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Basel 3 News November 2012

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Basel 3 News November 2012

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Basel 3 News November 2012

  1. 1. 1 Basel iii Compliance Professionals Association (BiiiCPA) 1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 Web: www.basel-iii-association.comDear Member,Today we will start from the assessmentmethodology for global systemicallyimportant banks (G-SIBs) from the BaselCommittee on Banking Supervision.BIS, A framework for dealing with domestic systemicallyimportant banksI. Introduction1. The Basel Committee on Banking Supervision(the Committee) issued the rules text on theassessment methodology for global systemicallyimportant banks (G-SIBs) and their additionalloss absorbency requirements in November 2011.The G-SIB rules text was endorsed by the G20Leaders at their November 2011 meeting.The G20 Leaders also asked the Committee and the Financial StabilityBoard to work on modalities to extend expeditiously the G-SIFIframework to domestic systemically important banks (D-SIBs).2. The rationale for adopting additional policy measures for G-SIBs wasbased on the “negative externalities” (ie adverse side effects) created by Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  2. 2. 2systemically important banks which current regulatory policies do notfully address.In maximising their private benefits, individual financial institutions mayrationally choose outcomes that, from a system-wide level, aresub-optimal because they do not take into account these externalities.These negative externalities include the impact of the failure orimpairment of large, interconnected global financial institutions that cansend shocks through the financial system which, in turn, can harm thereal economy.Moreover, the moral hazard costs associated with direct support andimplicit government guarantees may amplify risk-taking, reduce marketdiscipline, create competitive distortions, and further increase theprobability of distress in the future.As a result, the costs associated with moral hazard add to any direct costsof support that may be borne by taxpayers.3. The additional requirement applied to G-SIBs, which applies over andabove the Basel III requirements that are being introduced for allinternationally-active banks, is intended to limit these cross-bordernegative externalities on the global financial system and economyassociated with the most globally systemic banking institutions.But similar externalities can apply at a domestic level.There are many banks that are not significant from an internationalperspective, but nevertheless could have an important impact on theirdomestic financial system and economy compared to non-systemicinstitutions.Some of these banks may have cross-border externalities, even if theeffects are not global in nature. Similar to the case of G-SIBs, it was Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  3. 3. 3considered appropriate to review ways to address the externalities posedby D-SIBs.4. A D-SIB framework is best understood as taking the complementaryperspective to the G-SIB regime by focusing on the impact that thedistress or failure of banks (including by international banks) will have onthe domestic economy.As such, it is based on the assessment conducted by the local authorities,who are best placed to evaluate the impact of failure on the local financialsystem and the local economy.5. This point has two implications.The first is that in order to accommodate the structural characteristics ofindividual jurisdictions, the assessment and application of policy toolsshould allow for an appropriate degree of national discretion.This contrasts with the prescriptive approach in the G-SIB framework.The second implication is that because a D-SIB framework is stillrelevant for reducing cross-border externalities due to spillovers atregional or bilateral level, the effectiveness of local authorities inaddressing risks posed by individual banks is of interest to a wider groupof countries.A framework, therefore, should establish a minimum set of principles,which ensures that it is complementary with the G-SIB framework,addresses adequately cross-border externalities and promotes alevel-playing field.6. The principles developed by the Committee for D-SIBs would allow forappropriate national discretion to accommodate structural characteristicsof the domestic financial system, including the possibility for countries togo beyond the minimum D-SIB framework and impose additional Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  4. 4. 4requirements based on the specific features of the country and itsdomestic banking sector.7. The principles set out in the document focus on the higher lossabsorbency (HLA) requirement for D-SIBs. The Committee would like toemphasise that other policy tools, particularly more intensive supervision,can also play an important role in dealing with D-SIBs.8. The principles were developed to be applied to consolidated groupsand subsidiaries.However, national authorities may apply them to branches in theirjurisdictions in accordance with their legal and regulatory frameworks.9. The implementation of the principles will be combined with a strongpeer review process introduced by the Committee.The Committee intends to add the D-SIB framework to the scope of theBasel III regulatory consistency assessment programme.This will help ensure that appropriate and effective frameworks forD-SIBs are in place across different jurisdictions.10. Given that the D-SIB framework complements the G-SIB framework,the Committee considers that it would be appropriate if banks identifiedas D-SIBs by their national authorities are required by those authorities tocomply with the principles in line with the phase-in arrangements for theG-SIB framework, ie from January 2016.II. The principles11. The Committee has developed a set of principles that constitutes theD-SIB framework.The 12 principles can be broadly categorised into two groups: Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  5. 5. 5The first group (Principles 1 to 7) focuses mainly on the assessmentmethodology for D-SIBs while the second group (Principles 8 to 12)focuses on HLA for D-SIBs.12. The 12 principles are set out below:Assessment methodologyPrinciple 1:National authorities should establish a methodology for assessing thedegree to which banks are systemically important in a domestic context.Principle 2:The assessment methodology for a D-SIB should reflect the potentialimpact of, or externality imposed by, a bank’s failure.Principle 3:The reference system for assessing the impact of failure of a D-SIB shouldbe the domestic economy.Principle 4:Home authorities should assess banks for their degree of systemicimportance at the consolidated group level, while host authorities shouldassess subsidiaries in their jurisdictions, consolidated to include any oftheir own downstream subsidiaries, for their degree of systemicimportance.Principle 5:The impact of a D-SIB’s failure on the domestic economy should, inprinciple, be assessed having regard to bank-specific factors:(a) Size Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  6. 6. 6(b) Interconnectedness(c) Substitutability/financial institution infrastructure (includingconsiderations related to the concentrated nature of the banking sector)(d) Complexity (including the additional complexities from cross-borderactivity).In addition, national authorities can consider other measures/data thatwould inform these bank-specific indicators within each of the abovefactors, such as size of the domestic economy.Principle 6:National authorities should undertake regular assessments of thesystemic importance of the banks in their jurisdictions to ensure that theirassessment reflects the current state of the relevant financial systems andthat the interval between D-SIB assessments not be significantly longerthan the G-SIB assessment frequency.Principle 7:National authorities should publicly disclose information that provides anoutline of the methodology employed to assess the systemic importanceof banks in their domestic economy.Higher loss absorbencyPrinciple 8:National authorities should document the methodologies andconsiderations used to calibrate the level of HLA that the frameworkwould require for D-SIBs in their jurisdiction.The level of HLA calibrated for D-SIBs should be informed byquantitative methodologies (where available) and country-specific factorswithout prejudice to the use of supervisory judgement. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  7. 7. 7Principle 9:The HLA requirement imposed on a bank should be commensurate withthe degree of systemic importance, as identified under Principle 5.Principle 10:National authorities should ensure that the application of the G-SIB andD-SIB frameworks is compatible within their jurisdictions.Home authorities should impose HLA requirements that they calibrate atthe parent and/or consolidated level, and host authorities should imposeHLA requirements that they calibrate at the sub-consolidated/subsidiarylevel.The home authority should test that the parent bank is adequatelycapitalised on a stand-alone basis, including cases in which a D-SIB HLArequirement is applied at the subsidiary level.Home authorities should impose the higher of either the D-SIB or G-SIBHLA requirements in the case where the banking group has beenidentified as a D-SIB in the home jurisdiction as well as a G-SIB.Principle 11:In cases where the subsidiary of a bank is considered to be a D-SIB by ahost authority, home and host authorities should make arrangements tocoordinate and cooperate on the appropriate HLA requirement, withinthe constraints imposed by relevant laws in the host jurisdiction.Principle 12:The HLA requirement should be met fully by Common Equity Tier 1(CET1). In addition, national authorities should put in place anyadditional requirements and other policy measures they consider to beappropriate to address the risks posed by a D-SIB. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  8. 8. 8Assessment methodologyPrinciple 1: National authorities should establish a methodology forassessing the degree to which banks are systemically important in adomestic context.Principle 2: The assessment methodology for a D-SIB should reflectthe potential impact of, or externality imposed by, a bank’s failure.13. A starting point for the development of principles for the assessment ofD-SIBs is a requirement that all national authorities should undertake anassessment of the degree to which banks are systemically important in adomestic context.The rationale for focusing on the domestic context is outlined inparagraph 17 below.14. Paragraph 14 of the G-SIB rules text states that “global systemicimportance should be measured in terms of the impact that a failure of abank can have on the global financial system and wider economy ratherthan the risk that a failure can occur.This can be thought of as a global, system-wide, loss-given-default(LGD) concept rather than a probability of default (PD) concept.”Consistent with the G-SIB methodology, the Committee is of the viewthat D-SIBs should also be assessed in terms of the potential impact oftheir failure on the relevant reference system.One implication of this is that to the extent that D-SIB indicators areincluded in any methodology, they should primarily relate to “impact offailure” measures and not “risk of failure” measures.Principle 3: The reference system for assessing the impact of failureof a D-SIB should be the domestic economy. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  9. 9. 9Principle 4: Home authorities should assess banks for their degree ofsystemic importance at the consolidated group level, while hostauthorities should assess subsidiaries in their jurisdictions,consolidated to include any of their own downstream subsidiaries,for their degree of systemic importance.15. Two key aspects that shape the D-SIB framework and define itsrelationship to the G-SIB framework relate to how it deals with twoconceptual issues with important practical implications:• What is the reference system for the assessment of systemic impact• What is the appropriate unit of analysis (ie the entity which is beingassessed)?16. For the G-SIB framework, the appropriate reference system is theglobal economy, given the focus on cross-border spillovers and thenegative global externalities that arise from the failure of a globally activebank.As such this allowed for an assessment of the banks that are systemicallyimportant in a global context.The unit of analysis was naturally set at the globally consolidated level ofa banking group (paragraph 89 of the G-SIB rules text states that “(t)heassessment of the systemic importance of G-SIBs is made using data thatrelate to the consolidated group”).17. Correspondingly, a process for assessing systemic importance in adomestic context should focus on addressing the externalities that abank’s failure generates at a domestic level.Thus, the Committee is of the view that the appropriate reference systemshould be the domestic economy, ie that banks would be assessed by thenational authorities for their systemic importance to that specificjurisdiction. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  10. 10. 10The outcome would be an assessment of banks active in the domesticeconomy in terms of their systemic importance.18. In terms of the unit of analysis, the Committee is of the view that homeauthorities should consider banks from a (globally) consolidatedperspective.This is because the activities of a bank outside the home jurisdiction can,when the bank fails, have potential significant spillovers to the domestic(home) economy.Jurisdictions that are home to banking groups that engage incross-border activity could be impacted by the failure of the wholebanking group and not just the part of the group that undertakesdomestic activity in the home economy.This is particularly important given the possibility that the homegovernment may have to fund/resolve the foreign operations in theabsence of relevant cross-border agreements.This is in line with the concept of the G-SIB framework.19. When it comes to the host authorities, the Committee is of the viewthat they should assess foreign subsidiaries in their jurisdictions, alsoconsolidated to include any of their own downstream subsidiaries, someof which may be in other jurisdictions.For example, for a cross-border financial group headquartered in countryX, the authorities in country Y would only consider subsidiaries of thegroup in country Y plus the downstream subsidiaries, some of which maybe in country Z, and their impact on the economy Y.Thus, subsidiaries of foreign banking groups would be considered from alocal or sub-consolidated basis from the level starting in country Y. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  11. 11. 11The scope should be based on regulatory consolidation as in the case ofthe G-SIB framework.Therefore, for the purposes of assessing D-SIBs, insurance or othernon-banking activities should only be included insofar as they areincluded in the regulatory consolidation.20. The assessment of foreign subsidiaries at the local consolidated levelalso acknowledges the fact that the failure of global banking groups couldimpose outsized externalities at the local (host) level when thesesubsidiaries are significant elements in the local (host) banking system.This is important since there exist several jurisdictions that aredominated by foreign subsidiaries of internationally active bankinggroups.Principle 5: The impact of a D-SIB’s failure on the domesticeconomy should, in principle, be assessed having regard tobank-specific factors:(a) Size;(b) Interconnectedness;(c) Substitutability/financial institution infrastructure (includingconsiderations related to the concentrated nature of the bankingsector); and(d) Complexity (including the additional complexities fromcross-border activity).In addition, national authorities can consider other measures/datathat would inform these bank-specific indicators within each of theabove factors, such as size of the domestic economy.21. The G-SIB methodology identifies five broad categories of factors thatinfluence global systemic importance: size, cross-jurisdictional activity,interconnectedness, substitutability/financial institution infrastructureand complexity. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  12. 12. 12The indicator-based approach and weighting system in the G-SIBmethodology was developed to ensure a consistent international rankingof G-SIBs.The Committee is of the view that this degree of detail is not warrantedfor D-SIBs, given the focus is on the domestic impact of failure of a bankand the wide ranging differences in each jurisdiction’s financial structurehinder such international comparisons being made.This is one of the reasons why the D-SIB framework has been developedas a principles-based approach.22. Consistent with this view, it is appropriate to list, at a high level, thebroad category of factors (eg size) that jurisdictions should have regard toin assessing the impact of a D-SIB’s failure.Among the five categories in the G-SIB framework, size,interconnectedness, substitutability/financial institution infrastructureand complexity are all relevant for D-SIBs as well.Cross-jurisdictional activity, the remaining category, may not be asdirectly relevant, since it measures the degree of global(cross-jurisdictional) activity of a bank which is not the focus of theD-SIB framework.23. In addition, national authorities may choose to also include somecountry-specific factors.A good example is the size of a bank relative to domestic GDP.If the size of a bank is relatively large compared to the domestic GDP, itwould make sense for the national authority of the jurisdiction to identifyit as a D-SIB whereas a same-sized bank in another jurisdiction, which issmaller relative to the GDP of that jurisdiction, may not be identified as aD-SIB. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  13. 13. 1324. National authorities should have national discretion as to theappropriate relative weights they place on these factors depending onnational circumstances.Principle 6: National authorities should undertake regularassessments of the systemic importance of the banks in theirjurisdictions to ensure that their assessment reflects the current stateof the relevant financial systems and that the interval between D-SIBassessments not be significantly longer than the G-SIB assessmentfrequency.25. The list of G-SIBs (including their scores) is assessed annually, basedon updated data submitted by each participating bank, but measuredagainst a global sample that is largely unchanged for three years.It is expected that the names and buckets of G-SIBs and the data used toproduce the scores will be disclosed.26. The Committee believes it is good practice for national authorities toundertake a regular assessment as to the systemic importance of thebanks in their financial systems.The assessment should also be conducted if there are importantstructural changes to the banking system such as, for example, a mergerof major banks.A national authority’s assessment process and methodology will bereviewed by the Committee’s implementation monitoring process.27. It is also desirable that the interval of the assessments not besignificantly longer than that for G-SIBs (ie one year).For example, a SIB could be identified as a G-SIB but also a D-SIB in thesame jurisdiction or in other host jurisdictions.Alternatively, a G-SIB could drop from the G-SIB list andbecome/continue to be a D-SIB. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  14. 14. 14In order to keep a consistent approach in these cases, it would be sensibleto have a similar frequency of assessments for the two frameworks.Principle 7: National authorities should publicly discloseinformation that provides an outline of the methodology employedto assess the systemic importance of banks in their domesticeconomy.28. The assessment process used needs to be clearly articulated and madepublic so as to set up the appropriate incentives for banks to seek toreduce the systemic risk they pose to the reference system.This was the key aspect of the G-SIB framework where the assessmentmethodology and the disclosure requirements of the Committee and thebanks were set out in the G-SIB rules text.By taking these measures, the Committee sought to ensure that banks,regulators and market participants would be able to understand how theactions of banks could affect their systemic importance score and therebythe required magnitude of additional loss absorbency.The Committee believes that transparency of the assessment process forthe D-SIB framework is also important, even if it is likely to vary acrossjurisdictions given differences in frameworks and policy tools used toaddress the systemic importance of banks.Higher loss absorbencyPrinciple 8: National authorities should document themethodologies and considerations used to calibrate the level of HLAthat the framework would require for D-SIBs in their jurisdiction.The level of HLA calibrated for D-SIBs should be informed byquantitative methodologies (where available) and country-specificfactors without prejudice to the use of supervisory judgement. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  15. 15. 1529. The purpose of an HLA requirement for D-SIBs is to reduce furtherthe probability of failure compared to non-systemic institutions,reflecting the greater impact a D-SIB failure is expected to have on thedomestic financial system and economy.30. The Committee intends to assess the implementation of theframework by the home and host authorities for its degree ofcross-jurisdictional consistency, having regard to the differences innational circumstances.In order to increase the consistency in the implementation of the D-SIBframework and to avoid situations where banks similar in terms of thelevel of domestic systemic importance they pose in the same or differentjurisdictions have substantially different D-SIB frameworks applied tothem, it is important that there is sufficient documentation provided byhome and host authorities for the Committee to conduct an effectiveimplementation review assessment.It is important for the application of a D-SIB HLA, at both the parent andsubsidiary level, to be based on a transparent and well articulatedassessment framework to ensure the implications of the requirements arewell understood by both the home and the host authorities.31. The level of HLA for D-SIBs should be subject to policy judgement bynational authorities.That said, there needs to be some form of analytical framework thatwould inform policy judgements.This was the case for the policy judgement made by the Committee onthe level of the additional loss absorbency requirement for G-SIBs.32. The policy judgement on the level of HLA requirements should alsobe guided by country-specific factors which could include the degree ofconcentration in the banking sector or the size of the banking sectorrelative to GDP. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  16. 16. 16Specifically, countries that have a larger banking sector relative to GDPare more likely to suffer larger direct economic impacts of the failure of aD-SIB than those with smaller banking sectors.While size-to-GDP is easy to calculate, the concentration of the bankingsector could also be considered (as a failure in a medium-sized highlyconcentrated banking sector would likely create more of an impact on thedomestic economy than if it were to occur in a larger, more widelydispersed banking sector).33. The use of these factors in calibrating the HLA requirement wouldprovide justification for different intensities of policy responses acrosscountries for banks that are otherwise similar across the four keybank-specific factors outlined in Principle 5.Principle 9: The HLA requirement imposed on a bank should becommensurate with the degree of systemic importance, as identifiedunder Principle 5.34. In the G-SIB framework, G-SIBs are grouped into different categoriesof systemic importance based on the score produced by theindicator-based measurement approach.Different additional loss absorbency requirements are applied to thedifferent buckets (G-SIB rules text paragraphs 52 and 73).35. Although the D-SIB framework does not produce scores based on aprescribed methodology as in the case of the G-SIB framework, theCommittee is of the view that the HLA requirements for D-SIBs shouldalso be decided based on the degree of domestic systemic importance.This is to provide the appropriate incentives to banks which are subject tothe HLA requirements to reduce (or at least not increase) their systemicimportance over time. In the case where there are multiple D-SIB bucketsin a jurisdiction, this could imply differentiated levels of HLA betweenD-SIB buckets. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  17. 17. 17Principle 10: National authorities should ensure that the applicationof the G-SIB and D-SIB frameworks is compatible within theirjurisdictions. Home authorities should impose HLA requirementsthat they calibrate at the parent and/or consolidated level, and hostauthorities should impose HLA requirements that they calibrate atthe sub-consolidated/subsidiary level. The home authority shouldtest that the parent bank is adequately capitalised on a stand-alonebasis, including cases in which a D-SIB HLA requirement is appliedat the subsidiary level. Home authorities should impose the higherof either the D-SIB or G-SIB HLA requirements in the case wherethe banking group has been identified as a D-SIB in the homejurisdiction as well as a G-SIB.36. National authorities, including host authorities, currently have thecapacity to set and impose capital requirements they consider appropriateto banks within their jurisdictions.The G-SIB rules text states that host authorities of G-SIB subsidiariesmay apply an additional loss absorbency requirement at the individuallegal entity or consolidated level within their jurisdiction.The Committee has no intention to change this aspect of the status quowhen introducing the D-SIB framework.An imposition of a D-SIB HLA by a host authority is no different (exceptfor additional transparency) from their current capacity to impose a Pillar1 or 2 capital charge.Therefore, the ability of the host authorities to implement a D-SIB HLAon local subsidiaries does not raise any new home-host issues.37. National authorities should ensure that banks with the same degree ofsystemic importance in their jurisdiction, regardless of whether they aredomestic banks, subsidiaries of foreign banking groups, or subsidiaries of Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  18. 18. 18G-SIBs, are subject to the same HLA requirements, ceteris paribus.Banks in a jurisdiction should be subject to a consistent, coherent andnon-discriminatory treatment regardless of the ownership.The objective of the host authorities’ power to impose HLA onsubsidiaries is to bolster capital to mitigate the potential heightenedimpact of the subsidiaries’ failure on the domestic economy due to theirsystemic nature.This should be maintained in cases where a bank might not be (or mightbe less) systemic at home, but its subsidiary is (more) systemic in the hostjurisdiction.38. An action by the host authorities to impose a D-SIB HLA requirementleads to increases in capital at the subsidiary level which can be viewed asa shift in capital from the parent bank to the subsidiary, unless it alreadyholds an adequate capital buffer in the host jurisdiction or the additionalcapital raised by the subsidiary is from outside investors.This could, in the case of substantial or large subsidiaries, materiallydecrease the level of capital protecting the parent bank.Under such cases, it is important that the home authority continues toensure there are sufficient financial resources at the parent level, forexample through a solo capital requirement.Indeed, paragraph 23 of the Basel II rules text states “(f)urther, as one ofthe principal objectives of supervision is the protection of depositors, it isessential to ensure that capital recognised in capital adequacy measuresis readily available for those depositors.Accordingly, supervisors should test that individual banks are adequatelycapitalised on a stand-alone basis.” Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  19. 19. 1939. Within a jurisdiction, applying the D-SIB framework to both G-SIBsand non-G-SIBs will help ensure a level playing field within the nationalcontext.For example, in a jurisdiction with two banks that are roughly identical interms of their assessed systemic nature at the domestic level, but whereone is a G-SIB and the other is not, national authorities would have thecapacity to apply the same D-SIB HLA requirement to both.In such cases, the home authorities could face a situation where the HLArequirement on the consolidated group will be the higher of thoseprescribed by the G-SIB and D-SIB frameworks (ie the higher of eitherthe D-SIB or G-SIB requirement).40. This approach is also consistent with the Committee’s standards,which are minima rather than maxima.It is also consistent with the G-SIB rules text that is explicit in stating thathome authorities can impose higher requirements than the G-SIBadditional loss absorbency requirement (G-SIB rules text paragraph 74).41. The Committee is of the view that any form of double-counting shouldbe avoided and that the HLA requirements derived from the G-SIB andD-SIB frameworks should not be additive.This will ensure the overall consistency between the two frameworks andallows the D-SIB framework to take the complementary perspective to theG-SIB framework.Principle 11: In cases where the subsidiary of a bank is considered tobe a D-SIB by a host authority, home and host authorities shouldmake arrangements to coordinate and cooperate on the appropriateHLA requirement, within the constraints imposed by relevant lawsin the host jurisdiction. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  20. 20. 2042. The Committee recognises that there could be some concern that hostauthorities tend not to have a group-wide perspective when applyingHLA requirements to subsidiaries of foreign banking groups in theirjurisdiction.The home authorities, on the other hand, clearly need to know D-SIBHLA requirements on significant subsidiaries since there could beimplications for the allocation of financial resources within the bankinggroup.43. In these circumstances, it is important that arrangements tocoordinate and cooperate on the appropriate HLA requirement betweenhome and host authorities are established and maintained, within theconstraints imposed by relevant laws in the host jurisdiction, whenformulating HLA requirements.This is particularly important to make it possible for the home authorityto test the capital position of a parent on a stand-alone basis as mentionedin paragraph 38 and to prevent a situation where the home authorities aresurprised by the action of the host authorities.Home and host authorities should coordinate and cooperate with eachother on any plan to impose an HLA requirement on a subsidiary bank,and the amount of the requirement, before taking any action.The host authority should provide a rationale for their decision, and anindication of the steps the bank would need to take to avoid/reduce sucha requirement.The home and host authorities should also discuss(i) The resolution regimes (including recovery and resolution plans) inboth jurisdictions,(ii) Available resolution strategies and any specific resolution plan inplace for the firm, and Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  21. 21. 21(iii) The extent to which such arrangements should influence HLArequirements.Principle 12: The HLA requirement should be met fully by CommonEquity Tier 1 (CET1). In addition, national authorities should put inplace any additional requirements and other policy measures theyconsider to be appropriate to address the risks posed by a D-SIB.44. The additional loss absorbency requirement for G-SIBs is to be met byCET1, as stated in the G-SIBs rules text (paragraph 87).The Committee considered the use of CET1 to be the simplest and mosteffective way to increase the going concern loss-absorbing capacity of abank.HLA requirements for D-SIBs should also be fully met with CET1 toensure a maximum degree of consistency in terms of effective lossabsorbing capacity.This has the benefit of facilitating direct and transparent comparability ofthe application of requirements across jurisdictions, an element that isconsidered desirable given the fact that most of these banks will havecross-border operations being in direct competition with each other.In addition, national authorities should put in place any additionalrequirements and other policy measures they consider to be appropriateto address the risks posed by a D-SIB.45. National authorities should implement the HLA requirement throughan extension of the capital conservation buffer, maintaining the divisionof the buffer into four bands of equal size (as described in paragraph 147of the Basel III rules text).This is in line with the treatment of the additional loss absorbencyrequirement for G-SIBs. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  22. 22. 22The HLA requirement for D-SIBs is essentially a requirement that sits ontop of the capital buffers and minimum capital requirement, with apre-determined set of consequences for banks that do not meet thisrequirement.46. In some jurisdictions, it is possible that Pillar 2 may need to adapt toaccommodate the existence of the HLA requirements for D-SIBs.Specifically, it would make sense for authorities to ensure that a bank’sPillar 2 requirements do not require capital to be held twice for issues thatrelate to the externalities associated with distress or failure of D-SIBs ifthey are captured by the HLA requirement.However, Pillar 2 will normally capture other risks that are not directlyrelated to these externalities of D-SIBs (eg interest rate and concentrationrisks) and so capital meeting the HLA requirement should not bepermitted to be simultaneously used to meet Pillar 2 requirement thatrelate to these other risks. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  23. 23. 23Mario Draghi: Openingstatement at DeutscherBundestagSpeech by Mr Mario Draghi,President of the European CentralBank, at the discussion onECB policies with Members ofParliament, Berlin***Dear President Lammert,Honourable Committee Chairs,Honourable Members of the Bundestag,I am deeply honoured to be here today.As President of the European Central Bank (ECB), it is a privilege for meto come to the heart of German democracy to present our policyresponses to the challenges facing the euro area economy.I know that central bank actions are often a topic of debate amongpoliticians, the media and the general public in Germany.So I would like to thank President Lammert and all Committee Chairsmost warmly for this kind invitation – and the opportunity it gives me toparticipate in that discussion.It is rare for the ECB President to speak in a national parliament.The ECB is accountable to the European Parliament, where we havescheduled hearings every three months and occasional hearings ontopical matters. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  24. 24. 24We take these duties of accountability to the citizens of Europe and theirelected representatives very seriously.But I am here today not only to explain the ECB’s policies. I am also hereto listen.I am here to listen to your views on the ECB, on the euro area economyand on the longer-term vision for Europe.To lay the ground for our discussion, I would like to explain our view ofthe current situation and the rationale for our recent monetary policydecisions.I will focus in particular on the Outright Monetary Transactions (OMTs)that we formally announced in September.Financial markets and the disruptions of monetary policytransmissionLet me begin with the challenges facing the euro area.We expect the economy to remain weak in the near term, also reflectingthe adjustment that many countries are undergoing in order to lay thefoundations for sustainable future prosperity.For next year, we expect a very gradual recovery.Euro area unemployment remains deplorably high.In this environment, the ECB has responded by lowering its key interestrates.In normal times, such reductions would be passed on relatively evenly tofirms and households across the euro area. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  25. 25. 25But this is not what we have seen.In some countries, the reductions were fully passed on.In others, the rates charged on bank loans to the real economy declinedonly a little, if at all.And in a few countries, some lending rates have actually risen.Why did this divergence happen?Let me explain this in detail because it is so important for understandingour policies.A fundamental concept in central banking is what is known as “monetarypolicy transmission”.This is the way that changes in a central bank’s main interest rate arepassed via the financial system to the real economy.In a well-functioning financial system, there is a stable relationshipbetween changes to central bank rates and the cost of bank loans to firmsand households.This allows central banks to influence overall economic conditions andmaintain price stability.But the euro area financial system has become increasingly disturbed.There has been a severe fragmentation in the single financial market.Bank funding costs have diverged significantly across countries.The euro area interbank market has been effectively closed to a largenumber of banks and some countries’ entire banking systems. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  26. 26. 26Interest rates on government bonds in some countries have risen steeply,hurting the funding costs of domestic banks and limiting their access tofunding markets.This has been a key factor why banks have passed on interest rates verydifferently to firms and households across the euro area.Interest rates do not have to be identical across the euro area, but it isunacceptable if major differences arise from broken capital markets or theperception of a euro area break-up.The fragmentation of the single financial market has led to afragmentation of the single monetary policy.And in an economy like the euro area where about three quarters of firms’financing comes from banks, this has very severe consequences for thereal economy, investment and employment.It meant that countries in economic difficulties could not benefit from ourlow interest rates and return to health.Instead, they were experiencing a vicious circle.Economic growth was falling. Public finances were deteriorating.Banks and governments were being forced to pay even higher interestrates.And credit and economic growth were falling further, leading to risingunemployment and reduced consumption and investment.A number of economies could have seen risks of deflation.All of this meant that the outlook for the euro area economy as a wholewas increasingly fragile. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  27. 27. 27There were potentially negative consequences for Europe’s singlemarket, as access to finance was increasingly influenced by locationrather than creditworthiness and the quality of the project.The disruption of the monetary policy transmission is something deeplyprofound.It threatens the single monetary policy and the ECB’s ability to ensureprice stability.This was why the ECB decided that action was essential.Restoring the proper transmission of monetary policySo let me now turn directly to our recent policy announcements.To decide what type of action was appropriate, we had to make two keyassessments.First, we had to diagnose precisely why the transmission was disrupted.And second, we had to identify the most effective policy tool to repairthose disruptions, while remaining within our mandate to preserve pricestability.In our analysis, a main cause of disruptions in the transmission wasunfounded fears about the future of the euro area.Some investors had become excessively influenced by imagined scenariosof disaster.They were therefore charging interest rates to countries they perceived tobe most vulnerable that went beyond levels warranted by economicfundamentals and justifiable risk premia.Clearly, it was not by chance that some countries found themselves in amore difficult situation than others. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  28. 28. 28It was mainly those countries that had implemented inappropriateeconomic policies in the past.This is also why the first responsibility in this situation is for countries tomake determined reforms and convince markets that they are credible.But many were already doing this, only for interest rates to rise evenhigher.There was an element of fear in markets’ assessments that governments,acting alone, could not remove.Markets were not prepared to wait for the positive effects of reforms toemerge.In our view, to restore the proper transmission of monetary policy, thoseunfounded fears about the future of the euro area had to be removed.And the only way to do so was to establish a fully credible backstopagainst disaster scenarios.We designed the OMTs exactly to fulfil this role and restore monetarypolicy transmission in two key ways.First, it provides for ex ante unlimited interventions in government bondmarkets, focusing on bonds with a remaining maturity of up to threeyears.A lot of comments have been made about this commitment.But we have to understand how markets work.Interventions are designed to send a clear signal to investors that theirfears about the euro area are baseless. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  29. 29. 29Second, as a pre-requisite for OMTs, countries must have negotiated withthe other euro area governments a European Stability Mechanism (ESM)programme with strict and effective conditionality.This ensures that governments continue to correct economic weaknesseswhile the ECB is active.The involvement of the IMF, with its unparalleled track record inmonitoring adjustment programmes would be an additional safeguard.The consequences of the ECB’s actionsSo what are the likely consequences of the ECB’s actions?Before announcing the OMT programme, we considered very carefullythe possible risks – and we designed our operations to minimise them.But I am aware that some observers in this country remain concernedabout the potential impact of this policy.I would therefore like to use this opportunity to go through thoseconcerns – one by one – and explain our views.First, OMTs will not lead to disguised financing of governments.We have specifically designed our interventions to avoid this.They will take place solely on secondary markets, where bonds that havealready been issued are traded.If interventions take place, they will involve buying government debt frominvestors, not from governments.All this is fully consistent with the Treaty’s prohibition on monetaryfinancing. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  30. 30. 30Moreover, they will focus on shorter maturities and leave room for marketdiscipline.Second, OMTs will not compromise the independence of the ECB.The ECB will continue to take all decisions related to OMTs in fullindependence.It will decide whether to intervene based on its own assessment ofmonetary policy transmission and with the aim of safeguarding pricestability.The fact that governments have to comply with conditionality willactually protect our independence.The ECB will not be forced to step in for a lack of policy implementation.Third, OMTs will not create excessive risks for euro area taxpayers.Such risks would only materialise if a country were to run unsoundpolicies.This is explicitly prevented by the ESM programme.And we have been very clear that each time a programme starts beingreviewed, we will routinely suspend operations and resume them only ifthe review has been concluded positively.This will ensure that the ECB intervenes only in countries where theeconomy and public finances are on a sustainable path.Fourth, OMTs will not lead to inflation.We have designed our operations so that their effect on monetaryconditions will be neutral. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  31. 31. 31For every euro we inject, we will withdraw a euro.In our assessment, the greater risk to price stability is currently fallingprices in some euro area countries.In this sense, OMTs are not in contradiction to our mandate: in fact, theyare essential for ensuring we can continue to achieve it.Moreover, we see no signs that our announcement has affected inflationexpectations.They continue to be firmly anchored.This is testament to our track record on price stability over the last decadeand our credible commitment to maintaining price stability.The citizens of the euro area can be confident that we will remainpermanently alert to risks to price stability.We have all the necessary tools at our disposal to maintain it and towithdraw any excess liquidity in case of upward risks to price stability.ConclusionLet me conclude these opening remarks.Three elements are essential for understanding the policies of the ECB:immutable focus on price stability; acting within our mandate; and beingfully independent.The ECB’s new measures help to ensure price stability across the euroarea.They also contribute to improving the economic environment. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  32. 32. 32But completing that task of economic renewal demands continuingaction by the governments of the euro area.It is governments that must set right their public finances.It is governments that must reform their economies.And it is governments that must work together effectively to establish aninstitutional architecture for the euro area that best serves its citizens.We are already moving in the right direction. Across the euro area, deficitsare being cut.Competitiveness is being improved. Imbalances are closing.And governments are working seriously to complete economic andmonetary union.It is important that Europe’s leaders stay on course.In doing so, they will be able to unlock fully the enormous potential of theeuro to improve living standards and carry forward the project ofEuropean integration.Thank you for your attention – and I look forward to our discussion. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  33. 33. 33Andreas Dombret: As goesIreland, so goes Europe?Speech by Dr Andreas Dombret,Member of the Executive Board of theDeutsche Bundesbank, at theInstitute of International andEuropean Affairs, Dublin***1. IntroductionLadies and Gentlemen,Many thanks for inviting me to speak to you. I am delighted to have theopportunity to be with you here in Dublin today.One of the issues which the Institute of International and EuropeanAffairs features on its website is “The Future of Europe”. And, indeed,the future of Europe is at the centre of the current public debate.After nearly ten very successful years, the European Monetary Union hasencountered a serious crisis.Over the past few months, we have seen some progress in this regard: afiscal compact has been agreed, the ESM has come to life, there ispreliminary agreement on a European Single Supervisory Mechanism,and – most importantly – more member states of the euro area haveembarked on broader economic reforms.But the crisis is still not over, and progress is still too often painfully slow.When talking about the euro, the successes, the setbacks and the wayforward, Ireland plays an important role.As an open and flexible economy with a highly skilled work force, Ireland Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  34. 34. 34has seized the opportunities presented by global and especially byEuropean economic integration.When Ireland joined the EU in 1973, it was one of the poorer memberstates.Since then, your real per capita income has increased more than twofoldand is today among the highest in the euro area.Ireland has benefited from several factors: low barriers in terms oflanguage and culture vis à vis the US and the UK have certainly helped,but Ireland also has done a lot to raise its growth potential by improvingthe skills of its labour force, lowering corporate taxes and maintainingflexible labour and product markets.As a result, you attracted a lot of Foreign Direct Investment and became aremarkably open economy.As we all know, this remarkable success story has suffered a number ofsetbacks.In the light of the crisis, some economic developments have provedunsustainable.The Irish real estate boom – as so many others – provided a temporaryboost at the time, but raised private debt to worrying levels – to 215 % ofGDP in 2007 – and diverted capital away from potentially more productiveuses.Exploding unit labour costs have eroded the competitiveness of the Irisheconomy, undermining the very core of its growth model so far.But even though the last few years have been challenging, many signspoint to a silver lining. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  35. 35. 35There has been significant progress in reforms with the results to show forit: on-track deficit reduction, falling unit labour costs, a positive currentaccount and last but not least a return to positive growth.To sum it up: I am very much confident with regard to the Irish case.And I am more and more convinced that we are witnessing a resurgencethat is instructive for the euro area as a whole.The problems experienced by Ireland are by no means confined to the“Green Island”, but are typical of what went wrong in the run-up to thecrisis.Thus, the reforms undertaken in Ireland hold valuable lessons for thewider monetary union.But what exactly did go wrong at the onset of EMU?2. The origins of the crisisFor many euro-area member states, the introduction of the euro usheredin a new era of abundant capital.In the case of Ireland, for instance, capital inflows amounted to about twotrillion euro between 1999 and 2008.In principle, this is exactly what standard economic reasoning predicts:capital was flowing from capital-rich to capital-poor economies, wherereturns should be higher.Such flows complemented limited domestic saving in capital-poorcountries and reduced their cost of capital, boosting investment andgrowth.As we all know, it did not always work that way. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  36. 36. 36Overblown financial sectors channeled the capital flows intounproductive investments.Ireland is certainly a case in point as light-touch regulation and taxincentives encouraged the financial sector to balloon.Overinvestment in real estate as well as in public and privateconsumption failed to boost productivity.Unit labour costs soared, competitiveness declined, and rigid labour andproduct markets meant that this process gained additional momentum.When the financial crisis broke out in 2007, the vulnerabilities becameapparent in Ireland.Growth imploded, deficits – which were often already too high before thecrisis – exploded, and cracks in the Irish banking system started to show.As an aside, you may recall that these cracks extended right intoGermany, where Irish subsidiaries or special investment vehicles got theirGerman parent companies into trouble.Not surprisingly, investor sentiment began to shift, and also interest ratesin your country started to rise sharply, triggering a major crisis that is stillfar from being resolved.How could it all go so wrong?Key to understanding the crisis is the euro area’s unique institutionalset-up, a set-up that easily leads to simple, but faulty analogies with othereconomies.As you are well aware the euro area pairs a common monetary policy with17 national fiscal policies. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  37. 37. 37Firstly, this combination gives rise to a deficit bias, as it allows costs to beshifted partially on to others.If a worsening fiscal position in one country has repercussions for ourmonetary union as a whole, others may step in and bail out.And, secondly, central banks’ balance sheets can serve as a conduit forshifting risks among national taxpayers, even if there are no explicit fiscaltransfers.The founding fathers of the euro foresaw this risk.Precautions were taken in the form of the prohibition of monetaryfinancing of government deficits, price stability as the primary objective,the no-bail-out clause and the Stability and Growth Pact that was to giveteeth to the rules on sound public finances enshrined in the MaastrichtTreaty.However, the fiscal rules were breached numerous times, not least byGermany and France.In addition, investors made hardly any distinction between the bonds ofindividual member states – I leave it to you to decide whether this wasbecause they neglected the growing differences in the economicfundamentals or because they never really believed that the no-bail-outclause would hold once the going got tough.While the provisions against unstable fiscal positions proved to beinsufficient, the institutional framework took no account of othermacroeconomic imbalances.Risks stemming from divergences in competitiveness or exaggerations innational real estate sectors were not considered in the design of theEuropean Monetary Union. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  38. 38. 38Hence, even countries that had impressive fiscal data before the crisis raninto deep trouble once the enormous implicit liabilities in their bankingsectors became apparent.Ireland, unfortunately, was one of those countries.Assessing the Irish economy in 2007 the IMF – which I quote forconvenience, not to blame it – wrote: “Fiscal policy has been prudent,with a medium-term fiscal objective of close to balance or surplus, in linewith Fund advice.In the past couple [of] years, windfall property-related revenues weresaved and the fiscal stance was not procyclical, in line with Fund advice”.However, once the risks in the financial sector materialised and thegovernment had to step in, Irelands fiscal position deteriorated veryquickly.3. The way forwardTo overcome the current crisis, and to prevent future crises, we have toaddress these problems I have just described.And this has to happen both nationally and at the European level.So far, a number of steps have been taken.At the beginning of my speech I mentioned the ESM, to which I mightadd the fiscal compact and the new excessive imbalance procedure thathas been established to prevent macroeconomic developments fromdiverging too much in the future.Nevertheless, the painful task of correcting past mistakes lies mainly withthe member states. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  39. 39. 39In this context I wish to point to Ireland as a good example of what has tobe done and what can be achieved.In this regard I view Ireland as a “role model of the periphery”.I have already mentioned the decline in competitiveness that occurredprior to the crisis.In this respect Ireland certainly had a steep mountain to climb.In 2008, Irish unit labour costs, as an indicator of competitiveness, weremore than 40% higher than at the launch of EMU.Still, not least thanks to flexible labour markets, the necessary adjustmenthas been swifter in Ireland than in other member states.There was a similar experience with the bubble in the Irish real estatemarket.Your problems became apparent earlier than in other member states, withproperty prices starting to fall in the last quarter of 2007.Hence, Ireland responded earlier than other countries, and in adetermined manner, to a shock which, as of today, has cut property pricesin half.As a result, the restructuring of the banking sector is more advanced andcosts for bank loans to firms are now lower than in countries such as Italyor Spain.This highlights the fact that it is sometimes better to take a big bathrather than just a shower.And it is better to take it as soon as possible because the water typicallygets colder as time passes by. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  40. 40. 40But the situation in your country also highlights something else: thedangerous link between banks and sovereigns.Looking to the future, this link has to be broken, or at least to beweakened considerably, to prevent history from repeating itself.Let me first step back and take a look at why the close link between banksand sovereigns has proven to be so problematic and so dangerous in thiscrisis.If many banks run into trouble at the same time, possibly on account of alarge asset bubble bursting, financial stability as a whole is threatened.The government then often has no option but to step in if it wants toprevent a meltdown of the real economy.But such a rescue can place a huge burden on government finances – andno country knows that better than Ireland, where support for the financialsector was a major factor why the debt ratio soared from 25% of GDP in2007 to 108% in 2011.Conversely, weak government finances can destabilise banks – directlythrough their exposure to sovereign bonds, and, indirectly, throughworsening macroeconomic conditions.That is what we are also witnessing at this very moment.Thus, breaking the link between banks and sovereigns is vital for makingthe euro area more stable.A banking union can very well be a major step in that direction – but byharnessing the disciplinary forces of the market, not by doing away withthem.Core elements of a banking union therefore have to be: Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  41. 41. 41First, a comprehensive bail-in of bank creditors, and second, anappropriate risk-weighting of sovereign bonds.In order to minimise the risk that bank rescues pose to governmentfinances, creditors have to be the first in line when it comes to bearingbanks’ losses.Implicit guarantees have to be removed as taxpayers’ money can only bethe last resort.By the same token, sovereign bonds need to be risk-weightedappropriately when it comes to the adequacy of capital buffers.Riskier bonds have to become more expensive in terms of the amount ofequity that they tie down, as is already the case for non-sovereign bonds.This serves two purposes: On the one hand, surcharges of this kindshould translate into lower demand and, hence, into larger spreads, whichgives a disciplining signal to the respective sovereign.And, on the other hand, banks would become more resilient in the eventof market turmoil.Adequate risk-weighting of sovereign bonds helps to prevent fiscaldifficulties from translating directly into financial instability.If fiscal autonomy remains with national member states, which is still thestatus quo in the EU Treaties, this is crucial.Banks have to internalise the fiscal position of sovereigns in a similarmanner as they take into account the risk of corporate bonds or loans.Otherwise, the envisaged recapitalisation of banks via European fundscould turn out to be a backdoor for mutualising sovereign solvency risks.I therefore believe that these two regulatory reforms – a comprehensivebail-in of creditors as well as an adequate risk-weighting of sovereign Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  42. 42. 42bonds – need to complement the envisaged European supervisorymechanism.In principle, this single European supervisor can help prevent futurecrises by enforcing the same high standards irrespective of the banks’country of origin and by taking transnational interdependencies intoaccount.At the moment, it looks as though this task shall be carried out by theEuropean Central Bank.This is, first of all, an expression of confidence in the competence ofcentral banks in general and in the ECB in particular.But conducting monetary policy and financial supervision does not comewithout risks.If the institution responsible for ensuring the financial soundness ofbanks simultaneously influences banks’ financing conditions via itsmonetary policy, conflicts of interest may arise.Besides, the resolution of banks implies intervening in property rights,which requires democratic accountability.If the ECB is to be tasked with supervising European banks, there willhave to be a strict separation of monetary policy and supervision.Such a separation will be difficult from both a legal and an organisationalpoint of view.In this respect, there still are questions that need to be resolved.A banking union will contribute to financial stability, if its designpreserves sound incentives for all actors involved. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  43. 43. 43This holds true not only for future risks, but also for risks that havealready materialised.Economically speaking, a banking union is basically an insurancemechanism.And, as with any insurance, only future losses or damages that areunknown ex ante can be covered.No doubt, the banking union is an important building block for a morestable monetary union.But, as such, it is meant to mitigate future risks and not to cover pastsins.In this context, I fully understand that Ireland is closely following theconditions under which euro-area member states will provide financialassistance to Spain for the recapitalisation of its financial institutions.One specific point is the degree of bondholders’ participation in theSpanish restructuring process.The Eurogroup stated in July with respect to Ireland: “Similar cases willbe treated equally, taking into account changed circumstances.”However, as this issue is currently under discussion I prefer abstainingfrom public comments.Instead I like to share my view with you on the issue of legacy assets ingeneral.Legacy assets are those risks which evolved under the responsibility ofnational supervisors.From what I have already said, it follows that these assets have to be dealtwith by the respective member states. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  44. 44. 44Anything else would amount to a fiscal transfer.It may be that such fiscal transfers are desired or even deemed necessary.But then, they should be conducted via national budgets and subject toapproval of national parliaments, rather than under the guise of a bankingunion, which would then have to start under a heavy burden.And, in the event of such transfers the proper sequencing of events is thekey.We should not end up in a world where risks from bank balance sheets arerapidly mutualised, while an effective single supervisory mechanismwould be slow in coming.A banking union will therefore not be a quick fix.But it can be an important milestone towards a more stable and prospermonetary union and hence instrumental in regaining confidence inthe euro area.Ireland has already come a long way in this regard, as your successfulreturn to the capital markets in July has shown.Trust has been regained because Ireland has walked the talk.And I am sure you agree: Any deviation from this climb when themountaintop is already in sight would be both short-sighted and costly.More precisely, when listening to the discussion on more leniency forGreece, I can understand that demanding similar adjustments to the Irishprogramme seem tempting at first glance.But as we have learned the hard way over the last years, trust is as easilylost as it is hard to regain. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  45. 45. 45Ireland has made enormous progress in the process of regaining trust andconfidence.Important financial market indicators are an expression of this fact. CDSpremia for the Irish sovereign have fallen continuously in 2012.In the meantime Irish CDS premia are below those of Spain and evenItaly.The same development can be observed for the spread over Germanbunds.All of these developments are the result of “leading by example” withstructural reforms.Hence, I see no reason for Irish CDS changing the course, and I doubtthat this would truly be in Ireland’s best interest.I suggest not to jeopardise what has been achieved so far.4. ConclusionLadies and gentlemen,When we talk about Europe, Ireland is such an interesting example for anumber of reasons.First, it highlights the benefits of a unified Europe which still leaves itsmember states enough room to establish their own model of success –Ireland has certainly seized that opportunity.But the Irish experience at the same time also illustrates some of thethings that have gone wrong in Europe over the past decade, and I havementioned many of them in my speech.Nevertheless, and even more importantly, the Irish experience holdsvaluable lessons on how to overcome the current crisis. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  46. 46. 46Of course, Ireland has not yet overcome all of its problems – every countryis different and challenges are never exactly the same.But I believe we all can learn a great deal from the Irish way of handlingthe crisis: As goes Ireland, so goes Europe.Let me conclude my speech with the single most important and mostencouraging lesson we can draw from the Irish experience: “Yes, it can bedone”.Thank you for your attention. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  47. 47. 47Goldman Sachs GroupInteresting numbers before the Basel IIIdeadlinesThe Goldman Sachs Group, Inc. (NYSE: GS)reported net revenues of $8.35 billion and netearnings of $1.51 billion for the third quarter ended September 30, 2012.Diluted earnings per common share were $2.85 compared with a dilutedloss per common share of $0.84 for the third quarter of 2011 and dilutedearnings per common share of $1.78 for the second quarter of 2012.Annualized return on average common shareholders’ equity (ROE) was8.6% for the third quarter of 2012 and 8.8% for the first nine months of2012.The firm’s global core excess liquidity was $170 billion as of September 30,2012.In addition, the firm’s Tier 1 capital ratio under Basel 1 was 15.0% and thefirm’s Tier 1 common ratio under Basel 1 was 13.1% as of September 30,2012.CapitalAs of September 30, 2012, total capital was $241.57 billion, consisting of$73.69 billion in total shareholders’ equity (common shareholders’ equityof $68.34 billion and preferred stock of $5.35 billion) and $167.88 billion inunsecured long-term borrowings.Book value per common share was $140.58 and tangible book value percommon share was $129.69, both approximately 3% higher comparedwith the end of the second quarter of 2012. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  48. 48. 48Book value and tangible book value per common share are based oncommon shares outstanding, including restricted stock units granted toemployees with no future service requirements, of 486.1 million at periodend.On September 4, 2012, The Goldman Sachs Group, Inc. (Group Inc.)issued 5,000 shares of Perpetual Non-Cumulative Preferred Stock, SeriesF (Series F Preferred Stock), for aggregate proceeds of $500 million.During the quarter, the firm repurchased 11.8 million shares of itscommon stock at an average cost per share of $106.17, for a total cost of$1.25 billion.The remaining share authorization under the firm’s existing repurchaseprogram is 34.2 million shares.Under the regulatory capital guidelines currently applicable to bankholding companies (Basel 1), the firm’s Tier 1 capital ratio was 15.0% andthe firm’s Tier 1 common ratio was 13.1% as of September 30, 2012, bothunchanged compared with June 30, 2012.Other Balance Sheet and Liquidity Metrics The firm’s global core excess liquidity was $170 billion as of September30, 2012 and averaged $175 billion for the third quarter of 2012, comparedwith an average of $174 billion for the second quarter of 2012. Total assets were $949 billion as of September 30, 2012, unchangedcompared with June 30, 2012. Level 3 assets were $48 billion as of September 30, 2012, compared with$47 billion as of June 30, 2012 and represented 5.0% of total assets. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  49. 49. 49Basel 3In addition, the U.S. federal bank regulatory agencies issued revisedproposals to modify their market risk regulatory capital requirements forbanking organizations in the United States that have significant tradingactivities.The modifications are designed to address the adjustments to the marketrisk framework that were announced by the Basel Committee in June 2010(Basel 2.5), as well as the prohibition on the use of credit ratings, asrequired by the Dodd-Frank Act.We expect the federal banking agencies to propose further modificationsto their capital adequacy regulations to address both Basel 3 and otheraspects of the Dodd-Frank Act, including requirements for globalsystemically important banks.Once implemented, it is likely that these changes will result in increasedcapital requirements, although their full impact will not be known untilthe U.S. federal bank regulatory agencies publish their final rules.The Dodd-Frank Act also establishes a Bureau of Consumer FinancialProtection having broad authority to regulate providers of credit, paymentand other consumer financial products and services, and this Bureau hasoversight over certain of our products and services.Management’s Discussion and AnalysisWe are currently working to implement the requirements set out in theFederal Reserve Board’s Risk-Based Capital Standards: Advanced CapitalAdequacy Framework — Basel 2, as applicable to us as a bank holdingcompany (Basel 2), which are based on the advanced approaches underthe Revised Framework for the International Convergence of CapitalMeasurement and Capital Standards issued by the Basel Committee. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  50. 50. 50U.S. banking regulators have incorporated the Basel 2 framework into theexisting risk-based capital requirements by requiring that internationallyactive banking organizations, such as us, adopt Basel 2, once approved todo so by regulators.As required by the Dodd-Frank Act, U.S. banking regulators haveadopted a rule that requires large banking organizations, upon adoptionof Basel 2, to continue to calculate risk-based capital ratios under bothBasel 1 and Basel 2.For each of the Tier 1 and Total capital ratios, the lower of the Basel 1 andBasel 2 ratios calculated will be used to determine whether the bankmeets its minimum risk-based capital requirements.The U.S. federal bank regulatory agencies have issued revised proposalsto modify their market risk regulatory capital requirements for bankingorganizations in the United States that have significant trading activities.These modifications are designed to address the adjustments to Basel 2.5,as well as the prohibition on the use of credit ratings, as required by theDodd-Frank Act.Once implemented, it is likely that these changes will result in increasedcapital requirements for market risk.Additionally, the guidelines issued by the Basel Committee in December2010 (Basel 3) revise the definition of Tier 1 capital, introduce Tier 1common equity as a regulatory metric, set new minimum capital ratios(including a new “capital conservation buffer,” which must be composedexclusively of Tier 1 common equity and will be in addition to theminimum capital ratios), introduce a Tier 1 leverage ratio withininternational guidelines for the first time, and make substantial revisionsto the computation of RWAs for credit exposures.Implementation of the new requirements is expected to take place overthe next several years. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  51. 51. 51Although the U.S. federal banking agencies have now issued proposedrules that are intended to implement certain aspects of the Basel 2.5guidelines, they have not yet addressed all aspects of those guidelines orthe Basel 3 changes.The Basel Committee has published its final provisions for assessing theglobal systemic importance of banking institutions and the range ofadditional Tier 1 common equity that should be maintained by bankinginstitutions deemed to be globally systemically important.The additional capital for these institutions would initially range from1%to 2.5% of Tier 1 common equity and could be as much as 3.5% for abank that increases its systemic footprint (e.g., by increasing total assets).The firm was one of 29 institutions identified by the Financial StabilityBoard (established at the direction of the leaders of the Group of 20) asglobally systemically important under the Basel Committee’smethodology.Therefore, depending upon the manner and timing of the U.S. bankingregulators’ implementation of the Basel Committee’s methodology, weexpect that the minimum Tier 1 common ratio requirement applicable tous will include this additional capital assessment.The final determination of whether an institution is classified as globallysystemically important and the calculation of the required additionalcapital amount is expected to be disclosed by the Basel Committee nolater than November 2014 based on data through the end of 2013.The Dodd-Frank Act will subject us at a firmwide level to the sameleverage and risk-based capital requirements that apply to depositoryinstitutions and directs banking regulators to impose additional capitalrequirements as disclosed above.The Federal Reserve Board is expected to adopt the new leverage andrisk-based capital regulations in 2012. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  52. 52. 52As a consequence of these changes, Tier 1 capital treatment for our juniorsubordinated debt issued to trusts will be phased out over a three-yearperiod beginning on January 1, 2013.The interaction among the Dodd-Frank Act, the Basel Committee’sproposed changes and other proposed or announced changes from othergovernmental entities and regulators adds further uncertainty to ourfuture capital requirements.Internal Capital Adequacy Assessment ProcessWe perform an ICAAP with the objective of ensuring that the firm isappropriately capitalized relative to the risks in our business.As part of our ICAAP, we perform an internal risk-based capitalassessment.This assessment incorporates market risk, credit risk and operationalrisk.Market risk is calculated by using Value-at-Risk (VaR) calculationssupplemented by risk-based add-ons which include risks related to rareevents (tail risks).Credit risk utilizes assumptions about our counterparties’ probability ofdefault, the size of our losses in the event of a default and the maturity ofour counterparties’ contractual obligations to us.Operational risk is calculated based on scenarios incorporating multipletypes of operational failures.Backtesting is used to gauge the effectiveness of models at capturing andmeasuring relevant risks. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  53. 53. 53We evaluate capital adequacy based on the result of our internalrisk-based capital assessment, supplemented with the results of stresstests which measure the firm’s performance under various marketconditions.Our goal is to hold sufficient capital, under our internal risk-basedcapital framework, to ensure we remain adequately capitalized afterexperiencing a severe stress event.Our assessment of capital adequacy is viewed in tandem with ourassessment of liquidity adequacy and integrated into the overall riskmanagement structure, governance and policy framework of the firm.We attribute capital usage to each of our businesses based upon ourinternal risk-based capital and regulatory frameworks and manage thelevels of usage based upon the balance sheet and risk limits established. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  54. 54. 54Progress note on the Global LEIInitiativeThis is the third of a series of notes onthe implementation of the legal entity identifier (LEI) initiative.Following endorsement of the FSB report and recommendations by theG-20, the FSB LEI Implementation Group (IG) has been tasked withtaking forward the planning and development work to launch the globalLEI system by March 2013.The IG is collaborating closely with private sector experts through aPrivate Sector Preparatory Group (PSPG) of some 300 members from 25jurisdictions across the globe.Charter for the Regulatory Oversight Committee (ROC):The IG has prepared a draft Charter for the Regulatory OversightCommittee for review and endorsement by the FSB and G20.The draft was supported by the FSB at its recent meeting in Tokyo forsubmission to the early November G20 Finance Ministers and CentralBank Governors meeting for final endorsement.Approval of the Charter will initiate the process for the ROC to be formed.ROC membership will be open to public authorities from across the globethat assent to the Charter.Authorities will also be able to apply for Observer status.The objective is to launch the ROC as the permanent governance body forthe global LEI system in January 2013. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  55. 55. 55Location and legal form of the global LEI foundation:Formation of the ROC is a necessary step for the creation of the globalLEI foundation which is the legal form for the Central Operating Unit.The location and exact legal form of the global LEI foundation will have abearing on the overall governance framework for the Global LEI System.The IG and PSPG have analysed potential locations for the foundationand have now initiated a detailed assessment of a narrow set of potentialcandidates.The results of the assessment will facilitate the drafting of the necessarylegal documentation to establish the foundation and will be presented atthe first meeting of the ROC.Board of Directors of the LEI foundation:One of the first tasks for the ROC will be the appointment of the initialBoard of Directors.PSPG members are working closely with the IG to develop criteria forfitness, experience, regional and sectoral balance, term of office etceterathat will support the process for nomination and selection of the firstBoard and deliver a governance framework for the global LEI foundationto help sustain the public good nature of the system.The PSPG presented a number of initial recommendations and optionsrelated to these criteria for the Board of Directors on 16 October; theproposals are currently being reviewed by the IG and the final version ofthe recommendations will be presented at the first meeting of the ROC.Operational Solutions Demonstration Day:The FSB hosted a Global LEI System Operational SolutionDemonstration Day in Basel on 15 October. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  56. 56. 56Thirteen presentations from across the globe were made that containedproposals and solutions covering all or part of the proposed global LEIsystem as set out in the FSB report.Business Processes and Use Cases:PSPG members presented an initial set of deliverables containingbusiness processes and use cases for the operational elements of theglobal LEI system at the joint PSPG and IG meeting on 16 October.PSPG members have already undertaken detailed work in some areas andwill expand on a strong base.The next phase of the operational work is to build on these specificationdocuments, focusing on how the system can best address a number of keyissues in relation to areas such as data quality, addressing locallanguages, as well as how to draw most effectively on local infrastructureto deliver a truly global federated LEI system.The PSPG are requested to prepare clear proposals and recommendationsby the end of the year, in order to support a successful and speedy launchof the global LEI system.Number allocation scheme for the global LEI system:On 12 September, the IG requested an ‘engineering study’ from PSPGexperts to determine which scheme for the management of the issue ofidentifiers best serves the purposes of the global LEI system.Following receipt of response and discussion with private sector expertsat the 16 October PSPG meeting, the IG prepared a recommendation forthe technical specification of the LEI code structure which has beenendorsed by the FSB Plenary. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  57. 57. 57Annex sets out the FSB decision to adopt a ‘structured’ approach to thenumber allocation scheme, whereby LOUs are assigned a unique prefix.The FSB decision is provided now to deliver clarity and certainty to theprivate sector on the approach to be taken by potential pre-LEI systemsthat will facilitate the integration of such local precursor solutions into theglobal LEI system.Ownership and hierarchy data:Addition of information on ownership and corporate hierarchies isessential to support effective risk aggregation, which is a key objective forthe global LEI system.The IG is developing proposals for additional reference data on the directand ultimate parent(s) of legal entities and on relationship (includingownership) data more generally and will prepare initial recommendationsby the end of 2012.The IG is working closely with the PSPG to develop the proposals.Annex: Number Allocation Scheme for the Global LEI System -implications for local pre-LEI Issuers and other early moversIn response to requests for early clarity and guidance on thedetermination of the number allocation scheme for the management ofidentifiers for the Global LEI System, the FSB Implementation Grouprequested an ‘engineering study’ from the FSB LEI Private SectorPreparatory Group (PSPG) experts to explore the advantages anddisadvantages of different schemes.The FSB is very grateful for all of the responses and for the contributionsof members of the PSPG.While there are a range of different schemes to manage the issue ofidentifiers that fit the characteristics of the 20 digit code (including two Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  58. 58. 58check digits) approach outlined in the ISO 17442 standard, for simplicitythose schemes can be categorised into two general groups:- An unstructured numbering system – one where an 18 character unique identifier fills the whole numbering spectrum;- A structured numbering system – one where subsets of the spectrum of possible codes are partitioned for efficient allocation according to a structural guideline; for instance, an N digit prefix could be assigned to each Local Operating Unit (LOU) for its exclusive use.On the basis of the arguments presented, the FSB has concluded that astructured number offers the best approach for the Global LEI System.The following method is to be used:- Characters 1-4: A four character prefix allocated uniquely to each LOU.- Characters 5-6: Two reserved characters set to zero.- Characters 7-18: Entity-specific part of the code generated and assigned by LOUs according to transparent, sound and robust allocation policies.- Characters 19-20: Two check digits as described in the ISO 17442 standard.Public authorities wishing to sponsor local pre-LEI issuance that wouldtransition to the LEI system should ensure that new numbers areallocated according to the above guideline.Pre-LEI solutions wishing to transition into the Global LEI System uponits launch shall be required to adopt the numbering scheme outlinedabove no later than 30 November 2012. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  59. 59. 59This approach does not affect ISO 17442 compliant numbers issued priorto that date.Once the global LEI system is in place, pre-LEI codes issued accordingto the ISO 17442 standard (and if issued after November 30, complyingwith the above guideline and thus embodying an appropriate 4 digitprefix) will be transitioned into LEIs, subject to meeting the agreedglobal LEI standards, including survival rules adopted by the ROC or theCOU in the exceptional cases where entities have multiple ISO 17442compliant pre-LEI identifiers.The LEI will be portable within the global LEI system, implying that theLEI code may be transferred from one LOU to another.Each LOU should immediately transfer an LEI to a different LOUfollowing the request of the LEI registrant or an LOU acting on its behalfwithout any financial or operational hindrance.Each LOU must consequently have the capability to take overresponsibility for LEIs issued by other LOUs.Given the importance to the system of ensuring high data quality,recommendation 18 of the FSB LEI report highlighted that the LEIsystem should promote the provision of accurate LEI reference data atthe local level from LEI registrants, and that self-registration should beencouraged as a best practice for the global LEI system.To provide force to this recommendation, the FSB has agreed thatpre-LEI services should henceforth be based on self-registration.From November 9, all pre-LEI systems will allow self-registration only.Authorities sponsoring pre-LEI issuers are expected to sign the ROCCharter once it is approved by the G20. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com
  60. 60. 60The FSB welcomes the reportof the Enhanced DisclosureTask ForceThe Financial Stability Board (FSB) welcomes the publication of theReport of the Enhanced Disclosure Task Force (EDTF) and views it as avaluable step to improve the quality of risk disclosures.The EDTF’s principles andrecommendations for improved bankrisk disclosures and leading disclosurepractices are designed to provide timelyinformation useful to investors and otherusers, which together with currentregulatory developments and standardsetter recommendations can contribute,over time, to improved marketconfidence in financial institutions.The FSB encourages banks to continue to strive to improve riskdisclosures.The EDTF was formed in May at the initiative of the FSB.The task force represents a unique private sector initiative – one thatbrings together on a global basis, senior officials and experts fromfinancial institutions, investors, and audit firms – to developrecommendations for enhancing risk disclosure practices by major banksstarting with end-year 2012 annual risk disclosures and continuing into2013 and beyond.1. BackgroundIt has been five years since the beginning of the financial crisis and thepublic’s trust in financial institutions has yet to be fully restored. Basel iii Compliance Professionals Association (BiiiCPA) www.basel-iii-association.com

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