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2 Financial Reform Landscape remains Complex 2Source: E&Y. Financial Regulatory Reform - What it means for bank business models, November 2012.
3 Asia Policy Forum on Financial Regulatory Reform • Ensure that tighter standards, such as higher capital and liquidity requirements, do not choke off the global recovery. • Support the development of a global mechanism for managing volatile short-term capital flows, and development of macroprudential surveillance and regulation at the national and regional levels. • Establish an effective regulatory framework for macroprudential supervision and regulation at the national and regional levels.Source: Asian Development Bank Institute, Policy Recommendations to Secure Balanced and Sustainable 3Growth in Asia, October 2010.
4 Asia Policy Forum on Asian Voice and Interests • There needs to be an Asian voice on financial reform and regulation rather than allowing the debate on issues to be dominated by a perceived choice between American and European approaches. • A “one-size-fits-all” approach is inappropriate due to differences in financial systems, stages of development and banking industry practices, and may lead to excessive burdens in areas such as capital and liquidity adequacy requirements and leverage ratios. • In addition, there is a risk of spillover effects from developed country regulatory changes and low-interest-rate policies that lead to migration of risky financial activities to Asia that could affect regional financial stability. • Asian leaders should consider sponsoring their own research on the impacts of the new regulations on Asian financial institutions and markets.Source: Asian Development Bank Institute, Policy Recommendations to Secure Balanced and Sustainable 4Growth in Asia, October 2010.
5Key Points• We need to put the Implementation of Basel III in Asia within the proper context.• Post-2007 Global Financial Crisis, Basel III is an important standardization of minimum capital and liquidity standards for global banking.• This is a NECESSARY, but NOT SUFFICIENT CONDITION for global financial stability, because Financial Stability Board and national regulators have only just begun to address SHADOW BANKING, or non-bank financial intermediaries, risk issues. Although important, banks account for 43.1 percent of global financial assets as at the end of 2011, whereas stock market capitalization and bond markets (excluding derivative financial assets) account for more than half of financial sector risks.• Hence, to obtain overall financial system stability, we need to look also at real sector imbalances, monetary and fiscal policies, and interconnectivity and feedback mechanisms between financial sectors (banks and shadow banks) as a systemic whole.• We must never forget that Finance must serve the Real Sector, not the other way around. 5
6Key Questions• What are Basel III‟s main impact on (1) banking system and (2) growth and overall credit?• While Basel III are Minimum conditions for capital and liquidity, do the complex calculations on risk weights impair or disadvantage EME banks?• Which parts of Basel III should be priority for implementation? Should we move out of standard risk-based model towards Internal Risk-Based (IRB) models?• What areas of structure (shadow banking), financial infrastructure and other issues should we consider ( Basel III included as part of package) for financial system stability? 6
7Contents• Introduction• What are the key issues and concerns?• Role of Asia finance in rebalancing Asia‟s Growth Model• ConclusionAppendix: Amendments to the Liquidity Coverage Ratio (LCR)and the new BCBS Charter; and CRR4 7
10Asia finance must be there to serve the realsector 10
11Asian banks are the primary providers offunding for private sector growth Asia‟s shift towards a domestic and regionally-driven engine of growth would require continuous funding from Asia‟s bank- dominated financial system However, Asia faces funding issue under Basel III rules that would reduce the incentive for banks to lend to trade finance and SMEs, and discourage long-term lending for infrastructure at a time when this is critical for Asia‟s sustained growth While Basel III requirements on higher capital adequacy, enhanced liquidity and an overall leverage cap are commendable, the detailed rules on liquidity and risk-weighting may restrain the funding capacity of Asian banks 11
12 Banking sector has to adjust to unprecedented regulatory change 12Source: Mc Kinsey. The Triple Transformation, October 2012.
13 Global capital markets business also has to adjust to regulation 13Source: Mc Kinsey. The Triple Transformation, October 2012.
14 Need for adaptive business models to seize new growth trends 14Source: Mc Kinsey, BCG.
15 Going to where the new trade corridors are 15Source: BCG. The Transaction Banking Advantage, October 2012.
16 Revamping payments value chain 16Source: BCG. The Transaction Banking Advantage, October 2012.
17 Need true banking transformation to improve financial metrics 17Source: Mc Kinsey. The Triple Transformation, October 2012.
18 Need to reverse declining ROE due to lack of performance improvement and rising capital ratios 18Source: Mc Kinsey. The Triple Transformation, October 2012.
19 Business model transformation – the basis for future growth • Capital markets business is most challenging due to regulatory pressure, high funding costs, and shrinking revenues. 19Source: Mc Kinsey. The Triple Transformation, October 2012.
20The need for a balanced view, with appropriate“fit” for EMEs1. Basel III was designed to address the causes of the 2007-2009 Financial Crisis in the advanced markets, aimed to resolve the issue of under-capitalisation and over-leverage in the advanced wholesale banking model.2. Current Basel III on risk-taking governance requirements represent substantial improvement in quality, quantity and comparability of banks‟ risk/reward profile. Asia needs that and supports Basel III.3. However, there is substantial variation in quality of banks, supervisors and regulators between more retail-based systems (e.g., China, Canada, India, Australia) and wholesale systems (US, UK and some EU countries).4. Need for clarity on WHAT is National discretion? WHAT fits local conditions and what is necessary to supplement Basel III implementation to ensure overall systemic stability. 20
21Agree that under-capitalisation and illiquidity ofinternationally-active banks need to be solved Figure 1. Ratio of Debt to GDP Among Selected Advanced Economics (In percent, GDP-weighted, 1987=100) 21
22Do Basel III rules address the priority policy andreal sector needs in Asia?• While Asian banks can meet the current Basel III capital requirements, it is not clear as Asia grows faster with higher credit needs, whether there will capital constraints going forward.• Asian banks are at different stages of development and Asian countries have different national imperatives.• Capacity of Asian banks to implement Basel II/III vary hugely between banks, especially the smaller and non-internationally active banks.• Europe is expected to have the largest shortfall of over €272 billion in meeting Basel III capital requirements, and the US may have a shortfall of $60 billion. 22
23 Tighter financial conditions resulting in capital shortfalls, in turn worsening the real economySource: IIF. “The Cumulative Impact on the Global Economy of Changes in the Financial 23Regulatory Framework”. September 2011.
24Basel 2.5/III uses Risk Weighting and Models toassess Risks• Advanced country banks have high sovereign ratings and have experience in Internal Risk Based (IRB) Models which assign lower risks, if banks can prove with data.• Asian banks are less sophisticated and rely on standard model, and because sovereign credit ratings are lower, and Asian banks do not have good risk data, they automatically have higher capital costs relative to European banks (see next Slide).• Example: For top ASEAN banks For top European banks For top American banks • Basel III‟s CET1 = • Basel II‟s CT1 average = • Basel III‟s Tier 1 Common average of 10.7% 10.2% (one bank has an Ratio average = 8.4% • Basel II‟s CT1 = average average of below 7%) of 11.5% 24
25Asian banks disadvantaged with the use ofsovereign credit rating• Much more capital needed to support the same amount of loans or bonds (based on S&P risk weights, ASEAN+3 banks will need 300% more capital). 25
26Asian banks have high RWA relative to totalassets 26
27 Top banks in Asia Largest Total ROA CAR CAR Country bank Assets (%) (Tier 1 %) (Total %) US J.P. Morgan 2265.79 0.84 12.30 15.40 US Citibank 1873.88 0.59 13.60 16.99 Germany Deutsche Bank 2805.29 0.20 12.90 14.50 France BNP Paribas 2547.68 0.31 11.60 14.00 Philippines Banco de Oro 26.84 0.95 10.00 15.80 India ICICI Bank 94.73 1.61 12.70 18.50 Singapore DBS 279.49 0.89 12.90 15.80 South Korea Kookmin Bank 238.62 0.80 10.14 13.09 Hong Kong HSBC 1333.03 0.28 9.10 14.40 Indonesia Bank Mandiri 56.66 2.23 14.90 17.20 Malaysia Maybank 135.96 1.08 11.84 15.36 China ICBC 2476.30 1.35 10.07 13.17 Mitsubishi UFJ Financial Japan Group 2603.95 0.19 12.31 14.91 Taiwan Bank of Taiwan 135.74 0.09 10.50 11.38 Thailand Bangkok Bank 68.69 1.30 12.21 15.35 27Source: The Asset, Volume 14 Number 11, December 2012.
28Whither Basel III for Asia?• The US has postponed implementation of capital rules for the year 2013 and delayed implementation of liquidity rules. Pressure to delay the start date was due to concerns over the complexity of the rules and the cost to banks at a time of weak global economic growth.• Europe is also re-considering and the Bank of England has expressed concerns on the complexity of the rules, especially since bank supervision is returning to the Bank of England. “Rather than pushing through a flawed Basel III, we need to take the time to do it right so we do not have to do it over. … Basel III‟s implementation has been postponed, and that offers a real chance to get it right. If we do, we won‟t need Basel IV” – Thomas M. Hoenig, 2012*As a result, Basel Committee announced agreement on Liquidity Rules witha delayed phase in period.* Get Basel III right and avoid Basel IV. http://www.ft.com/intl/cms/s/0/99ece1b0-3fa0-11e2-b2ce- 00144feabdc0.html#axzz2HRMF1qU1 28
29Section 2 What are the key issues and concerns?
30Emerging Market banks find it currently easierto meet Basel III requirements Figure 2. International Comparison of the Financial Liabilities/Assets Ratio 30
31Asia has its own national banking developmentagenda and time frame• The extensiveness of the rules will have tremendous implications on re-shaping and micro-managing the business models of banks locally, regionally and worldwide.• This raises the question of whether national regulators should be given more discretion to adjust their regulatory and supervisory guidelines in line with the Basel principles in a manner that suit their national banking development agenda and time frame.• BCBS has now created a small team to look at “simplifying Basel III”. This is the time to engage BCBS through Asian regulators which can influence the final outcome, especially those which are represented either at G20 or FSB/BCBS levels. 31
32Implementation of Basel III will have costs on allbanks, global or local Constrained credit provision by Emerging Market banks Risk of synchronised slowdown globally if Asian growth also constrained by limits on credit Retrenchment and deleveraging by global banks 32
33Issue 1: Potential trap of synchronizedrecession• If the unintended consequences of implementing Basel III are to slow Asian growth because of the limited capacity of the banking system to support the growth of the real economy, especially for SMEs, trade and infrastructure finance, then the whole world may be trapped in a policy-induced unintended synchronized recession.• Solution: Each Asian country should study what are the credit needs projected to 2020 and see if addition capital would be required to meet the new credit needs. 33
34Issue 2: Risk-weightings biased against Asianbanks• Basel capital rules favour banks that have developed “advanced risk models” for determining risk-weighted assets (RWA). Asian banks are some 10 years behind in this respect. Hence, they will not be able to use efficient conversion factors even if they are given a transition period up to 2019.• Solution: Each Asian country will have to develop better data- bases on credit history in order to re-calculate the risk weights; this will enable the larger banks to move toward Internal Risk- Based models with their own risk weights. 34
35Issue 3: Credit ratings biased against Asianbanks• The Basel III risk-weightings are based on current sovereign credit ratings.• Asian economies (and by definition, Asian banks) have lower credit ratings, even though their sovereign debt has high foreign exchange backing (up to 50%) and Asian economies have higher savings and lower fiscal debt.• Many Asian banks are state-owned, thus the urgency to raise large capital cushions is not as imperative as the European case.• Solution: Asia should consider creating Mutual (owned by users and industry) not-for-profit Credit Rating Agencies that can give ratings that are more objectively based. This will provide competition to current top 3 that have become TBTF. 35
36Issue 4: Liquidity risk framework not directlyrelevant to Asian banks• The Basel liquidity risk framework aims to restrain the balance sheets of banks which: (1) are highly leveraged; (2) have significant maturity mismatches; and (3) are funded mainly by the wholesale markets.• However, Asian banks generally do not fall within any of these three categories because they have large deposit bases, the population has high savings rate, and the fiscal and balance of payments positions at the national level are much more robust.Solution: Asian banks should work with central banks toexamine how domestic liquidity can be provided in mannerwhich would not create a „rush for funding‟. 36
37Basel liquidity rules vs. Asian situation • Flexible exchange rates• High loan-to- deposit ratios • Substantial liquid assets• High leverage • Low nominal leverage With low fiscal debt and high foreign exchange, limits on loan-to-deposit ratio, Central Banks can easily provide liquidity to domestic banks. 37
38Issue 5: Asia has huge need for infrastructurefunding• The detailed rules on liquidity, risk-weightings and leverage may constrain the capacity of Asian banks to fund infrastructure since there is growing maturity mismatch risk.• Furthermore, Basel III rules also make asset securitization more expensive.• The ADB estimates that US$8 trillion will be required to finance infrastructure, creating massive potential for the development of Asian municipal and infrastructure bond markets.• Solution: Develop Asia‟s fixed income markets through asset securitization. This would help to lessen the maturity mismatch in bank balance sheets [e.g., Cagamas and HKMC]. 38
39Large interest in infrastructure financing• Asia is at the early stages of securitized debt markets.• China also needs mortgage securitization to reduce maturity mismatch, particularly through bond market. 39
40Issue 6: Trade finance is Asia‟s lifeblood• Trade finance business is forecast to grow at 9% annually to 60% of all global trade by 2020, with one leg in Asia. Trade finance underpins 30–40% of the lending SMEs received. It forms the most relevant part of working capital financing• Solution: Central banks should incentivise banks to promote trade finance and consider establishing a “Trade window” for real market transactions. 40
41How to ringfence trade finance in times of crisis• Central bank could offer low-cost liquidity to commercial banks, against “ringfenced” portfolios of trade assets.• Public entity could purchase trade and hold trade assets directly.• Public entity could “guarantee” specific trade obligations, to support a liquid market in trade assets. 41
42 Basel III‟s impact on trade BAFT-IFSA: Basel III Demand for trade may raise trade finance finance rising rapidly costs by 18-40% 42* BAFT-IFSA, Basel III-Impact on Trade, Tod Burwell, November 2011, Washington, D.C.
43Issue 7: Asia‟s SME development drive and jobcreation• Asia is at the cusp of an SME development drive to promote job creation, innovation and market competition. SMEs rely heavily on trade finance and short-term bank credit, they account for 80-90% of job creation to address employment and equity challenges.• Both European Commission and UK recognize that lending to SMEs, though carrying higher credit risks, have large social benefits in terms of growth and employment generation.• The net effect of higher risk-weights on SMEs and higher costs and lesser credit to SMEs may generate exactly the economic slowdown that creates higher risk for the banking system.• Hence, policymakers have to weigh the positive spillover effects of SME health vs protecting banks against credit risk.• Solution: Policy-makers should work alongside private sources of equity to meet SME financing needs. 43
44Lending to small enterprises still lower thanmedium and large enterprises Figure 3. Growth Rate of Outstanding Loans Extended to Large Enterprises, Medium Enterprises, and Small Enterprises 44
45Access to finance is a major problem for SMEs• A ECB survey shows that access to finance is perceived as the second most pressing problem for SMEs, after their order book.*• Accordingly, the European Banking Authority (EBA) is examining a proposal by the European Parliament to adjust the risk-weights for lending to SMEs, and an increase in the threshold of EUR2 million for the Standardised Approach and EUR5 million for the Internal Ratings-Based (IRB) Approach.* European Central Bank, Survey on the Access to Finance of SMEs in Euro Area, April 2012. 45
46We are in a self-fulfilling vicious cycle Risk- SME weighting have high increases risks risk Economy We do will slow not lend down to SMEs SMEs will not be able to growWe have to distinguish the positive externalities of SMEs, trade finance,infrastructure, which creates jobs and future growth, from the negative externalitiesof fast trading, high leverage, things that will destroy the economy systemically 46
47Issue 8: Implementation cost on bankingoperations• Lastly, the implementation of complex Basel III rules will result in Asian banks incurring disproportionately large costs.• Asian banks are still in the process of implementing Basel I and II (and 2.5); and yet they are now burdened by Basel III.• Asian banks‟ expertise and experience are scarce. –Whether scarcity management and regulatory resources should be focused on developing a banking system that supports and fits Asian realities, rather than “one-size-fits-all” rules designed for implementation by advanced countries.• Global banks have the capacity to absorb these costs but not the smaller national banks in Asia, which are at different stages of development.• Solution: Asian banks should review their business models that can help generate new revenues to help fund these costs. 47
48Non-Bank Assets (NBFI or shadow banking) morethan Bank Assets• Regulatory arbitrage from banks to shadow banks more than bank assets.• Contagion can occur between banks and shadow banking. Risk are not just in banks. 48
49 Basel Rules are not law and do not have legal force • Whilst national regulators need to use Basel III as standards, the total national requirements and law are still paramount. “3. Legal Status. The BCBS does not possess any formal supranational authority. Its decisions do not have legal force. Rather, the BCBS relies on its members commitments, as described in Section 5, to achieve its mandate.” - New Basel Committee on Banking Supervision (BCBS) Charter, January 2013Source: BIS. Group of Governors and Heads of Supervision endorses revised liquidity standard for 49banks http://www.bis.org/speeches/sp130106.htm
50Section 3 Role of Asia finance in rebalancing Asia‟s Growth Model
52National rebalancing must address mismatchesand gaps 52
53Impact of rebalancing on non-reserve currencycountries• For every 10% revaluation relative to G4 countries, the surplus holders of global FX reserves stand to lose roughly 5% of their GDP. Table 2: Impact of Global Imbalances on Surplus Countries - Global Net Foreign Asset (NFA) and Liability Position, 2008 Region/Country Net Foreign GDP NFA/GDP Exchange rate Impact as Asset (+), Deficit 2008 % impact due to % of GDP (-) US$ bn 10% change in US$ bn USD Asian Surplus + 4,994 12,309 + 40.6 - 499 - 4.1 Other Surplus + 2,863 3,706 + 77.3 - 286 - 7.7 Total Surplus + 7,857 16,015 + 49.1 - 786 - 4.9 Euro Area - 2,584 13,631 - 16.9 +258 + 1.9 USA - 3,690 14,441 - 25.6 +369 + 2.6 Australia - 501 1,062 - 47.2 + 50 + 4.7 Subtotal Deficit - 6,775 29,134 - 23.3 + 678 + 2.3 Other Countries - 1,082 16,070 - 6.7 -108 +0.1 Global Total 0 61,219 Source: Author‟s calculations. 53
55What should be Asia‟s stance on Basel III?• Basel III is now a complex rule book of over 600 pages and has become a “one-size-fits-all” rule-book.• Risk that Basel rules have become too prescriptive, leaving little room for banks and regulators in developing countries to exercise judgment in conducting lending activities that support the national development agenda.• The issue is trust between industry and regulators. Board of Directors have fiduciary duty and must be trusted to make their judgment on risks and rewards. Supervisory authorities should step in when there is supervisory judgment that the bank has not recognized the risks and may contribute to systemic risks.• BCBS must trust national regulators to monitor their system risks and only step in (via FSAP/FSB/IMF) if the activities of D-SIFIs, G-SIFIs or national system contribute to global systemic risks. 55
56Basel III is necessary, but not sufficient. Look atsystem as a whole (including shadow banking)• We support Basel III‟s capital adequacy and we are also fine with the compromise on liquidity requirements. The use of model – risk-weighting is still under dispute.• The question is can we solve the banking problem by only looking at the banking system while ignoring the shadow banking, NBFI, and long-term funding issues?• The banking problem is that it is too short-term. Basel III only concentrates on banking but not on shadow banking, capital markets, pension, insurance (the whole system). There is no proper pension or insurance system in place to take the long-term risks.• It doesn‟t mean that “if institutions are fixed, then everything will be fixed”. It‟s the whole class of systemic assets and the linkages of systemic liabilities which cut across different institutions that will cause things to blow up if they become fragile. We need to focus on cross-cutting issues along with institutions. The current policy approach is an “either or” situation. 56
57An implementation time table, customized todomestic conditions and imperatives• Asian policymakers should reconsider the practicality of the time frame in implementing Basel III, and the urgency of adopting broader financial infrastructure and national risk management framework that would help to enhance overall system resilience against endogenous and exogenous shocks.• So long as local banks do not have systemic implications on global markets with negative spillovers, national regulators should reserve the discretion to draw up a timetable for implementation that is customized to domestic conditions and imperatives. 57
58Need to work together• Emerging Asia needs practical implementable rules that best- fit Asian conditions.• We seek to achieve the most effective OUTCOMES of Basel objectives AND systemic stability, including NBFIs. Unless we coordinate, we are less likely to have impact in the global debate. We need to rebalance between implementing rules and financial markets to serve the real economy. We have to avoid rules that will fragilize the Asian economy. 58
59Appendix Amendments to the Liquidity Coverage Ratio (LCR) and the new BCBS Charter; and CRR4
60 Amendments to LCR in four main areas – BCBS, 6 January 2013 High quality assets Definition of high quality assets for LCR (numerator of the ratio) and the factors that (HQLA) & net cash determine the net liquidity outflows that banks would face in stress (denominator of the outflows ratio) Revised timetable • Same as that of capital requirements: coming fully into effect only in 2019 for introduction of • The LCR will be introduced as planned on 1 January 2015. But the minimum the LCR – phase-in requirement will begin at 60%, rising in equal annual steps of 10 percentage points to arrangements reach 100% on 1 January 2019 • This will ensure that the new liquidity standard will in no way hinder the ability of the global banking system to finance a recovery Usability of stock of • During periods of stress, banks can use their stock of HQLA, thereby falling below the liquid assets in minimum. It is the responsibility of bank supervisors to give guidance on usability distress/transition according to circumstances • Countries with distressed banking systems have complete flexibility in their application of the LCR until the distress has passed • Liquidity buffers defined by the LCR are to be used in times of stress • This is applicable both during the transition and in steady state Further work on the • Deposits with central banks are the most liquid asset, the interaction between the LCR interaction between and the provision of central bank facilities is important LCR & the provision • Ensure that banks hold sufficient liquid assets to prevent central banks becoming the of central bank "lender of first resort" facilitiesSource: BIS. Group of Governors and Heads of Supervision endorses revised liquidity standard for 60banks http://www.bis.org/speeches/sp130106.htm
61 LCR - Description • To promote short-term resilience of a bank‟s liquidity risk profile. • To ensure that a bank has an adequate stock of unencumbered high quality liquid assets (HQLA). – Consists of cash or assets that can be converted into cash at little or no loss of value in private markets, to meet liquidity needs for a 30 calendar day liquidity stress scenario. • Two components: Stock of HQLA Total net cash outflows over the next 30 calendar days • Absent a situation of financial stress, the value of the ratio be no lower than 100%1 (i.e. the stock of HQLA should at least equal total net cash outflows). Banks are expected to meet this requirement continuously and hold a stock of unencumbered HQLA as a defence against the potential onset of liquidity stress. During a period of financial stress, banks may use their stock of HQLA, thereby falling below 100%. 61Source: BIS. Annex 1 - Summary description of the LCR.
62 LCR – Detailed changes: HQLA (1/3) Expand the definition of • Corporate debt securities rated A+ to BBB– with a 50% haircut HQLA subject to a higher • Certain unencumbered equities subject to a 50% haircut haircut and limit • Certain residential mortgage-backed securities rated AA or higher with a 25% haircut Aggregate of additional assets, after haircuts, subject to a 15% limit of the HQLA Rating requirement on Use of local rating scales and inclusion of qualifying commercial paper qualifying Level 2 assets Usability of the liquidity Incorporate language related to the expectation that banks will use their pool of pool HQLA during periods of stress Operational requirements Refine and clarify the operational requirements for HQLA Operation of the cap on Revise and improve the operation of the cap Level 2 HQLA Alternative liquid asset Develop the alternative treatments and include a fourth option for sharia- (ALA) framework compliant banks Central bank reserves Clarify language to confirm that supervisors have national discretion to include or exclude required central bank reserves (as well as overnight and certain term deposits) as HQLA as they consider appropriate 62Source: BIS. Annex 2 - Complete set of agreed changes to the Liquidity Coverage Ratio.
63 LCR – Detailed changes: Inflows and Outflows (2/3) Insured deposits • Reduce outflow on certain fully insured retail deposits from 5% to 3% • Reduce outflow on fully insured non-operational deposits from non-financial corporates, sovereigns, central banks and public sector entities (PSEs) from 40% to 20% Non-financial corporate Reduce the outflow rate for “non-operational” deposits provided by non-financial corporates, deposits sovereigns, central banks and PSEs from 75% to 40% Committed liquidity Clarify the definition of liquidity facilities and reduce the drawdown rate on the unused portion of facilities to non-financial committed liquidity facilities to non-financial corporates, sovereigns, central banks and PSEs corporates from 100% to 30% Committed but unfunded Distinguish between interbank and inter-financial credit and liquidity facilities and reduce the inter-financial liquidity and outflow rate on the former from 100% to 40% credit facilities Derivatives • Additional derivatives risks included in the LCR with a 100% outflow (relates to collateral substitution, and excess collateral that the bank is contractually obligated to return/provide if required by a counterparty) • Introduce a standardised approach for liquidity risk related to market value changes in derivatives positions • Assume net outflow of 0% for derivatives (and commitments) that are contractually secured/collateralised by HQLA Trade finance Guidance to indicate that a low outflow rate (0–5%) is expected to apply Equivalence of central Reduce the outflow rate on maturing secured funding transactions with central banks from 25% bank operations to 0% Client servicing brokerage Clarify the treatment of activities related to client servicing brokerage (which generally lead to an increase in net outflows) 63Source: BIS. Annex 2. http://www.bis.org/press/p130106.htm
64 LCR – Detailed changes: Clarification to rule text and LCR phase-in (3/3) Rules text • Clearer guidance on the usability of HQLA, and the clarifications appropriate supervisory response, has been developed to ensure that the stock of liquid assets is available to be used when needed • A number of clarifications to the rules text to promote consistent application and reduce arbitrage opportunities (e.g., operational deposits from wholesale clients, derivatives cash flows, open maturity loans). Also incorporating previously agreed FAQ Internationally The minimum LCR in 2015 would be 60% and agreed phase-in increase by 10 percentage points per year to reach of the LCR 100% in 2019 64Source: BIS. Annex 2. http://www.bis.org/press/p130106.htm
65 Capital Requirements Regulation (CRR 4) – Overall impact on trade finance (TF) • CRR 4 is the equivalent of Basel 3 and will be implemented in Europe across all 27 countries. • Proposed changes under CRR4 in the treatment of TF products supportive of TF, which is a critical part to keep the economy ticking on an even keel. • Recognition that TF is a low risk activity. – ICC study for 2011* shows on an industry-wide basis, there were fewer than 3,000 defaults observed in a dataset comprising 11.4 million transactions collected for 2005-2010. Typical loss rates for 2008-2010: for TF products like L/Cs were 0.007%, export confirmed L/Cs 0.03%, Import loans 0.07%, export loans 0.017%. – Strong case for arguing that Trade deserves a better treatment under the internal ratings based approach (IRB). A lower asset value correlation charge (AVC) for TF products would go some way to ensure that trade products get the appropriate capital treatment they deserve. 65Source: International Chamber of Commerce (ICC). Global Risks ‒ Trade Finance, 2011.
66 Capital Requirements Regulation (CRR 4) – Proposed changes Uniform • Under Basel 2, local regulators had to translate the European rules into local rules and rule book regulations – this created scope for differences in the rules and regulations Maturity Floor • Basel left open the option to national discretion to extend the MFW to all TF products – Waiver (MFW) CRR-4 proposes to extend the MFW to all TF productsCredit Conversion • To reduce CCF applied to non-financial guarantees (i.e. bid bond, advance payment, Factor (CCF) performance and retention guarantees) from 50% to 20% • Under Basel III and CRR 4, exposures to large financial institutions (assets > $100bn) will attract a 1.25 scaling factor to account for systemic risk • While systemic risk is an important issue for banks, trade finance was not a contributor to Asset Value the increased systemic risk within banks during the crisis and should not be penalised Correlation • Important to note that increased linkages between banks, at least for trade finance, is a (AVC) function of a bank‟s primary role in facilitating payments within the financial system and not necessarily one of taking on increased counter party risk • Hence, strong case for arguing that the scaling factor applied should be a range varying from anything greater than 1 to a max. of 1.25 instead of applying a flat scaling factor of 1.25 across all banks Leverage • To apply more favourable CCF of 20% and 50% to TF products like L/Cs and guarantees. Ratio Basel III proposes to apply a 100% CCF to all contingent liabilities including TF products Liquidity • To recognise 100% of trade inflows in the calculation of the liquidity coverage ratio (LCR) Ratios in lieu of the Basel III proposed 50% of trade inflows 66