbetweentheEuropean BankingAuthority (EBA), European Securitiesand MarketsAuthority(ESMA) andEuropeanInsuranceand Occupational PensionsAuthority (EIOPA), collectivelyknown asthe threeEuropeanSupervisoryAuthorities (ESAs).Throughthe Joint Committee, the three ESAscooperateregularlyandcloselyand ensure consistencyin their practices.In particular, theJoint Committeeworksin theareasof supervisionoffinancial conglomerates,accounting and auditing, microprudentialanalysesof crosssectoraldevelopments, risksand vulnerabilitiesforfinancial stability, retail investment productsand measurescombatingmoneylaundering. In addition tobeing a forum for cooperation, theJoint Committee alsoplays an important role in the exchangeofinformation withthe European Systemic RiskBoard (ESRB) and indevelopingtherelationshipbetweentheESRB and the ESAs.InterestingAbbreviationsAML – Anti MoneyLaunderingAMLTF – Anti-MoneyLaunderingTaskForce of the EBA, ESMA andEIOPAAML Committee– The Joint Committeeof theEuropean SupervisoryAuthorities‘Sub CommitteeonAnti MoneyLaunderingCDD - Customer Due DiligenceCPMLTF – EU CommitteeonthePreventionofMoneyLaunderingandTerrorist FinancingCTF – Counter Terrorist FinancingEBA - European BankingAuthorityEC – European CommissionEEA - European EconomicArea
  30. 30. EDD – Enhanced Due DiligenceESMA - European Securitiesand MarketsAuthorityEU – European UnionFATF – FinancialAction Task ForceID - IdentityML – MoneyLaunderingMS – Member Stateof the European UnionSDD - Simplified Due DiligenceTF – Terrorist FinancingUBO – Ultimate BeneficialOwnerWG – WorkingGroup3rd MLD - Third MoneyLaunderingDirective(2005/60/ EC)
  31. 31. BIS - Peer review of supervisory authorities implementation ofstresstesting principles-April 2012Stresstestingisanimportant toolused bybankstoidentify thepotentialfor unexpectedadverse outcomesacrossa rangeof risks and scenarios.In 2009, the Committeereviewedtheperformanceof stresstestingpracticesduring thefinancialcrisisand publishedrecommendationsforbanksand supervisorsentitled Principlesfor sound stresstestingpracticesand supervision.As part of its mandateto assessthe implementationof standardsacrosscountriesand tofoster thepromotion of good supervisory practice, theCommitteesStandardsImplementationGroup (SIG) conducted apeerreview during 2011of supervisoryauthorities implementationof theprinciples.Thereview foundthat stresstestinghasbecome akey component of thesupervisoryassessment processaswell asa tool for contingencyplanningand communication.Countriesare, however,at varying stagesof maturityin theimplementationof theprinciples;asa result, more workremainstobedone to fullyimplement the principlesin many countries.Overall, the review found the 2009stresstestingprinciplesto begenerallyeffective.TheCommittee, however, will continuetomonitor implementationoftheprinciplesand determinewhether,in thefuture, additionalguidancemight be necessary.Peer review of supervisory authorities‘ implementation ofstresstesting principles, April 2012Executive summary
  32. 32. This report summarisestheBasel Committee‘speer review on howsupervisoryauthoritieshave implemented the Committee‘s2009Principlesfor sound stresstestingpracticesand supervision.Theglobal financial crisis and the 2009stresstesting principlesStresstestingis an important tool for bankstoidentify unexpectedadverseoutcomesacrossa rangeof risks. It plays a particularlyimportant role in:- providingforward-lookingassessmentsof risk;- overcominglimitationsof modelsand historicaldata;- supportinginternaland external communication;- feeding intocapital and liquidityplanningprocedures;- informing the settingof banks‘risk tolerance;and- facilitating thedevelopment of risk mitigation or contingencyplansacrossa range of stressedconditions.In 2009, the Committeereviewedtheperformanceof stresstestingpracticesduring thecrisisand found weaknessesin variousareas.Basedon thefindings,and aspart of itseffortsto incorporatelessonsfrom thecrisisin supervisorypractices,the Committee publishedrecommendationsfor banks and supervisorsentitledPrinciplesforsoundstresstestingpracticesand supervision.Theguidance setsout a comprehensiveset of principlesfor the soundgovernance,designandimplementationofstresstestingprogrammesatbanks.Theprinciplesalsoestablishedhigh-levelexpectationsfor therole andresponsibilitiesof supervisorsin evaluatingstresstestingpractices.Scope of the reviewAs part of its mandateto assessthe implementationof standardsacrosscountries,during 2011theCommittees StandardsImplementationGroup undertook a peer review of supervisory authorities‘implementationof theprinciples.Thereview wasconducted via an off-sitesurvey of supervisoryauthorities.All Committeemember countries and one non-member countryparticipatedin the review.Thereview focused primarily on progressin supervisoryprocessesused
  33. 33. In contrast, a few countries wereconsideredtobe advanced.toimplement the principles.It wasnot designedtoprovideadetailedcountry-by-country assessmentor toassessthe adequacyof banks stresstestingprogrammes.Increasingly, supervisorystresstestsarebeing used toset minimumcapital requirements, determineexplicit capital buffersor tolimitcapital distributionsby banks.This recent development wasnot extensively consideredin theprinciplesand asa result wasnot a key focusof the review.Key findingsProgressoverviewIn the period since the principleswere issued, stresstesting has becomea key component of the supervisory assessment processas well as a toolfor contingencyplanningand communication.Many of the countriesparticipatingin this peer review havebeenworkingtoimplement and refinestresstestingframeworksandmethodologies at thesametime astheir economiesand bankingsystemshave been affectedby a high degree of global economic andfinancial uncertainty.Althoughmanysupervisoryauthoritiesandbankshadoperationalstresstestingframeworksin place, existingguidanceand ruleshad toberevisedand new expectationsput in placeto broaden and deepen stresstestingcapabilitiesat both banksand supervisory authorities.Thereviewfound that countriesareat varyingstagesof maturity in theirimplementationof theprinciples.Nearlyhalf of thecountries wereconsideredtobe at an earlystage.Thesecountriesshowedsome progresstowardimplementingtheprinciples,but theymay not haveissued or finalisedprudentialrequirementson enterprise-widestresstestingsincethe principleswerepublished.Theygenerallyhad not conducted regular on-siteor off-sitereviewsotherthanin thecontext ofrisk-specificmodellingrequirementssuchasfor market risk, and had conducted industry-wide stresstestsinfrequently, or onlyaspart of International MonetaryFund FinancialSectorAssessment Program (FSAP) reviews.
  34. 34. internaltask forcesfor stresstesting.For thesecountries,the surveyresponsesprovided evidenceof arigorousregular review processthat included a combination of on-siteand off-siteassessments,some review and feedbackon detailed stresstestingmodelsusedby banks, evidenceof follow-upactionsand awell-embeddedsupervisorystresstestingprogrammethat wasnotlimitedtoexternallyimposedscenarios.Theremainder of countries werefound tofall betweentheabove twogroups.Thesecountrieshave issuedsome formal requirementsor guidanceconsistent withthe principles,are generallyperformingregularsupervisorystresstestson largebanksin their jurisdictionsand arereviewingstresstestingin thecontext of annual internal capitaladequacyassessment process(ICAAP) reviewsand specific riskreviews.Thesecountrieshave more todo in deepeningtheir stresstestingprogrammes,includingissuingupdated requirementsand conductingmore detailed on-siteand off-sitereviewsof banks stresstestingcapabilities.Remaining challengesand examplesof good practicesThemost commonoverall supervisoryapproachwasto conduct somereviewof banks stresstestingaspart of regularICAAP assessmentsandin thecontext of specific riskswhereongoingsupervisory review ofexposure modellingis now routine, notablymarket and liquidityrisks.Conductingmore detailed, comprehensivereviewsof banksenterprise-widestresstesting governanceand modellingasenvisionedin theprinciplesrequires expert skillsand resourcing at both banksandsupervisors,and asa result hasnot yet becomestandard practice inmanycountries.Asignificant development in the last several yearshasbeen theincreaseduse of supervisorystresstests.Amajorityof countriesnow regularlyconduct mandated stresstestswith prescribedscenarios acrossthe largebanksin theirjurisdictions,although for some countries, thisis limitedto theFSAPstresstests.Anumber of countriesnoted theresource-intensivenature ofindustry-wide stresstests.In particular, themore advancedcountriesnote that resourcing at bothsupervisoryauthoritiesand bankstosupport stresstestingischallenging, with a trend towardsestablishingspeciallystaffed unitsor
  35. 35. andmagnitudeof keyrisks.Many, however, found that these exercises have been helpful in terms ofenhancing the visibility of stress testing and providing a structured basisfor dialoguewithbanks on their capabilities.It wasnotedthat industrydialoguearoundmandatedstresstestshadledtoimprovementsin bank capabilities.Thefollowingtypesof practicesare alsoassociatedwithrelatively moreadvancedcountries:- plansfor, or completed horizontal or thematicreviewsof, stresstestingeither at an enterprise-widelevel or for specificportfolios;- engagement withboards of directorson stresstestingscenarios andgovernance;- review of detailed evidenceof howbanksare using stresstestoutcomesin their decision-makingand risk-appetitesetting;- well-articulatedplansfor improving their stresstesting supervisionprogrammes;- involvement of both generalist and specialist supervision staff; and- publicationof the resultsand provision of consistent feedback tobanks.While not a primary focusof thepeer review, many countriesprovidedviewson areasfor improvement in stresstestingpracticesat banks.Theseresponsesfocusedfairlyconsistentlyonareassuchasgovernanceandtheuse of stresstestingin bank decision-making, data andinformation technologyinfrastructure, severityof scenariosandfirm-widemodellingchallenges.Thereview found theprinciplesto be generallyeffective.TheCommittee, however, will continuetomonitor implementationoftheprinciplesand determinewhether,in thefuture, additionalguidancemight be necessary.IntroductionStresstestingis an important tool for banks toidentify unexpectedadverseoutcomesacrossa rangeof risks.Thefinancial crisishighlighted significant weaknessesin banks stresstestingprogrammesthat contributed to failurestoidentify thenature
  36. 36. As a result, the Committee engaged with the industry in examiningstress testing practices and, in May 2009, the Committee publishedrecommendations for banks and supervisors entitled Principles forsoundstresstestingpracticesand supervision.Theguidance set out a comprehensive set of principlesfor thesoundgovernance,designandimplementationof stresstestingprogrammesatbanks.Theprinciplesestablishedexpectationsfor the roleand responsibilitiesof supervisorsin evaluatingstresstesting practices. Overall, theguidanceincludesfifteenprinciplesfor banksand six principlesforsupervisors.As part of its mandateto assessthe implementationof its standardsacrosscountries,the CommitteesStandards ImplementationGroupundertook a peer review of supervisoryauthorities‘implementation oftheprinciples.Theobjectivesof thisreview wereto:- assesstheextent towhichtheprincipleshavebeenimplementedin arigorousand consistent manner acrosstheCommittees memberauthorities;- identify and providefeedback on factorsthat aremost critical to theeffectiveimplementationof the principles;and- assessthe effectivenessof theprinciplesthemselves.An important element of thereview wasthe context in whichtheprinciplesare beingimplemented.Many of the countriesparticipatingin this peer review have beenworkingtoimplement and refinestresstestingframeworksandmethodologies at thesametime their economiesand banking systemshavebeen affected by a high degreeof global economicand financialuncertainty.Althoughmanysupervisoryauthoritiesandbankshadoperationalstresstestingframeworksin place, existingguidanceand ruleshad toberevisedand new expectationsput in placeto broaden and deepen stresstestingcapabilitiesat both banksand supervisors.This is beingdone in a stressedenvironment and is alsobeingconducted at a time when stresstesting infrastructure, includingtheabilitytocollect appropriatedata, developmodelsandaggregateresults,is evolving.As a result, the current environment hasprovided a useful earlytest ofhow countriesare putting theprinciplesintopractice.
  37. 37. Morebroadly, it wasevident that countriesare implementingstresstestingregimesand activitiesin different ways that may reflect theirindividualsituationsandnot all will followthesame progression or pathin implementingtheprinciples.Thereview wasintended todeliver feedback on good supervisorypractice tohelp supervisorsimplement standardsmore effectively.Indeed, several countries havereported significant progresssubsequenttothe completion of thepeer review survey, particularlywithregard tosupervisorystresstestingpractices.MethodologyThepeer review wasconducted through a questionnairewhichwasdistributedtoCommitteemember countriesin September 2011.Analysis of the responseswasconducted by a workinggroup ofrepresentativesofsupervisoryauthoritieswithexpertiseinstresstesting.The questionnaire focused primarily on the implementation activities ofsupervisors and consisted of both factual multiple choice questions andfree-form responses.Thereview team used the information providedby eachcountryand, whererelevant, sourcedocumentsdemonstrating itsimplementationof the principles,to assessand compare theprogressmadeacrosscountries.Giventheoff-siteandhigh-levelnatureof thereview,it wasnot intendedtoproducea definitiveassessment of individual countriesimplementationof theprinciples,but, rather, to allowan overall view ofprogressacrosscountries.Adetailed report wasprovided tothe StandardsImplementation Groupandtothe Committee.The review focused primarily on the implementation of principles 16-21for supervisors, asit wasnot within the scope of the peer review toassesscomplianceby bankswithprinciples1-15on stresstesting practices.However,countrieswereinvited to provide their viewson theeaseandeffectivenessof implementation for each of theprinciplesfor banksintheir jurisdiction.In their responses, supervisory authoritieswereaskedtofocusonsupervisionof thelargestbanksin their jurisdiction, although somealsoaddressedtheir supervisoryexpectationsfor stresstesting at smallerbanks.
  38. 38. Assessment of principlesfor supervisorsOverall maturity of implementationFor purposesof assessingand comparingimplementation of theprinciples,participatingcountries werestratified asbeing in anearly, intermediateor advanced state of implementation.Theseassessmentswerebased on indicatorsof maturitydeveloped forthispurposebythereviewteam, aswellasthequalityandthoroughnessof the questionnaireresponses.Countriesin theearlycategory (nearlyhalf of respondents) showedsomeprogresstowardsimplementingtheprinciples;however, theymaynothaveissued or finalised prudential requirementson enterprise-widestresstestingsincethe principleswerepublished.Thesecountriesgenerallyhad not conducted regular on-site or off-sitereviewsother than in the context of risk-specific modellingrequirementssuchasfor market risk,andhaveconductedindustry-widestresstestsinfrequently, or onlyaspart of FSAP reviews.In contrast, a few countries wereclassifiedasadvanced. For thesecountries,the review team saw evidenceof a rigorousregular reviewprocessthat included a combination of:- on-siteand off-siteassessments;- some review and feedback on detailedstresstestingmodelsused bybanks;- evidenceof follow-upactions;and- a well-embeddedsupervisory stresstestingprogramme that wasnotlimitedtoFSAP or regionally-imposed scenarios.Theremainderof countries (approximatelyhalf of respondents) fell intotheintermediatecategory.Thesecountrieshave issuedsome formal requirementsor guidanceconsistent withthe principles,weregenerallyperformingregularsupervisorystresstestson their largebanks and werereviewingstresstestingin thecontext of annual ICAAP reviewsandspecific riskreviews.Thesecountrieshave more todo in deepeningtheirprogrammes,includingissuingupdated requirementsand conductingmore detailed on-siteand off-sitereviewsof banks stresstestingcapabilities.Notably, several countrieshave reportedsignificant progresssubsequenttothecompletionofthepeerreviewsurvey, particularlywith regard tosupervisorystresstestingpracticesand alsoin somecasesissuanceofstresstestingrequirementsor guidance.
  39. 39. anyimpedimentstoimplementing theprinciples.Specific areasof supervisoryactivityin relationtothe principlesarediscussed in more detail below.Prudential frameworkThereview found that all countrieshavein placeprudentialrequirementsrelatingto stresstesting.In manycasestheserequirementswereimplementedasacomponent ofBasel II, namely theICAAP requirements, or otherwisepre-date theprinciples.In addition, a largemajorityof the respondentsstated that theyhadissuedspecific rulesor guidanceimplementingtheprinciples.However,approximatelyone-third of respondentshasnot issuedanyrules or guidanceon stresstesting post-2009, and thuswouldnot beconsideredtohave implemented the principlesexplicitly.Thesecountriesrelyon other rules relatingto stresstesting, particularlyunder the Basel II credit or market risk requirements.In termsof future plans,a number of countries acrossdifferent levelsofmaturityare in theprocessof, or are planningtostrengthen or finaliseguidanceor regulations.In some cases,key elementsof theprincipleshavebeen incorporatedintothe Pillar 2 requirementsand in other casesas(non-mandatory)guidancefor banks.Somecountries issuedinformal guidancebased generallyon theprinciplesor on other regional guidelines.Anumber of countriesare still in theearlyphasesof issuingprudentialexpectationsfor enterprise-widestresstesting.At least a few countries have not yet issuedrequirementsrelating toBasel II ICAAPs, whichwasthemost common meansof implementingtheprinciples.Other countrieshave already updated their rulesand adapted theprinciplesor other guidelinesfor their owncircumstances.Thesewouldbe consideredtohave a more mature supervisionframeworkfor stresstesting.Afew other countrieshave issued their owngood practiceguidelineswhichincorporatetheprinciplesaswell askeyfindingsfromsupervisoryactivitiesand industrydialogue.Roughlythree-quartersofrespondentsreportedthat therehavenot been
  40. 40. regularlycovered stresstestingfor firm-widerisks,general credit risks,However,resourcing and other supervisoryprioritieswerenoted asaconstraint by a number of other countries.Anumber of countriesasserted that becausetheir banks or bankingsystemsare not complex, some of the aspectsof the principlesare notrelevant (eg structuredproductsand highlyleveraged counterparties).Further, banks in some jurisdictionsgenerallydo not have theinfrastructureand skillsto be ableto complywithsophisticatedstresstestingrequirements.Supervisory reviewPrinciple16 recommendsthat supervisorsshould make regular andcomprehensiveassessmentsof banks stresstestingprogrammes.Thereview found that supervisoryauthoritiesusea combination ofon-siteand off-sitereviewstoassessbanks‘stresstestingpractices.Most countriesindicatedthat theyhaveconductedsome form of on-sitereview of stresstestingat banks.For specific risk areas(primarilymarket, liquidityand tosome extentcredit risk), there are well establishedsupervisory review programmes.Almost three-quartersof countriesindicatedthat theyperform extensiveregular review of firm-widestresstestingpractices.Themost common approachfor assessingfirm-widestresstestingisthrough annual ICAAP reviews, which generallycover capital planningaswell asother matters.Given the scope of ICAAP reviews, it may be difficult toassessall of theprinciplesduring a routineICAAP review.Indeed, a few countries indicated that theyconduct horizontal orthematic reviewsspecificallyon firm-widestresstesting includingtheprinciples,whichisconsidereda more advanced practice.Thefrequencyof on-sitereviewsof firm-widestresstesting variedacrosscountries.About one-third of countries conducted less-than-annual reviews (every2-4 years) while roughly half of responding countries reported that theyconduct annual or more frequent on-site reviewsof stresstesting.Somesupervisorshave conducted a one-timereview of theprinciplesthrough self-assessments,questionnaires,or benchmarkingstudiesacrossa range of banks.In termsof thescope of supervisoryreview,supervisory activities
  41. 41. retail mortgagesand corporatecredit risks,market risk, bankingbookinterest rate risk and liquidityrisk.Authoritiesreported that areassuch asoperational risk, overseasoperations,aswell asspecific portfoliossuch ascommercialpropertyand sovereign risks,receivelesscoverage.Supervisoryauthoritiesin most countriesreported conductingannual ormore frequent review of board and senior management reportingofstresstest results.Use of stresstestingin loanlossprovisioningwasreviewedregularly byabout half of the countries.Therole of stresstestingtohelp set riskappetiteand identify riskconcentrationswereareasthat werelesscommonly reviewed;thisis anarea wheresupervisoryand bank practiceis at a very earlystage.Review of contingencyplansfor operational risk is the surveyed arealeast likely tohave been assessed by supervisorsin thecontext of stresstesting.Somecountries noted different requirementsor expectationsof stresstesting acrossbanks, mainlydependingon the banks‘systemicimportance(includingsize, complexityand relevancetoeconomy) andrisk profile.Most emphasised that supervisorshaveproportionately differentexpectationswhenconducting stresstestingreviewsof smaller banks.Several countries(particularlythoseat the more advanced stagesofimplementationof theprinciples)indicatedthat theyareplanning toincreasetheexpectationsof smallerinstitutionswithrespect tostresstestinggoing forward.Supervisory actionPrinciple17indicatesthat supervisorsshouldtakeactionondeficienciesin banks stresstestingprogrammes.Thereview found that the twomost common areasfor supervisoryfollow-upwereimproving governanceprocessesfor stresstesting anduseof additional (in particular, more severe) scenarios.Many countrieseither regularlyor occasionallyimposed requirementstoimprove data or model validation processes.Theleast common supervisory follow-upaction indicatedin theresponseswasto require thebank toreview or changelimitsorexposures(lessthan half of the countriesreported takingthisactionregularly).
  42. 42. stresstesting.Principle19encouragessupervisorstoconsidertheresultsof stresstestsin assessingcapital adequacyand in settingprudential buffersfor capitaland liquidity.Alargemajorityof countriesindicated that theysometimesor regularlyimposecapital or liquidityrequirementsasa result of stresstestingdeficiencies.In particular, use of stressscenariosfor setting liquidityrequirementsappearsto be fairlywellestablished, particularlyascountries worktowardimplementingtheBasel III liquidityframework, whichis basedon stressedcashflows.Nearlyall of thecountriesindicatedregular review of liquiditystresstesting.Use of stresstestsfor settingminimum capital requirements,determiningexplicit capital buffersor for limitingcapital distributionsbybanks isa more recent development that wasnot extensivelyconsideredin theprinciplesand asa result wasnot a key focusof thereview.Asmall number of countriesindicated that stresstestinghasbecome akey tool for setting or assessing capital requirements.Somecountries haveissuednew requirementsin the past year or sospecificallyrelated totheuseof stresstestsin assessingcapitaladequacy.While useof stressteststoset formal minimum capital requirementsisnot common, useof standard supervisorystressscenariosasabenchmarkingtool isincreasinglyprevalent.Othercountriestooktheviewthat stresstestresultsarejust onefactorinassessinghow much capital is needed tooffset the risk of unexpectedlosses.In a number of countries, and even thosewithfairly advanced stresstestingsupervision programmes, stresstesting wasseen asone of severaltoolsin assessingcapital adequacyand there wasa reluctancetoplaceprimary relianceon stresstest scenario outcomes.This may reflect theevolving natureof supervisory and bank practices.Supervisory resourcingAs stresstesting is a fairlynew and specialisedarea of supervision, thereview found that resourcingand capabilitiesfor stresstestingsupervision werekeychallengesfor many supervisoryauthorities.Onlya few countrieshave establishedunitsspecificallydedicatedto
  43. 43. area of focus in their future plans.Most countriesare primarily relying on separateteamsof staff toconduct supervisorystresstestsand, in manycases,alsotoreview stresstestingpracticesat banks.Theseteamsalsoperform other tasksin additiontoreviewingorconductingstresstesting.Typically, a set of speciallytrainedsupervisorsis responsibleforcoordinatingwith bankswithrespect to the collectionof data for stresstestingand reviewingand consolidatingthestresstest information.Oftenan inter-departmental team isused to conduct thestresstests.In general, it wasnotedthat staff withavariety of different backgroundscanbeuseful in stresstesting, includingmacro-surveillanceeconomists,risk specialistsand modellingexperts, aswell asgeneralistsupervisorswhoaremost familiarwithindividualinstitutionsoraccountingexperts.Similarly, most countriesutiliseboth risk specialistsand generalistsupervisorsin reviewingstresstesting practicesat banks.In most countries, generalist supervisorsare involved in the review ofstresstestingpractices;however, theyarenot generallyinvolved inconductingsupervisorystresstests.At the same time, some countriesnoted that wherestresstesting isallocatedtoa separate unit, it can bemore difficult to ensure that stresstestingisembeddedwithin routinesupervisionand that stresstestoutcomesare understood and used by the generalist supervisors.This wasseen asan evolving challenge.Themore advancedcountries, in particular, noted a general lack ofspecialisedstresstesting resources.Indeed, somecountriesfound that prioritisationof supervisoryworkisamajor issueaskey individualsinvolved oftenhaveother responsibilities.Most countriesindicatedtheyhad establishedsome form of trainingprogrammeon stresstestingfor supervisors.In many cases,the trainingwasof a quitegeneral nature and in somecaseslimitedtopresentation of the resultsof supervisorystresstestsorhigh-level discussion in the context of introductorytraining on Pillar 2approaches.A few countries provide quite advanced training programmes, includingcase studies, and some offer training to other countries supervisorsor tobanksin their jurisdiction.Not surprisingly, severalcountriesnotedthat stresstestingtrainingisan
  44. 44. consideredtobeamoreadvanced practicefor supervisors,asit requiresSupervisory stresstestingPrinciple20recommendsthat supervisorsshould considerimplementingstresstest exercisesbased on common scenarios.It is clearthat there has been a significant increasein the use ofsupervisorystresstestsin recent years.In fact, all countriesindicatedthat theyconduct some form ofsupervisorystresstest.As a result, progressin this area canbe considered more advancedgenerallythan some other aspectsof theprinciples.Portfolio-levelstresstestswerereported by more than half of thecountries.In recent years, this hasincluded specificstresstestson, forexample,housing loanportfolios, consumer debt, sovereign risksandliquidityrisk.Somecountries indicatedthat they conduct very frequent sensitivitytestingfor specificrisks, for example,applying market risk andliquidityshockson a regular basis.In termsof firm-widestresstestsbased on a common scenario, therewasa rangeof experience.Afew countries have performed FSAP stresstestsonly.While thesestresstestsprovide an important basisand experiencefordesigningsupervisory stresstests,in many casestheytended to be ledbytheFSAP mission team and thenational central bank, and did nothavea supervisory focus.About one-third of countrieswerenot running stresstestson afirm-widebasis.In a couple of countries,firm-widestresstestswereconducted by the(non-supervisory) central bank, although withsome involvement by thesupervisoryauthority.Many countriesconduct both bank-run and supervisor-runstresstests.This can involve thesupervisoryauthorityrunningthe same scenariousingsupervisoryor public data in order to benchmark banks resultsfrom thebank-run stresstest. Some countries run both regional andcountry-specific stresstests.Directingbanks torun a stresstest usinga common scenariois
  45. 45. banksis a more advanced practiceasit allowsbetter benchmarkingofmore detailed understandingof bank modellingcapabilitiesand anabilityto assesstheresults.About half of the countries have conducted bank-run, firm-wide stresstests (outside of the FSAP process), of which about half conduct theseon an annual basis.Supervisory assessment and challengeTheoverall assessment and challengeof the reasonablenessof banksstresstest scenariosand outputsisa difficult area for supervision.In many countries, the models, assumptionsand approachesused areevolving, and banksare at varying degreesof sophistication.At a general level, the review found a rangeof supervisorymethodsforchallengingthe scope and resultsof banks‘stresstestsand scenarios.Themost widelyused method wasto compare outputswithhistoricalexperience,such asa pastsevere recession.However,in countrieswithlittlehistoryof financial crisis,thisapproachmay be more difficult.Anumber of countriesconductedtheir ownparallel stresstestson bankfinancial data to benchmark resultsproduced by banks or placedhighrelianceon reasonablenesschecksbased on supervisors‘understandingof portfolios.Peer comparisonswerevery useful in countries wherebankssubjecttostresstestingare comparablein size and scope.Somecountries facilitatethis by requiringbanks toreport theresultsoftheir stresstestsin a standardisedmanner.Anumber of countriesalsoplacemoderate to high relianceon banksowninternal model validation reporting.Independent review by external auditorsor consultantscan be oneelement of the assessment and challengeprocessfor some countries.But more than half of countries indicatedtheydonot rely at all onindependent review of stresstesting resultsaspart of their supervisionactivities.Another supervisorytrend is that supervisoryauthoritiesare moreactivelyreviewingscenarioschosen by the banksin their internal stresstesting and, for example, the banks‘ICAAPs.Monitoring or keepinga systematic inventory of scenariosused by
  46. 46. tested.peer banks‘internal view of stressed conditionsand possiblevulnerabilities.Several countriesmaintain adatabaseof scenarios used by theirbanks, and othershaveplansto dothis.Over half of the countriesperiodicallyreview thescenariosusedbybanksin their internal stresstesting.Afew countries in theearlier stagesof maturitywerenot regularlyreviewingscenariosused by banks.Supervisoryauthorities in several countriesindicated that theyhaveperformed reversestresstests,that is, stresstestsdesignedtobesufficientlysevere that theychallengetheviabilityof thebank.However,reverse stresstesting hasnot becomea common supervisorypractice.In fact, thesupervisorystresstestsappear tobethevehicle for assessingtheimpact of more severe scenarios.In terms of the choice of scenario for supervisory stresstests, the mostcommon approach was to look to a previous severe recession or inputfrom thecentral bank.Also very common wastotarget thescenario toknownvulnerabilities.About half of the countries have usedexternallyprescribed scenarios(for example, from a regional authority or FSAP process).Dialogue with public and private sectorsStresstestingis increasinglypart of thepublic debateon thestrengthandtransparencyof supervision.Supervisoryauthorities have regular discussionswithbanking industryriskofficersorhold occasionalseminars,workshopsorroundtableswithbanksto exchangeexperienceson stresstestingmethodologiesand useof results.In somecases, thishasresultedinpublicationoflocalindustryguidancebased on the Committees principles.Somesupervisorsalsohave a formal processfor coordinatingwith otherofficial organisationswithintheir country.In some cases,a formal committeeof regulatorsand other authorities(includingthe central bank) discussessystemic vulnerabilitiesandprovidesinput intostresstesting programmesand the scenariosto be
  47. 47. dialogueonscenarioselection, dynamicsof models,reportingtemplatesAnumber of other supervisorscoordinatewiththeir central bank inconductinga quantitativemacroeconomic stresstest, includingconsiderationof potential systemic issuesthat may be caused by banks‘management reactionsto a common stressscenario.Regional-level coordinatingbodieshavealsobecome increasinglyimportant.Effective supervisory approachesThereview highlighteda number of different supervisoryapproachesthat appear tohavebeen more effectiveand arereflectiveof moreadvancedprogress.Oneof themost effectivetoolsin advancingstresstesting practiceshasbeen thesignificantlyheightened focuson industry-widesupervisorystresstests.Many countriesfound that thisprocesshashelpedfocuson commonexpectations,provideastructuredapproachfordialogueonbetterstresstestingpractices,and identify gapsin banks stresstestinginfrastructure.By challengingthelossresultsreportedby banks on theprescribedscenarios, supervisorshave motivated banks tojustify their resultsandhenceimprove their internalassessment of key risk areas.In contrast, there wassome evidencethat countries that have onlyconducted supervisorystresstestsor supervisoryreviewof stresstestingpracticeswithout leveragingthesetwoaspectstogether havenot madeasmuch progressin implementingthe principles.In addition, countriesthat addressbank stresstestingpracticesthroughtheICAAP review processhave generallyfound this tobe an effectivemechanism, althoughperiodic horizontal or thematicreviewsthat allowdetailed comparison of practicesacrossbanksis a more advancedapproachthat is in useor under considerationin some countries.A formal self-assessment process conducted in some countries helpedbanks identify where their practices are consistent with the principlesandwheregapsexist in stresstestingprogrammes.Opendialoguewithbankswasalsoseen asakey element of an effectivesupervisoryprogramme.Annual meetingswith banks can includediscussionsof riskdevelopmentsand best practicesin stresstesting that effectivelycreateincentivesfor bankstostrengthen their ownpractices.Another approach highlightedby some countrieswastoengage in
  48. 48. adequacyand liquiditywasevident in a few countries, withsome alsoanddata capabilities, and overall robustnessof thestresstest at thehighest level of bank management.Several countrieshaveissued publicationsdescribingobserved goodpracticesarising from benchmarking or initial implementationreviewsof the principles.This type of guidanceallowsbanks tobenchmark themselvesagainsttheir localpeers.Banks, and to some extent regulators,areincreasinglyusingstresstestingasa meansof communicatingtheir risk profiles tothemarket.However,disclosurerequirementsand practicesvary considerably bycountry.Many countriesnow publish aggregatesummaries of stresstestsresultsin their regular financial stabilityreports,and in some casesoutcomesfor individual banks.Somebanks now routinely provide stresstest resultsaspart of theirfinancial results.Future plansMost supervisoryauthoritiesdescribed future enhancementsto theirstresstestingsupervisionprogrammes.Those countries in the early phases of maturity are planning toissue, finalise or update rules on stress testing and to commencereview and assessment of stresstestingpractices.Someare alsoconductingsupervisorystresstestsfor the first time.Thosesupervisoryauthorities in intermediatetoadvanced stagesofmaturityplan to focuson deepeningtheir current on-siteand off-sitereview programmes, with the aim of better assessing how stresstestoutcomesare used in bank decision-makingand risk appetitesetting.Stresstestingresultsare expectedtohave a greater impact oncontingencyplanningincludingrecoveryand resolution.Additional supervisory workis planned for identifying and assessinghowbanksare integratingstresstestsresultsin thedevelopment of riskappetiteand overall risk management.Some supervisors will also use horizontal reviews across multiple banksto assess these areas as well as to benchmark banks‘ internal stress testscenarios and assumptions.Greater focuson the use of stresstest outputsin assessing capital
  49. 49. incorporatingstresstest resultsintobusinessand strategicdecisions.planningmore explicit consideration of stresstest outcomesin settingcapital buffers.Principlesfor BanksAs the peer review focused on supervisory implementation, anassessment of stresstestingpracticesat bankswasnot within thescopeof this review.Nevertheless, manycountriesprovided high-level commentsonprogressof banksin their jurisdictionsthat werereasonablyconsistentandmay be of broader interest.In particular, all countriesreported significant improvementsin stresstestingcapabilitiesat banks sincepublication of the principles.Authoritiesnoted an overall improvement in the rigor and qualityofstresstestingand thequalityof information presentedin ICAAPs.Risk-specific stresstesting, particularlyregardingmarket and liquidityrisk, wasfound tobe reasonablywell developed.Morerecently, bankshave focused increasinglyon centralised,firm-widestresstestingthat encompassesa broader rangeof risks, butmanycountries note this area is still evolving.Bankshavestrengthenedtheir resourcing, withsomebanksnowhavingset up dedicatedstresstestingunits.Banks are using a broader range of scenarios, includingthosethat aremore severe and complex.However, as noted below, many countries indicated that banks‘scenarios continue to be less severe than supervisors might findappropriate.Banks generallyareestablishingstronger governanceframeworkswithclear linesof responsibilityfor stresstesting, and some banksare givingmore importancetostresstest resultsin their decisionmaking.Somecountrieshaveseenanimprovement in datasystemsandabilitytoadapt to new vulnerabilitiesand specific scenarios.Thelevel of documentation hasalsoimproved.Countries responsesto thereview surveyhighlightedthefollowingcommon areasof future improvement in bank stresstestingpractices.Integrating resultsinto decision-making.Anumber of countriespointed tochallengesbankshave in
  50. 50. Stresstestingtoolsare still immature and some countries felt that inmanycasesthe bankstake a compliance-orientedapproachin order tomeet regulatory requirements.GovernanceThere is a sensethat banks need to have a better understanding of stresstesting limitations, assumptions, and uncertainties by users of stress testresults,includingsenior management and the board of directors.Severity of scenariosAnumber of countriessawa need for firmsto deepen the severityofscenarios.Supervisorsin thesecountriesremain concernedthat banks internalstresstest scenariosdo not plausiblyreflect potential severe scenariosand outcomes.Data and IT infrastructure.Anumber of countriesnoted that data and IT systems remain a keyimpediment toimplementingeffectivestresstesting programmes.Accumulation of sufficient data for modellingpurposesis a challengefor banks in some countries and aggregatinginformationacrossthebank remainsan issue.Generally, some manual intervention isneeded to support thebanks‘current IT and data infrastructuretorun regular stresstests.Modelling issuesTranslatingand calibratingscenariosintostressoutcomescontinuestobean area wherebanks capabilitiesarechallenged.Multiplerisk classimpactsgenerallyhave not been modelled in asophisticated manner, although some banks attempt to take intoaccount correlationsbetweenrisks.Incorporatingfeedback effectsand system-wideinteractionsremainsvery difficult.Another technical area cited is the identification and aggregation ofcorrelated risks and integration between credit, market and liquidityrisks.
  51. 51. ConclusionsThecurrent environment hasprovided asoundtest of howcountriesareputtingintopracticetheCommittees2009principlesfor stresstestingsupervision.There is clearlyroom for further progressamong the supervisorycommunityin the supervisionof stresstesting.Many countries in the early to intermediate stages of implementationare working to finalise their prudential requirements for stress testingand implement regular review programmes that cover enterprise-widestresstestinggovernance, capabilitiesand models.Even those countriesconsideredtobe in the advancedphaseofimplementationof theprinciplesfelt that there are many remainingchallengeswithrespect totheir own stresstestingprogrammes.Authoritiesare continuing withtheir effortsto embed theuse of stresstestingwithin their supervisory programmes.In many cases,this requires additional resourcesand trainingfor bothgeneralist and specialist supervision staff.Stresstestinginfrastructure, includingtheabilityto collect appropriatedata, develop modelsand aggregateresults,continuesto evolve.Explicit considerationof stresstest outcomesin assessingliquidityandmarket riskcapital requirementsis well establishedin supervisoryframeworks.Stresstestinghastraditionallynot featured asprominentlyinassessment of overall bank capital adequacybut practicesare evolvingin this area.Thepeer review hashighlightedthat there are different supervisoryapproachesand it is difficult to statewhichis most effective.Acombination of supervisory stressteststogether withinvolvement ofgeneralist and specialist supervision staff in reviewsof banks‘stresstestingpracticesat anenterprise-widelevel oftencharacterisesthemorewell developed supervisoryprogrammes.Moreadvancedcountriesare encouraging development of morerigorouspracticesat banksby conductinghorizontal and thematicreviews, publishingthe resultsand providingfeedback to banks.Finally, while thereview found theprinciplesthemselvestobegenerallyeffectivein settinghigh-level expectations,theCommitteewill continue
  52. 52. tomonitor implementationof the principlesand determinewhether, inthefuture, additional guidancemight benecessary.1 Stress testing should form an integral partof the overall governance and riskmanagement culture of the bank. Stresstesting should be actionable, with theresults from stress testing analysesimpacting business decisions of the boardand senior management. Board and seniormanagement involvement in the stresstesting programme is essential for itseffective operation2 A bank should operate a stress testingprogramme that promotes risk identificationand control; provides a complementary riskperspective to other risk managementtools; improves capital and liquiditymanagement; and enhances internal andexternal communication.3 Stress testing programmes should takeinto account of views from across theorganisation and should cover a range ofperspectives and techniques.4 A bank should have written policies andprocedures governing the stress testingprogramme. The operation of theprogramme should be appropriatelydocumented.5 A bank should have a suitably robustinfrastructure in place, which is sufficientlyflexible to accommodate different andpossibly challenging stress tests at anappropriate level of granularity.6 A bank should regularly maintain andupdate its stress testing framework. Theeffectiveness of the stress testingprogramme, as well as the robustness ofmajor individual components, should beassessed regularly and independently.7 Stress tests should cover a range of risksand business areas, including at the firm-wide level. A bank should be able tointegrate effectively, in a meaningfulfashion, across the range of its stresstesting activities to deliver a completepicture of firm-wide risk.8 Stress testing programmes should cover arange of scenarios, including forward-looking scenarios, and aim to take intoaccount system-wide interactions andfeedback effects.9 Stress tests should feature a range ofseverities, including events capable ofgenerating the most damage whetherthrough size of loss or through loss ofreputation. A stress testing programmeshould also determine what scenarioscould challenge the viability of the bank(reverse stress tests) and thereby uncoverhidden risks and interactions among risks.10 As part of an overall stress testingprogramme, a bank should aim to takeaccount of simultaneous pressures infunding and asset markets, and the impactof a reduction in market liquidity onexposure valuation.11 The effectiveness of risk mitigationtechniques should be systematically
  53. 53. 12 The stress testing programme shouldexplicitly cover complex and bespokeproducts such as securitised exposures.Stress tests for securitised assets shouldconsider the underlying assets, theirexposure to systematic market factors,relevant contractual arrangements andembedded triggers, and the impact ofleverage, particularly as it relates to thesubordination level in the issue structure.13 The stress testing programme should coverpipeline and warehousing risks. A bankshould include such exposures in its stresstests regardless of their probability of beingsecuritised.14 A bank should enhance its stress testingmethodologies to capture the effect ofreputational risk. The bank should integraterisks arising from off-balance sheetvehicles and other related entities in itsstress testing programme.15 A bank should enhance its stress testingapproaches for highly leveragedcounterparties in considering itsvulnerability to specific asset categories ormarket movements and in assessingpotential wrong-way risk related to riskmitigation techniques.16 Supervisors should make regular andcomprehensive assessments of abanks stress testing programme.17 Supervisors should require management totake corrective action if materialdeficiencies in the stress testingprogramme are identified or if the results ofstress tests are not adequately taken intoconsideration in the decision-makingprocess.18 Supervisors should assess and ifnecessary challenge the scope and severityof firm-wide scenarios. Supervisors mayask banks to perform sensitivity analysiswith respect to specific portfolios orparameters, use specific scenarios or toevaluate scenarios under which theirviability is threatened (reverse stresstesting scenarios).19 Under Pillar 2 (supervisory review process)of the Basel II framework, supervisorsshould examine a banks stress testingresults as part of a supervisory review ofboth the banks internal capital assessmentand its liquidity risk management. Inparticular, supervisors should consider theresults of forward-looking stress testing forassessing the adequacy of capital andliquidity.20 Supervisors should consider implementingstress test exercises based on commonscenarios.21 Supervisors should engage in aconstructive dialogue with other publicauthorities and the industry to identifysystemic vulnerabilities. Supervisors shouldalso ensure that they have the capacity andskills to assess a banks stress testingprogramme.
  54. 54. April 2012Resultsof the Basel III monitoring exercise asof 30 June 2011Toassesstheimpact of thenew capital and liquidityrequirementsset out in theconsultativedocumentsof June and December 2009,both theBasel Committeeon BankingSupervision and the Committeeof European BankingSupervisors(CEBS) conducted a so-calledcomprehensivequantitativeimpact study(C-QIS) for their member jurisdictionsbasedon data asof 31December 2009.Themain resultsof both impact studieshavebeenpublishedin December 2010.After finalisat ion of th e regulatory framework (referred to as ―Basel III‖)inDecember2010,theimpact of thisnew frameworkis monitored semi-annuallybyboth the Basel Committeeat a global level and theEuropean BankingAuthority (EBA, formerlyCEBS) at theEuropean level, using data provided byparticipatingbankson a voluntary and confidential basis.This report summarisesthe resultsof thelatestmonitoring exerciseusingconsolidateddata of Europeanbanks asof 30June 2011. Atotal of 158bankssubmitteddatafor thisexercise,consistingof48Group1banksand 110Group2banks.[Group 1banksare thosewith Tier 1capit al in ex cess of €3 b n andinternationallyactive.All other banks are categorised asGroup 2banks]Member countries‘coverageof their banking system wasveryhigh for Group 1banks,reaching 100% coveragefor many jurisdictions(aggregate coverageintermsof Basel II risk-weightedassets:98.5%), whilefor Group 2banksit waslowerwith a larger variation acrossjurisdictions(aggregate coverage:35.8%).Furthermore,Group 2 bank resultsare driven by a relatively small number oflargebut non-internationallyactivebanks,ie theresultspresentedin thisreportmay not be asrepresentativeasit is thecasefor Group 1banks.[There are 19Group 2 banksthat have Tier 1capital in excessof €3billion.Thesebanksaccount for 64.3% of total Group 2RWA.]
  55. 55. Sincethe new EU directiveand regulation are not finalisedyet, no EU specificrules are analysed in this report.Accordingly, this monitoring exerciseiscarried out assumingfullimplementationof theBaselIII framework, ie transitionalarrangementssuchasphase-inof deductionsand grandfatheringarrangementsare not taken intoaccount.Theresultsarecomparedwiththerespectivecurrent national implementationoftheBasel II framework.In addition, it is important to note that the monitoring exercise is based on staticbalance sheet assumptions, ie capital elementsare only included if the eligibilitycriteria have been fulfilledat thereportingdate.Plannedmanagement actionstoincreasecapital or decreaserisk-weightedassetsare not taken intoaccount (―static balancesheet assumption‖).This allowsfor identifying effectivechangesin banks‘capital base instead ofidentifying changeswhichare solely based on changesin underlying modellingassumptions.As a consequence, monitoring results are not comparable to industry estimatesas the latter usually include assumptions on banks‘ future profitability, plannedcapitaland/ orfurthermanagement actionsthat mitigatetheimpactofBaselIII.In addition, monitoringresultsare not comparableto C-QIS results,whichassessed the impact of policy proposalspublished in 2009that differedsignificantlyfrom thefinal Basel III framework.Theactual capital and liquidityshortfallsrelatedtothenew requirementsbythetimeBaselIII is fullyimplementedwill differ from thoseshownin this report asthebanking sectorreactsto thechangingeconomic and regulatory environment.Themonitoring exerciseprovidesan impact assessment of thefollowingaspects:- Changesto banks‘capital ratios under Basel III, and estimates of any capitalshortfalls. In addition, estimates of capital surchargesfor global systemicallyimportant banks(G-SIBs) are included, whereapplicable;- Changestothedefinitionof capitalthat result fromthenewcapitalstandard,referred to ascommon equity Tier 1(CET1), includingmodifiedruleson capital deductions, and changesto theeligibility criteria for Tier 1and total capital;- Changesin the calculationof risk-weightedassets(RWA) resultingfromchangestothe definitionof capital, securitisation, trading book andcounterpartycredit risk requirements;
  56. 56. - Thecapital conservation buffer;- Theleverageratio;and- Twoliquiditystandards – the liquiditycoverageratio(LCR) and thenetstablefunding ratio(NSFR).Key results - Impact on regulatory capital ratios and estimated capitalshortfallAssuming full implementationof theBaselIII frameworkasof 30June 2011(i.e.without takingintoaccount transitional arrangements), theCET1capital ratiosof Group 1banks wouldhavedeclined from an averageCET1ratio of 10.2%(withall country averagesabovethe 7.0% target level) to an averageCET1ratioof 6.5%.80%of Group 1bankswouldbeat orabovethe4.5%minimum while44% wouldbeat or above 7.0% target level.TheCET1capital shortfall for Group 1banks is €18bn at a minimumrequirement of 4.5% and €242bn at a target level of 7.0% (includingthe G-SIBsurcharge).As a point of reference, the sum of profits after tax prior to distributions acrossthe Group 1 sample in the second half of 2010 and the first h alf of 2011 was€102 bn.With respect totheaverageTier1andtotalcapitalratio,monitoring resultsshowa declinefrom 11.9%to6.7% and from 14.4% to 7.8%, respectively.Capital shortfallscomparingto theminimum ratios(excl. thecapitalconservation buffer) amount for €51bn (Tier 1capital) and €128bn (totalcapital).Takingintoaccount the capital conservation buffer and thesurcharge forsystemically important banks, the Group 1banks‘capital shortfall risesto €361bn (Tier 1capital) and €485bn (total capital).For Group 2banks, the averageCET1ratio declinesfrom 9.8% to 6.8% underBaselIII, where87% of thebankswouldbe at or abovethe4.5% minimum and72%wouldbe at or above the7.0% target level.TherespectiveCET1shortfall is approx. €11bn at a minimum requirement of4.5% and €35 bn at a target level of 7.0%.Thesum of profitsafter tax prior todistributionsacrossthe Group 2sampleinthesecond half of 2010and the first half of 2011was€17 bn.
  57. 57. Main driversof changesin banks‘ capital ratiosFor Group 1banks,the overall impact on theCET1ratio can be attributedinalmost equal partstochangesin the definition of capital and to changesrelatedtothe calculationof risk-weightedassets:while CET1declinesby 22.7%, RWAincreaseby21.2%, on average.For Group 2banks, while the change in thedefinition of capital resultsin adeclinein CET1 of 25.9%, the new ruleson RWA affect Group 2banks far less(+6.9%), which may be explained bythe fact that thesebanks businessmodelsare lessreliant on exposurestocounterparty and market risks(whichare themain driversof theRWAincreaseunder thenew framework).Reductions in Group 1and Group 2 banks‘ CET1are mainly driven by goodwill(-17.3% and -14.8%, respectively), followed by deductions for holdings of capitalof other financial companies(-4.4% and -7.0%, respectively).As to the denominator of regulatory capital ratios, themain driver is theintroductionof CVA capital chargeswhichresult in an averageRWAincreaseof8.0% and of 2.9% for Group 1and Group 2 banks, respectively.In addition to CVA capital charges, trading book exposures and the transitionfrom Basel II 50/50 deductions to a 1250% risk weight treatment are the maincontributorsto theincreasein Group 1banks‘RWA.As Group 2 banksare in general lessaffected by therevised counterparty creditrisk rules, these banksshow a much lowerincreasein overall RWA (+6.9%).However,even withinthis group, the RWA increaseis driven by CVAcapitalcharges,followedbychangesrelatedtothetransitionfromBaselII 50/50capitaldeductionstoa 1250% risk weight treatment, and totheitemsthat fall below the10/15% thresholds.Leverage ratioMonitoring resultsindicatea positivecorrelationbetweenbank size and thelevel of leverage, sincethe averageLR is significantlylowerfor Group 1banks.Assuming full implementationof Basel III, Group 1banksshow an averageBasel III Tier 1leverageratio(LR) of 2.7%, while Group 2 banks‘leverageratiois 3.4%.41%of participatingGroup 1and 72% Group 2 banks wouldmeet the 3% targetlevel asof June 2011.If ahypothetical current leverageratiowasalreadyin place,Group1andGroup2banks‘LR wouldbe4.0% and 4.7%, respectively.