basel 2 to basel 3 - proposed changes and required amendments
TRANSCRIPT
Basel 2 to Basel 3 – Proposed Changes and Required Amendments
Basel 2 to Basel 3 -
Proposed Changes and
Required Amendments
13th
July 2011
Amendments to Basel 2 Page 1
Amendments to Basel 2
(taken from the 3 July 2009 Basel 2 papers)
The changes listed below are to be brought into effect by 31.12.2011 in the
EU and G20 countries. Subsidiaries of Bahraini banks in these countries will
be obliged to comply with these measures even if their head offices do not.
Trading Book
New stressed VaR requirement (for one year period) for banks using
VaR models in the trading book
New incremental risk capital charge (default & migration risk) for IRB
banks
Capital charges used in the banking book must be applied to securitised
products in the trading book to avoid regulatory arbitrage (see page 6 of
July doc)
Removal of concessionary 4% RW treatment for “liquid and
diversified” portfolios
Complex Securitisations
Resecuritisations obtain higher risk weights in the banking book
Securitisation Resecuritisations
AAA 20% 40%
A+ to A- 50% 100%
BBB+ to BBB- 100% 225%
BB+ to BB- 350% 650%
B+ to unrated Deduction Deduction
No self-guarantees allowed to improve credit ratings of securities
guaranteed by the bank itself when such securities are held on the
bank’s own books
Amendments to Basel 2 Page 2
Operational criteria must be applied before banks may use above risk
weights in the Basel 2 securitisation framework. Otherwise all holdings
of securitisations must be deducted from capital
Standard 50% CCF for liquidity facilities in the securitisation
framework (no more concessionary risk weights)
Enhanced Pillar Two requirements for ICAAPs and internal controls
generally
This means the need for new Pillar 2 modules in the Rulebook (the
CBB drafted a module called SR in 2008, but this was never released)
Enhanced Pillar Three requirements
Enhanced disclosures for securitisations and credit risk mitigants
Basel 3 changes Page 1
Basel 3 changes (Paragraph references from December 2010 Basel paper)
1. Capital Ratio
Tier One (6% of total RWAs) – paragraphs 50, 53
A. Minimum common equity ≥ 4.5% of total RWAs (by 1.1.2015) after
all deductions below (including unaudited/audited losses or audited
profits for current period plus all eligible reserves). Paragraph 52
There are tougher requirements for Common Equity:
Common shares only and must be recognised as equity by
accounting standards
Most subordinated claim, not fixed or capped
Perpetual and never repaid outside liquidation
No features that encourage buy-backs, redemption or
cancellation
Distributions not contractually capped or linked to amount
paid in
No obligatory or preferential payment of dividend (which can
create a technical event of default)
Issued and paid up
Unsecured, unguaranteed
Only issued with explicit shareholders’ approval
May include share premium, retained earnings and p&l
Deductions from common equity (full deduction by 1.1.2018)
Intangibles (paragraph 67)
Investments in own shares (paragraph 78)
Any outstanding Tier 1 instruments that do not meet the definition
of common equity (w.e.f. 1.1.2013)
Minority interests in financial subsidiaries (see section G)
Deferred tax assets (paragraphs 69 & 70)
Mortgage servicing rights
Basel 3 changes Page 2
Cash flow hedge reserves for items not fair valued (paragraphs 11,
71 & 72)
Any shortfall of provisions to expected losses under IRB
(paragraph 73)
Gains on sales due to securitisation transactions (paragraph 74)
Unrealised gains arising from changes in the fair value of liabilities
caused by changes in the bank’s own credit risk/rating
(paragraph 75)
Defined pension fund assets and liabilities (paragraph 76)
Reciprocal cross shareholdings in the capital of financial and
insurance entities (paragraph 79)
Investments in the capital of other financial and insurance entities
where the bank owns < 10% of the issued common share capital of
that entity (applies to both trading and banking book). If the
aggregate of all holdings listed above exceed 10% of the bank’s
common equity (after applying all other deductions), then the
amount exceeding 10% of the concerned bank’s capital (of such
holdings) must be deducted applying a corresponding deduction
approach (i.e. common equity from common equity, tier two from
tier two). Amounts below the 10% threshold will continue to be
risk-weighted (paragraph 80 & 81)
Investments in the capital of other financial institutions and
insurance companies where the bank owns > 10% of the issued
common capital of the entity (applies to trading and banking book).
All such investments must be deducted (paragraphs 84 – 86) after
above deductions where the aggregate of such investments exceeds
15% of a bank’s common equity. There must be full disclosure of
these deductions. Any (remaining) holdings below 15% of capital
will be weighted at 250% (paragraph 89).
Basel 3 changes Page 3
B. Net Common Equity
Amount A after all deductions above
Basel 3 changes Page 4
C. Additional “Going Concern” Capital – paragraph 54 and 13
January 2011 Annex
There are enhanced criteria for classification as additional
“Going Concern” Capital
Issued & paid up
Subordinated to depositors, general creditors and subordinated
debt
Not secured or guaranteed
Perpetual and no step-ups or other incentives to redeem
Callable only at initiative of issuer after minimum 5 years,
subject to prior supervisory approval
Documentation should not create the expectation of a call by the
issuer
Call cannot be made without bank concurrently replacing capital
without issuance of capital of same or better quality, and capital
must be well above minimum required capital level
Coupon payments must be discretionary
Cancellation of payments must not constitute an event of default
Cancellation of payments must not put restrictions on the bank
Dividend only payable out of distributable items
No credit sensitive dividend payment features
Must be convertible at the option of the supervisory authority to
common equity or to be written down in value (e.g. by reducing
the amount repaid at call point), or contain a write-down feature
which allocates losses to the instrument before tax payers are
exposed to loss* (see bullet point below)
Issuer and connected counterparties may not have purchased the
instrument, nor can the bank have funded the purchase of the
instrument
No compensation features if other similar instruments are
subsequently issued at a lower price
Proceeds must be immediately available without limitation
(e.g. from an SPV that is part of the consolidated group)
May include share premium
Basel 3 changes Page 5
The convertibility feature above must be supported by a law (not a
directive) that the instrument must be written off/down or fully
absorb losses before tax payers (i.e. the Government) are exposed
to loss. Furthermore, there must be a peer group review to confirm
that such laws are in place and both the bank and the regulator (in
issuing documents) disclose that these instruments are loss-bearing.
Only common stock may be issued to instrument holders (i.e. no
payment of cash or other compensation may be given) if a
“trigger event” (see bullet point below) occurs.
The bank must have all approvals to issue common equity to the
amount required should a trigger event occur.
A trigger event is the earlier of: (1) a decision that a write-off
(without which the bank would be unviable) is necessary, as
determined by the supervisor; or (2) the decision to make a
public sector injection of capital (or equivalent support) without
which the bank would have become unviable (as determined by
the supervisor).
Deduct investment in own shares.
Deduct holdings of such instruments issued by other financial and
insurance entities which do not exceed 10% of the investee’s
capital, but which in aggregate exceed 10% of the concerned bank’s
capital (paragraph 80).
All instruments issued after 1 January 2013 must meet the above
criteria to be included in regulatory capital. Instruments issued
prior to 1 January 2013 that do not meet the criteria above will be
phased out from 1 January 2013 (90% cap in 2013, reducing by
10% per annum). Instruments with early calls or step-ups will not
generally be recognised as regulatory capital.
Basel 3 changes Page 6
D. Total Tier One Capital
Item B plus item C
Basel 3 changes Page 7
E. Tier Two Capital (i.e. “gone concern” capital) –
paragraphs 57 & 58 and 13 January Annex
There are simplified and tougher requirements for Tier 2:
Issued and paid in
Subordinated to depositors and general creditors
Unsecured and not guaranteed
Minimum maturity of 5 years with straight line amortisation over last
five years to maturity
No redemption incentives
Callable only at the initiative of issuer after minimum of five years
Early calls subject to prior supervisory approval
No expectation of early calls to be created by the documentation
Calls may not be exercised unless capital of the same or better quality is
issued concurrently and the issuer demonstrates its capital is well above
minimum required
Investors may not accelerate the repayment of payments (except in
bankruptcy or liquidation)
No credit sensitive dividend feature
The issuer and its related parties may not have purchased or funded the
purchase of the instrument
Proceeds must be immediately available without limitation
(where raised by an SPV that is part of the consolidated group)
Basel 3 changes Page 8
Interim unaudited profits for the current period will still be allowed
Expected loss approach to provisioning still under review, but general
provisions up to 1.25% of credit risk weighted assets (i.e. not including
operational risk or market risk charges) – paragraphs 60 – 61
Includes stock surplus (i.e. premium)
Deduct holdings of own Tier 2 capital
Must be convertible at the option of the supervisory authority to
common equity or to be written down in value (e.g. by reducing the
amount repaid at call point), or contain a write-down feature which
allocates losses to the instrument before tax payers are exposed to loss*
(see bullet point below)
The convertibility feature above must be supported by a law (not a
directive) that the instrument must be written off/down or fully absorb
losses before tax payers (i.e. the Government) are exposed to loss.
Furthermore, there must be a peer group review to confirm that such
laws are in place and both the bank and the regulator (in issuing
documents) disclose that these instruments are loss-bearing. Only
common stock may be issued to instrument holders (i.e. no payment of
cash or other compensation may be given) if a “trigger event” (see
bullet point below) occurs. The bank must have all approvals to issue
common equity to the amount required should a trigger event occur.
A trigger event is the earlier of: (1) a decision that a write-off (without
which the bank would be unviable) is necessary, as determined by the
supervisor; or (2) the decision to make a public sector injection of
capital (or equivalent support) without which the bank would have
become unviable (as determined by the supervisor).
All instruments issued after 1 January 2013 must meet the above criteria
to be included in regulatory capital. Instruments issued prior to 1
January 2013 that do not meet the criteria above will be phased out
from 1 January 2013 (90% cap in 2013, reducing by 10% per annum).
Instruments with early calls or step-ups will not generally be recognised
as regulatory capital.
Basel 3 changes Page 9
Tier Three
(Abolished).
Basel 3 changes Page 10
F. Total Capital (w.e.f. 1.1.2015)
This is the sum of D and E above. Banks must have a Minimum ratio
of 8%, of which 6% must be Tier One. Remaining 2% can be met by
Tier 2 (paragraph 50)
Basel 3 changes Page 11
G. Minority Interests (paragraph 62)
Minority interests in the common equity Tier One of a fully
consolidated subsidiary may receive recognition in Common Equity
Tier One if:
The instruments meet all the criteria for common equity
The subsidiary is a bank (i.e. not an SPV)
The subsidiary has a surplus above its minimum Tier One capital
requirements
The surplus is added after deducting: a) the lower of the required
minimum common equity Tier One plus its capital conservation
buffer; or the proportion of consolidated minimum common equity
Tier One plus the capital conservation buffer that relates to the
subsidiary; and b) the amount of surplus Common Equity Tier One
attributable to the minority shareholders.
Minority interests attributable to other Tier One and Tier Two Capital
instruments will be allowed under similar conditions (see paragraphs
63 and 64).
Capital issued by SPVs can be included in consolidated Additional
Tier One and Tier Two capital, but not in Common Equity
(paragraph 65).
Basel 3 changes Page 12
H. Countercyclical Buffers (0-2.5% of RWAs)
The size of the Buffer is set by the regulator and must take account of
macroeconomic environment in which the bank(s) operate. This may
mean that wholesale banks and retail banks will legitimately have
different buffers
Although each jurisdiction must decide for itself on the extent of the
buffer, there are references and principles to follow (FSD of the CBB
will have to be involved to apply individual buffers or the CBB may
simply impose an industry wide percentage)
The buffer is a function of the weighted average of capital buffer add-
ons applied in each jurisdiction where the bank has exposure
(this process could potentially be very complex for some banks)
The countercyclical buffer would increase the 2.5% capital conservation
buffer (see next page) by up to an additional 2.5% during periods of
“excessive” credit growth
Buffer can be released when the released capital would absorb losses in
the system that pare a threat to financial stability
Banks will be forced to conserve earnings where the buffer is below
that required by the supervisor (paragraph 147)
Basel 3 changes Page 13
J. Capital Conservation Buffer (2.5% of RWAs)
Capital in excess of minimum to be used in times of stress (2.5% - must
be common equity)
Constraint on dividends, share buybacks and bonuses (subject to 100%
conservation ratio (paragraph 131) if CET1 below 5.125% and sliding
conservation scale up to 7% CET1 ratio)
Phased in from 1.1.2016 to 1.1.2019
Basel 3 changes Page 14
K. New Risk Weightings
A 1,250% Risk Weight will apply for the following items:
Securitisation (and resecuritisations) exposures B+ or below
Certain Equity exposures under the PD/LGD approach
Non-payment/delivery on non Delivery versus payment transactions
Significant investments in commercial entities (above 15% of capital
base) – paragraph 90
Basel 3 changes Page 15
2. Leverage Ratio
Based on Tier One Capital only (but subject to review)
Off-balance sheet items subject to uniform 10% CCF
All derivatives will be subject to Basel 2 netting plus PFE
Minimum 3% ratio (w.e.f. 1.1.2018) – i.e.
Tier One Capital .
Unweighted on-balance sheet + 10% off-balance sheet assets
Disclosure of the leverage ratio will start w.e.f. 1.1.2015
Calculation will be on an “average” basis over the reporting quarter
Basel 3 changes Page 16
3. Counterparty credit risk (paragraph 98 onward)
Stressed inputs to be used
Elements of counterparty risk charges are related to MTM losses as a
result of the fall in the credit – worthiness of a counterparty
Collateral and margining requirements strengthened
Increase in risk weights on financial institutions
An additional capital charge (the CVA)
These changes only apply to banks using the internal model method.
Basel 3 changes Page 17
4. Liquidity
Liquidity Coverage Ratio – 30 day stressed funding scenario set by
supervisor dictates level of high quality liquid assets to be held at all
times (w.e.f. 1.1.2015)
Net Stable Funding Ratio (w.e.f. 1.1.2018)
Basel 3 changes Page 18
5. New Disclosure Requirements (paragraph 91 – 93)
Full reconciliation of all regulatory capital elements to the balance sheet
Separate disclosure of all regulatory adjustments
Disclosure of all capital limits and minima
Description of main features of capital instruments
Disclosure of Equity Tier One ratio as well as other capital ratios
(Tier One, Total)
Any transitional provisions
Summary of Basel 3 Page 1
Summary of Basel 3
1. Raise Quality of Capital Base
Raise Quality of Common Equity (2013).
Abolish “Innovative” Instruments from Tier One and only allow
“Going Concern/Loss Participating” Tier One instruments (2013).
Additional deductions from Tier One (2014 onward).
Simplify and toughen Tier Two Capital (2013).
Only limited inclusion of non-equity elements in Tier One.
2. Enhanced capital charges for securitisation and off-balance sheet
exposures (December 2011)
July 2009 securitisation and trading book requirements.
New counterparty credit risk charges and requirements.
3. New 3% Leverage Ratio (2015)
Based on Tier One Capital only.
Will include off-balance sheet exposures at 10% CCF.
4. New Liquidity Standards
Liquidity Coverage Ratio (2015).
Net Stable Funding Ratio (2018).
5. New Capital Buffers
Capital conservation buffer (2.5% of RWAs – starting 2016 →
2019).
Countercyclical buffer (0-2.5% of RWAs – no set date).
Also forward looking provisioning may play a role (expected loss
approach to be explored).
Revised Basel 3 Page 1
Revised Basel 3
Capital Components and Capital Adequacy Calculation –
Step-by-step
The items below the revised components of eligible regulatory capital.
1. Common Equity plus disclosed reserves (using new criteria in
17/12/2009 Basel Paper) including unaudited or audited losses and
including audited profits for the current period – unrealised gains to be
included at 45% as previously or at CBB discretion
2. Regulatory Deductions from Common Equity:
a) Deduction of minority interests in subsidiaries (no longer
included in Common Equity – assume worst case).
b) Deduction of goodwill and all other intangibles.
c) Deduction of any deferred tax assets (should normally only apply
to foreign subsidiaries).
d) Deduction of any investments in own shares (treasury stock), any
own share purchases funded by the bank (e.g. employee stock
incentive programs).
e) Deduction of investments in the capital of financial institutions (including banking and insurance and investment business
institutions). This deduction will include all holdings of
common equity in other financial institutions which are less
than 10% of the concerned financial institution’s capital (above a
10% threshold for the reporting bank). The full amount of such
holdings (above the 10% own funds threshold) must be deducted
from the reporting bank’s common equity. Secondly, the holdings
of all common stock in all other financial institutions above 10% of
the investee’s capital must be aggregated (after performing
the above deduction). Where the aggregate of any such
holdings exceeds 15% of the reporting bank’s common equity,
then the amount over 15% of the reporting bank’s common equity
Revised Basel 3 Page 2
must be deducted. Note that these deductions will apply
irrespective of the location of the exposure in the trading book or in
the banking book.
3. Common Equity after regulatory deductions (Item 1 less item 2)
4. Additional Going Concern Capital (using new criteria – for most
banks this should be a zero item, but certain preference shares or other
loss-bearing instruments may be included here subject to the new Basel
limits)
5. Total Tier One Capital (Item 3 plus item 4 but subject to cap)
6. Tier Two Capital (subject to 2% cap and using new conditions)
7. Total Eligible Capital (Item 5 plus item 6)
8. Risk-Weighted Assets
Calculate total risk weighted assets for the banking book, the trading
book and operational risk as under existing PIR/Rulebook
requirements, but note that all significant investments in commercial
entities above 15% of capital base must be risk-weighted at 1,250%.
Assume no “grandfathering” of concessions.
9. Calculation of Capital Ratios
Calculate the following ratios:
a) Common Equity Capital Ratio (Item 3 divided by item 8)
b) Tier One Capital Ratio (Item 5 divided by item 8)
c) Total Capital Ratio (item 7 divided by item 8)
For the solo capital adequacy calculation, all shareholdings in subsidiaries
must be deducted from common equity in addition to the deductions made in
item 2e) above. Also all risk-weighted assets of subsidiaries for items 7 and
8 above must be deducted from the risk-weighted asset base of the reporting
bank, prior to calculation of the solo capital ratios.