The document discusses stress testing credit risk portfolios. It outlines the function of stress testing as investigating unexpected losses under extreme conditions not experienced in historical data. Stress testing is important for assessing capital adequacy and challenging risk models. The document describes regulatory requirements for stress testing, key credit risk parameters to consider in stress tests, and different types of stress test scenarios. It emphasizes that stress testing is a key risk management tool and supervisory expectation.
Empirical Analysis of Bank Capital and New Regulatory Requirements for Risks ...Michael Jacobs, Jr.
The document summarizes a study on analyzing the impact of new bank capital regulations for risks in trading portfolios. It finds that incremental risk charges may be substantially more than expected by regulators or previous studies. It develops a theoretical credit risk framework and uses empirical analysis of extensive bond and credit default swap data to estimate capital charges under different portfolio dynamics, rating systems, risk models, and sectors. The results show higher capital estimates when using point-in-time ratings versus through-the-cycle ratings, and for financial and sovereign sectors versus industrial sectors. A multi-factor risk model also produces higher estimates than a single-factor model.
Beaman Capital Group is a private equity, venture capital, and consulting firm based in Dallas, Texas. It was founded by Michael Beaman, who has extensive experience in private equity and business ownership. The firm invests in early-stage companies, mezzanine financing, and provides strategic consulting services including financial modeling. Its investments and consulting aim to maximize returns through rigorous analysis of economic, financial, and technical metrics.
Brady Dougan, Chief Executive Officer of Credit Suisse, is scheduled to prese...QuarterlyEarningsReports2
The document summarizes Brady W. Dougan's presentation at the Merrill Lynch Banking & Insurance Conference on October 8, 2008 in London. The summary highlights that Credit Suisse is well positioned despite challenging market conditions, with a strong capital position, balance sheet, and integrated business model focused on wealth management and reducing risk. Credit Suisse has maintained strong performance in private banking and is transforming its investment banking business.
i. Valuation under uncertainty uses simulation modeling to calculate the value of an entity, debt, and equity over time while accounting for uncertainty.
ii. Key inputs to the model include invested capital, excess marketable securities, capital charges, the net present value of translation gains/losses, forecasted earnings per share, and continuing value.
iii. The model provides probability distributions of the value of the entity, debt, and equity over time which help assess valuation risk under different scenarios.
The document provides an asset allocation review and outlook for the first half of 2012. In the first section, it summarizes that returns surprised to the upside in Q1 due to liquidity effects, but the global context weakened since April. Central bank balance sheets stopped expanding, and the model score deteriorated in Q2. The outlook section notes the crisis in Europe is deepening but risk has not become systemic. A rapid and credible solution in Europe is needed to avoid investors losing hope. Valuations remain compelling for long-term investors. The strategies discussed for H2 2012 include growing dividends and convertible bonds.
This document provides a review and outlook of asset allocation strategies for the first half of 2012 and beyond. Some key points:
- In Q1 markets surprised to the upside due to liquidity support from central banks, but the global context weakened since April as central bank balance sheets stopped expanding.
- The outlook is between a best and worst case - a deepening European crisis but risk has not become systemic. Rapid credible answers are needed from European leaders.
- Valuations remain compelling for equities over the long term if current risk levels are discounted. Preferred strategies include growing dividends and convertible bonds.
- A credible solution is needed in Europe to avoid investors losing hope as patience wears thin
111103 divulgação de resultados 3 t11 inglesMultiplus
Multiplus reported financial results for 3Q11. Points issued increased 38.5% YoY to 20 billion while points redeemed grew 171.7% to 12.5 billion. Gross billings rose 32.4% to R$397.3 million and net revenue increased 147.3% to R$321.5 million. EBITDA grew 64.5% but adjusted EBITDA fell 7%. Most agreements are USD denominated so Multiplus uses currency hedges like zero cost collars to manage foreign exchange risk exposure from partners representing 70% of gross billings. Hedge accounting aims to record intrinsic value changes in equity and time value in financial results.
The document discusses stress testing credit risk portfolios. It outlines the function of stress testing as investigating unexpected losses under extreme conditions not experienced in historical data. Stress testing is important for assessing capital adequacy and challenging risk models. The document describes regulatory requirements for stress testing, key credit risk parameters to consider in stress tests, and different types of stress test scenarios. It emphasizes that stress testing is a key risk management tool and supervisory expectation.
Empirical Analysis of Bank Capital and New Regulatory Requirements for Risks ...Michael Jacobs, Jr.
The document summarizes a study on analyzing the impact of new bank capital regulations for risks in trading portfolios. It finds that incremental risk charges may be substantially more than expected by regulators or previous studies. It develops a theoretical credit risk framework and uses empirical analysis of extensive bond and credit default swap data to estimate capital charges under different portfolio dynamics, rating systems, risk models, and sectors. The results show higher capital estimates when using point-in-time ratings versus through-the-cycle ratings, and for financial and sovereign sectors versus industrial sectors. A multi-factor risk model also produces higher estimates than a single-factor model.
Beaman Capital Group is a private equity, venture capital, and consulting firm based in Dallas, Texas. It was founded by Michael Beaman, who has extensive experience in private equity and business ownership. The firm invests in early-stage companies, mezzanine financing, and provides strategic consulting services including financial modeling. Its investments and consulting aim to maximize returns through rigorous analysis of economic, financial, and technical metrics.
Brady Dougan, Chief Executive Officer of Credit Suisse, is scheduled to prese...QuarterlyEarningsReports2
The document summarizes Brady W. Dougan's presentation at the Merrill Lynch Banking & Insurance Conference on October 8, 2008 in London. The summary highlights that Credit Suisse is well positioned despite challenging market conditions, with a strong capital position, balance sheet, and integrated business model focused on wealth management and reducing risk. Credit Suisse has maintained strong performance in private banking and is transforming its investment banking business.
i. Valuation under uncertainty uses simulation modeling to calculate the value of an entity, debt, and equity over time while accounting for uncertainty.
ii. Key inputs to the model include invested capital, excess marketable securities, capital charges, the net present value of translation gains/losses, forecasted earnings per share, and continuing value.
iii. The model provides probability distributions of the value of the entity, debt, and equity over time which help assess valuation risk under different scenarios.
The document provides an asset allocation review and outlook for the first half of 2012. In the first section, it summarizes that returns surprised to the upside in Q1 due to liquidity effects, but the global context weakened since April. Central bank balance sheets stopped expanding, and the model score deteriorated in Q2. The outlook section notes the crisis in Europe is deepening but risk has not become systemic. A rapid and credible solution in Europe is needed to avoid investors losing hope. Valuations remain compelling for long-term investors. The strategies discussed for H2 2012 include growing dividends and convertible bonds.
This document provides a review and outlook of asset allocation strategies for the first half of 2012 and beyond. Some key points:
- In Q1 markets surprised to the upside due to liquidity support from central banks, but the global context weakened since April as central bank balance sheets stopped expanding.
- The outlook is between a best and worst case - a deepening European crisis but risk has not become systemic. Rapid credible answers are needed from European leaders.
- Valuations remain compelling for equities over the long term if current risk levels are discounted. Preferred strategies include growing dividends and convertible bonds.
- A credible solution is needed in Europe to avoid investors losing hope as patience wears thin
111103 divulgação de resultados 3 t11 inglesMultiplus
Multiplus reported financial results for 3Q11. Points issued increased 38.5% YoY to 20 billion while points redeemed grew 171.7% to 12.5 billion. Gross billings rose 32.4% to R$397.3 million and net revenue increased 147.3% to R$321.5 million. EBITDA grew 64.5% but adjusted EBITDA fell 7%. Most agreements are USD denominated so Multiplus uses currency hedges like zero cost collars to manage foreign exchange risk exposure from partners representing 70% of gross billings. Hedge accounting aims to record intrinsic value changes in equity and time value in financial results.
This document summarizes an agenda for a presentation on infrastructure debt. It discusses the growing interest from institutional investors in long-term infrastructure investments and financing new infrastructure projects. It also examines the nature of infrastructure debt, specifically project finance debt, and how it captures the characteristics of underlying infrastructure assets. Finally, it analyzes the determinants of infrastructure debt credit spreads, including loan, macroeconomic, and project-specific factors, as well as the systematic drivers of credit risk for this asset class over time.
1. The document contains technical analyses and models created by the author to evaluate Nigerian stock and money markets, including: an equities volatility model, sector trend analysis, portfolio strategy backtesting, fundamental factor regressions, and performance attribution.
2. Credit risk models are presented to appraise money market counterparties and debt instruments, including default probability models and expected loss projections.
3. Additional analyses include option-adjusted bond spreads, counterparty credit allocation based on risk scores, and modeling of market default risk conditions.
Sl12 keynote - will economic growth return - finalcabotmoney
The document summarizes Rob Lutts' presentation at the 23rd Annual Investment Conference & Luncheon on the themes of economic growth returning in 2013, governments' fiscal crisis status, and Cabot's top three investment themes. Lutts discusses that slowly improving global economics, government solutions to sovereign debt crises through currency debasement, and attractive stock valuations provide opportunities for investors willing to take risk. Currency debasement through money printing risks inflation increasing in the next 2-3 years.
1) The document discusses the need to incorporate financial intermediation into macroeconomic models in light of lessons from the financial crisis.
2) It summarizes a DSGE model developed by Gerali et al. that includes financial frictions and intermediation to analyze monetary and macroprudential policies.
3) The model finds that macroprudential policy can effectively lean against financial cycles when used to contain expansion of bank lending.
This document discusses using boosted decision trees to select important hyperspectral bands for geology classification. It aims to reduce dimensionality and processing time while maintaining classification accuracy. The method embeds band selection within the boosting process to identify the most informative bands. Experiments are conducted on hyperspectral data from an iron ore mine to evaluate the approach.
While mortgage delinquencies increased slightly in the first quarter of 2011, delinquency and foreclosure rates decreased on a non-seasonally adjusted basis. The number of seriously delinquent loans (90+ days past due or in foreclosure) fell to 8.14% from 9.65% a year prior. Foreclosure starts and inventory declined across all regions, with the largest decreases in the West and South. Overall delinquency and foreclosure trends continued to improve in the first quarter of 2011 compared to the prior year.
The document provides information on potential equity investments for a 100 million peso fund, including sector outlooks, individual stock analyses, and optimization recommendations. Key sectors identified are consumer staples, utilities, financials, real estate, and tourism. Stock screening is done based on fundamentals like P/E, P/B, growth, and technical analyses. Optimization suggests allocations like 50% in SECB and BPI for banks, and 55% in MPI for holding firms. The fund needs to achieve a 10% annual return while meeting other constraints.
This document is Quest Diagnostics' 2005 annual report which discusses their financial performance and business strategy.
1) Quest Diagnostics saw increases in net revenues, operating income, net income, and earnings per share in 2005 compared to 2004.
2) The company's strategy focuses on enhancing the patient experience, driving profitable growth, and supporting their over 41,500 employees.
3) In 2005, Quest Diagnostics made progress in these strategic areas through service improvements, acquisitions, innovation in diagnostic testing, and programs to support employee health.
“SCORECARD” Incentive Remuneration System for MicrofinanceMABSIV
Ms. Vivian Lim of First Valley Bank shares their bank experience on using the EAGLE Scorecard to optimize the bank's microfinance operations during the 2012 RBAP-MABS National Roundtable Conference on June 7.
- The document provides financial statements for Villa Alhambra of Coral Gables Condominium Association for the period ending August 31, 2012.
- As of August 31, 2012 the Association had total assets of $127,035 including current assets of $96,803 and restricted funds for reserves of $27,860.
- Current liabilities were minimal at $(11).
SEB Resultatpresentation January September 2008SEBgroup
This document provides an overview of Annika Falkengren's presentation of SEB Group's Q3 2008 results. Key points include:
- Markets were extremely challenging in 2008, negatively impacting SEB's profits, though the underlying customer business remained stable.
- SEB maintained a strong capital position and liquidity despite financial crisis impacts. Impaired loans increased in the Baltic countries.
- Cost cuts and efficiency measures helped offset negative effects from the crisis. Asset quality remained solid overall.
- While profits declined from turmoil, Falkengren emphasized SEB's resilient franchise, strong capital, and focus on customers through the downturn.
The document discusses the state of the US economy and the role of monetary policy. It provides an analysis of key economic indicators and headwinds facing recovery. GDP growth in 2012 was supported by consumption, investment and government spending. Housing prices and production are improving but wages remain low. The document evaluates current monetary policy tools and makes recommendations, suggesting policy should remain accommodative given unemployment and deflation risks outweigh inflation concerns. It recommends the Federal Reserve continue its current policy path.
The document discusses Newmont Mining Corporation's presentation at the Barclays Americas Mining & Materials Conference on March 20-21, 2013. It includes cautionary statements regarding forward-looking statements and estimates of resources. Newmont highlights its strategic priorities of strong free cash flow growth, leverage to gold prices, returning capital to shareholders, total cost management, and maximizing asset value. Newmont also discusses its record reduction in injury rates in 2012, profitable production growth prospects, capital discipline, and focus on reducing total costs.
Conco Phillips- Presentations & Conference Calls Howard Weil Annual Energy Co...Manya Mohan
This document provides an overview of ConocoPhillips' annual energy conference in March 2009. It summarizes the major changes in the global economic and energy environment over the past year, including a recession, declining commodity prices, and reduced energy demand. The document outlines how ConocoPhillips has adjusted its operating plans and cost structure in response. It reaffirms the company's long-term strategic objectives and provides details on its exploration and production and refining activities and investments over the past decade.
Breakfast with Bob: The Obamacare Rulingtuckalumni
The document provides an overview of key provisions and issues related to the Affordable Care Act (ACA). It summarizes major ACA policies such as the individual mandate, subsidies, Medicaid expansion, and employer requirements. It also discusses ongoing debates around the ACA, including the impact on states, employers, costs, and the health care workforce. Overall, the summary captures the high-level goal of expanding coverage while acknowledging implementation challenges and differing opinions about the law.
The document summarizes an economic analysis predicting a "W-shaped" recovery over the next few years for the US economy. It states that massive fiscal stimulus financed by monetary easing could lead to GDP growth resuming in late 2009, but this stimulus could also cause inflation and further monetary tightening, risking another recession in 2011-2012. Downside risks to the economy remain substantial in the near-term, with GDP forecast to contract sharply again in Q1 2009 and several indicators like housing remaining weak.
Stratégie d'allocation d'actif des assureurs - les changements induits par S2...AssurFinance
1. Low interest rates and bond yields have negatively impacted insurers' investment returns and competitive positioning.
2. Regulatory changes under Solvency II have prompted shifts toward fixed income and away from equity allocations.
3. Insurers have increased use of interest rate options to hedge risks in a low rate environment as Solvency II is implemented.
marriott international 2000 Annual Reportfinance20
Marriott International is a leading global hospitality company with over 2,200 operating units across 60 countries. With 21 distinct brands, Marriott offers the broadest portfolio of hotel brands in the world. Each brand is a leader in its category with high customer preference and growth potential. Collectively, the unique strengths of these brands form a powerful network that allows Marriott to leverage economies of scale and capitalize on profitable opportunities, strengthening the entire company. Marriott's wide distribution ensures a strong presence in markets where customers want them, and their brands are becoming more recognizable and preferred globally.
This document provides an asset allocation recommendation for a $5 million portfolio. It recommends an allocation of 65% to equities, 29% to fixed income, and 6% to cash. Specific equity and fixed income funds and indexes are recommended across large cap US and international developed and emerging markets. Alternative investments including real estate, commodities, and natural resources are also recommended totaling 24% of the portfolio. Performance histories for the past 1, 3, 5, and 10 years are provided for many of the recommended securities.
In this study we survey practices and supervisory expectations for stress testing (ST), in a credit risk framework for banking book exposures. We introduce and motivate ST; and discuss the function, supervisory requirements and expectations, credit risk parameters, interpretation results
with respect to ST. This includes a typology of ST (uniform testing, risk factor sensitivities, scenario analysis; and historical, statistical and hypothetical scenarios) and procedures for con-ducting ST. We conclude with two simple and practical stress testing examples, one a ratings migration based approach, and the other a top-down ARIMA modeling approach.
This document summarizes regulatory changes to the market risk capital framework. It discusses revisions made by the Basel Committee on Banking Supervision (BCBS) following weaknesses exposed in the financial crisis. The proposed US rule implements BCBS standards in a manner consistent with Dodd-Frank Act requirements. It modifies the 1996 market risk capital rule, introducing new standards like stressed Value-at-Risk, an incremental risk charge, and counterparty credit risk capital requirements.
More Related Content
Similar to Jacobs Dodd Frank&Basel3 July12 7 15 12 V16
This document summarizes an agenda for a presentation on infrastructure debt. It discusses the growing interest from institutional investors in long-term infrastructure investments and financing new infrastructure projects. It also examines the nature of infrastructure debt, specifically project finance debt, and how it captures the characteristics of underlying infrastructure assets. Finally, it analyzes the determinants of infrastructure debt credit spreads, including loan, macroeconomic, and project-specific factors, as well as the systematic drivers of credit risk for this asset class over time.
1. The document contains technical analyses and models created by the author to evaluate Nigerian stock and money markets, including: an equities volatility model, sector trend analysis, portfolio strategy backtesting, fundamental factor regressions, and performance attribution.
2. Credit risk models are presented to appraise money market counterparties and debt instruments, including default probability models and expected loss projections.
3. Additional analyses include option-adjusted bond spreads, counterparty credit allocation based on risk scores, and modeling of market default risk conditions.
Sl12 keynote - will economic growth return - finalcabotmoney
The document summarizes Rob Lutts' presentation at the 23rd Annual Investment Conference & Luncheon on the themes of economic growth returning in 2013, governments' fiscal crisis status, and Cabot's top three investment themes. Lutts discusses that slowly improving global economics, government solutions to sovereign debt crises through currency debasement, and attractive stock valuations provide opportunities for investors willing to take risk. Currency debasement through money printing risks inflation increasing in the next 2-3 years.
1) The document discusses the need to incorporate financial intermediation into macroeconomic models in light of lessons from the financial crisis.
2) It summarizes a DSGE model developed by Gerali et al. that includes financial frictions and intermediation to analyze monetary and macroprudential policies.
3) The model finds that macroprudential policy can effectively lean against financial cycles when used to contain expansion of bank lending.
This document discusses using boosted decision trees to select important hyperspectral bands for geology classification. It aims to reduce dimensionality and processing time while maintaining classification accuracy. The method embeds band selection within the boosting process to identify the most informative bands. Experiments are conducted on hyperspectral data from an iron ore mine to evaluate the approach.
While mortgage delinquencies increased slightly in the first quarter of 2011, delinquency and foreclosure rates decreased on a non-seasonally adjusted basis. The number of seriously delinquent loans (90+ days past due or in foreclosure) fell to 8.14% from 9.65% a year prior. Foreclosure starts and inventory declined across all regions, with the largest decreases in the West and South. Overall delinquency and foreclosure trends continued to improve in the first quarter of 2011 compared to the prior year.
The document provides information on potential equity investments for a 100 million peso fund, including sector outlooks, individual stock analyses, and optimization recommendations. Key sectors identified are consumer staples, utilities, financials, real estate, and tourism. Stock screening is done based on fundamentals like P/E, P/B, growth, and technical analyses. Optimization suggests allocations like 50% in SECB and BPI for banks, and 55% in MPI for holding firms. The fund needs to achieve a 10% annual return while meeting other constraints.
This document is Quest Diagnostics' 2005 annual report which discusses their financial performance and business strategy.
1) Quest Diagnostics saw increases in net revenues, operating income, net income, and earnings per share in 2005 compared to 2004.
2) The company's strategy focuses on enhancing the patient experience, driving profitable growth, and supporting their over 41,500 employees.
3) In 2005, Quest Diagnostics made progress in these strategic areas through service improvements, acquisitions, innovation in diagnostic testing, and programs to support employee health.
“SCORECARD” Incentive Remuneration System for MicrofinanceMABSIV
Ms. Vivian Lim of First Valley Bank shares their bank experience on using the EAGLE Scorecard to optimize the bank's microfinance operations during the 2012 RBAP-MABS National Roundtable Conference on June 7.
- The document provides financial statements for Villa Alhambra of Coral Gables Condominium Association for the period ending August 31, 2012.
- As of August 31, 2012 the Association had total assets of $127,035 including current assets of $96,803 and restricted funds for reserves of $27,860.
- Current liabilities were minimal at $(11).
SEB Resultatpresentation January September 2008SEBgroup
This document provides an overview of Annika Falkengren's presentation of SEB Group's Q3 2008 results. Key points include:
- Markets were extremely challenging in 2008, negatively impacting SEB's profits, though the underlying customer business remained stable.
- SEB maintained a strong capital position and liquidity despite financial crisis impacts. Impaired loans increased in the Baltic countries.
- Cost cuts and efficiency measures helped offset negative effects from the crisis. Asset quality remained solid overall.
- While profits declined from turmoil, Falkengren emphasized SEB's resilient franchise, strong capital, and focus on customers through the downturn.
The document discusses the state of the US economy and the role of monetary policy. It provides an analysis of key economic indicators and headwinds facing recovery. GDP growth in 2012 was supported by consumption, investment and government spending. Housing prices and production are improving but wages remain low. The document evaluates current monetary policy tools and makes recommendations, suggesting policy should remain accommodative given unemployment and deflation risks outweigh inflation concerns. It recommends the Federal Reserve continue its current policy path.
The document discusses Newmont Mining Corporation's presentation at the Barclays Americas Mining & Materials Conference on March 20-21, 2013. It includes cautionary statements regarding forward-looking statements and estimates of resources. Newmont highlights its strategic priorities of strong free cash flow growth, leverage to gold prices, returning capital to shareholders, total cost management, and maximizing asset value. Newmont also discusses its record reduction in injury rates in 2012, profitable production growth prospects, capital discipline, and focus on reducing total costs.
Conco Phillips- Presentations & Conference Calls Howard Weil Annual Energy Co...Manya Mohan
This document provides an overview of ConocoPhillips' annual energy conference in March 2009. It summarizes the major changes in the global economic and energy environment over the past year, including a recession, declining commodity prices, and reduced energy demand. The document outlines how ConocoPhillips has adjusted its operating plans and cost structure in response. It reaffirms the company's long-term strategic objectives and provides details on its exploration and production and refining activities and investments over the past decade.
Breakfast with Bob: The Obamacare Rulingtuckalumni
The document provides an overview of key provisions and issues related to the Affordable Care Act (ACA). It summarizes major ACA policies such as the individual mandate, subsidies, Medicaid expansion, and employer requirements. It also discusses ongoing debates around the ACA, including the impact on states, employers, costs, and the health care workforce. Overall, the summary captures the high-level goal of expanding coverage while acknowledging implementation challenges and differing opinions about the law.
The document summarizes an economic analysis predicting a "W-shaped" recovery over the next few years for the US economy. It states that massive fiscal stimulus financed by monetary easing could lead to GDP growth resuming in late 2009, but this stimulus could also cause inflation and further monetary tightening, risking another recession in 2011-2012. Downside risks to the economy remain substantial in the near-term, with GDP forecast to contract sharply again in Q1 2009 and several indicators like housing remaining weak.
Stratégie d'allocation d'actif des assureurs - les changements induits par S2...AssurFinance
1. Low interest rates and bond yields have negatively impacted insurers' investment returns and competitive positioning.
2. Regulatory changes under Solvency II have prompted shifts toward fixed income and away from equity allocations.
3. Insurers have increased use of interest rate options to hedge risks in a low rate environment as Solvency II is implemented.
marriott international 2000 Annual Reportfinance20
Marriott International is a leading global hospitality company with over 2,200 operating units across 60 countries. With 21 distinct brands, Marriott offers the broadest portfolio of hotel brands in the world. Each brand is a leader in its category with high customer preference and growth potential. Collectively, the unique strengths of these brands form a powerful network that allows Marriott to leverage economies of scale and capitalize on profitable opportunities, strengthening the entire company. Marriott's wide distribution ensures a strong presence in markets where customers want them, and their brands are becoming more recognizable and preferred globally.
This document provides an asset allocation recommendation for a $5 million portfolio. It recommends an allocation of 65% to equities, 29% to fixed income, and 6% to cash. Specific equity and fixed income funds and indexes are recommended across large cap US and international developed and emerging markets. Alternative investments including real estate, commodities, and natural resources are also recommended totaling 24% of the portfolio. Performance histories for the past 1, 3, 5, and 10 years are provided for many of the recommended securities.
Similar to Jacobs Dodd Frank&Basel3 July12 7 15 12 V16 (20)
In this study we survey practices and supervisory expectations for stress testing (ST), in a credit risk framework for banking book exposures. We introduce and motivate ST; and discuss the function, supervisory requirements and expectations, credit risk parameters, interpretation results
with respect to ST. This includes a typology of ST (uniform testing, risk factor sensitivities, scenario analysis; and historical, statistical and hypothetical scenarios) and procedures for con-ducting ST. We conclude with two simple and practical stress testing examples, one a ratings migration based approach, and the other a top-down ARIMA modeling approach.
This document summarizes regulatory changes to the market risk capital framework. It discusses revisions made by the Basel Committee on Banking Supervision (BCBS) following weaknesses exposed in the financial crisis. The proposed US rule implements BCBS standards in a manner consistent with Dodd-Frank Act requirements. It modifies the 1996 market risk capital rule, introducing new standards like stressed Value-at-Risk, an incremental risk charge, and counterparty credit risk capital requirements.
It is not difficult to find situations of marked change in variables and with unpredictable event risk implies estimation problems. E.g.,
Credit spreads in 2008 rise to levels that could never have been forecast based upon previous history. The subprime crisis of 2007/8: credit spreads & volatility rise to unseen levels & shift in debtor behavior (delinquency patterns)
E.g., estimating the volatility from data in a calm (turbulent) period implies under (over) estimation of future realized volatility
This presentation will survey and discuss various quantitative considerations in liquidity risk for a financial institution. This includes the concept of liquidity-at-risk (LaR) as a determinant of buffers, as well as how one defines and quantifies such buffers. We will also examine issues such as limit-related input for liquidity policy and transfer pricing as an alternative concept. Two stylized models of liquidity risk are presented and analyzed.
odd-Frank and Basel III Post-Financial Crisis Developments and New Expectations in Regulatory Capital. Following the recent global financial crisis of 2009, financial regulators have responded with arrays of proposals to revise existing risk frameworks for financial institutions with the objective to further strengthen and improve upon bank models. In this meeting, Dr. Michael Jacobs will discuss new developments and expectations in regulatory capital with particular reference to the definition of the capital base, counterparty credit risk, procyclicality of capital, liquidity risk management, and sound compensation practices. He will also explain the implications of the Frank-Dodd rule for financial institutions and will conclude by presenting the implementation schedule for Basel III.
This study provides a practical way to anticipate systematic LGD risk. It introduces an LGD function that requires no parameters other than PD, expected LGD, and correlation. This function survives testing against more-elaborate models of corporate credit loss that allow either greater or less LGD risk. Unless a significant improvement were discovered, the LGD function presented here can be used to anticipate systematic LGD risk within a credit loss model or to quantify downturn LGD.
The document presents a model for estimating exposure at default (EAD) for contingent credit lines (CCLs) at the portfolio level. It models each CCL as a portfolio of put options, with the exercise of each put following a Poisson process. The model convolutes the usage distributions of individual obligors, sub-segments, and segments to estimate the portfolio-level EAD distribution. The authors test the model using data from Moody's and find near-Gaussian results. They discuss future work to refine the model and make it more practical for banks to estimate regulatory capital requirements.
This document outlines the steps for conducting a Bayesian analysis to estimate default probabilities using both empirical data and expert elicitation. It presents three statistical models of increasing complexity to model default, applies the analysis to Moody's corporate bond default data from 1999-2009, and elicits expert opinions to specify prior distributions. The results provide posterior distributions over model parameters and show that the data favors a lower level of default rate autocorrelation than assumed priorly. The Bayesian approach allows formal incorporation of both hard data and soft expert knowledge.
The document discusses validation of economic capital models from a regulatory perspective. It outlines a range of qualitative and quantitative validation approaches used in practice to assess different properties of economic capital models, from integrity of implementation to predictive ability. While individual tests have limitations, a layered approach using multiple validation techniques can provide more robust evidence of a model's fitness for its intended purposes. Key challenges include validating conceptual soundness and assumptions given many are untestable, as well as assessing accuracy, particularly in tail distributions where data is scarce.
The document summarizes a study on modeling risk aggregation and sensitivity analysis for economic capital at banks. It finds that different risk aggregation methodologies, such as historical bootstrap, normal approximation, and copula models, produce significantly different economic capital estimates ranging from 10% to 60% differences. The empirical copula approach tends to be the most conservative while normal approximation is the least conservative. The results indicate banks should take a conservative approach to quantify integrated risk and consider the impact of methodology choice and parameter uncertainty on economic capital estimates.
Understanding and Predicting Ultimate Loss-Given-Default on Bonds and LoansMichael Jacobs, Jr.
The document summarizes research on modeling and predicting ultimate loss-given-default (LGD) on bonds and loans. It discusses issues in LGD measurement, reviews theoretical and empirical credit risk models, and presents alternative econometric models to estimate LGD including a beta link generalized linear model. The research finds leverage, profitability, and market factors are associated with lower LGD, while contractual features like seniority and collateral impact LGD. Modeling LGD at both the obligor and instrument level improves performance.
This document summarizes an empirical study on exposure at default (EAD) for revolving credit facilities. It outlines the methodology used, which estimates EAD through a loan equivalency factor (LEQ) applied to unused balances. The LEQ is estimated via quantile regression of dollar changes in usage from current to default. The study analyzes EAD risk measures for 496 defaulted large corporate borrowers with revolving lines of credit from 1985-2007. Summary statistics are provided on various exposure measures including EAD and changes in usage up to default.
An Empirical Study of the Returns on Defaulted Debt and the Discount Rate for...Michael Jacobs, Jr.
This document summarizes an empirical study on estimating appropriate discount rates for loss-given-default (LGD) calculations. It analyzed returns on defaulted corporate debt from 1985-2007 using Moody's database. It found an average return on defaulted debt (RDD) of 29.2%, higher than previous benchmarks. RDD estimates varied by factors like collateral, seniority, and obligor characteristics. It proposed a theoretical 2-factor model incorporating systematic and idiosyncratic recovery risk. The study aimed to provide useful benchmarks for banks implementing Basel II internal ratings-based models and estimating economic capital.
An Empirical Study of the Returns on Defaulted Debt and the Discount Rate for...
Jacobs Dodd Frank&Basel3 July12 7 15 12 V16
1. Dodd-Frank and Basel III: Post-Financial
Crisis Developments and New
Expectations in Regulatory Capital
Michael Jacobs, Ph.D., CFA
Senior Manager
Deloitte and Touche LLP
Governance, Regulatory and Risk Strategies / Enterprise Risk Service
July 2012
Important Disclaimer: The views expressed herein are those of the author and do not necessarily
represent the views of Deloitte & Touche LLP
2. Outline
• Motivation: The Financial Crisis and “Too Big to Fail”
• Frank-Dodd and Implications for Financial Institutions
– History
– Summary
– Critique
• Basel III Supervisory Expectations and Guidance
• Overview of Basel III New Capital & Liquidity Standards
– Key Elements
– Implementation Issues
– Critique
3. Motivation: The Financial Crisis and
“Too Big to Fail” • Bank losses in
Figure 3: Average Ratio of Total Charge-offs to Total Value of Loans for
Top 50 Banks as of 4Q09 the recent
0.035
(Call Report Data 1984-2009) financial crisis
exceed levels
0.03
observed in
0.025 recent history!
0.02 • This illustrates
0.015
the inherent
limitations of
0.01
backward
0.005 looking models
0
– we must
anticipate risk
84 1
85 1
86 0
87 0
87 1
88 1
89 0
90 0
90 1
91 1
92 0
93 0
93 1
94 1
95 0
96 0
96 1
97 1
98 0
99 0
99 1
00 1
01 0
02 0
02 1
03 1
04 0
05 0
05 1
06 1
07 0
08 0
08 1
09 1
30
19 033
19 123
19 093
19 063
19 033
19 123
19 093
19 063
19 033
19 123
19 093
19 063
19 033
19 123
19 093
19 063
19 033
19 123
19 093
19 063
19 033
20 123
20 093
20 063
20 033
20 123
20 093
20 063
20 033
20 123
20 093
20 063
20 033
20 123
09
84
19
• Reproduced from: Inanoglu, H., Jacobs, Jr., M., and Robin Sickles, 2010 (July), Analyzing bank
efficiency: Are “too-big-to-fail” banks efficient?, forthcoming in the Journal of Efficiency
4. Motivation: The Financial Crisis
and “Too Big to Fail” (cont’d.)
Averaged efficiencies from each estimator FIX
1 RND • Across several
HT
0.95 PSS1 econometric
0.9
PSS2W
PSS2G
models, we find
0.85
PSS3
BC
evidence that the
0.8
BIE average the
efficiency of the
Efficiency
0.75
largest banks has
0.7
decreased over
0.65
time, as the
0.6
financial sector in
0.55 the U.S. has
0.5
10 20 30 40 50 60 70 80 90 100
grown
Time
• Reproduced from: Inanoglu, H., Jacobs, Jr., M., and Robin Sickles, 2010 (July), Analyzing bank
efficiency: Are “too-big-to-fail” banks efficient?, forthcoming in the Journal of Efficiency
5. Frank-Dodd & Implications for Financial
Institutions: History
• The Dodd-Frank Wall Street Reform and Consumer Protection Act of
2010 (“Dodd-Frank”) is perhaps the most ambitious and far-reaching
overhaul of financial regulation since the 1930s
• The Banking Act of 1933 (“Glass-Steagall”), designed to prevent
against financial panics that occurred since the mid-19th century, had
been largely undone by the dawn of the financial crisis circa 2004
• Intent of Glass-Steagall was to prevent bank runs & provide an
orderly resolution of troubled banks before they failed
• Established the Federal Deposit Insurance Corporation (FDIC) to
protect retail depositors & ring-fenced banks’ permissible activities
– Commercial lending, government bonds & general-obligation municipals
– Riskier capital markets activity to be spun off into investment banks
.
6. Frank-Dodd & Implications for Financial
Institutions: History
• It has been argued that overall Glass-Steagall reflected a sound
economic approach to regulation:
– Identify the market failure: collective outcome of individual economic agents
does not lead to socially efficient outcomes (depositor runs)
– Address market failure through a government intervention (insuring retail
depositors against losses)
– Recognize & contain the direct & indirect costs of intervention through upfront
premiums for deposit insurance, restricting investment banking activities &
“prompt corrective action” (early & orderly distress resolution)
• Easy regulatory era starting in the 1970s allowed a “shadow banking
system” (money market funds, investment banks, derivatives &
securitization markets) to evolve
– Both opaque & highly leveraged, reflected regulatory arbitrage, the opportunity &
propensity of the financial sector to adopt organizational forms / innovations that would
circumvent the regulatory apparatus designed to contain bank risk-taking
• This is considered the beginning of the end for of Glass-Seagall
7. Frank-Dodd & Implications for Financial
Institutions: History
• By mid-2004s large complex financial institutions (LCFIs) were
seeking massive capital flows into the U.S. & U.K. by short-term
borrowing financed at historically low interest rates
• They began to manufacture huge quantities of “tail risk”: i.e., small
likelihood but catastrophic outcomes
– Key example: senior, AAA rated tranches of subprime-backed mortgages that
would fail only if there was a secular collapse in the housing
• A credit boom was fueled as LCFIs were willing buy loans from
originating lenders, distribute or hold after repackaging them
– In 2008 over 20% of the US mortgage-backed exposure was guaranteed by
“non-agencies” (the private sector )
• Unlike traditional securitization in which the AAA-tranches get placed
with institutional investors, in a significant measure these were
originated and retained by banks
8. Frank-Dodd & Implications for Financial
Institutions: History
• Table 1: Distribution of
the United States real-
estate exposures,
source – Lehman
Brothers Fixed Income
Report, June 2008
• Net result was that balance sheets at LCFIs grew 2-fold in the 2004 to
2007 period
• LCFIs (plus Fannie, Freddie-Mac & AIG) had taken a highly
undercapitalized one-way bet on the housing market
• While these institutions seemed individually safe, collectively they
were vulnerable: as the housing market crashed in 2007, the tail risk
materialized & LCFIs crashed too
9. Frank-Dodd & Implications for Financial
Institutions: Summary
• The first big banks to fail were in the shadow banking world were
initially propped up by Fed assistance
• Strains in the interbank markets & inherently poor quality of the
underlying housing bets even in commercial bank portfolios meant
that in the fall of 2008 some banks had to fail
• A panic ensued internationally making it clear that the entire global
banking system was imperiled & needed taxpayer funds
• In the aftermath of this governments and regulators looked for ways
to prevent or render less likely its recurrence
• Led first to a bill from the House of Representatives & then from the
Senate, combined into the Dodd-Frank Act
• The critical task of Dodd-Frank Act viewed as addressing the
increasing propensity of the financial sector to put the entire system
at risk & eventually bailed out at taxpayer expense
10. Frank-Dodd & Implications for Financial
Institutions: Summary
Highlights of the Dodd-Frank Act are:
• Identifying & regulating systemic risk: set up a Council that can deem
non-bank financial firms as systemically important, regulate them &
as a last resort break them up
– Also establishes an Office under the Treasury to collect, analyze and
disseminate relevant information for anticipating future crises
• Proposing an end to “too-big-to-fail”: requires funeral plans & orderly
liquidation procedures for unwinding of systemically important
institutions
– Rules out taxpayer funding of wind-downs instead requiring management of
failing institutions be dismissed & costs be borne by shareholders, creditors,
and if required ex post levies on surviving large financial firms
• Expands the responsibility & authority of the Fed: authority over all
systemic institutions & responsibility for financial stability
• Restricts discretionary regulatory interventions: prevent or limit
emergency federal assistance to single non-bank institutions
11. Frank-Dodd & Implications for Financial
Institutions: Summary
• Reinstate a limited form of the “Volcker rule”: limit bank holding
company investments in proprietary trading activities (hedge funds,
private equity) & prohibits bailing out these investments
• Regulation & transparency of derivatives: central clearing of
standardized & regulation of OTC complex ones, transparency of all &
separation of non-vanilla positions into well-capitalized subsidiaries,
with exceptions for commercial hedging uses
• Introduces a range of reforms for mortgage lending practices, hedge
fund disclosure, conflict resolution at rating agencies, skin-in-the-
game requirement for securitization, risk-taking by money market
funds & shareholder say on pay and governance
• And perhaps its most popular reform, albeit secondary to the
financial crisis, creates a Bureau of Consumer Financial Protection,
that will write rules governing consumer financial services and
products offered by banks and non-banks
12. Frank-Dodd & Implications for Financial
Institutions: Critique
• It is highly encouraging that the purpose is explicitly aimed at
developing tools to deal with systemically important institutions
• Strives to give regulators authority & tools to deal with this risk
– Requirement of funeral plans to unwind LCFIs should help demystify their
organizational structure & resolution challenges when they fail
• If enforced well, it could serve as a “tax” on complexity, another
market failure in that private far exceed the social gains
• But the final language is a highly diluted version of the original
Volcker Rule proposal limiting LCFI’s proprietary trading
– Volcker Rule provides a more direct restriction on complexity & would help
simplify their resolution
– Also addresses moral hazard: direct guarantees to banks are meant to support
payment / settlement systems & ensure robust lending
– But the bank holding company structure effectively lower the costs for more
cyclical and riskier functions (proprietary investments), where there are
thriving markets and commercial banking presence is not critical
13. Frank-Dodd & Implications for Financial
Institutions: Critique
• Another positive feature is comprehensive overhaul of derivatives
markets to promote transparency & avoid market failures when large
derivatives dealer fails (e.g., Bear Stearns)
– Transparency of prices, volumes and exposures to regulators & public enables
better pricing & assessing of counterparty in bilateral contracts
• The Act also pushes for greater transparency by making systemic non-
bank firms subject to scrutiny by the Fed & SEC
• But the Act requires over 225 new financial rules across 11 federal
agencies with little attempt at regulatory consolidation
– The financial sector will have to live with great uncertainty left unresolved until
various regulators (Fed, SEC, CFTC) details the implementation
• Economically sound & robust regulation: weaknesses remain
– Implicit government guarantees persist in some & escalate in other areas
– Capital allocation may migrate to these pockets & newer ones may arise
– Implementation of the Act and future regulation may guard against this danger,
but that remains to be seen
14. Basel III Supervisory Expectations and
Guidance
• Objective of the reform package is to improve banking sector’s ability
to absorb shocks arising from financial/economic stress & reducing
risk of spillover to the real economy
• Aims to improve risk management, governance & strengthen banks’
transparency / disclosures including efforts to strengthen the
resolution of systemically significant cross-border banks
• Reforms are part of the global initiatives to strengthen the financial
regulatory system endorsed by the Financial Stability Board (FSB) and
the G20 Leaders
• Supervisors attribute the severity of the financial crisis to banks
building up excessive leverage & erosion of level/quality of capital
base along with insufficient liquidity buffers
• System therefore was not able to absorb the resulting systemic
trading & credit losses nor cope with reintermediation of large off-
balance sheet exposures built up in shadow bank system
15. Basel III Supervisory Expectations and
Guidance (cont’d.)
• Weaknesses in the banking sector were transmitted to the rest of the
financial system & real economy resulting in massive contraction of
liquidity & credit availability
• Ultimately the public sector had to step in with unprecedented
injections of liquidity, capital support and guarantees, exposing the
taxpayer to large losses
• The effect on banks, financial systems and economies at the
epicentre of the crisis was immediate; however, the crisis also spread
to a wider circle of countries around the globe.
– For these countries the transmission channels were less direct, resulting from a
severe contraction in global liquidity, cross border credit availability and
demand for exports
• Scope & speed with which the crisis was transmitted around the
globe implies all countries raise the resilience of banking sectors to
internal & external shocks
16. Basel III Supervisory Expectations and
Guidance (cont’d.)
• To address the market failures revealed by the crisis BCBS introduced
a number of fundamental reforms to the international regulatory
framework to strengthen bank-level regulation to help raise the
resilience of individual institutions to stress
• The reforms also have a macroprudential focus, addressing system
wide risks that can build up across the banking sector as well as the
procyclical amplification of these risks over time
• Clearly these two micro and macroprudential approaches to
supervision are interrelated, as greater resilience at the individual
bank level reduces the risk of system wide shocks
• Building on the agreements reached at the 6 September 2009
meeting of the BCBS’s governing body, the key elements of the
proposals were issued for consultation at the end of 2009
17. Basel III Supervisory Expectations and
Guidance (cont’d.)
• First, the quality, consistency, and transparency of the capital base
will be raised to ensure that large, internationally active banks are in
a better position to absorb losses on both a going concern and gone
concern basis
– For example, under the previous BCBS standard, banks could hold as little as 2%
common equity to risk-based assets
• Second, the risk coverage of the capital framework will be
strengthened
– In addition to the trading book & securitization reforms announced in 7-09,
strengthen the capital requirements for counterparty credit risk exposures
arising from derivatives, repos & securities financing activities
– Enhancements will strengthen the resilience of individual institutions & reduce
the risk that shocks are transmitted from one institution to the next through
the derivatives & financing channel
– The strengthened counterparty capital requirements also will increase
incentives to move OTC derivatives to central clearinghouses
18. Basel III Supervisory Expectations and
Guidance (cont’d.)
• Third, introduced a leverage ratio as a supplementary measure to the
Basel II risk-based framework with a view to migrating to a Pillar 1
treatment based on appropriate review & calibration
– This will help contain the build up of excessive leverage in the banking system,
introduce additional safeguards against attempts to game the risk based
requirements & help address model risk
– To ensure comparability details of the leverage ratio will be harmonised
internationally, fully adjusting for any remaining differences in accounting
– Ratio will be calibrated so that it serves as a credible supplementary measure
to the risk based requirements, taking into account the forthcoming changes to
the Basel II framework
• Fourth, measures to promote the build up of capital buffers in good
times that can be drawn upon in periods of stress
– Countercyclical capital framework contributes to a more stable banking system,
which will help dampen vs. amplify economic & financial shocks
– Promote forward looking provisioning based on expected losses that reflect
actual losses transparently & is less procyclical than incurred loss
19. Basel III Supervisory Expectations and
Guidance (cont’d.)
• Fifth, a global minimum liquidity standard for internationally active
banks: a 30-day liquidity coverage ratio requirement underpinned by
a longer-term structural liquidity ratio
– Framework also includes a common set of monitoring metrics to assist in
identifying & analysing liquidity risk trends at bank & system wide level
– Standards and monitoring metrics complement BCBS “Principles for Sound
Liquidity Risk Management and Supervision” issued 9-08
• BCBS is reviewing the need for additional capital, liquidity or other
supervisory measures to reduce the externalities created by
systemically important institutions
• Market pressure has already forced the banking system to raise the
level and quality of the capital and liquidity base
– The proposed changes will ensure that these gains are maintained over the
long run, resulting in a banking sector that is less leveraged, less procyclical and
more resilient to system wide stress
20. Basel III Supervisory Expectations and
Guidance (cont’d.)
• BCBS conducted a comprehensive impact assessment of the
enhanced capital and liquidity standards in the first half of 2010
• Based upon the conclusion that the effect on the global banking
system would be favorable, BCBS reviewed & finalized the regulatory
minimum level of capital in the second half of 2010
• Taking into account the reforms proposed, BCBS asserts that an
appropriately calibrated total level and quality of capital has been
achieved, considering all the elements of the reform
• The fully calibrated set of standards was developed by the end of
2010 to be phased in as financial/economic conditions improve with
the aim of implementation by end-2012
• Within this context BCBS also will consider appropriate transition and
grandfathering arrangements & believes these measures will
promote a better balance between financial innovation, economic
efficiency & sustainable long run growth
21. Overview of Basel III New Capital &
Liquidity Standards
• Basel III proposes
many new capital,
leverage &
liquidity standards
to strengthen the
regulation,
supervision & risk
management of
the banking sector
• The capital standards & new capital buffers will require banks to hold
more & higher quality of capital than under current Basel II
• The new leverage & liquidity ratios introduce a non-risk based
measure to supplement the risk-based minimum capital
requirements (aka, leverage ratio) & measures to ensure that
adequate funding is maintained in case of crisis
22. Overview of Basel III New Capital &
Liquidity Standards (cont’d.)
• Alongside higher
capital requirement
& increased capital
ratios, Basel III
introduces new
liquidity & leverage
ratios
• Also counterparty
credit risk & market
risk enhancements
for the trading book
(new capital
requirements for
Credit Value
Adjustment, Wrong
Way Risk, Stressed
Value-at-Risk and
Incremental Risk)
23. Basel III Capital & Liquidity Standards: Key
Elements
• New regulations raise the quality, consistency & transparency of the
capital base and strengthen the risk coverage of the capital
framework
• Basel III strengthens the three Basel II pillars, especially Pillar 1 with
enhanced minimum capital and liquidity requirements
What are the key elements of the new regulations?
• Higher minimum Tier 1 capital requirement
– Tier 1 Capital Ratio: increases from 4% to 6%
– The ratio will be set at 4.5% from 1 January 2013, 5.5% from 1 January 2014
and 6% from 1 January 2015
– Predominance of common equity will now reach 82.3% of Tier 1 capital,
inclusive of capital conservation buffer
• New Capital Conservation Buffer
– Used to absorb losses during periods of financial and economic stress
24. Basel III Capital & Liquidity Standards:
Key Elements (cont’d.)
What are the key elements of the new regulations?
• New Capital Conservation Buffer (continued)
– Banks will be required to hold a capital conservation buffer of 2.5% to
withstand future periods of stress bringing the total common equity
requirement to 7%
• 4.5% common equity requirement and the 2.5% capital conservation buffer
– The capital conservation buffer must be met exclusively with common equity
– Banks that do not maintain the capital conservation buffer will face restrictions
on payouts of dividends, share buybacks and bonuses
• New Countercyclical Capital Buffer
– A countercyclical buffer within a range of 0% - 2.5% of common equity or other
fully loss absorbing capital will be implemented according to national
circumstances
– When in effect, this is an extension to the conservation buffer
25. Basel III Capital & Liquidity Standards:
Key Elements (cont’d.)
What are the key elements of the new regulations?
• Liquidity Standards
– Liquidity Coverage Ratio (LCR): to ensure that sufficient high quality liquid
resources are available for one month survival in case of a stress scenario.
• Introduced 1 January 2015
– Net Stable Funding Ratio (NSFR): to promote resiliency over longer-term time
horizons by creating additional incentives for banks to fund their activities with
more stable sources of funding on an ongoing structural basis
– Additional liquidity monitoring metrics focused on maturity mismatch,
concentration of funding and available unencumbered assets
26. Basel III Capital & Liquidity Standards:
Key Elements (cont’d.)
What are the key elements of the new regulations?
• Leverage Ratio
– A supplemental 3% non-risk based leverage ratio which serves as a backstop to
the measures outlined above
– Parallel run between 2013-2017; migration to Pillar 1 from 2018
• Minimum Total Capital Ratio
– Remains at 8%
– The addition of the capital conservation buffer increases the total amount of
capital a bank must hold to 10.5% of risk-weighted assets, of which 8.5% must
be Tier 1 capital
– Tier 2 capital instruments will be harmonized
– Tier 3 capital will be phased out
27. Basel III Capital & Liquidity Standards:
Implementation
• The Basel
Committee has
outlined phase-in
arrangements
• Specific
implementation
timelines for
individual
countries, both
members and
non-members of
the Basel
Committee on
Banking
Supervision, may
vary
28. Basel III Capital & Liquidity Standards:
Implementation(cont’d.)
• The new Basel III regulations will affect all banks, however the
severity of the impact may differ across types and size of banks
• Most impacted by increases in quantity & quality of capital, liquidity
& leverage ratios, new Pillar 2 & capital preservation
• Most sophisticated banks affected by the amended treatment of
counterparty credit risk, more robust market risk framework and to
some extent, the amended treatment of securitizations
• Systemic Important Financial Institutions (SIFIs) may have to cope
with higher capital requirements or be subject to at least additional
supervision
– Rules for SIFIs were defined by the Basel Committee in 2011
• The U.S. has stated on numerous occasions that they will move to
Basel III – probably all US banks required to meet Basel III
– But smaller institutions may have their capital requirements reduced
29. Basel III Capital & Liquidity Standards:
Implementation(cont’d.)
• US specific rules are to be clarified in 2012 and Basel III should take
effect in early 2013
• Many institutions in several countries including the U.S. are not Basel
II compliant, but their regulatory authorities have indicated that they
will eventually move to a Basel III framework
• This creates an interesting situation because Basel II is the building
block for Basel III – therefore, if implement a Basel II solution before
Basel III, should ensure that solution is flexible
• Data infrastructure implemented should be able to easily
accommodate a granular level of data to support both assets &
liabilities for calculation of regulatory capital & liquidity ratios
• A vended solution needs a clear product roadmap that allows
migration from Basel II to III system including regulatory capital
calculation engines and regulatory reports
30. Basel III Capital & Liquidity Standards:
Implementation(cont’d.)
• As capital requirements are increasing the solution should optimize
regulatory capital calculations to not hold an excess
• If able to bypass Basel II and implement Basel III then planning to
update/replace existing Basel I systems quickly as possible
• In implementing Basel II systems, data is the most challenging & time
consuming steps: should be considered early
– Having granular level data has been identified as one of the biggest business
benefits from Basel II
• While implementing an advanced approach can result in lower capital
requirements beneficial from a return of capital perspective, this
benefit is not guaranteed
• Probably more institutions will leverage the advanced approach as a
result of the higher capital requirements, which will likely make it
more attractive from a capital reduction perspective
31. Basel III Capital & Liquidity Standards:
Implementation(cont’d.)
• With increased capital requirements, allocating capital efficiently &
maximizing risk based returns becomes more important ever
• Should evaluate risk and banking systems to determine if newer
systems and processes can help you reduce operating costs, increase
return on risk & more effective capital allocation
• National regulators may increase the quality and quantity of data
included in their national regulatory reports, especially around
liquidity and leverage ratios
• Existing capital adequacy reports will also be updated: Such
additional information will also have to be reported to the market via
enhancing the current bank Pillar 3 disclosures
32. Basel III Capital & Liquidity Standards:
Critique
• Basel III is in its finalized form only since September 2010, so it is too
early to tell whether it will be effective in practice, but critics have
already begun to voice their opinions
• Obvious criticism surrounds the high level of capital it requires banks
to hold & the suppressive impact it will have on lending
– E.g., if a bank has $100 of capital, under Basel II it could lend up to $1250 of
risk-weighted loans (8% minimum capital level under Basel II)
– When Basel III is fully implemented that same $100 could represent up to 13%
of risk-weighted assets implies the bank can lend up to $770
• A reduction in lending will inhibit economic growth: in the form of
higher capital requirements, Basel III is effectively restricting banks
from sponsoring a robust and healthy economy
• Counterargument is that the leverage & liquidity requirements result
in healthier banks that can better withstand downturns and less
financial contagion, but then again at what cost?
33. Basel III Capital & Liquidity Standards:
Critique (continued)
• A macro-prudential tool should be concerned with & address
systemic risk contributions of financial firms, but the Basel rules are
focused instead on individual risk of financial firms
• Reducing the individual risk of financial firms can in principle
augment systemic risk
– If encouraged to diversify perfectly at all costs, then banks can wind up hold the
same aggregate risk if diversify away all idiosyncratic risk
– If the costs to bank failures are non-linearly increasing in number of failures,
then this form of diversification could be welfare-reducing
• Even ignoring the possibility of individual institutions becoming more
correlated as they reduce their own risks, Basel ignores endogenous
or dynamic evolution of risks of underlying assets
– E.g., AAA-backed residential MBS: Basel providing a relative advantage to this
asset class explicitly encouraged greater lending in the aggregate
– As banks lent down the quality curve->worse mortgages->although MBS
historically safe a static favorable risk-weight made it endogenously risky
34. Basel III Capital & Liquidity Standards:
Critique (continued)
• Basel rules ignore that when risk of an asset class materializes, since
the institutions are over-leveraged on this asset class & in a
correlated manner, they face endogenous liquidity risk
– E.g., all firms at once attempts to de-leverage by selling its AAA MBS implying
that there is not enough capital in the system to deal with this & systemic risk is
created ex post as well as ex ante
– In this sense, Basel requirements induce pro-cyclicality over and above the fact
that risks are inherently pro-cyclical
• In economic terms the Basel risk-weight approach attempts to target
relative prices for activities vs. restrict quantities directly
– Absent price-discovery of day-to-day markets regulators have little hope in
achieving price efficiency sufficiently dynamic & reflective of latent risk
– But concentration limits on asset class exposure for the economy as a whole or
simple leverage restriction are more likely to be robust and counter-cyclical
macro-prudential tools
– They do not directly address systemic risk but at least offer hope of limiting
risks of individual financial firms and asset classes