1. Workshop – What are the
Regulators Thinking?
Canadian Conference for Credit Union Leaders
May 3, 2011
Richard Gresser
Managing Director, Bank Capital
OSFI
3. Regulatory Capital Changes
What are the objectives of Basel III?
3. Macro Economic Concerns
4. Missing Parts
5. Emphasis on Capital
6. Better Risk Assessment
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4. The Macro Concerns
Systemic Risk and Interconnectedness
• Interconnectedness among large global
systemically important financial institutions
(GSIFIs) transmitted shocks across the
financial system and economy
• Solutions being envisaged:
– Capital surcharges
– Contingent capital
– Bail-in debt
• To be developed in 2011
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5. The Macro Concerns
Countercyclical Capital Buffer
• Excessive credit growth → Period of
financial stress → bank reduce credit
supply to maintain solvency → real
economy affected → additional credit
losses in banking system
• Countercyclical buffer to be built up capital
buffer when aggregate credit growth is
excessive → increasing credit cost →
dampen credit growth
• Buffer 0 to 2.5% of RWA – expected to be
deployed on an infrequent basis (once
every 10 to 20 years)
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6. The Missing Pieces
• The financial crisis demonstrated that the
regulatory tool box needed to be expanded
-- risk-based capital requirements are
essential but not sufficient
• Basel III will introduce liquidity requirements
and leverage constraints
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7. Liquidity
• Liquidity Coverage Ratio (LCR)
– To ensure enough short term liquid assets are
available
– Banks to have enough high-quality liquid assets
to withstand a 30-day funding scenario specified
by supervisors
• Net Stable Funding Ratio (NSFR)
– To limit over-reliance on short-term wholesale
funding and encourage better assessment of
liquidity risk
– Banks to have enough sources of funding over a
one-year horizon
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8. Leverage
• Excessive build-up of on- and off-balance
sheet leverage contributed to the financial
crisis.
• A leverage ratio will be introduced to act as
a backstop to the risk-based capital
requirements
• Leverage ratio also introduces additional
safeguards against model risk and
measurements error risk present in the risk-
based approach
• Unlike most countries, Canada already has
leverage constraints
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9. Emphasis on Capital
• Risk-based regulatory capital is the core
instrument of financial regulation but crisis
highlighted deficiencies
– Emphasis should be on capital of the highest
quality (i.e. truly loss absorbing) – rules
emphasize common equity requirements (or
equivalent for non-stock entities)
– Definition of capital should be more uniform in all
countries – deductions from capital harmonized
internationally
– The requirements should be higher – 7%
“minimum” common equity ratio; 10.5% total
capital
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10. Better Risk Assessment
• Another lesson from the crisis has been the
need to strengthen the risk coverage of the
capital framework
• Trading book and securitization rules
already strengthened in 2009 (stressed
VAR; higher capital requirements for
resecuritizations)
• Counterparty Credit Risk rules to be
improved – incentives the use of central
counterparties to reduce counterparty credit
risk
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12. Enterprise Risk Management
• Continued emphasis on ERM
• A framework for risk management which
involves:
– identifying particular events or circumstances
relevant to the institution's objectives (risks and
opportunities),
– assessing them in terms of likelihood and
magnitude of impact
– determining a response strategy
– monitoring progress
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13. Enterprise Risk Management
• A way to aggregate similar risks or
exposures across the organization and get
a good understanding of what the risks,
based on historical experience that
produces the benefit of:
– Apples to apples comparison of risk adjusted
returns
– Manage a complex web of risks against an
enterprise wide risk appetite (the risks may be
greater or less than the sum of the parts)
• Need to do more/better stress testing
– Challenge historical experience
– Anticipate impact of sea change in markets
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14. Stress Testing
• A key risk management tool
• Used to evaluate the potential effects on an
institution’s financial condition of a set of
specific changes in risk factors,
corresponding to exceptional but plausible
events
• Financial crisis underlined the importance of
stress testing and also shortcomings of
stress testing practices
• OSFI Guideline on Stress Testing
December 2009
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15. Expectations for Stress Testing
• Commensurate with the nature and
complexity of the institution and with its risk
profile
• Embedded in enterprise wide risk
management
• Actionable
• Feed into the institution’s decision making
process
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16. ICAAP
• Internal Capital Adequacy Assessment
Process
• Capital requirements set out in the Basel
Framework and in OSFI’s CAR guideline for
banks are regulatory minimums that
assume a highly granular and widely
diversified portfolio of risks
• Guideline issued October 2010 sets out
expectations for banks
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17. ICAAP
• Through ICAAP, an institution sets its
internal capital target and develops
strategies for achieving the target that are
consistent with its business plan, risk profile
and operating environment
• ICAAP is a vital component of a strong risk
management process
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18. ICAAP
• Stress testing is a key part of ICAAP
• The results of rigorous, forward-looking
stress testing should be considered when
looking at the adequacy of an institution’s
capital
• OSFI assesses institutions’ ICAAPs as part
of the supervisory review process
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19. Proportionality
in Stress Testing and ICAAP
• Formalization and sophistication of ICAAPs will
differ, depending on the institution’s complexity,
range of business activities risk profile, and
operating environment
• The board has ultimate responsibility for the
overall stress testing program and should be
aware of the key findings from stress tests.
• Senior management is accountable for the
program’s implementation, management and
oversight and for ensuring that the institution
has adequate plans to deal with remote but
plausible stress scenarios.
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20. Rules vs. Supervisory Review
• Capital and Liquidity Rules are not a safe
harbor, they are minimums
• OSFI Supervisory review assesses
– Inherent risk of significant businesses and the
direction of those risks. (analog of rules
quantitative standards)
– Quality of risk management and whether it
mitigates or amplifies inherent risk
• Rules could be seen as a sort of baseline
for inherent risk and risk management
assessments
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21. Summary
• The financial crisis has prompted regulators
to review the regulatory framework to:
– Address macro economic concerns
– Improve risk measurement
– Require more and better quality capital
– Reduce counterparty credit risk
– Introduce liquidity and leverage standards
– Improve internal risk management and controls
(ERM, ICAAP, Stress testing)
• How will this impact provincially regulated
Credit Unions?
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Editor's Notes
The guideline sets out OSFI’s expectations with respect to the use of stress testing by all federally regulated financial institutions – banks, insurers and credit union centrals.
Actionable – playing an important role in facilitating the development of risk mitigation or contingency plans across a range of stressed conditions Feed into the institution’s decision making process, including setting risk appetite, setting exposure limits and evaluating strategic choices in longer term business planning
ICAAP guideline does not apply to credit union centrals – federal test is a leverage test - not a risk based capital test
.
An institution’s capital planning process should incorporate rigorous, forward-looking stress testing that identifies possible events or changes in market conditions that could adversely impact the institutions. In their ICAAPs, institutions should examine future capital resources and capital requirements under adverse scenarios. The results of forward-looking stress testing should be considered when evaluating the adequacy of an institution’s capital.
