Basel 3 July 2012


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Basel iii Compliance Professionals Association (BiiiCPA)

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Basel 3 July 2012

  1. 1. 1Basel iii Compliance ProfessionalsAssociation (BiiiCPA)1200G Street NW Suite800Washington, DC 20005-6705USA Tel:202-449-9750Web: www.basel-iii-association.comDear Member,Todaywewill start from the3reallyimportant papersthat havetodowiththeimplementationof the Basel iii frameworkin theUSA.Thethree noticesof proposed rulemaking (NPRs), taken together, willrestructuretheBoard‘scurrent regulatorycapital rulesintoaharmonized,comprehensiveframework,and will revisethecapital requirementstomake them consistent withthe BaselIII capital standardsestablishedbytheBasel Committeeon Banking Supervision (BCBS) and certainprovisionsof the Dodd-Frank Wall Street Reform and ConsumerProtectionAct (Dodd-Frank Act).Theproposalsarepublished in separate NPRsto reflect thedistinctobjectivesof each proposal,toallowinterested partiesto betterunderstandthevariousaspectsoftheoverall capitalframework,includingwhichaspectsof therule wouldapplyto whichbanking organizations,andtohelp interestedparties better focustheir commentson areasofparticular interest.Theproblem iswedid not learnmore about thequantitativeliquidityrequirementsand thecapital surcharge for global systemically importantbanks(thesearenot part of this rulemaking).I hopewewill havemore detailssoon.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  2. 2. 2Basel III in the USABasel iii ComplianceProfessionalsAssociation (BiiiCPA)
  3. 3. 3Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  4. 4. 4Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  5. 5. 5Basel III in the USA, Board of Governorsof the Federal Reserve3:30PM, Thursday, June 7, 2012- MarrinerS.Eccles FederalReserveBoard Building, 20th Street entrancebetweenConstitutionAvenue andC Streets,N.W., Washington, D.C.Mattersto be Considered:Discussion Agenda:1.Proposed interagencyrulemakings:strengtheningand harmonizingtheregulatorycapital frameworkfor banking organizations,includingproposedrules for implementingBasel III for banking organizationsandproposedconsolidatedcapital requirementsfor savingsand loan holdingcompanies.2. Final interagencyrulemaking:market risk capital rule.Proposed Rulemakingsfor an Integrated Regulatory CapitalFramework, Questions and AnswersJune7, 2012Question 1:What doesthe package of proposed rulemakingscontain and whyisit divided into three parts?Thepackagecontainsthreenoticesof proposedrulemaking(NPRs)that, taken together, wouldrestructure the Board‘s current regulatorycapital rules intoa harmonized, comprehensiveframework,and wouldrevisethecapital requirementsto make them consistent withtheBaselIIIcapital standardsestablishedby the BaselCommitteeon BankingSupervision (BCBS) andcertainprovisionsof theDodd-Frank Wall StreetReform and Consumer ProtectionAct (Dodd-FrankAct).Theproposalsarepublished in separate NPRsto reflect thedistinctobjectivesof each proposal,toallowinterested partiesto betterunderstandthevariousaspectsoftheoverall capitalframework,includingwhichaspectsof therulewouldapplyto whichbankingorganizations,and tohelp interestedparties better focustheir commentsonareasof particular interest.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  6. 6. 6TheBCBS quantitativeliquidityrequirementsand the BCBS capitalsurchargefor global systemically important banksare not part of thisrulemaking.First Paper: The Basel III NPR1.Thefirst NPR, Regulatory Capital Rules:RegulatoryCapital, Implementation ofBasel III, MinimumRegulatory CapitalRatios,Capital Adequacy, Transition Provisions,and Prompt CorrectiveAction (Basel III NPR), is primarily focused on proposed reformsthatwouldimprovethe overall qualityand quantityof banking organizations‘capital.TheNPR wouldrevisetheBoard‘srisk-basedand leveragecapitalrequirements,consistent withthe Dodd-FrankAct and withagreementsreached by the BCBSin Basel III: AGlobal Regulatory FrameworkforMoreResilient Banksand BankingSystems (Basel III).Theproposalincludestransitionprovisionsdesignedtoprovidesufficienttimefor banking organizationstomeet the new capital standards whilesupporting lendingtotheeconomy.Second Paper: The Standardized Approach NPR2.Thesecond NPR, RegulatoryCapital Rules:StandardizedApproachfor Risk-weightedAssets;Market Disciplineand DisclosureRequirements(StandardizedApproach NPR), wouldrevise andharmonizethe Board‘srulesfor calculatingrisk-weightedassetstoenhancetheir risk sensitivityand addressweaknessesidentifiedoverrecent years.It wouldincorporateaspectsof theBCBS‘sBasel II standardizedframeworkintheInternationalConvergenceof Capital Measurement andCapital Standards:ARevised Framework (Basel II), Basel III, andalternativestocredit ratingsfor the treatment of certainexposures,consistent withtheDodd-FrankAct.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  7. 7. 7Third Paper: TheAdvanced Approaches and Market Risk NPR3. The third NPR, Regulatory Capital Rules:AdvancedApproachesRisk-basedCapital Rule;Market RiskCapital Rule(AdvancedApproachesand Market Risk NPR), wouldrevise the advancedapproachesrisk-basedcapital rule (in amanner consistent withtheDodd-FrankAct) and incorporatecertain aspectsof Basel III that theBoard wouldapply onlyto advanced approachesbanking organizations(generally, the largest, most complex banking organizations).This NPR wouldalsocodify the Board‘smarket riskcapital rule and, incombination withthe other componentsdescribedabove, wouldapplyconsolidatedcapitalrequirementstosavingsandloanholdingcompanies(SLHCs).Question 2: Which banking organizationsare covered by theproposed rulemakings?TheBasel III NPR and the StandardizedApproach NPR wouldapply tostatemember banks, bank holding companiesdomiciledin the UnitedStatesnot subject tothe Board‘s Small Bank Holding Company PolicyStatement (generally, bank holdingcompanieswithlessthan$500millionin consolidatedassets), and SLHCsdomiciledin theUnitedStates.Consistent withSection 171of the Dodd- FrankAct, the proposedrulemakingswouldapplytoall SLHCs regardlessof assetsize.TheAdvanced Approachesand Market Risk NPR would generallyapplytobanking organizationsmeeting specified thresholds.In general, the advanced approachesrisk based capital ruleappliestothosebankingorganizationswithconsolidatedtotal assetsof at least$250billion or consolidatedtotal on-balancesheet foreign exposuresof at least$10billion(excludinginsuranceunderwritingassets)and their depositoryinstitutionsubsidiaries.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  8. 8. 8Themarket risk capital rule generallyappliestothosebankingorganizationswithaggregate trading assetsand tradingliabilitiesequaltoat least 10 percent of quarter-endtotal assetsor $1billion.Question 3: How are these proposed rulemakingsrelated to theDodd-Frank Act?TheNPRs are consistent withstatutoryrequirementsin theDodd-FrankAct.For example, pursuant tosection 171of the Act, the NPRs would establishminimum riskbased and leverage capital requirements for SLHCs, phaseout certain capital instrumentsover a three-year period, and establish newminimum generallyapplicablecapital requirements.In addition, pursuant to section 939Aof theact, theNPRs removereferencesto, or requirementsof relianceon, credit ratingsin theBoard‘scapital rulesand replacethem withalternativestandardsofcreditworthiness.Question 4: What are the main changesto the minimum capitalrequirements?Theproposal includesa new common equity tier 1minimum capitalrequirement of 4.5percent of risk-weightedassetsand a common equitytier 1capital conservation buffer of 2.5 percent of risk-weightedassets.Theproposal alsoincreasesthe minimum tier 1capital requirement from4to 6 percent of risk-weightedassets.Theminimum total riskbasedcapital requirement would remainunchanged at 8 percent.Theproposal introducesa supplementaryleverageratiothat incorporatesa broader set of exposuresin thedenominatormeasure of theratioforbankingorganizationssubject tothe advanced approachescapital rule.This supplementaryleverageratiois based on the international leverageratio in BaselIII.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  9. 9. 9Question 5: What arethe main changesrelated to the definitionof capital being proposed?Capital instrumentsissuedbybanking organizationswouldbe subject toa set of strict eligibilitycriteria that wouldprohibit, for example, theinclusionin tier 1capital of instrumentsthat are not perpetual or thatpermit the accumulationof unpaid dividendsor interest.Trust preferred securities,for example, wouldbe excluded from tier 1capital, consistent withboth Basel III and the Dodd-Frank Act.Under the Basel III NPR, banking organizationswould be subject togenerally stricter regulatory capital deductions (the majority of whichwouldbe taken from common equitytier 1capital).For example, deductionsrelatedtomortgageservicingassets, deferredtax assets,and certain investmentsin thecapital of unconsolidatedfinancial institutionswouldgenerallybe more stringent than thoseunderthecurrent rules.Question 6: What is the capital conservation buffer and howwould it work?In order toavoid limitationson capital distributions(includingdividendpayments, discretionarypaymentson tier 1instruments,and sharebuybacks) and certain discretionarybonuspayments, under the proposalbankingorganizationswouldneed to hold a specific amount of commonequitytier 1capital in excessof their minimum risk based capital ratios.Thefullyphased-inbuffer amount wouldbe equal to 2.5percent ofrisk-weightedassets.Question 7: Will the new capital requirements and capitalconservation buffer be imposed immediately or will there be atransition period?Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  10. 10. 10TheBasel III NPR containstransition provisionsdesigned togive ampletimeto adjust to thenew capital requirements, consistent with theagreement in Basel.Thenew minimum regulatory capital ratiosand changesto thecalculationof risk weightedassetswouldbe fullyimplementedJanuary1,2015.Thecapital conservation buffer framework wouldphase-in between2016and 2018,withfull implementationJanuary 1,2019.Question 8: What is common equity tier 1capital and whyareyou proposing a new common equity tier 1requirement?Common equitytier 1capital is a new regulatory capital component thatis predominantlymade up of retained earningsand common stockinstruments(that complywitha seriesof strict eligibilitycriteria), net oftreasury stock, and net of a series of regulatory capital deductionsandadjustments.Common equitytier 1capital may alsoincludelimitedamountsofcommon stock issued by consolidatedsubsidiariesto third parties(minorityinterest). Common equitytier 1capital is the highestqualityform of regulatory capital because of its superior ability toabsorblossesin timesof market and economic stress.Question 9: What are the main elements of the StandardizedApproach NPR?It wouldincreasethe risk sensitivityof the Board‘sgeneral risk-basedcapital requirementsfor determiningrisk-weightedassets(that is, thecalculationof thedenominator of a banking organization‘srisk-basedcapital ratios) by proposingrevised methodologiesfor determiningrisk-weightedassetsfor:- Residential mortgageexposuresby applying a more risk-sensitivetreatment that wouldrisk-weight an exposurebased on certain loancharacteristicsand itsloan-tovalueratio;Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  11. 11. 11- Certaincommercial real estatecredit facilitiesthat financetheacquisition, development, or construction of real property byassigninga higher riskweight;- Exposuresthat aremore than 90days past due or on nonaccrual(excludingsovereignand residential mortgage exposures) byassigninga higher riskweight;and- Exposurestoforeign sovereigns,foreign banks, and foreign publicsectorentitiesbybasingtherisk weight for each exposuretype onthecountry riskclassificationof the sovereignentity.TheNPR wouldalsoreplacetheuseof credit ratingsfor securitizationexposureswitha formula-based approach.Additionally, theNPR wouldprovidegreater recognitionof collateralandguarantees.However,for most exposures,no changesare beingproposed in theNPR.Morespecifically, the treatment of exposurestothe U.S.government, government-sponsoredentities,U.S. statesandmunicipalities,most corporations,and most consumer loanswouldremainunchanged.It would introduce disclosure requirements that would apply to bankingorganizations domiciled in the United States with $50 billion or more intotal assets, includingdisclosuresrelatedto regulatory capital.Thechangesin theStandardizedApproach NPR areproposed to takeeffect January 1,2015.Bankingorganizationsmay choosetocomplywiththe proposedrequirementsprior tothat date.Question 10:What are the primary objectives of theAdvancedApproachesand Market Risk NPR?It wouldrevisethe advanced approachesrisk-basedcapital rule in amanner consistent withthe Dodd-Frank Act by removingreferencestoBasel iii ComplianceProfessionalsAssociation (BiiiCPA)
  12. 12. 12credit ratingsfrom the securitizationframework, requiring an enhancedset of quantitativeand qualitativedisclosures(especiallyin regard todefinitionof capital and securitization exposures), implement a highercounterpartycredit risk capital requirement toaccount for creditvaluation adjustments,and proposecapital requirementsfor clearedtransactionswithcentral counterparties.TheNPR wouldincorporate the market risk capital rulesintotheintegratedregulatory capital frameworkand proposeitsapplicationtosavingsand loan holdingcompanies that meet the tradingthresholds.Question 11:How will the Prompt Corrective Action (PCA)framework change asa result of the proposed rulemakings?Under the proposal, the capital thresholdsfor thedifferent PCAcategorieswouldbe updatedtoreflectthe proposed changesto thedefinitionof capital and the regulatorycapital minimum ratios.Likewise,the proposal wouldaugment the PCAcapital categories byincorporatinga common equitytier 1capital measure.In addition, theproposal wouldincludein the PCAframework theproposed supplementaryleverageratio for advanced approachesbankingorganizations.Note thatthenewPCAframeworkwouldtakeeffectstartingonJanuary1,2015,consistent withthefull transition of theminimum capitalrequirementsand theStandardizedApproach for the calculation of riskweightedassets.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  13. 13. 13Basel Committeeon BankingSupervisionReport to G20 Leaders on Basel IIIimplementationJune2012Introduction and summaryAt their 2010summit in Seoul, the G20LeadersendorsedtheBasel III regulatoryframeworkasfollows:―Weendorsed thelandmark agreementreached bytheBCBSonthenewbankcapital and liquidityframework,whichincreasestheresilience oftheglobal bankingsystem byraising thequality, quantityandinternational consistency ofbank capital andliquidity, constrainsthebuild-up of leverage andmaturitymismatches,and introducescapital buffers abovetheminimumrequirementsthat canbedrawnuponin bad times.‖In November 2011, the Leaders,at their summit in Cannes,emphasisedtheimportanceof implementingBaselIII:―Wearecommitted toimprovebanks resiliencetofinancial andeconomicshocks. Buildingonprogressmadeto date, wecall onjurisdictionsto meet their commitment toimplement fullyandconsistentlytheBasel II risk-based framework aswell astheBasel IIadditional requirementsonmarket activitiesand securitisation byend2011andtheBasel III capital and liquiditystandards, whilerespectingobservation periodsand review clauses, startingin 2013and completingfull implementation by1January 2019.‖This interim report details the progressthemembersof theBaselCommitteeon BankingSupervision havemade todate in implementingtheBasel III regulatory framework(includingBaselII and Basel 2.5,whichnow form integral parts of BaselIII).Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  14. 14. 14The report also describes various implementation issues identifiedthrough the comprehensive process the Committee has adopted tomonitor members‘implementationof BaselIII.Compared to the statusat end-September 2011and end-March 2012, whenthe Committee published previous reports, significant progress has beenobserved.However,there are jurisdictionswhichhavemissedthe globally-agreedimplementationdatesfor Basel II and 2.5.There are also jurisdictions that have not made enough progress to dateon Basel III and thus pose concern as to their ability to meet the agreedBasel III implementationdate.As of end-May 2012,21of 27Basel member countrieshave implementedBasel II, whichhad been due tocome intoforce from end-2006.In addition, Indonesia and Russiahave implemented BaselII‘sPillar 1(minimum capital requirements).Argentina, China, Turkey and theUnited Statesare in theprocessofimplementingBaselII.With regard toBasel 2.5, whichwasdue tobe implementedfrom end2011, 20 member countrieshave final rulesthat are in force.Argentina, Indonesia,Mexico,Russia,TurkeyandtheUnitedStateshavenot issued final regulations.Russiaand theUnitedStateshaveissueddraft regulationswhichpartiallycover Basel 2.5.SaudiArabia hasissuedfinal regulationsbut thesehavenot yet comeintoforce.Among the 29 global systemically important banks (G-SIBs) identified inNovember 2011, nine are headquartered in jurisdictions that have not yetfullyimplementedBasel II and/ or Basel 2.5.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  15. 15. 15Draft Basel III regulationshavenot yet been issuedby seven BaselCommitteemember jurisdictions:Argentina, Hong KongSAR, Indonesia, Korea, Russia, Turkeyand theUnited States.Themajorityof thesejurisdictionsbelievetheycan issuefinal regulationsin time toimplement by the deadlineof 1January 2013.However,for others, dependingon their domesticrule-makingprocess,meetingthedeadlinecould be a significant challenge.In additiontomonitoring whetheritsmembershaveissuedregulationstoimplement theBaselIII rules,the BaselCommittee hasestablished aprocessto review thecontent of the new rules.This second level of review is meant to ensure that thenationaladaptationsof Basel III are consistent withthe minimum standardsagreedto under Basel III.TheBasel Committeehasinitiatedpeer reviewsof the domesticregulationsof theEuropean Union, Japanand theUnited Statestoassesstheir consistencywiththe globallyagreed standards.Thefindingsof these reviewsarepreliminarysincetheformulation ofnational standardsis still ongoing and the analysisis not yet completed.Nevertheless, there isa possibilitythat national implementation will beweakerthan theglobally-agreedstandardsin some key areas.TheBasel CommitteeurgesG20 Leadersto call on jurisdictionstomeettheir commitmentsmadein Cannestoimplement Basel III fully andconsistently, and within the agreedtimetable.AthirdlevelofimplementationreviewconductedbytheBaselCommitteeexamineswhetherthere areunjustifiableinconsistenciesin riskmeasurement approachesacrossbanksand jurisdictionsand theimplicationsthesemight have for the calculationof regulatorycapital.This review of banks‘ risk-weightingpracticesincludestheuse of testportfolio exercises,horizontal reviewsof practicesacrossbanksandjurisdictions,andjoint on-sitevisitstolarge, internationally-activebanks.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  16. 16. 16TheBasel Committeefirmly believesthat full, timely and consistentimplementationof Basel III amongitsmembersis essential for restoringconfidencein theregulatory frameworkfor banks and to help ensure asafeand stableglobal banking system.TheCommitteewill providean updated progressreport toG20FinanceMinistersand central bank governors at their meetingin November 2012.That report will provide(i)An updateon Basel Committee members‘domestic rule-making,(ii)Thefinal outcome of the regulatoryconsistencyassessment of theEuropean Union, Japan and the UnitedStates,and(iii)Preliminaryfindingsfrom theCommittee‘sdeeperanalysisonbanks‘risk measurement approachesand regulatorycapital calculations.This interim report isbased on the informationthat wasavailableto theBasel Committeeon 31May2012.Subsequent tothisdate, furtherinformation hasbecomeavailablein boththeEU and USbut there hasbeen insufficient time toassesswhethertheselatestdevelopmentsare compliant withthe Baseltext for thisinterim report.Basel standardsIn June 2004, a package of reformsknown asBasel II introducedmorerisk-sensitiveminimum capital requirementsfor banks, includinganenhancedmeasurement of credit risk, and captureof operational risk.Basel II alsoreinforcedthe requirementsby settingout principlesforbankstoassesstheadequacyof their capitalandfor supervisorstoreviewsuch assessmentsto ensure bankshave the necessarycapital to supporttheir risks.It alsostrengthenedmarket disciplineby enhancingtransparencyinbanks‘financial reporting.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  17. 17. 17Thedeadlinefor implementation of theBasel II frameworkby memberjurisdictionswastheend of 2006.In July2009, enhancementsto themeasurement of risks relatedtosecuritisationand tradingbook exposureswereagreed in responsetoearlylessonsfrom the2007/ 08crisis.An implementationdeadlineof theend of 2011wasset for thesereforms,referredto asBasel 2.5.In December 2010,the BaselCommitteepublished Basel III, acomprehensiveset of reforms toraisetheresilienceof banks. Basel IIIaddressesboth firm-specific and broader, systemic risksby:- Raisingthequalityof capital, withafocusoncommon equity, andthequantitytoensure banksarebetter ableto absorblosses;- Enhancingthe coverage of risk, in particular for capital marketactivities;- Introducingadditional capital buffers for the mostsystemicallyimportant institutionsto addresstheissueof ―toobig tofail‖;- Introducingan internationallyharmonised leverageratiotoserve asabackstop to the risk-basedcapital measure and tocontain thebuild-upof excessiveleveragein the system;- Stronger standardsfor supervision (Pillar 2), public disclosures (Pillar3), and risk management;- Introducingminimum global liquiditystandardstoimprove banks‘resiliencetoacuteshort term stressand toimprove longer termfunding;and- Introducingcapital bufferswhichshould be built up in good timessothat theycan be drawndown during periodsof stress.Theimplementationperiod startsfrom 1January 2013and includestransitional arrangementsuntil 1January 2019.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  18. 18. 18Thetransitional arrangementsare availableto give bankstime to meetthehigher standards, whilestill supportinglendingto the economy. Theliquidityrequirements,leverageratio and systemic surchargescome intoforceon a phasedapproach startingfrom 2015and will, therefore,beassessed later and are not covered in this report.Design of the Committee‘s Basel III Implementation ReviewProgrammeIn January 2012, the Group of Central Bank Governors and HeadsofSupervision(GHOS), theBasel Committee‘soversight body, endorsedthecomprehensiveprocessproposedby theCommitteetomonitormembers‘implementationof Basel III.Theprocessconsistsof the followingthree levelsof review:- Level 1: ensuring thetimely adoption of Basel III;- Level 2: ensuringregulatory consistencywithBaselIII; and- Level 3: ensuringconsistencyof outcomes(initiallyfocusingonrisk-weightedassets).TheBaselCommitteehaspublished two―Level 1‖ progressreports. Ithasagreed on a detailed ―Level 2‖ assessment processand startedreviewsof the European Union, Japan and theUnited States.Its ―Level 3‖ reviewsanalyse existingdata on risk measuredby banks‘modelsand are designingprocessesfor deeper analysis.TheBasel Committeehasworked in closecollaboration withtheFinancial Stability Board (FSB) given theFSB‘s role in coordinatingthemonitoring of implementationof regulatoryreforms.TheCommitteedesigned itsprogrammeto be consistent withtheFSB‘sCoordination Frameworkfor MonitoringtheImplementationofFinancial Reforms(CFIM) agreed by the G20.Theobjectivesand the processof each of the three levelsof review are asfollows.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  19. 19. 19Level 1:Timely adoption of Basel IIITheobjectiveof the―Level 1‖assessment is to ensure that BaselIII istransformedintodomestic regulationsaccordingto the agreedinternational timelines.It does not include the review of the content or substance of the domesticrules. Each Basel Committee member jurisdiction‘s statusis reported in asimpletable.Separately, theFinancial Stability Institute(FSI) of the Bank forInternational Settlementsissurveying non-Basel Committeemembercountries.Theoutcome of this workwill be publishedby the FSI in thecomingmonths.Level 2: Regulatory consistencyTheobjectiveof the―Level 2‖ assessmentsis toensurecomplianceofdomesticregulationswiththeinternational minimum requirements.Delays or failures toadopt domesticregulationsidentifiedby the Level 1review will feed intothe Level 2 assessment.All Level 2 assessmentswill be summarised usingthe followingfour-gradescale:compliant, largely compliant, materiallynon-compliantandnon-compliant.TheCommitteeintendsto produce an overall assessment, aswell asassessmentsof themain componentsof Basel III.All Basel Committeemember countrieswill be assessed over time.TheCommitteedecidedtoprioritiseitsreviews, focusing first on thehomejurisdictionsof global systemicallyimportant banks (G-SIBs).Thefirstreviewscommencedin February 2012withtheEuropeanUnion, Japan and the United States.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  20. 20. 20Asummary of the processfor the Level 2reviewsis included in appendix2of thisreport.Level 3: Risk-weighted assets consistencyTheobjectiveof the―Level 3‖ assessmentsistoensurethat theoutcomesof the new rulesare consistent in practiceacrossbanksand jurisdictions.It extendsthe findingsof Levels1and 2, both of whichfocuson nationalrules and regulations,tosupervisoryimplementation at the bank level.TheCommitteehasestablishedtwoexpert groups, one on the bankingbook and the other on the tradingbook.Thesegroupswill identify areasof material inconsistenciesin thecalculationof risk-weightedassets(RWAs, or the denominator of theBasel capital ratio).Depending on the outcome, thework may result in policyrecommendationstoaddressidentified inconsistencies.Preliminary findingsLevel 1Thetablesin appendix 1show member countries‘implementationstatusasof end-May 2012.The tablesusethe followingnumber codes:- ―1‖ for draft regulationnot published,- ―2‖ for draft regulationpublished,- ―3‖ for final rule published, and- ―4‖ for final rule in force.Summaryinformationabout thenext stepsandtheimplementationplansbeingconsidered by membersare alsoprovided for each jurisdiction.Separatetablesare produced for each of Basel II, Basel 2.5 and Basel III.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  21. 21. 21For Basel II and 2.5, whichshould be implementedalreadyaccordingtotheagreed timetable, countries that havefullyimplementedare showningreen;thosein the processof implementingare shownin yellow;andthosethat have not yet issued draft regulationsare shown in red.Compared to the statusat end-September 2011and end-March 2012, whenthe Committee published previous reports, significant progress has beenobserved.However,there are jurisdictionswhichhave missedtheglobally-agreedimplementationdatesfor Basel II and2.5. There arealsojurisdictionsthat havenot madeenough progresstodate on Basel III and thuspose concern asto their abilityto meet theagreedBaselIII implementation date.Basel IIThree-quartersof member countries have implementedtheBasel IIrequirements.Of the remainingsix countries, Indonesiaand Russiahave implementedPillar 1(minimum capital requirements) but not Pillar 2 (supervisoryreview process) or Pillar 3 (disclosureand market discipline).Turkeyexpectsto be fullycompliant by July2012.Chinahasissuedfinalregulationsand iscurrentlyassessingapplicationsfor advancedapproachessubmittedby largebanks.TheUnited Statesis in ―parallelrun‖ (ie runningboth Basel I and BaselII calculationfor itslargest banks), although Basel I rules remain thelegal minimum.Argentina implementedruleson operational risk in April 2012.Basel 2.5Again, a majorityof Basel Committeemember countries (20out of 27Basel Committeemembers) have implemented therequirements, but aBasel iii ComplianceProfessionalsAssociation (BiiiCPA)
  22. 22. 22significant minorityare either still in theprocessof implementationorhavenot started theprocessfor implementation.Russiaand the United Stateshave issued draft regulationscoveringthemarket riskelementsof the enhancements.TheUS regulationsweremodified in December 2011to incorporaterestrictionson theuseof credit ratingsasset forth in theDodd-Frankregulatoryreform legislation.Other member countries whichhavenot implemented Basel 2.5 areArgentina, Indonesia, Mexico, Saudi Arabia and Turkey.Basel IIIThree countries – India, Japan and SaudiArabia – havepublishedfinalregulationsnecessaryfor implementingthe BaselIII packagefrom 1January 2013.Full application startsin Japan at the end of March2013to matchJapanesebanks‘fiscal year end.TheEuropean Union haspublishedseveral roundsof draft directivesandregulations(CRD4/ CRR) and is expectingto have final rulesby the endof June.TheEU level regulationsimplement most elementsof the BaselIIIpackagedirectly.This meansthereis noneed for national regulationstotransposetheregulationsintotheir domesticlegislation.Thefollowingseven member jurisdictionshave not issued draftregulations:Argentina, Hong KongSAR, Indonesia, Korea,Russia, Turkey and the UnitedStates.Themajorityof these countriesbelieve theycan finaliseregulationsintimefor the agreed start dateof 1January 2013.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  23. 23. 23However,for others, dependingon thedomestic rule-makingprocess,meetingthedeadlinecould be a significant challenge.Level 2Thefirst three BaselIII regulatory consistencyassessmentsare currentlyunder wayfor the European Union, Japan and the United States, whichare beingconductedin parallel.In the initial phaseof the Level 2 assessment process,the jurisdictionshavebeen askedtocompletea detailed self-assessment questionnaireandtoprovideall componentsoftheregulationsthat implement BaselIII atthedomesticlevel.After receivingthe completed questionnaires, peer review teamsofsupervisorshave reviewedthecompleted selfassessment and drafted aninitial list of preliminary findings.TheEuropean Union, Japan and theUnitedStatesare at different stagesof Basel III implementation.Given thesedifferences, the depth of thepreliminary Level 2findingsdiffers.The reviews are still work in progress and this interim report is basedsolely on preliminary findings that are subject to further review as theanalysisprogresses.Currently, thepeer review teamsarein the processof furtheranalysingthepreliminaryfindingsbasedon additional clarificationsthat werereceivedfrom the jurisdictionsconcerned.Thereview teamsare alsoworkingon theassessment of thepotentialmaterialityof their findings,usingquantitativebank-specific data thatwasprovided by the authorities.An important element in the second phaseof theassessment will be anon-sitevisit wherethe teamswill discusstheir findingswiththeBasel iii ComplianceProfessionalsAssociation (BiiiCPA)
  24. 24. 24authoritiestofurther narrowdownthematerialityof thefindingstoarriveat a final assessment.Theon-site visits are tentativelyscheduledin June and July. The finalreport isexpected tobe submitted totheBasel Committeein September2012,and will be published shortlythereafter.Theabsenceof any item among the topicsmentionedabovedoesnotnecessarilymean that thereviewteamwill not add new itemstothelist ofissuesfor further investigationduring theprogresstowardsthe finalreport.European UnionThereview of the European Union (EU) rulesrelatedto Basel III hasbeen complicatedbytheabsenceof a stableEU text implementingBaselIII.As a pragmaticchoice,the review team selectedthe Third DanishPresidencyCompromiseproposalsfor the basisof thisinterim report.This choice does not imply any endorsement by the assessment team ofthese proposals, but simply responds to the need to use the most recentdraft such that the text remains stable for the time required to completetheinterim review.At the timethis interim report wasprepared, the final version ofCRD4/CRR – therulesfor implementingBasel III in theEuropeanUnion – werenot yet published.Thereforethe number and nature of thefindingsset out in theBaselCommittee‘sfinal report may changesubstantiallyfrom those containedin this interim report to the extent that the final CRD4/CRR rules differfrom theThird DanishCompromise proposals.BesidesthechangingnatureoftheEU proposals,theassessment hasalsobeen difficult due tothe particularitiesof theEU rule-makingprocess.Thismeant that theEuropean Commission(EC) wasunabletocompletetherequested self-assessment questionnaire, beyond mapping theBaselBasel iii ComplianceProfessionalsAssociation (BiiiCPA)
  25. 25. 25frameworktotheJuly2011EC proposalsand providingexplanatorynoteson thecomplianceof key areasof theEU regulationwith Basel III.Unlike the other assessments,whichhave benefitedfrom countryself-assessments,theEU review team hasnot been able to draw on acomprehensiveself-assessment from which tobegin itsassessmentprocess.Despitethesedifficulties, thereview team conducteda detailedpreliminaryassessment of theEU framework.This assessment benefitedfrom face-to-facediscussionsbetweentheleaderofthereviewteamandEC staff aswellaswithrepresentativesfromtheEuropeanBankingAuthority, theEuropeanCentral Bank, theDanishPresidency, and thenineEU countrieswhicharealsoBCBSmembers.Preliminary findingsTheinitialassessment processhasidentifiedalargenumber offeaturesofthecurrent EU Basel III proposalsthat will require further investigation.Most of these issueswill probablyproveeither consistent with the Baselframework,or immaterial in practice.There seems to be a small number of issues, however, that are potentiallymaterial and will need to be subject toa detailed assessment by the reviewteam.TheEU frameworkhasbeen developed withtheprincipleof ―maximumharmonisation.‖This is designed with the aim of achieving a high level of harmonisationof banking rules and limiting divergence between the approaches takenbyindividual national authorities.While not a matter of direct relevancetothe assessment in the firstinstance,theability for an individual national regulator tocomply withBasel III where EU regulation is found tobe inconsistent will depend onthedegreeof ―maximum harmonisation‖ at the EU level.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  26. 26. 26In this case, it may worktolimit theroom an individual regulator hastoadopt compliant regulationson itsown.The review team has identified the following specific areas of potentialdifference. These areas require further review and/ or an assessment oftheir potential materiality beforedefinitiveconclusionscan be drawn:Definition of CapitalThere arethree specific issuesthat warrant particular attention:TheBasel III rulesrequire bankstodeduct significant investmentsinunconsolidatedfinancial entities,includinginsuranceentities,from thehighestqualityform of capital (Common EquityTier 1– CET1).TheCRD IV/ CRR proposalsgivecompetent authoritiesthepossibilitytopermit banksnot to deduct insuranceholdingsunder certain conditions.Thereviewteam will need toassesswhethertheCRD IV/ CRR proposalsare consistent withtheBasel requirementsthat only permit approachesother than deduction whereit can be demonstrated that thesearemoreconservative (ie wouldproducehigher capital requirements) thanthededuction approach.TheBasel III rulesare explicit that for joint stock companies, onlycommon shares,whichcomplywitha list of substantivecriteria, can beincludedin CET1.However, the CRD IV/CRR proposals recognise any capitalinstrument, which satisfies a list of substantive criteria in line with BaselIII, aspart of CET1even if they might not be common shares.Thereview team will need toevaluatewhetherthisdeviationfrom BaselIII hasthepotential tounderminethequalityof capitalthat banksshouldhaveto absorb losses.BaselIII requiresthat all classesof capitalinstrumentsfullyabsorblossesat the point of non-viabilitybeforetaxpayers are exposed to loss.Thisrequirement hasbeenacknowledgedintheCRD IV/ CRR proposalsbut not reflectedaccordingtothe Basel rules.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  27. 27. 27Going forward, the review team will closely monitor how thisrequirementis being reflected in the EU regulations, including within the forthcomingEU resolution and crisis management rules.Pillar 1:Credit Risk – Internal Ratings-Based (IRB) ApproachUnder the Baselrules, a bank electingto usean internal model tocalculate itsregulatory capital requirementsfor credit risk (IRB Bank)may only permanentlyapply thestandardised approach for non -significant or immaterialbusinessunitsor asset classes(referredtoasthe―partial useexemption‖).TheCRD IV/CRR framework allowsIRB banksto permanentlyusethestandardisedapproachfor some exposuresunder certain conditionsthatmight not appear tobe related tothe immaterialityor non-significancedescribedabove.In particular, an IRB Bank in the EU is ableto permanentlyapplya zerorisk weight toEU sovereign exposuresafter receivingthe permission ofthecompetent authorities.Thereview team will need tofurther analyse the consistencyof theCRDIV/ CRR framework with the Basel rulesregardingthepermanent partialuseavailabletoIRB Banks, with special focus on internationallyactivebanks‘sovereignexposures.Next stepsThereview team‘s keyfocusgoingforwardwill be toresolveconsistencyissues,and assessthe materialityof any inconsistency.Thelatterwill be mainlybased on bank-specificdata.ThenineEU member countriesof theBasel Committeehaveundertakentoassist with securingthe data that will be neededfor thematerialityassessment.Response from the European CommissionTwopreliminarypointsneed tobe made. First, from thepoint of view ofbankingregulation, theEuropean Union (EU) is a singlejurisdiction:Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  28. 28. 28lawsadoptedat EU level are agreed by, and applyto, all EU MemberStates.Second, theEU haschosentoapplytheBasel rules toall its banks(aswell to investment firms), not just large, internationallyactivebanks;thelawthereforeneedstoallownational authoritiestoexerciseacertainlevelof proportionalityin applying therules.Thefirst point is particularlyimportant with respect to the ―maximumharmonisation‖ principlereferred to in the report.In this context, the assessment fails toprovidevalid argumentson whythedegreeof harmonisation pursuedin the EU could be consideredanissuefor any of thespecificareasof potential differencementionedin thereport.Thesecond point is relevant to all thespecific issueslistedin thereport.For example, thepossibility for IRB banks to permanentlyusethestandardisedapproachfor certain exposures wasnever meant to be usedforinternationallyactivebanksandsupervisorswere(andwillcontinuetobe) expected not toapprove it for thosebanks.Concerningthe specific issues,there are someadditional points.Firstly, the proposedapproachon significant investmentsin insurancereflectsthe existenceof strict and harmonised rulesfor insuranceandfinancial conglomeratesat EU level, takesintoaccount the recentlyrevisedJoint Forumsprinciplesfor financial conglomeratessupervision, providesappropriateincentivesfor insurancecompaniescapitalisationand preventsdoublecounting of capital.Theassessment should takethesefactsintoaccount.Secondly, theconcept of common sharesdoesnot exist in a largenumberof EU Member States, whichexplainsthe choiceof approach based onthecharacteristicsof capital instruments, rather than their form.Nevertheless, publiclylistedbanks are expectedtomeet their CET1requirement only withsharesmeetingthe 14 criteria.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  29. 29. 29Furthermore,specificmonitoring powershave been conferredupon theEuropean BankingAuthority in order toidentify any misuseof thisapproachby banks.Lastly, the European Commission expectstoadopt legislationimplementingthe point-of-non-viabilityrequirement before summer ofthisyear.JapanBy end March2012,theJapaneseauthoritiespublished final rulesimplementingBaselIII withrespect to the definitionof capital and risk-weightedassets(RWA), whilethe BaselII and Basel 2.5regulationhadalreadybeen transposed intodomestic rules previously.The documents for the Japan Level 2 review include notices, supervisoryguidelines, inspection manualsand Qs and As issued by the FSA to spellout thedetailed interpretation, all of which are binding.Where applicable, the Japanese authorities have provided data for 16internationally active banks, which account for more than 50% of theJapanesebanking assets.Japan hasissued final Basel III regulations.This means that the review of Japan is more detailed than the reviewsofthe European Union and United States where the assessments are basedon drafts.Thereview isbasedontheEnglishtranslationof theJapaneserules, mostof which havebeen translatedintoEnglish.In specificcases,thereviewteamcomparedtheEnglishtranslationof thedocumentswiththe original Japanesetext toverify the translation.Afinal judgment of thepotential discrepanciesin thetranslation will besubjecttofurther analysis.TheJapaneseauthoritiesalsohaveprovidedsupplemental informationrequestedby theteam.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  30. 30. 30Preliminary findingsOverall, the preliminaryanalysisof Japan‘sBasel II/ III frameworksuggestsbroad consistencywith themajorityof the sectionsof the Baselrules.Theanalysis, however, revealed certaindifferencesthat will be the focusof further review by the assessment team:(I)TheBasel III capital rulesare not fullyimplemented (additionalguidanceisunder preparation) and deviatein specific areas,while therulesfor capital buffersareplanned tobepublishedonlyin 2015,oneyearaheadof the Basel III schedulefor the implementation;(II) MostPillar 2 rulesare not in place; and(III)There are a number of issues in certain aspects of riskmeasurement, both in terms of Pillar 1 and 2, for which the review teamwill seek further clarification.Definition of Capital and Capital BuffersWhile theJapaneseauthoritieshavealreadyfinalisedtherulesconcerningthedefinition of capital and RWA, more detailed guidanceto ensureconsistencywiththeBasel III text isnot yet established.This is particularlyrelevant in theareasconcerningthe recognitionofstockacquisitionrightsascommon equity Tier 1capital and thededuction of deferred tax assets.Theimplementationteam hasalsoidentified potential deviationsin theareasof the recognition criteria for additional Tier 1instrumentsaswell aswithrespect to the cut-off datefor thegrandfatheringof state aidinstruments,whichneed tobeinvestigatedfurther in order tounderstandthepotential impact.For thecapital buffers(capital conservation, countercyclical), thedomesticrulesare not yet in place.TheJapaneseauthoritiesplantoissuethe rulesby2015,ie, one yearaheadof the international schedulefor implementation(2016).Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  31. 31. 31Lossabsorbencyat the point of non-viability (PON) is partiallyimplemented, suchastheresolutionschemein Japan‘sdeposit insurancelaw.Theauthoritiesare currentlyanalysing how to organise thelinkagebetweenPON requirementsand the domestic resolution schemeandplanto finalisethe details of theframework by theend of 2012.Pillar 1- Minimum Capital RequirementFor securitisation, several areasof deviation havebeen identified, suchasin termsof re-securitisation, forABCP exposuresunder theStandardisedApproach and specific aspectsin termsof the InternalAssessmentApproach (IAA) and theSupervisory FormulaApproach (SFA).Other areasof credit risk will alsobe subject to further analysis. Intermsof counterparty credit riskand cross-product netting, theInternal Model Method(IMM) is not yet implemented.While in practicenobank hasadopted theIMM, implementationintodomesticregulation is still desirable.Concerningmarket risk, theteam hasidentified areasof non-compliancewith respect to thetreatment of smallertradingbooks(<100billion JPYandnolarger than 10% of thebank‘stotal assets) and thetreatment ofcommodity risk, whereJapaneselegislation onlyallowsbanksto usethesimplified approach (for thosebanksthat choosetheStandardisedMeasurement Method, SMM).In the former case, bankswithtradingactivitiesslightlybelow thematerialitythresholdwouldbenefit from thisexception.While thisissue isunlikely tohave systemic implications,capitaladequacycould be slightlyoverstated. Banks‘commodityrisk islimited, but the ultimatejudgement of materialitywill be subject toadditionalanalysis.With regard tooperational risk, some of the detailed requirementswithregard to theAdvanced Measurement Approach (AMA) are not specifiedin thenotice.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  32. 32. 32JapanindicatesthateachofthedetailedrequirementsintheBaselAccordis validated in the processof assessment asnecessary.Pillar 2 – Supervisory Review ProcessIn termsof Pillar 2, most of the rulesare currentlynot implementedinJapan.While there is a lack of implementation, the authoritiesseem tobe in apositionto imposeadditional capital chargesby theBankingAct.In practice, however, the FSAdoesnot generallyappear totake such anapproach.Rather the FSAexaminestheappropriatenessof banks comprehensiverisk management and, if necessary, theFSArequiresbankstotakeremedial actiontomitigatethe risksinstead of requiring an additionalcapital charge.Next stepsTheteamwill follow-upwiththeJapaneseauthoritiestoseek clarificationanddata with a view towardscompletinga preliminaryfinal assessmentof complianceand materialityin June.Thesefindingswill thenbe further discussed and assessedduring theon-sitevisit scheduled for earlyJulyin order to determine a finalassessment and drafting of the final report, tobe shared withtheauthoritiesin the second half of July.Thefinal report will be delivered tothe Basel Committeein September.Response from the Japanese authoritiesTheJapaneseauthoritiesappreciatethedetailed analysisdone by theassessment team todate. In particular, the authoritieswelcometheacknowledgement of broad consistencywith the majorityof thesectionsof the Basel rules.TheFSAis in the processof developingQs andAsand supervisoryguidelineswhich will supplement the notices,and oncetheyareBasel iii ComplianceProfessionalsAssociation (BiiiCPA)
  33. 33. 33published, issuesidentified aslack of implementationrulesin this reportwill be rectified.Wedisagreewiththereport‘sassertionthat our rulesontherecognitionofadditional Tier 1instrumentsdeviatefrom Basel III.Thecut-off date for the grandfatheringof state aid instrumentsis set on31March2013instead of 1January2013merely reflectingthefact that theJapan‘sfiscal year starts in April and endsin March.With regard tothe credit and securitisationpartsof Pillar 1,someadditional rulesneed to be incorporated intoour domesticrules,and theFSAintendstodevelop necessarynoticesand guidelinesin thecomingperiod.However,the current rulesdonot result in any material overstatement ofcapital ratios.Most of theadditional elementsneeded are only relevant to advancedmodel methodssuch asIMM and IAA, whichnoJapanesebank hasadopted yet.Regarding the market risk exception for bankswith small trading book,our impact analysis shows that the impact is very limited and is at most0.34%of total RWA.Asforcommodityrisk, banksareallowedtochoosebetweentheIM Aandsimplified SMM, which areboth fullycompliant withtheBasel text.Banks withmaterial commodity exposuresuse IMA.In termsof Pillar 2, the overall processand framework is provided in thesupervisoryguidelinesand inspection manualsand forms thebasisforon-siteand off-sitereview by the FSA.There are, however, somespecific areaswheredetails are not welldocumented yet (egthoserelated toIMM, residual risk and implicitsupport).TheFSAintendsto develop domesticruleson thoseelementsin thenearfuture.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  34. 34. 34United StatesAs noted above, at thetime of thisinterim assessment, the USauthoritieshadnot published thefinal rule to implement the improvementsto theBasel II market risk framework(Basel 2.5), nor had theypublished theproposed regulationsto implement Basel III.[On 7 June, theFederal Reserve‘sBoard of GovernorspublishedfinalBasel 2.5 and draft Basel III rules. The review team hasnot had time toassesswhethertheselatestdevelopmentsarecompliant with theBaseltext for the interim report, rather theseand/ orany subsequent textswillform part of the final assessment.]Thesearemajor componentsof theBasel Committee‘sreformprogramme.Therefore, the number and nature of findings set out in the final reportmay change substantially from those contained in this interim report ifthe United Statesmakes progressin its rulemaking processprior to thefinalisation of thisreport.Preliminary findingsThereview team hasidentified a number of overarching issuesrelatedtotheUS implementationof theBasel standards:Adoption of Basel 2.5 and Basel III regulationsTheabsenceof the final rule on Basel2.5and theproposed ruleon BaselIII representsa potentiallysignificant gap in USimplementation and hasthusfar limitedtheassessment conducted by the review team to the USadoption of Basel II and tothe proposed US rules for Basel 2.5.Scope of applicationUS core banksare required toadopt theadvancedBasel IIstandards,while all other banksremain subject to theBasel Istandards,unlesstheyelect tobe subjecttoBaselII standards(thesearereferred to asopt-inbanks).Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  35. 35. 35TheBaselFramework is explicitlydirectedat ―internationallyactive‖banks– though thisexpression hasnot been defined.Basel Committeemember countries arenot required, therefore, to applytheframework toall their banks.However,the review team intendstoassesswhethertheUS definitionofcorebanksinadvertentlyresultsin anynon-coreUS bank withsubstantialinternational activitiesnot being subject toBasel II standards.US authorities‘selection of Basel II approachesTheUS agencieshaveimplemented theadvancedBasel IIapproaches,but not thelessadvanced Basel II approaches.While jurisdictionsarenot requiredtoimplement thelessadvancedBaselII approaches, themanner in whichthe US agencieshave implementedBasel II impliesthat US core banksthat donot comply – or ceasetocomply– withthe requirementsof theadvanced approachesare subjecttoapproachesthat differ from thosecontemplated in the Basel II frameworkfor banksthat do not qualify for the advancedapproaches.In theUnited States,theadvanced Basel II approachesapplicabletocorebanksare complemented by three other capital requirements,whichtheUS authoritieshaveasserted result in higher minimum capitalrequirements:(i)Apermanent floor calculatedunder theagencies‘general risk-basedcapital rules(whichcurrentlyimplement Basel I);(ii)Thenon-risk-weightedUSleverageratio; and(iii)ThePillar 2requirements,includingthoseunder theFederalReserveBoard‘s―capital plan rule‖.However,a core bank that doesnot satisfytheconditionsfor theadvancedBasel II approachesremainssubject to a Basel I-basedcalculationof risk-weightedassets,thusnot beingsubject to Basel IIminimum capital requirements.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  36. 36. 36For example, Basel I doesnot includea charge for operational risk. Thereviewteam intendsto discusswiththe USauthoritiesthe basisfortheir applying a Basel I-based approach for thecalculationofrisk-weightedassetsto core banksthat donot qualify for theadvancedapproachesrather than the optionsprovided by thesimplified, standardisedand foundation approachesunder Basel II.NotesTheLevel 2assessment teamof theUnitedStatesisbeingconductedbyateamof expertsledbyMr Arthur Yuen (Hong KongMonetaryAuthority).Thefull review team comprises:Mr ThierryBayle (Banque deFrance), Mr PierpaoloGrippa (Banca d‘Italia), Mr Sebastijan Hrovatin(EuropeanCommission), Mr CarlosLuna (National BankingandSecuritiesCommission of Mexico) and Mr Naruki Mori (Bank of Japan).Theteam is supported by Mr Maarten Hendrikx of the Basel CommitteeSecretariat.Thedefinitionof corebanksincludesanydepository institution(ie bankor savingsassociation) meeting either of the followingtwocriteria:(i)Consolidatedtotal assetsof $250billion or more; or(ii)Consolidated total on-balancesheet foreign exposureof $10billion ormore;or anyUS-charteredbank holding company (BHC) meeting any of thefollowingthreecriteria:(i)Consolidatedtotal assets(excludingassetsheld by an insuranceunderwritingsubsidiary) of $250billion or more;(ii)Consolidatedtotal on-balancesheet foreign exposureof $10billion ormore; or(iii)Havinga subsidiary depositoryinstitutionthat is a core bank oropt-in bank.Finally, anydepositoryinstitution that isa subsidiary of a core or opt-inbank isalsoa corebank.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  37. 37. 37Under the ―capital plan rule‖, based on the Comprehensive CapitalAnalysis and Review (CCAR) frameworkusing stresstests, bank holdingcompanies withconsolidatedassetsof greater than $50billion mustdemonstratetheir ability tomaintain capital above existingminimumregulatorycapital ratios and above a tier 1common ratioof 5 percentunder both expected and stressed conditionsover a minimumnine-quarter planninghorizon.Basel II parallel runAt the timethis interim report wasprepared, none of thecoreUS bankshad receivedpermissiontoexit thetransitional parallel run, whichwouldrequirea bank tobaseitscapital requirementson the advancedBasel IIapproaches(supplementedby the additional requirementsdiscussedabove).Theregulatorycapitalratios ofthecoreUS bankscontinuetobebasedonrisk-weightedassetscalculatedaccordingto the general (Basel I)risk-basedcapital rules,andthere isnorulerequiringbankstohold morecapital asa consequenceof higher risk-weightedassetsascalculatedunder the advancedBasel II approaches.Thereview team will assesstheconsistencyof UStransitionalarrangementswiththecorrespondingBaselII standardsandwhetherthismay lead to a situationin whichcore banks that are not allowedtoleavetheparallel run over an indeterminateperiod are effectivelysubject tolowercapital requirementsthan those providedfor by Basel II for banksthat do not qualify for the advanced approaches.Elimination of referencesto external credit ratingsTheDodd-Frank Wall Street Reform and Consumer ProtectionAct (theDodd-FrankAct) mandatesthe US agenciestoremove referencesto andrequirementsofrelianceonexternalcredit ratingsfromregulationsandtoreplace them withappropriatealternativesfor evaluatingcreditworthiness.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  38. 38. 38As a first step in this context, in December 2011the USagencies issued anotice of proposedrulemaking (NPR) that containsalternativemethodologies for calculatingspecific risk capital requirementsfordebt, securitisationand equitypositionsunder the market risk capitalrules.Thereview team will engagewith the USagenciesto assess– both inqualitativeand quantitativeterms– whetherthe proposedrulemaking isat leastasrobust asthe corresponding Basel requirements.In additiontothe overarchingissues,the review team hasidentifiedanumberofspecificareasofpotential differencebasedonitsassessment ofthecomponentsof Basel II rulesand the proposed rulesfor Basel 2.5.Theseareasrequirefurtherreviewand/ oranassessment oftheirpotentialmateriality– taking intoaccount that their relevancemay bediminishedonceBasel III is implemented. So far, the main areasidentifiedinclude:Definition of capitalThecurrent US capital treatment of insurance subsidiariesof bankholdingcompaniesdiffersfrom theBasel II full deconsolidation anddeductionapproach.This could result in a potential overstatement of capital ratios.TheBasel II treatment ishowever supersededby Basel III, and the issuemay turn out tobe irrelevant if theUnited Statesaltersitstreatment toalign withBasel III.Pillar 1– Minimum capital requirementsTheBasel criteria for credit riskmitigation– such asrequirementsforcollateral management, operational procedures,legal certaintyand riskmanagement processes– appearabsent from the current USregulations,while thescope of eligible collateral and guarantorsseemstobelarger than thosespecifiedby the Basel Framework.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  39. 39. 39Differenceshave alsobeen identifiedin thedefinitionsand/ or treatmentof specific asset classes(eg credit card exposuresand leasing).Further, certain overarchingprinciples,such asthe IRB approaches‘minimum requirements‘―usetest‖, appear not tobe explicitlyenshrinedin regulation.Concerning the treatment of securitisation exposures, the main area ofdifference relates to the removal of references to external credit ratingsandtheconsistencywith theBasel requirements.Another area relatesto the treatment of securitisationscontainingearlyamortisation featureswhichappearstodeviatefrom theBasel treatment.With regard to operational risk, the main area of difference relates to thepossibility as permitted in the USrules of using risk mitigants other thaninsurancetohedgeoperational risk.This contrastswiththeBasel Framework, whichonlyallowsinsuranceasa risk mitigant.Concerningmarket risk, theproposed replacement of external creditratingswith new creditworthinessmetricsfor specific risk posesan issueof alignment withthe Basel standards.It alsoraises the question of whethertheresultingcapital chargeswouldbeequallyor comparably robust.Pillar 2 – Supervisory review processRegardingsecuritisations,potential significant differenceshave beenidentifiedfor thetreatment of provisionof implicit support and of therecognition of protection against first losscredit enhancementsandrelatedsupervisory actions.Next stepsThefirst stage of theassessment – thequalitativereview of the USself-assessment – hasprogressed accordingto schedule.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  40. 40. 40However, due to the delay in publishing the final Basel 2.5 rule and theproposed Basel III rule, the review team‘s completion of the US reviewwithinthe agreedtimelineshasbecome increasinglychallenging.The on-site component of the review, in which the review team will meetface-to-face with the US agencies, is currently scheduled for 25 – 29 June2012.Response from the US authorities:TheUS agencieswelcomethe opportunityto respond to the interimreport on theUSbanking agencies‘implementation of the Baselframework.We wishto comment on three of the overarchingissuesraised in thereport.First isthe scope of application, where aquestion israised, doestheUSapplicationof BaselII standardsto―corebanks,‖ astheyarecalledin thereport, cover all banks withsignificant international activities?TheUS agenciesareconfident that it does.Thesecond issueisthe selection of Basel II approaches.Theinterim report notesthat the UnitedStateshasimplementedtheadvancedapproaches,but has not offered any of the lessadvancedapproachesasoptionsfor core banks,asallowedbytheBasel framework.Thereport goestosuggest that, in thisregard, theUS implementationmay fall short.Thepossibleimplication is that jurisdictionsthat only adopt theadvancedapproachesought to developtheir own versionsof lessadvancedapproachesthat are closeto theBasel II optionsand applythesetonon-qualifying internationallyactivebanks.TheUS agenciesdonot seeany requirement for this in theBaselframeworkand, indeed, wewouldnote that usingBasel I is specificallypermitted.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  41. 41. 41Thethird issueis related and concernsthe BaselII parallel run process.Here, the review team saythat theywant to look intowhether―core‖banksnot allowedto leavethe parallel run ... are effectivelysubject tolowercapitalrequirements[thantheBaselII lessadvancedapproaches].‖This is a fair question.However,asnoted in the report, the US Basel I implementation iscomplementedby a leverageratiorequirement and theFederal ReserveBoard‘scapital plan rule, whichcoversall ―core‖ holding companies.Unsatisfactorycapital plans have severe and specific regulatoryconsequences.Moreover,the Board‘s2012ComprehensiveCapitalAnalysisand Reviewframework requiredenough capital to meet the BaselIII transitionschedule.Taken together, these and other US requirements such as the promptcorrective action regime are both demanding and effective relative toBasel standards.TheUS agenciesfullysupport theeffortsof theBasel Committeetomonitorprogressin implementing theBaselcapital framework indifferent jurisdictionsand look forwardtoworkingwith theUS Level 2review team in themonthsahead astheycompletetheir work.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  42. 42. 42Level 3Analysisof risk-weighted assets in the banking bookIn December2011, theBaselCommitteeapprovedaworkplantoevaluatesourcesof material differencesin risk-weightedassets(RWAs) acrossbanksusing theInternal Ratings-Based(IRB) approach for credit riskinthebanking book, and assessthe extent to whichRWAcalculationsareconsistent withrelevant Basel standards.Thework,conductedbyrepresentativesof 30regulatoryagenciesfrom 23countries,relies on a combination of top-downanalysis of data asreportedbybanks,bottom-upportfolio benchmarking, observationof therange ofpracticesacrossbanks and supervisors, and on-sitework at banksasappropriate.Theworkdistinguishesbetweenvariationsin RWAs that arerisk-based(thosedue to differencesin underlying risk at theexposure/portfoliolevel) and thosethat are practice-based(eg thosedue to model selectionor calibrationof model parameters,exerciseof judgement, application ofnational discretion, etc).Practice-basedvariationscan be further subdivided intodifferencesthatare specificallyprovided for under the BaselFramework(eg IRBrollout, national discretions), and othersthat arisemore from differencesin interpretationof standardsin theframeworkor from specific practicessuch asthoserelated to calibration of riskparameters.Recommendationstonarrow thevariationin RWAs are appropriateprimarilyfor practice-basedRWA variation.Todate, workhasconsidered and assesseda widerangeof existinganalysesof RWAs acrossbanks and countries.Most studiesacknowledgethat underlying differencesin risk are likely tobea key driver in variationsin RWA; theseincludedifferencesin riskarisingfrom differencesin businessmodel and portfolio mix.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  43. 43. 43However,most studiesalsoconcludethat at leastsomeof thevariationinRWAscould be attributabletopractice-basedfactors.For example, several studiesfrom theregulatory communityraisemodelcalibration (particularlyPD and LGD estimation) and thestageof IRBadoption aspotential driversof RWAvariation.On the other hand, external analystshavefocused more on differencesintheapplicationof supervisoryprinciples,with regulatory and accountingapproachesbeingfrequentlycited asreasonsfor differencesin RWAmeasurement.Existingstudies reveal that, whilethere are many potentialcandidates,thereis nodefinitiveconsensuson thetrue sourcesof RWAdifferencesacrossbanks, or on the extent towhichdifferencesare due todifferencesin risksor differencesin practices.Thus, additional work is clearlynecessary, and is beingpursued. Toextend existing analysesand determine an appropriatefocusforregulatoryeffortsto enhanceconvergence, the group is undertakingadditional high-level analysesof RWAvariationusing supervisorydatafrom the BaselCommittee‘sCapital Monitoring Group (CMG).- TheCMG hascollectedinformation on Basel II RWA, capitalrequirements,and riskparameterssemi-annuallysinceend-June2008.Thedataareextractedfromnationalreportingframeworksofmembercountries,and submittedtothe BaselCommitteeSecretariat instandardisedreportingtemplates.- Theanalytical frameworkthat will be applied tothe CMG datacombinesexistingmethodswithadditional approachesbeingdeveloped aspart of thisproject.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  44. 44. 44- Thesourcesand materialityof RWAdifferenceswill be assessedacrossportfolios,acrossbanks, and acrosscountries, with a focusonparticular driversbelieved to playa material rolein RWAdispersion.- Tosafeguarddata confidentiality, resultswill be presented inanonymised or aggregated form.Conclusionsbased on top-downanalysis of aggregated data asdescribedaboveare necessarilylimited.Thus,that analysisisbeing supplemented withbottom-up analysisusingtest portfolios, in which theriskparametersbanks assign togroupsofcommon exposuresare compared and analysed.Theportfolio exerciseis currentlyin development.- Informed by a comprehensivestock-takeof similarexercisesconducted by the industry and by variousregulatory authorities, theinitial focushasbeen narrowedtowholesalecredit.Similar analysiscan be extendedtoother typesof credit at a laterstagebased on the lessonsand conclusionsof theinitial exercise.- Adata collectiontemplatehasbeendeveloped, together withinstructionsfor completion of the template.- Alist of exposuresis being developed tobe provided to participatingbanks;bankswillbeaskedtorespondwithPD andLGD estimatesforeach exposure.- Thecomposition of thehypothetical portfolio hasnot beenfinalised, but is being designed to ensure maximum overlap acrossparticipatingbanks, and includeslargesovereignborrowers,largefinancial institutions, and largenon-financial corporateborrowers.Output from this work will includevariousbenchmarkanalyses, includingpair-wiserank-orderinganalysis, analysisof thedistribution of PD and LGD estimatesacrossbanks, and assessment ofhowtheimpactBasel iii ComplianceProfessionalsAssociation (BiiiCPA)
  45. 45. 45of the observed parameter estimateson RWAsdependson different riskprofiles or businessstrategies.Quantitativeanalysisusing either aggregateddata or hypotheticalportfolio resultscan highlight sourcesof RWAvariation, but will notnecessarilypinpoint the reasonsfor that variation.Therefore, workis alsounder waytoidentify the specificpracticesthatmight underliedifferencesin RWAs.- In a first phase, an extensivelist of potential drivers of RWAdifferenceshasbeen developed, drawingon existing supervisoryknowledgeand judgement and informed by analysis of existingstudies.Thelist of drivershasbeen divided intothoserelated to underlyingrisk or risk profile, and thoserelated topractices.- Thepotential significanceof the drivershasbeen assessedbased onboth magnitudeand prevalence; the assessmentsof significancecurrentlyare being refined.- Further analyseswill be conductedtoassessthematerialityand thenature of a selectednumber of drivers.Theworkdescribedhere – combiningtop-downdataanalysis,bottom-upportfolio benchmarking, and supervisoryevaluation of the rangeofpractice in specificareas– will extend thepreliminaryconclusionsfromprior analysesby identifying selected industryand supervisorypracticesthat appear likely tobe causing differencesin RWA and capital acrossinstitutionsand countriesthat arenot reflectiveof underlying risk.Specific recommendationsfor narrowingof therangeof practice will beprovided totheBasel Committeefor considerationand possibleactionasappropriate.Theanalytical frameworkdevelopedfor analysing RWA differencescanalsoserve asan approach for ongoingmonitoring of RWAdifferences.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  46. 46. 46Analysisof risk-weighted assets in the trading bookThis interim report containstheinitial findingsof thepotential driversofdifferencesin market risk-relatedrisk-weightedassets(mRWA) usingdata that is publicly disclosed by banksin financial and regulatoryreports.Thescope of theseinitial findingsisthereforelimited, sincethe analysisappliesto public data prior tothe implementationof Basel 2.5and isbasedonlyonthosebanksforwhichsufficient datawasavailabletomakemeaningful comparisons.TheCommittee‘stask force is currentlyworkingon completingthepublicdataanalysisby, amongothers,evaluatingtheutilityofnon-publicsupervisorydata.In addition, it isperforminga test portfolio exercisein whichthemRWAcalculationsof banksare compared on a common set of positions,withtheresultsto be further investigatedby meansof on-sitevisits.Anumber of bankshave volunteered to be included in thetest portfolioexercise, whichis well under wayand thefirst resultsare expectedin thesecond half of thisyear.Thetask forcewill includethefindingsof this complementary workin afinal report that is expected by theend of this year.Based on public disclosures bya sample of 17large bankswith significanttrading activities, the analysis reveals considerable differences in mRWAasa ratio tototal tradingassetsreported in financial disclosures.Such variationcan be justifiedwhenit reflectsthe varying risk profile oftradingactivities,giventhe differencesin tradingstrategiesand businessmodelsamong the banks.In thisregard, apreliminaryanalysisof thepublic disclosuresona subsetof banksin thesample suggeststhat thosebanks that trade risky assets,Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  47. 47. 47such asdistressed loansor lessliquid equities, exhibit a higher ratio ofmRWAtototal tradingasset.However,theresultsare not conclusive, asthere remainssubstantialunexplainedvariation, and in manyinstancespublic disclosuresareinsufficient toexplain the observed variation in mRWAratiosacrossbanks.Onepotential policy responseisthereforeto investigatefurtherimprovementsin public disclosuresfor market risk, for instance,byincludingmore informationabout mRWAand its componentsandprovidingmore direction to banksregarding Pillar 3 disclosure.Thesepolicy optionswill be investigatedfurther.Notes: This graphic presentsbanks in increasing order of average marketrisk weighted assets(mRWA) calculated as the ratio of mRWA to TradingAssets, showingthesubstantial variation, from below 5% to about 45%.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  48. 48. 48TradingAssetsis defined asthevalue of all instrumentsin the tradingaccount, includingsecurities,traded loans,and net derivativeswithapositivereplacement value.Toput banks on a comparablebasisthemeasurement of total tradingassetshasbeen adjusted for the effect of different accountingregimes.In particular, thedatahasbeenadjustedtotakeintoaccount thedifferentapproachestonetting of derivatives.Source:public informationbased on banks‘financial and publicregulatoryreporting.For bank Adata isbased on Q4 2010for all other banksdata is from Q22011.Thepreliminaryanalysisshowsa number of potential reasonsforvariation in mRWA(the list doesnot reflect a rankingin order ofimportanceasthe analysisdoesnot allowfor that at this stage):- Differencesdue to variation in the compositionof tradingassetsasevident tosome extent in publicdisclosures.- Differencesin thewaythat banks applyaccounting requirementstotheir businessmodel in allocatingassetsbetweenthe trading andbankingbooks, for example, the treatment of securitiesfinancingtransactionsand loans.- Differencesin methodologyand inputsfor market risk modelsusedfor regulatory capital calculations.- Differencesin supervisory approaches,with some jurisdictionsrelying more heavily on the internal models approach and integratedVaR models while otherscontinuetousethe standardisedapproachselectively for some debt and equitypositions.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  49. 49. 49- Differencesin regulatory add-onsand notablytheuse of VaRmultipliershigher than the minimum of 3 to account for modeluncertainty.With regard tothe last twopoints, the analysisindicatesthat some of thevariation in mRWAasa percentageof total tradingassetsmay be relatedtothe degreeof relianceon internal models based on Value-at-Risk(VaR).Banks for whichinternal modelshave a more important role indeterminingmRWAtend to show a lower averageratioof mRWAtototaltradingassetscomparedtobanks for which models have a lesserrole, with standardised approachesmore important.This is in linewithexpectationsasthe standardisedapproach providesfor lesshedging and diversificationbenefits and is thereforegenerallymore conservativethantheinternal modelsapproach.At the same time, however, there remainssubstantial unexplainedvariation, asthere is a widerangeof mRWA ratiosfor bankswith similarrelianceon models and alsobanks withsimilar mRWAratiosbut varyingdegreesof relianceon internal models.This variation will be examinedfurther by meansof thetest portfolioexercisethat is currentlyunder way.It should benoted that therelationshipbetweenthedegreeof relianceoninternalmodels and the ratio of mRWAaspercentageof total RWA maychangein the future.Basel 2.5 implementation (from end-2011) is expectedto raisethecapitalchargefor banksusing internal models approachesfor market risk andthefundamental review of thetradingbook aimstostrengthen therelationship betweenthe models-basedand standardised approachesbyestablishinga closer link between the calibration of thetwoapproaches.This may reducetheimportanceof the degreeof relianceon internalBasel iii ComplianceProfessionalsAssociation (BiiiCPA)
  50. 50. 50modelsasanexplanatory factorbehind the observeddifferencesamongbanks.Notes: The horizontal axis showsmRWAfrom internal models approach(IMA) aspercentageof total mRWA.Thevertical axis showstotal mRWA asa percentage of total tradingassets.Thesizesof the circlesin the figure indicate the size of tradingassets(inUSD) for each bank.It should be noted that the ratio of IMA aspercentageof total mRWAisan imperfect proxy for degreeof relianceon internal modelsasfor somebanksa lowratio may still implya high degreeof relianceon internalmodels,forinstance,whentheinternalmodelproducesaverylowmRWAcomparedtototal mRWA.Source:public informationbased on banks‘financial and publicregulatoryreporting. Of the 17banksin the sample, sufficient disclosurewasonlyavailablefor 14banksin quarter 4, 2010and for only 7 banksinquarter 2, 2011.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  51. 51. 51Thetask forcehasa workprogramme in placeto further analyse thedriversof differencein mRWAacrossglobal banks.This includes:- Completingtheanalysisofpublicdatatotest, refine,andextendtheseinitial findings;- Evaluatingtheutilityof internalsupervisorydatatobetterunderstandthedrivers of observed differences;- Identifying keydrivers of IRC (Incremental Risk Charge), VaR andstressed VaR based on existingdomesticsupervisoryknowledgeofbank‘smodels (and at a later stageCRM, ComprehensiveRiskMeasure).Theobjectivesof thisworkare toidentify thekeyaspectsof modelmethodologythat drive thedifferencesin internal modelsbasedapproachesand toassessthe materialityof thesedriversat ahigh-level.This work will support the test portfolio exerciseand help tofocusattention tothoseareasof the internal models that most likelycontributeto differences;Performinga test portfolio exercisetocompare and assessthemRWAcalculationsby a sampleof large, internationally-activebanksfor a set ofhypothetical tradingportfolios.Theaim of theexercise is tomeasurepotential mRWAvariability due totheimplementationof VaR, stressed VaR and IRC models. Inaddition, banksare beingrequested to completequestionnairestospecify theworkingsof their internal models;Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  52. 52. 52Carrying out selected on-site visits to some participatingbanks toallowfor a deeper investigation of the sourcesof variabilityin thecalculatedmRWA.It should be stressedthat the on-sitevisits will not be model-validationexercises,but are meant toprovidefurther information about theworkingsof thebanks‘internalmodelsandtheresultingmRWAnumbersfrom thetest portfolioexercise.This exercisewill help to identify themajor sourcesof mRWAvariabilityduetomodellingchoicesin largebanks.However,asit isa hypothetical portfolioexerciseit will not be able toexplainmRWAvariability due tothedifferingbusinessstrategies of largetradingbanks.Further workThe Basel Committee will continue to work to attain the full, timely andconsistent implementation among itsmembers.The Committee will update G20 in November on its work on all of thethreelevels.Level 1The Level 1 reports will continue to be published until all BaselCommitteemembershave fullyimplemented therequirements.Thenext publicationofthetablesinappendix 1willreflectthepositionasat end September 2012.Level 2Final reports for thethree Level 2 assessmentsof theEuropeanUnion, Japan and theUnited Statesare expected to be publishedinSeptember.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  53. 53. 53Somefollow-upwork may be required after September dependingon thefindingsof the reviews.Additional work will alsoincludethenew liquidityrequirements,theleverageratio, and thesurchargesfor systemically important banks, oncetheCommitteeconcludesitsreview on any revisionor final adjustmentsfor theseelementsof the framework.In linewiththe threecurrent reviews, the review of liquidityrequirements,the leverageratioand systemic surchargeswill take placeaheadof the deadlineand assessdraft regulationswhereappropriateaccordingto the staggeredimplementation dates.Areview of Singaporewill commence later in 2012,and reviewsof ChinaandSwitzerlandin 2013.This schedulewill mean that all countries whichare home of G-SIBs willhavebeen reviewedbeforethemiddleof 2013.ReviewsofAustralia and Brazil will take place during the second half of2013.TheBasel Committeeis collaboratingwiththe IMF and World Bank toensure that itsscheduleis complementary and non-duplicativeto theIM F and World Bank‘sFSAP review process.Level 3ThetwoLevel 3 groupsassessingtheconsistencyof risk-weightedassetsin thebankingbook and tradingbook will continuetheir detailedanalyses, includinghypothetical portfolioexercises,questionnaireshorizontallyreviewingpracticesacrossbanksand jurisdictionsandon-sitevisitstobanks.Preliminaryconclusionsfrom thedetailed analysesshould be availableinthefourth quarter of 2012.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  54. 54. 54Interesting…Statusof Basel II, Basel 2.5 and Basel III adoption:Number code:1= draft regulationnot published;2= draft regulation published;3= final rule published;4= final rule in force.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.comCountry Basel IIINext steps - Implementation plansArgentina 1 On-going work to draft preliminary documents.Australia 2 Draft rules for capital requirements issuedon 30 March 2012.Draft rules to implement liquidity requirementsissued in November 2011 for publicconsultation until 17 February 2012.Belgium (2) (Follow EU process - third compromisetext published)Brazil 2 Draft regulation published for publicconsultation on 17 February 2012.Canada 2 On 1 February 2011, banks were directed tomeet the 7% CET1 standard as of January2013.Regulations for (i) non-viability contingentcapitaland (ii) transitioning for non-qualifyinginstruments published August and October2011 respectively.Draft regulation for definition of capital andcounterparty credit risk issued to banks inMarch2012.China 2 Draft regulation combines BII, B2.5 and BIII.Public consultation ended in 2011. Final ruleexpected to
  55. 55. 55Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.comcome into force in Q3 2012. Will be appliedto all banking institutions.France (2) (Follow EU process - third compromisetext published)Germany (2) (Follow EU process - third compromisetext published)Hong Kong 1, 3 (3) Bill passed by the Legislative Council on 29February 2012 and published for the purposeof creating rule-making powers for theimplementation of Basel III.(1) Industry consultation underway onpolicy proposals for inclusion in rules.Consultation ondraft text of rules scheduled for second half of2012.India 2 Draft regulation released for commentson 30 December 2011.Indonesia 1 Draft regulation to be released forconsultation with industry in Q2 2012.Italy (2) (Follow EU process - third compromisetext published)Japan 3 Draft regulation published on 7 February 2012 -Final rules published on 30 March 2012 -Implementation of final rules (end of March2013 - In Japan, the fiscal year for banks startsin April and ends in March).Korea 1 Draft regulation to be published in the firsthalf of 2012.Luxembourg(2) (Follow EU process - third compromisetext published)Mexico 1 Final rule expected in Q2 2012.TheNetherlands(2) (Follow EU process - third compromisetext published)Russia 1 Draft regulations under development.
  56. 56. 56Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.comSaudiArabia3 Final regulation issued to banks.Singapore 2 Public consultation on draft ended in February2012. Final rule is expected to be published inmid-2012.South Africa1 Draft amendments to legislation issued on 30March 2012 for consultation.Spain (2) (Follow EU process - third compromisetext published)Sweden (2) (Follow EU process - third compromisetext published)Switzerland 2 Public consultation on draft regulation onBasel III has been finished in January 2012.Decision on final rules text expected until mid-2012. Final SIFI regulation (level: Banking Act)adopted by Parliament on 30 September 2011 -Draft SIFI regulation (level: accompanyingordinances) was published in December 2011;decision on final rule text expected beforeend-2012.Turkey 1 Draft regulation expected to bepublished in mid-2012.UnitedKingdom(2) (Follow EU process - third compromisetext published)UnitedStates1 Draft regulation for consultation plannedduring Q2 2012. Basel 2.5 and Basel IIIrulemakings in the United States must becoordinated with applicable work onimplementation of the Dodd-Frank regulatoryreform legislation.European Union2 Third compromise text (directive andregulation) published by the DanishPresidency on 28 March 2012.
  57. 57. 57Subject: LiquidityDate: June 8, 2012Description: Comptroller‘s Handbook RevisionsandRescissionsTheOfficeof the Comptrollerof the Currency(OCC) recentlyrevisedthe―Liquidity‖ booklet of the Comptroller‘sHandbook, whichreplacesasimilarlytitledbooklet issued in February 2001.This revised booklet providesupdated guidanceto examinersandbankerson assessingthequantityof liquidityriskexposure and thequalityof liquidityriskmanagement.Themajor revisionstothis booklet includethe following:Narrativemore heavily focused on management ofliquidity, includingo Emphasison the importanceof maintainingappropriatelevelsof highlyliquid assets,ando Enhanceddiscussion regarding the importanceof awell-developedplanningprocessfor contingencyfunding.Additional guidance—particularlyfor thoseexaminersresponsiblefor examininglargeand internationallyactivebanks—from theSeptember 2008―Principlesfor Sound LiquidityRisk ManagementandSupervision,‖ issued by the Basel Committeeon BankSupervisionand formallyadopted by theOCC and other U.S.bankingregulatory agencies.Addition of eight appendixesprovidingspecific guidancetoexaminersand bankerson a varietyof topics and examplesoffundamental liquiditymanagement reports.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  58. 58. 58In accordancewiththe OCC‘ssupervision-by-risk approach, examinerswill generallyusethe liquiditycore examinationprocedures, whichcanbefound in the 2010―CommunityBank Supervision‖ booklet and the2010―LargeBank Supervision‖ booklet in the Comptroller‘sHandbook.Examinerswill supplement the procedureslistedin thesebooklets,asappropriate, withtheupdatedproceduresdetailed in the ―Liquidity‖booklet, for additional analysis of liquidityrisk.With the issuanceof this guidance, the followingOffice of ThriftSupervisionguidancepertainingto liquidityrisk is herebyrescinded:ExaminationHandbook:Liquidityo Section 510, ―FundsManagement‖ (and related program)o Section 530, ―LiquidityRisk Management‖ (and relatedprogram and appendixes)o Section 560, ―Deposits/ BorrowedFunds‖ (and relatedprogram and questionnaire)Chief ExecutiveOfficer Memo#295, ―Monitoring andDocumenting the Useof Fundsfrom Federal Financial Stabilityand GuarantyPrograms‖TheOCC‘s―FundsManagement‖ booklet of the Comptroller‘sHandbook hasalsobeen rescinded, effectiveimmediately.OCC Advisory Letter 2001-5,―Brokered and Rate-SensitiveDeposits,‖hasbeen rescinded, whilethe―Joint AgencyAdvisory on Brokered andRate-SensitiveDeposits‖hasbeen incorporatedintothe ―Liquidity‖booklet asan appendix.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  59. 59. 59LiquidityComptroller‘sHandbookJune2012This booklet providesguidancetoexaminersand bankers on assessingthe quantityof liquidityrisk exposureand the qualityof liquidityriskmanagement.Thesophisticationof a bank‘sliquiditymanagement processdependsonitsbusinessactivitiesand appetitefor risk, aswell asthe overall level ofliquidityrisk.Awell-managedbank, regardlessof size and complexity, must be able toidentify, measure, monitor, and control itsexposure toliquidityrisk in atimely and comprehensivemanner.Liquiditycoreprocedurescan be found in the Community BankSupervisionHandbook (January 2010) and in Examiner View (EV).This handbook providesexaminerswithsupplemental proceduresforfurther analyzing thequantityand qualityof liquidityrisk.Examinersshould refer to the Bank Supervision ProcessHandbook forfurther guidanceon CAMELSRatingSystem.Additional guidance, particularlyfor thoseexaminersresponsibleforexamininglargeand internationallyactivebanks, is provided in theSeptember 2008―Principlesfor Sound Liquidity Risk Management andSupervision,― issued by the Basel Committeeon Banking Supervision(BCBS) and formally adopted by theOCC and other U.S. bankingregulatoryagenciesin that same year.BackgroundTraditionally, bankshave relied on localretail deposits(transaction andBasel iii ComplianceProfessionalsAssociation (BiiiCPA)
  60. 60. 60savingsaccounts) tosupport asset growth.Most retail deposit balancesare federallyinsured, stable, and relativelyinexpensive.Fundingdynamics at community, midsize, and largebanks,however, have evolved over time.Technological advancesin thedeliveryof financialproductsandservices,the removal of interstatebanking restrictions,and thederegulationofinterest ratespaid on deposit accountschanged both depositor andbanker behavior.Legislativereforms wereintendedtogivedepositoryinstitutionsthetoolsto compete withother market participantsfor deposits,but theyalsoincreasedcompetition among the banksthemselves.The combination of these reforms and technological advances also madeit easier for depositors, looking for better returns on their money, to leavetheir localmarkets.Consequently, in some cases,retail bank deposit growth did not keeppacewithasset growth.Somebanks became reliant on alternativedeposit, nondeposit, andoffbalance-sheet fundingsourcestocover the shortfall in traditional retaildeposit funding.Changesin technology, product innovation, andfundingdynamicscreatenew challengesfor liquiditymanagers.Intensecompetitionand decliningcustomer loyalty increasethe ratesensitivityof traditional retail deposits.As banking customersarenow using deposit accountsmore astransactionvehicles than savingsvehicles, therebymaintainingloweraverageexcessbalances,bankerscan nolonger relyupon historicallyinelasticdepositorbehavior.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  61. 61. 61Thus, therelianceon alternativesourcesof funding from the wholesaleandbrokeredmarketsexposesbankstomorerateandliquiditysensitivitythan the relianceon traditional retail depositsdid.Moreover,many banks have increasedtheir use of productswithembedded optionalityon both sidesof the balancesheet, which makesitmore challengingtomanagethe correspondingcashflows.Liquidityrisk management systems and controlsmust keeppace withthesechangesand added complexities.Given thesechangesin fundingdynamics, liquiditymanagement ismorecomplex and requiresa more robust risk management process.Toeffectivelyidentify, measure, monitor, and control liquidityriskexposure, well-managedbanks supplement traditional liquidityriskmeasureslike static-balance-sheet ratioswith more prospectiveanalyses.Bankers and examinersshould have, at a minimum, a soundunderstandingof a bank‘sprojectedfundingsourcesand needsunder a varietyof cash flow and liquid asset positionsgiven planned and unplannedbalancesheetchanges.projectedborrowingcapacityunder stableconditionsand underadversescenariosof varying severityand duration.highly liquid asset and collateral position, includingtheeligibility andmarketabilityof such assetsunder a varietyof market environments.vulnerability torollover risk.fundingrequirementsfor unfunded commitmentsover varioustimehorizons.projectedfundingcosts, aswell asearningsand capital positionsunder varying rate scenariosand market conditions.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  62. 62. 62DefinitionLiquidityisa financial institution‘scapacitytoreadily meet itscash andcollateral obligationsat a reasonablecost.Maintainingan adequatelevel of liquiditydependson the institution‘sabilityto efficientlymeet both expected and unexpected cash flowsandcollateral needswithout adverselyaffectingeither daily operationsor thefinancial condition of the institution.Abank‘sliquidityexistsin itsassetsreadily convertibletocash, netoperatingcashflows, and itsabilitytoacquire funding throughdeposits,borrowings,and capital injections.By definition, liquidityrisk is therisk that an institution‘sfinancialcondition or overall safetyand soundnessis adversely affected by aninability (or perceived inability) to meet itsobligations.An institution‘s obligations, and the funding sources used to meetthem, depend significantly on its business mix, its balance sheetstructure, and the cash flow profiles of its on- and off-balance sheetobligations.In managingitscash flows, an institutionconfrontsvarioussituationsthat can giveriseto increased liquidityrisk.Theseincludefundingmismatches,market constraintson theabilitytoconvert assetsintocash or in accessingsourcesof funds(i.e., marketliquidity), and contingent liquidityevents.Changesin economicconditionsor exposure tocredit, market, operational, legal, and reputation risksalsocan affectan institution‘sliquidityrisk profile and should be considered in theassessment of liquidityand asset or liability management.In assessinga bank‘sliquidityposition, examinersshould consider abank‘saccesstofundsaswell asits costof funding.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  63. 63. 63Depending on the current interestrateand competitiveenvironments,undue relianceon wholesaleor market based fundingmay increasea bank‘scost structure.Thecost of acquiringor renewingsuch fundingis purelymarketdriven, asopposed toratespaid on retail deposits,which may be set atmanagement‘sdiscretionwithin theparametersof localand nationalmarketconditions.Risingorhighfundingcosts,especiallyincomparisontopeer and market rates,is a sign of potential liquidityproblems.Importance of Liquidity ManagementLiquidityisthe lifebloodof anyinstitution, but it isparticularlycrucial tohighly leveragedentitiessuch asbanks.Morebroadly, the financial crisisbeginningin 2008demonstrated howliquidityproblemsand riskscan be transmittedthroughout the entirefinancial system.For all banks, theimmediateand dire repercussionsof insufficientliquiditymakesliquidityrisk management a key element in a bank‘soverall risk management structure.TheOCC expectsall banks tomanage liquidityrisk with sophisticationequal tothe risksundertakenand complexityof exposures.Critical elementsof a sound liquidityrisk management processestablished by theboard includeappropriatecorporate governance and activeinvolvement bymanagement.appropriatestrategies, policies,procedures,andlimitsusedtomanageand control liquidityrisk, even in stressed conditions.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  64. 64. 64appropriateliquidityrisk measurement and monitoring systems.activemanagement of intradayliquidityand collateral.maintainingan appropriately diversemix of existing and potentialfuturefunding sources.adequatelevelsof highly liquid marketablesecurities, withno legal,regulatory, or operational impediments,that can be used tomeetliquidityneedsin stressful situations.comprehensivecontingencyfunding plans (CFP) sufficient toaddresspotential adverse liquidityeventsand emergencycash flow needs.adequateinternalcontrolssurroundingall aspectsof liquidityriskmanagement.Sourcesof LiquidityStructural changesin banks‘deposit baseshave prompted bankstotakeadvantageof improved accesstowholesaleand market-basedfundingsources.Examplesof alternativefundingsourcesincludefederal fundslines,repurchaseagreements(repos), correspondent bank lines,Federal HomeLoan Bank (FHLB) advances,Internet deposits,deposit-sharingarrangements,and brokered deposits.Accesstothesefundsproviders enablesbanksto meet fundingrequirementswhile still maintainingadequatefundingdiversification.Fundsfrom the wholesalemarketscan be accessed at a variety of tenorsthat providebankerswithgreater flexibilityto managetheir cashflowsand liquidityneeds.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)
  65. 65. 65On the other hand, toomuch relianceon wholesaleand market-basedfundingsourceselevatesa bank‘sliquidityrisk profile.Bankerswhoareunfamiliar withwholesalefundingmarketsmay becomeoverlycomplacent during stableeconomic times.Fundingthrough alternativesourcesexposesbanksto theheightenedinterest-rateand credit sensitivityof these fundsproviders.Providersof wholesalefunding often require a bank‘smore liquidassetsascollateral, whichmay impair the overall liquidityof a bank‘sasset base.Further, if that collateralbecomeslessliquid, or itsvalue becomesuncertain, wholesalefundsproviders may be unwillingto extend or rollover fundingat maturity.Abank‘sfinancial conditionaswell asmarket or systemic eventsunrelatedto the institutionmay adverselyaffect the cost to a bank toacquire fundsor itsabilityto accessthe wholesalemarkets.Asabank‘srelianceonwholesaleandmarket-basedfundingincreases, soshould thequalityof liquidityrisk-management processes.Theseprocessesshould includeperiodic assessmentsof a bank‘sexposure to changesin market conditions,and a bank should developcorrespondingrisk control systemsto accompany theseassessments.Asset salesandsecuritizationarealsoimportant sourcesofbank liquidity.Banks of all sizeshave increasedtheuseof asset salesand securitizationto accessalternativefunding sources,manage concentrations, improvefinancial performanceratios,and more efficientlymeet customer needs.Someof thesetransactions,however,carry explicit recourseprovisionswithincontractual documents, aswell asthepotential implied recourseBasel iii ComplianceProfessionalsAssociation (BiiiCPA)