© Fung Global Institute

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Balance between Regulation and Growth - Implementation of Basel III in Asia

Andrew Sheng

President, Fung Global Institute

Advanced Programme for Central Bankers and Regulators on Basel III

17-19, January 2013

The Chinese University of Hong Kong

Institute of Global Economics and Finance

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Financial Reform Landscape remains Complex

Source: E&Y. Financial Regulatory Reform - What it means for bank business models, November 2012.

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Financial Regulatory Reform

• Ensure that tighter standards, such as higher capital and

liquidity requirements, do not choke off the global recovery.

• Support the development of a global mechanism for managing

volatile short-term capital flows, and development of

macroprudential surveillance and regulation at the national and

regional levels.

• Establish an effective regulatory framework for

macroprudential supervision and regulation at the national and

regional levels.

Source: Asian Development Bank Institute, Policy Recommendations to Secure Balanced and Sustainable

Growth in Asia, October 2010.

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Asian Voice and Interests

• There needs to be an Asian voice on financial reform and regulation

rather than allowing the debate on issues to be dominated by a

perceived choice between American and European approaches.

• A “one-size-fits-all” approach is inappropriate due to differences in

financial systems, stages of development and banking industry

practices, and may lead to excessive burdens in areas such as

capital and liquidity adequacy requirements and leverage ratios.

• In addition, there is a risk of spillover effects from developed country

regulatory changes and low-interest-rate policies that lead to

migration of risky financial activities to Asia that could affect regional

financial stability.

• Asian leaders should consider sponsoring their own research on the

impacts of the new regulations on Asian financial institutions and

markets.

Source: Asian Development Bank Institute, Policy Recommendations to Secure Balanced and Sustainable

Growth in Asia, October 2010.

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Key Points

• We need to put the Implementation of Basel III in Asia within the proper context.

• Post-2007 Global Financial Crisis, Basel III is an important standardization of

minimum capital and liquidity standards for global banking.

• This is a NECESSARY, but NOT SUFFICIENT CONDITION for global financial

stability, because Financial Stability Board and national regulators have only just

begun to address SHADOW BANKING, or non-bank financial intermediaries, risk

issues. Although important, banks account for 43.1 percent of global financial

assets as at the end of 2011, whereas stock market capitalization and bond markets

(excluding derivative financial assets) account for more than half of financial sector

risks.

• Hence, to obtain overall financial system stability, we need to look also at real sector

imbalances, monetary and fiscal policies, and interconnectivity and feedback

mechanisms between financial sectors (banks and shadow banks) as a systemic

whole.

• We must never forget that Finance must serve the Real Sector, not the other way

around.

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Key Questions

• What are Basel III’s main impact on (1) banking system and (2)

growth and overall credit?

• While Basel III are Minimum conditions for capital and liquidity,

do the complex calculations on risk weights impair or

disadvantage EME banks?

• Which parts of Basel III should be priority for implementation?

Should we move out of standard risk-based model towards

Internal Risk-Based (IRB) models?

• What areas of structure (shadow banking), financial

infrastructure and other issues should we consider ( Basel III

included as part of package) for financial system stability?

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Contents

• Introduction

• What are the key issues and concerns?

• Role of Asia finance in rebalancing Asia’s Growth

Model

• Conclusion

Appendix: Amendments to the Liquidity Coverage Ratio (LCR)

and the new BCBS Charter; and CRR4

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Introduction Section 1

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Asia finance must be there to serve the real sector

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Asian banks are the primary providers of funding for private sector growth

Asia’s shift towards a domestic and regionally-driven engine of growth would require continuous funding from Asia’s bank-dominated financial system

However, Asia faces funding issue under Basel III rules that would reduce the incentive for banks to lend to trade finance and SMEs, and discourage long-term lending for infrastructure at a time when this is critical for Asia’s sustained growth

While Basel III requirements on higher capital adequacy, enhanced liquidity and an overall leverage cap are commendable, the detailed rules on liquidity and risk-weighting may restrain the funding capacity of Asian banks

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Banking sector has to adjust to unprecedented regulatory change

Source: McKinsey. The Triple Transformation, October 2012.

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Global capital markets business also has to adjust to regulation

Source: McKinsey. The Triple Transformation, October 2012.

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Need for adaptive business models to seize new growth trends

Source: McKinsey, BCG.

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Going to where the new trade corridors are

Source: BCG. The Transaction Banking Advantage, October 2012.

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Revamping payments value chain

Source: BCG. The Transaction Banking Advantage, October 2012.

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Need true banking transformation to improve financial metrics

Source: McKinsey. The Triple Transformation, October 2012.

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Need to reverse declining ROE due to lack of performance improvement and rising capital ratios

Source: McKinsey. The Triple Transformation, October 2012.

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Business model transformation – the basis for future growth • Capital markets business is most challenging due to regulatory

pressure, high funding costs, and shrinking revenues.

Source: McKinsey. The Triple Transformation, October 2012.

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The need for a balanced view, with appropriate “fit” for EMEs

1. Basel III was designed to address the causes of the 2007-2009

Financial Crisis in the advanced markets, aimed to resolve the

issue of under-capitalisation and over-leverage in the advanced

wholesale banking model.

2. Current Basel III on risk-taking governance requirements represent

substantial improvement in quality, quantity and comparability of

banks’ risk/reward profile. Asia needs that and supports Basel III.

3. However, there is substantial variation in quality of banks,

supervisors and regulators between more retail-based systems

(e.g., China, Canada, India, Australia) and wholesale systems (US,

UK and some EU countries).

4. Need for clarity on WHAT is National discretion? WHAT fits local

conditions and what is necessary to supplement Basel III

implementation to ensure overall systemic stability.

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Agree that under-capitalisation and illiquidity of internationally-active banks need to be solved

Figure 1. Ratio of Debt to GDP Among Selected Advanced Economics

(In percent, GDP-weighted, 1987=100)

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Do Basel III rules address the priority policy and real sector needs in Asia?

• While Asian banks can meet the current Basel III capital

requirements, it is not clear as Asia grows faster with higher

credit needs, whether there will capital constraints going

forward.

• Asian banks are at different stages of development and Asian

countries have different national imperatives.

• Capacity of Asian banks to implement Basel II/III vary hugely

between banks, especially the smaller and non-internationally

active banks.

• Europe is expected to have the largest shortfall of over €272

billion in meeting Basel III capital requirements, and the US

may have a shortfall of $60 billion.

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Tighter financial conditions resulting in capital shortfalls, in turn worsening the real economy

Source: IIF. “The Cumulative Impact on the Global Economy of Changes in the Financial Regulatory Framework”. September 2011.

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Basel 2.5/III uses Risk Weighting and Models to assess Risks

• Advanced country banks have high sovereign ratings and have

experience in Internal Risk Based (IRB) Models which assign

lower risks, if banks can prove with data.

• Asian banks are less sophisticated and rely on standard

model, and because sovereign credit ratings are lower, and

Asian banks do not have good risk data, they automatically

have higher capital costs relative to European banks (see next

Slide).

• Example:

For top ASEAN banks For top European banks For top American banks

• Basel III’s CET1 =

average of 10.7%

• Basel II’s CT1 = average

of 11.5%

• Basel II’s CT1 average =

10.2% (one bank has an

average of below 7%)

• Basel III’s Tier 1 Common

Ratio average = 8.4%

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Asian banks disadvantaged with the use of sovereign credit rating

• Much more capital needed to support the same amount of

loans or bonds (based on S&P risk weights, ASEAN+3 banks

will need 300% more capital).

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Asian banks have high RWA relative to total assets

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Top banks in Asia

Country Largest Bank Total

Assets ROA

% CAR

(Tier 1 %) CAR

(Total %) Cost to Income

% LTD Ratio

%

Germany Deutsche Bank 2805.29 0.20 12.90 14.50 82.83 68.55

France BNP Paribas 2547.68 0.31 11.60 14.00 NA 121.88

US J.P. Morgan 2265.79 0.84 12.30 15.40 64.70 64.17

US Citibank 1873.88 0.59 13.60 16.99 65.00 71.25

Japan Mitsubishi UFJ 2603.95 0.19 12.31 14.91 NA NA

China ICBC 2476.30 1.35 10.07 13.17 29.91 63.50

Hong Kong HSBC 1333.03 0.28 9.10 14.40 66.20 83.20

Singapore DBS 279.49 0.89 12.90 15.80 43.30 86.40

South Korea Kookmin Bank 238.62 0.80 10.14 13.09 NA 105.00

Malaysia Maybank 135.96 1.08 11.84 15.36 49.60 90.10

Taiwan Bank of Taiwan 135.74 0.09 10.50 11.38 NA 67.61

India ICICI Bank 94.73 1.61 12.70 18.50 42.91 76.10

Thailand Bangkok Bank 68.69 1.30 12.21 15.35 NA 92.60

Indonesia Bank Mandiri 56.66 2.23 14.90 17.20 41.60 74.10

Philippines Banco de Oro 26.84 0.95 10.00 15.80 67.90 66.73

Source: The Asset, Volume 14 Number 11, December 2012.

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Whither Basel III for Asia?

• The US has postponed implementation of capital rules for the year 2013

and delayed implementation of liquidity rules. Pressure to delay the start

date was due to concerns over the complexity of the rules and the cost to

banks at a time of weak global economic growth.

• Europe is also re-considering and the Bank of England has expressed

concerns on the complexity of the rules, especially since bank supervision

is returning to the Bank of England.

“Rather than pushing through a flawed Basel III, we need to take the time to

do it right so we do not have to do it over. … Basel III’s implementation has

been postponed, and that offers a real chance to get it right. If we do, we

won’t need Basel IV” – Thomas M. Hoenig, 2012*

As a result, Basel Committee announced agreement on Liquidity Rules with

a delayed phase in period.

* Get Basel III right and avoid Basel IV. http://www.ft.com/intl/cms/s/0/99ece1b0-3fa0-11e2-b2ce-

00144feabdc0.html#axzz2HRMF1qU1

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What are the key issues and

concerns?

Section 2

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Emerging Market banks find it currently easier to meet Basel III requirements

Figure 2. International Comparison of the Financial Liabilities/Assets Ratio

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Asia has its own national banking development agenda and time frame

• The extensiveness of the rules will have tremendous

implications on re-shaping and micro-managing the business

models of banks locally, regionally and worldwide.

• This raises the question of whether national regulators should

be given more discretion to adjust their regulatory and

supervisory guidelines in line with the Basel principles in a

manner that suit their national banking development agenda

and time frame.

• BCBS has now created a small team to look at “simplifying

Basel III”. This is the time to engage BCBS through Asian

regulators which can influence the final outcome, especially

those which are represented either at G20 or FSB/BCBS

levels.

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Implementation of Basel III will have costs on all banks, global or local

Constrained credit

provision by Emerging Market banks

Retrenchment and deleveraging by global

banks

Risk of synchronised slowdown globally if Asian growth also

constrained by limits on credit

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Issue 1: Potential trap of synchronized recession

• If the unintended consequences of implementing Basel III are

to slow Asian growth because of the limited capacity of the

banking system to support the growth of the real economy,

especially for SMEs, trade and infrastructure finance, then the

whole world may be trapped in a policy-induced unintended

synchronized recession.

• Solution: Each Asian country should study what are the credit

needs projected to 2020 and see if addition capital would be

required to meet the new credit needs.

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Issue 2: Risk-weightings biased against Asian banks

• Basel capital rules favour banks that have developed

“advanced risk models” for determining risk-weighted assets

(RWA). Asian banks are some 10 years behind in this respect.

Hence, they will not be able to use efficient conversion factors

even if they are given a transition period up to 2019.

• Solution: Each Asian country will have to develop better data-

bases on credit history in order to re-calculate the risk weights;

this will enable the larger banks to move toward Internal Risk-

Based models with their own risk weights.

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Issue 3: Credit ratings biased against Asian banks

• The Basel III risk-weightings are based on current sovereign

credit ratings.

• Asian economies (and by definition, Asian banks) have lower

credit ratings, even though their sovereign debt has high

foreign exchange backing (up to 50%) and Asian economies

have higher savings and lower fiscal debt.

• Many Asian banks are state-owned, thus the urgency to raise

large capital cushions is not as imperative as the European

case.

• Solution: Asia should consider creating Mutual (owned by

users and industry) not-for-profit Credit Rating Agencies that

can give ratings that are more objectively based. This will

provide competition to current top 3 that have become TBTF.

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Issue 4: Liquidity risk framework not directly relevant to Asian banks

• The Basel liquidity risk framework aims to restrain the balance

sheets of banks which: (1) are highly leveraged; (2) have

significant maturity mismatches; and (3) are funded mainly by

the wholesale markets.

• However, Asian banks generally do not fall within any of these

three categories because they have large deposit bases, the

population has high savings rate, and the fiscal and balance of

payments positions at the national level are much more robust.

Solution: Asian banks should work with central banks to

examine how domestic liquidity can be provided in manner

which would not create a ‘rush for funding’.

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Basel liquidity rules vs. Asian situation

• High loan-to-

deposit ratios

• High leverage

• Flexible exchange rates

• Substantial liquid assets

• Low nominal leverage

With low fiscal debt and high foreign

exchange, limits on loan-to-deposit

ratio, Central Banks can easily

provide liquidity to domestic banks.

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Issue 5: Asia has huge need for infrastructure funding

• The detailed rules on liquidity, risk-weightings and leverage

may constrain the capacity of Asian banks to fund

infrastructure since there is growing maturity mismatch risk.

• Furthermore, Basel III rules also make asset securitization

more expensive.

• The ADB estimates that US$8 trillion will be required to finance

infrastructure, creating massive potential for the development

of Asian municipal and infrastructure bond markets.

• Solution: Develop Asia’s fixed income markets through asset

securitization. This would help to lessen the maturity mismatch

in bank balance sheets [e.g., Cagamas and HKMC].

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Large interest in infrastructure financing

• Asia is at the early stages of securitized debt markets.

• China also needs mortgage securitization to reduce maturity

mismatch, particularly through bond market.

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Issue 6: Trade finance is Asia’s lifeblood

• Trade finance business is forecast to grow at 9% annually to 60% of

all global trade by 2020, with one leg in Asia.

• Solution: Central banks should incentivise banks to promote trade

finance and consider establishing a “Trade window” for real market

transactions.

Trade finance underpins 30–40% of the lending SMEs received. It forms the most relevant part of working capital financing

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How to ringfence trade finance in times of crisis

• Central bank could offer low-cost liquidity to commercial banks,

against “ringfenced” portfolios of trade assets.

• Public entity could purchase trade and hold trade assets

directly.

• Public entity could “guarantee” specific trade obligations, to

support a liquid market in trade assets.

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Basel III’s impact on trade

BAFT-IFSA: Basel III may raise trade finance

costs by 18-40%

Demand for trade finance rising rapidly

* BAFT-IFSA, Basel III-Impact on Trade, Tod Burwell, November 2011, Washington, D.C.

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Issue 7: Asia’s SME development drive and job creation

• Asia is at the cusp of an SME development drive to promote job

creation, innovation and market competition. SMEs rely heavily on

trade finance and short-term bank credit, they account for 80-90% of

job creation to address employment and equity challenges.

• Both European Commission and UK recognize that lending to

SMEs, though carrying higher credit risks, have large social benefits

in terms of growth and employment generation.

• The net effect of higher risk-weights on SMEs and higher costs and

lesser credit to SMEs may generate exactly the economic slowdown

that creates higher risk for the banking system.

• Hence, policymakers have to weigh the positive spillover effects of

SME health vs protecting banks against credit risk.

• Solution: Policy-makers should work alongside private sources of

equity to meet SME financing needs.

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Lending to small enterprises still lower than medium and large enterprises

Figure 3. Growth Rate of Outstanding Loans Extended to Large Enterprises, Medium

Enterprises, and Small Enterprises

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Access to finance is a major problem for SMEs

• A ECB survey shows that access to finance is perceived as the

second most pressing problem for SMEs, after their order

book.*

• Accordingly, the European Banking Authority (EBA) is

examining a proposal by the European Parliament to adjust the

risk-weights for lending to SMEs, and an increase in the

threshold of EUR2 million for the Standardised Approach and

EUR5 million for the Internal Ratings-Based (IRB) Approach.

* European Central Bank, Survey on the Access to Finance of SMEs in Euro Area, April 2012.

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We are in a self-fulfilling vicious cycle

SME have high

risks

We do not lend to SMEs

SMEs will not be able to grow

Economy will slow

down

Risk-weighting increases

risk

We have to distinguish the positive externalities of SMEs, trade finance, infrastructure, which creates jobs and future growth, from the negative externalities of fast trading, high leverage, things that will destroy the economy systemically

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Issue 8: Implementation cost on banking operations

• Lastly, the implementation of complex Basel III rules will result in

Asian banks incurring disproportionately large costs.

• Asian banks are still in the process of implementing Basel I and II

(and 2.5); and yet they are now burdened by Basel III.

• Asian banks’ expertise and experience are scarce.

–Whether scarcity management and regulatory resources should be

focused on developing a banking system that supports and fits

Asian realities, rather than “one-size-fits-all” rules designed for

implementation by advanced countries.

• Global banks have the capacity to absorb these costs but not the

smaller national banks in Asia, which are at different stages of

development.

• Solution: Asian banks should review their business models that can

help generate new revenues to help fund these costs.

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Non-Bank Assets (NBFI or shadow banking) more than Bank Assets

• Regulatory arbitrage from banks to shadow banks more than bank

assets.

• Contagion can occur between banks and shadow banking. Risk are

not just in banks.

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Basel Rules are not law and do not have legal force

• Whilst national regulators need to use Basel III as standards,

the total national requirements and law are still paramount.

Source: BIS. Group of Governors and Heads of Supervision endorses revised liquidity standard for banks http://www.bis.org/speeches/sp130106.htm

“3. Legal Status. The BCBS does not possess any formal supranational authority. Its decisions do not have legal force. Rather, the BCBS relies on its members' commitments, as described in Section 5, to achieve its mandate.” - New Basel Committee on Banking Supervision (BCBS) Charter, January 2013

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Role of Asia finance in

rebalancing Asia’s Growth Model

Section 3

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What do we mean by “Rebalancing”?

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National rebalancing must address mismatches and gaps

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Impact of rebalancing on non-reserve currency countries

Region/Country Net Foreign Asset (+), Deficit

(-) US$ bn

GDP 2008

US$ bn

NFA/GDP %

Exchange rate impact due to 10% change in

USD

Impact as % of GDP

Asian Surplus + 4,994 12,309 + 40.6 - 499 - 4.1 Other Surplus + 2,863 3,706 + 77.3 - 286 - 7.7

Total Surplus + 7,857 16,015 + 49.1 - 786 - 4.9

Euro Area - 2,584 13,631 - 16.9 +258 + 1.9 USA - 3,690 14,441 - 25.6 +369 + 2.6

Australia - 501 1,062 - 47.2 + 50 + 4.7 Subtotal Deficit - 6,775 29,134 - 23.3 + 678 + 2.3 Other Countries - 1,082 16,070 - 6.7 -108 +0.1

Global Total 0 61,219

Table 2: Impact of Global Imbalances on Surplus Countries

- Global Net Foreign Asset (NFA) and Liability Position, 2008

Source: Author’s calculations.

• For every 10% revaluation relative to G4 countries, the surplus holders of global FX reserves stand to lose roughly 5% of their GDP.

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Conclusion Section 4

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What should be Asia’s stance on Basel III?

• Basel III is now a complex rule books of over 600 pages and has become a

“one-size-fits-all” rule-book.

• Risk that Basel rules have become too prescriptive, leaving little room for

banks and regulators in developing countries to exercise judgment in

conducting lending activities that support the national development agenda.

• The issue is trust between industry and regulators. Board of Directors

have fiduciary duty and must be trusted to make their judgment on risks and

rewards. Supervisory authorities should step in when there is supervisory

judgment that the bank has not recognized the risks and may contribute to

systemic risks.

• BCBS must trust national regulators to monitor their system risks and only

step in (via FSAP/FSB/IMF) if the activities of D-SIFIs, G-SIFIs or national

system contribute to global systemic risks.

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Basel III is necessary, but not sufficient. Look at system as a whole (including shadow banking)

• We support Basel III’s capital adequacy and we are also fine with the

compromise on liquidity requirements. The use of model – risk-weighting is

still under dispute.

• The question is can we solve the banking problem by only looking at the

banking system while ignoring the shadow banking, NBFI, and long-term?

• The banking problem is that it is too short-term. Basel III only concentrates

on banking but not on shadow banking, capital markets, pension, insurance

(the whole system). There is no proper pension or insurance system in

place to take the long-term risks.

• It doesn’t mean that “if institutions are fixed, then everything will be fixed”.

It’s the whole class of systemic assets and the linkages of systemic

liabilities which cut across different institutions that will cause things to blow

up if they become fragile. We need to focus on cross-cutting issues along

with institutions. The current policy approach is an “either or” situation.

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An implementation time table, customized to domestic conditions and imperatives

• Asian policymakers should reconsider the practicality of the time

frame in implementing Basel III, and the urgency of adopting broader

financial infrastructure and national risk management framework that

would help to enhance overall system resilience against

endogenous and exogenous shocks.

• So long as local banks do not have systemic implications on global

markets with negative spillovers, national regulators should reserve

the discretion to draw up a timetable for implementation that is

customized to domestic conditions and imperatives.

US: postponed adoption of Basel III

Europe: adopting their own approach and argue that they are

“broadly consistent” with Basel rules

Bank of England: argued against the complexity of bank

regulatory rules, and the opacity these rules create

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Need to work together

• Emerging Asia needs practical implementable rules that best-

fit Asian conditions.

• We seek to achieve the most effective OUTCOMES of Basel

objectives AND systemic stability, including NBFIs.

Unless we coordinate, we are less likely to have impact in the

global debate.

We need to rebalance between implementing rules and

financial markets to serve the real economy.

We have to avoid rules that will fragilize the Asian economy.

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Amendments to the Liquidity

Coverage Ratio (LCR) and the

new BCBS Charter; and

CRR4

Appendix

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Amendments to LCR in four main areas – BCBS, 6 January 2013

High quality assets

(HQLA) & net cash

outflows

Definition of high quality assets for LCR (numerator of the ratio) and the factors that

determine the net liquidity outflows that banks would face in stress (denominator of the

ratio)

Revised timetable

for introduction of

the LCR – phase-in

arrangements

• Same as that of capital requirements: coming fully into effect only in 2019

• The LCR will be introduced as planned on 1 January 2015. But the minimum

requirement will begin at 60%, rising in equal annual steps of 10 percentage points to

reach 100% on 1 January 2019

• This will ensure that the new liquidity standard will in no way hinder the ability of the

global banking system to finance a recovery

Usability of stock of

liquid assets in

distress/transition

• During periods of stress, banks can use their stock of HQLA, thereby falling below the

minimum. It is the responsibility of bank supervisors to give guidance on usability

according to circumstances

• Countries with distressed banking systems have complete flexibility in their application

of the LCR until the distress has passed

• Liquidity buffers defined by the LCR are to be used in times of stress

• This is applicable both during the transition and in steady state

Further work on the

interaction between

LCR & the provision

of central bank

facilities

• Deposits with central banks are the most liquid asset, the interaction between the LCR

and the provision of central bank facilities is important

• Ensure that banks hold sufficient liquid assets to prevent central banks becoming the

"lender of first resort"

Source: BIS. Group of Governors and Heads of Supervision endorses revised liquidity standard for banks http://www.bis.org/speeches/sp130106.htm

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LCR - Description

• To promote short-term resilience of a bank’s liquidity risk profile.

• To ensure that a bank has an adequate stock of unencumbered high quality

liquid assets (HQLA).

–Consists of cash or assets that can be converted into cash at little or no

loss of value in private markets, to meet liquidity needs for a 30 calendar

day liquidity stress scenario.

• Two components:

• Absent a situation of financial stress, the value of the ratio be no lower than

100%1 (i.e. the stock of HQLA should at least equal total net cash

outflows). Banks are expected to meet this requirement continuously and

hold a stock of unencumbered HQLA as a defence against the potential

onset of liquidity stress. During a period of financial stress, banks may use

their stock of HQLA, thereby falling below 100%.

Source: BIS. Annex 1 - Summary description of the LCR.

Stock of HQLA

Total net cash outflows over the next 30 calendar days

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LCR – Detailed changes: HQLA (1/3)

Expand the definition of

HQLA subject to a higher

haircut and limit

• Corporate debt securities rated A+ to BBB– with a 50% haircut

• Certain unencumbered equities subject to a 50% haircut

• Certain residential mortgage-backed securities rated AA or higher with a 25%

haircut

Aggregate of additional assets, after haircuts, subject to a 15% limit of the

HQLA

Rating requirement on

qualifying Level 2 assets

Use of local rating scales and inclusion of qualifying commercial paper

Usability of the liquidity

pool

Incorporate language related to the expectation that banks will use their pool of

HQLA during periods of stress

Operational requirements Refine and clarify the operational requirements for HQLA

Operation of the cap on

Level 2 HQLA

Revise and improve the operation of the cap

Alternative liquid asset

(ALA) framework

Develop the alternative treatments and include a fourth option for sharia-

compliant banks

Central bank reserves

Clarify language to confirm that supervisors have national discretion to include

or exclude required central bank reserves (as well as overnight and certain

term deposits) as HQLA as they consider appropriate

Source: BIS. Annex 2 - Complete set of agreed changes to the Liquidity Coverage Ratio.

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LCR – Detailed changes: Inflows and Outflows (2/3)

Source: BIS. Annex 2. http://www.bis.org/press/p130106.htm

Insured deposits • Reduce outflow on certain fully insured retail deposits from 5% to 3%

• Reduce outflow on fully insured non-operational deposits from non-financial corporates,

sovereigns, central banks and public sector entities (PSEs) from 40% to 20%

Non-financial corporate

deposits

Reduce the outflow rate for “non-operational” deposits provided by non-financial corporates,

sovereigns, central banks and PSEs from 75% to 40%

Committed liquidity

facilities to non-financial

corporates

Clarify the definition of liquidity facilities and reduce the drawdown rate on the unused portion of

committed liquidity facilities to non-financial corporates, sovereigns, central banks and PSEs

from 100% to 30%

Committed but unfunded

inter-financial liquidity and

credit facilities

Distinguish between interbank and inter-financial credit and liquidity facilities and reduce the

outflow rate on the former from 100% to 40%

Derivatives • Additional derivatives risks included in the LCR with a 100% outflow (relates to collateral

substitution, and excess collateral that the bank is contractually obligated to

return/provide if required by a counterparty)

• Introduce a standardised approach for liquidity risk related to market value changes in

derivatives positions

• Assume net outflow of 0% for derivatives (and commitments) that are contractually

secured/collateralised by HQLA

Trade finance Guidance to indicate that a low outflow rate (0–5%) is expected to apply

Equivalence of central

bank operations

Reduce the outflow rate on maturing secured funding transactions with central banks from 25%

to 0%

Client servicing brokerage Clarify the treatment of activities related to client servicing brokerage (which generally lead to an

increase in net outflows)

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LCR – Detailed changes: Clarification to rule text and LCR phase-in (3/3)

Source: BIS. Annex 2. http://www.bis.org/press/p130106.htm

Rules text

clarifications

• Clearer guidance on the usability of HQLA, and the

appropriate supervisory response, has been

developed to ensure that the stock of liquid assets is

available to be used when needed

• A number of clarifications to the rules text to promote

consistent application and reduce arbitrage

opportunities (e.g., operational deposits from

wholesale clients, derivatives cash flows, open

maturity loans). Also incorporating previously agreed

FAQ

Internationally

agreed phase-in

of the LCR

The minimum LCR in 2015 would be 60% and

increase by 10 percentage points per year to reach

100% in 2019

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Capital Requirements Regulation (CRR 4) – Overall impact on trade finance (TF)

• CRR 4 is the equivalent of Basel 3 and will be implemented in Europe

across all 27 countries.

• Proposed changes under CRR4 in the treatment of TF products supportive

of TF, which is a critical part to keep the economy ticking on an even keel.

• Recognition that TF is a low risk activity.

– ICC study for 2011* shows on an industry-wide basis, there were fewer

than 3,000 defaults observed in a dataset comprising 11.4 million

transactions collected for 2005-2010. Typical loss rates for 2008-2010: for

TF products like L/Cs were 0.007%, export confirmed L/Cs 0.03%, Import

loans 0.07%, export loans 0.017%.

–Strong case for arguing that Trade deserves a better treatment under the

internal ratings based approach (IRB). A lower asset value correlation

charge (AVC) for TF products would go some way to ensure that trade

products get the appropriate capital treatment they deserve.

Source: International Chamber of Commerce (ICC). Global Risks ‒ Trade Finance, 2011.

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Capital Requirements Regulation (CRR 4) – Proposed changes

Uniform

rule book

Maturity Floor Waiver (MFW)

Credit Conversion Factor (CCF)

Asset Value Correlation

(AVC)

Leverage Ratio

Liquidity Ratios

• Under Basel 2, local regulators had to translate the European rules into local rules and

regulations – this created scope for differences in the rules and regulations

• Basel left open the option to national discretion to extend the MFW to all TF products –

CRR-4 proposes to extend the MFW to all TF products

• To reduce CCF applied to non-financial guarantees (i.e. bid bond, advance payment,

performance and retention guarantees) from 50% to 20%

• Under Basel III and CRR 4, exposures to large financial institutions (assets > $100bn) will

attract a 1.25 scaling factor to account for systemic risk

• While systemic risk is an important issue for banks, trade finance was not a contributor to

the increased systemic risk within banks during the crisis and should not be penalised

• Important to note that increased linkages between banks, at least for trade finance, is a

function of a bank’s primary role in facilitating payments within the financial system and not

necessarily one of taking on increased counter party risk

• Hence, strong case for arguing that the scaling factor applied should be a range varying

from anything greater than 1 to a max. of 1.25 instead of applying a flat scaling factor of

1.25 across all banks

• To apply more favourable CCF of 20% and 50% to TF products like L/Cs and guarantees.

Basel III proposes to apply a 100% CCF to all contingent liabilities including TF products

• To recognise 100% of trade inflows in the calculation of the liquidity coverage ratio (LCR)

in lieu of the Basel III proposed 50% of trade inflows

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