could ballooning loss reserves from new accounting rules deflate bank capital ratios

Could Ballooning Loss Reserves FromNew Accounting Rules Deflate BankCapital Ratios?

Primary Credit Analysts:

Jonathan Nus, CPA, New York (1) 212-438-3471; [email protected]

Osman Sattar, ACA, London (44) 20-7176-7198; [email protected]

Secondary Contacts:

Joyce T Joseph, CPA, New York (1) 212-438-1217; [email protected]

Rohina Verdes, CA, Mumbai +91 22 40405829; [email protected]

Table Of Contents

Overview

Higher Credit Losses May Have A Meaningful Impact On Bank Capital

Key Ratios For The Top 100 Banks We Rate Would Slip, Some Significantly

Banks In Western Europe Would Take The Biggest Hit

Analysis Of The Impact On RAC Ratios Shows A Similar Picture

Regional Differences Likely Are Attributable To Many Factors

The New IFRS 9 Credit Loss Model Does Not Go Far Enough

Forward-Looking Assumptions Weigh Heavily On Expected Reserve

Levels, As Do Other Factors

Regulators Likely Will Require Adjustments From Accounting Credit Loss

Allowances For Regulatory Capital Calculations

For Every Accounting Action, There May Be An Equal And Opposite

Reaction

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Table Of Contents (cont.)

Major Differences Undermine Global Comparability

We Do Not Discern A Bank's Financial Strength From Capital Metrics

Alone

Appendices

Related Criteria And Research

Footnotes


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Could Ballooning Loss Reserves From NewAccounting Rules Deflate Bank Capital Ratios?

Sweeping new rule changes for the way banks estimate credit losses in their financial reports likely will have a

significant impact on banks applying International Financial Reporting Standards (IFRS) or U.S. Generally Accepted

Accounting Principles (U.S. GAAP). The changes are the culmination of a key objective to shift the accounting for

credit losses to a more forward-looking, counter-cyclical credit impairment model that will require earlier recognition

of credit losses--a weakness highlighted during the last financial crisis. As a result, capital and earnings could become

less predictable and bank managements may seek to build higher capital buffers to mitigate this effect, although the

extent to which bank regulators will adapt regulatory capital requirements remains to be seen. Higher loan-loss reserve

levels may also affect banks' planned distributions of capital in the form of dividends or share buybacks. Standard &

Poor's Ratings Services believes bank managements may take actions such as increased pricing on certain loan

products or shortening loan durations, to help offset the potential accounting consequences.

The new requirements are mandatory under IFRS for accounting periods beginning Jan. 1, 2018. We expect the

requirements for U.S. GAAP to be finalized in the first quarter of 2015, with mandatory application unlikely to be

before 2018 (with 2019 likely). In both cases, the new rules will require bank managements to consider more

forward-looking information when estimating credit losses (such as loan loss provisions), including internally

developed or third-party macroeconomic assumptions and forecasts. This implies that, although management's

judgment will remain a key factor in the estimation of credit losses, there will be less scope to delay or spread the

recognition of such losses to future periods, which we believe benefits investors.

Overview

• Moving from the existing 'incurred' credit loss model--which only considers past and current events when

estimating credit losses--to an 'expected' credit loss model that requires consideration of likely future outcomes will

result in an earlier recognition of credit losses that better reflects their timing.

• The new models will likely result in higher credit loss allowances on adoption of the new accounting standards,

decreasing banks' capital. All else being equal, our analysis suggests that among the top 100 global banks we rate,

western European banks could see core tier 1 ratios falling by an average of 53 basis points (bps) for each 10% rise

in new required reserves.

• U.S. banks' core tier 1 ratios would fall by much less, by 12 bps for each 10% rise in allowances; however, the U.S.

expected single-measurement model will result in relatively higher percentage increases in loan-loss reserves for

U.S. banks compared with banks using IFRS' dual-measurement approach.

• The new accounting-rule changes could lead some banks to shift loan product strategies, favoring shorter-duration

loan products over longer-term loan products to achieve a more favorable accounting outcome. In extreme cases,

bank management may decide to curtail the underwriting of new loan products.

• We prefer the proposed U.S. expected credit loss model--primarily because it requires the immediate recognition of

all expected credit losses--over the IFRS model, which is based on subjective evidence of credit deterioration over

time. More importantly, the lack of convergence between IFRS and U.S. GAAP in this critical area of bank financial

reporting creates unnecessary complexity in understanding financial reporting and undermines peer analysis

globally. We therefore believe investors would be best served if banks using IFRS disclosed their estimated lifetime


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credit losses.

The new IFRS credit loss requirements were set out in IFRS 9 (Financial Instruments) published July 24, 2014, by the

International Accounting Standards Board (IASB). The new rules apply to a wide range of financial assets, including

most loans and receivables, financial assets that are required to be measured at fair value through other

comprehensive income, trade receivables, and lease receivables. The scope extends to many off-balance-sheet loan

commitments and financial guarantee contracts. While IFRS 9 itself allows companies to adopt the new requirements

earlier than 2018, companies in the EU cannot do so until the EU legally endorses the standard, and the timing of that

is not yet clear. Similar restrictions also apply in other jurisdictions. Given the significant changes that IFRS 9 brings,

we believe most banks will need until 2018 to prepare for adopting the standard, and we are unlikely to see significant

rates of early adoption by banks using IFRS.

Like IFRS 9, we expect the Financial Accounting Standards Board's (FASB's) revised requirements for credit losses--an

Accounting Standards Update (ASU) "Financial Instruments—Credit Losses (Subtopic 825-15)--once finalized, to apply

to a wide range of financial assets and affect a wide range of companies, but we believe large global banks are most

likely to feel the impact.

IFRS 9 and the expected U.S. GAAP rules will be markedly different, because the respective standard-setters failed to

achieve convergence in this important area of accounting, particularly for banks. IFRS 9 has a "dual measurement"

approach, under which a 12-month expected loss allowance is established when the underlying asset (such as a loan) is

recognized. The rules require a lifetime loss allowance if the credit risk of the asset deteriorates significantly. The

expected U.S. GAAP model uses a "single measurement" approach that requires a lifetime loss allowance to be

established at the time the underlying asset is recognized. We believe this lack of convergence creates unnecessary

complexity in understanding financial reporting and undermines peer analysis globally. Bank regulators may need to

step in to mandate additional disclosures in banks' financial statements to address this complexity.

Higher Credit Losses May Have A Meaningful Impact On Bank Capital

Many factors suggest that a move to an expected credit loss method in accounting may have a significant impact on

transition. For example, the IASB's fieldwork, which involved 15 companies (including major banks) indicates that on

transition to IFRS 9, credit loss allowances would increase:

• By 25% to 60% on nonmortgage portfolios; and

• By 30% to 250% on mortgage portfolios (1).

A June 2014 global banking survey by Deloitte gathered the views of 54 banks: 29 based in the Europe, Middle East,

and Africa (EMEA) region; 17 in Asia-Pacific; and 8 in North America (2). This includes 14 banks that the Financial

Stability Board has classified as Global Systemically Important Financial Institutions (G-SIFIs). The survey revealed

that:

• More than half believe credit loss provisions will increase by up to 50% as a result of IFRS 9 (see chart 1);

• 70% believe IFRS 9 will increase Common Equity Tier 1 (CET1) capital requirements, because accounting

provisions will be higher than regulatory expected losses; and


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Could Ballooning Loss Reserves From New Accounting Rules Deflate Bank Capital Ratios?

• European banks reported the largest increases.

Chart 1

Regulatory impact studies in the U.S. also show credit impairment accounting changes could have sizable implications.

In a Sept. 16, 2013, speech about the possible effect on U.S. banks, Thomas J. Curry, head of the Office of the

Comptroller of the Currency (OCC, which supervises national banks, federal savings associations, and the federal

branches and agencies of foreign banks), said the OCC's impact analysis showed credit loss allowances would increase

by 30% to 50% across the U.S. banking system if the proposed U.S. GAAP model was applied, with the effect on

individual banks depending on specific factors such as each bank's loan portfolio (3).

These reports clearly indicate that the move to the new more forward-looking credit loss models in IFRS and U.S.

GAAP will be significant for banks globally. However, we believe estimating the effect on individual banks is difficult

because it will depend on a host of factors. These include a bank's region of operations, business model, loan portfolio

mix, underwriting standards, assumptions used, reserve levels in the current credit cycle, and asset write-off policies,

as well as the economic environment at the time of implementation and the accounting regime in place. Banks also

may take actions to address some of the accounting results. Despite these challenges, we believe investors should be

aware of the potential effect on existing capital measures under various potential scenarios if higher credit loss

requirements--whether under IFRS 9 or expected U.S. GAAP--currently were applied.


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Key Ratios For The Top 100 Banks We Rate Would Slip, Some Significantly

We reviewed the potential impact on regulatory core tier 1 capital under potentially various rising credit loss

allowance scenarios for the top 100 global banks we rate, grouped by region (see appendix I). We also examined the

effect of potentially rising credit loss allowances on Standard & Poor's Risk-Adjusted Capital (RAC) measure. We use

RAC ratios to measure the adequacy of bank's capital, regardless of the type of bank or where it operates. We found

that, on average, for every 10% rise in the allowance, the core tier 1 ratio drops by 30bps and the RAC ratio drops by

19bps.

Most large banks that are subject to Basel II or Basel III rules apply the internal ratings-based (IRB) approach on the

bulk of their loan portfolios in their regulatory capital calculations. The IRB approach replaces the accounting credit

loss allowances with a (usually higher) expected loss amount calculated under Basel rules. However, for simplicity, the

methodology we use here assumes that increases in credit loss allowances for accounting purposes directly translate

into a deduction from regulatory capital (see appendix II).

Banks In Western Europe Would Take The Biggest Hit

Western European banks could experience the most significant drop in capital from a rise in credit loss allowances (see

table 1 and chart 2). For every 10% rise in the allowance, western European banks' core tier 1 ratios tumble, on

average, by 53bps. For Eastern Europe, Middle East and Africa (EEMEA) banks, the fall in core tier 1 ratio averages

17bps. The impact on western European banks is very different from that on banks in North America, which fare

considerably better. In the U.S., core tier 1 ratios drop by 12bps on average for each 10% rise in credit loss allowances;

in Canada, the drop is 10bps on average.

Table 1

Impact On Core Tier 1 Ratios From Rising Credit Loss Allowances For Top 100 Rated Banks, By Region

(Based on 2013 year-end data)

--Average % decrease in core Tier 1 ratio if allowance rises by--

10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 100%

U.S. banks (0.12) (0.18) (0.24) (0.31) (0.37) (0.43) (0.49) (0.55) (0.61) (0.67) (0.73) (0.79) (0.85) (0.92) (1.22)

Canada banks (0.10) (0.14) (0.19) (0.24) (0.29) (0.34) (0.38) (0.43) (0.48) (0.53) (0.58) (0.63) (0.67) (0.72) (0.96)

Western Europe

banks

(0.53) (0.79) (1.06) (1.32) (1.59) (1.85) (2.12) (2.38) (2.65) (2.91) (3.18) (3.44) (3.71) (3.97) (5.30)

EEMEA banks (0.17) (0.25) (0.33) (0.42) (0.50) (0.59) (0.67) (0.75) (0.84) (0.92) (1.00) (1.09) (1.17) (1.26) (1.67)

Asia-Pacific

banks

(0.16) (0.24) (0.32) (0.40) (0.47) (0.55) (0.63) (0.71) (0.79) (0.87) (0.95) (1.03) (1.11) (1.19) (1.58)

Latin America

banks

(0.35) (0.52) (0.69) (0.87) (1.04) (1.21) (1.39) (1.56) (1.74) (1.91) (2.08) (2.26) (2.43) (2.60) (3.47)

Top 100 rated

banks

(0.30) (0.45) (0.60) (0.75) (0.90) (1.05) (1.20) (1.35) (1.50) (1.65) (1.80) (1.95) (2.10) (2.25) (3.01)

Source: Capital IQ, Standard & Poor's estimates.


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Chart 2

In other regions, our analysis shows that higher credit loss allowances may also significantly affect banks in Latin

American, with core tier 1 ratios falling by an average of 35bps for each 10% rise in allowances. For Asia Pacific banks,

the impact is similar to that for U.S. banks, with core tier 1 ratios falling by an average of 16bps for each 10% rise in the

allowance.

If credit-loss allowances rise by up to 50%, as some expect (including the OCC for the U.S. banking system and

respondents to Deloitte's Fourth Global Banking Survey), we estimate that for U.S. banks, core tier 1 ratios could take a

hit of up to 61bps. Western European banks could take a hit of up to 265bps--more than four times as much.

While our analysis is based on banks' 2013 year-end data, we observed similar trends when using average allowance

levels over the past five years, rather than 2013 levels, which are benefitting from favorable asset quality trends--and

relatively lower reserve coverage levels--in some regions, such as the U.S. and Canada (see table 2 and chart 3).


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Table 2

Impact On Core Tier 1 Ratios From Rising Credit Loss Allowances For Top 100 Rated Banks, By Region

(Based on 2013 year-end data for capital and a five-year average loan loss allowance)

--Average % decrease in core Tier 1 ratio if alllowance rises by--

10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 100%

U.S. banks (0.15) (0.23) (0.30) (0.38) (0.45) (0.53) (0.60) (0.68) (0.75) (0.83) (0.90) (0.98) (1.05) (1.13) (1.50)

Canada banks (0.09) (0.14) (0.19) (0.24) (0.28) (0.33) (0.38) (0.42) (0.47) (0.52) (0.56) (0.61) (0.66) (0.71) (0.94)

Western

Europe banks

(0.42) (0.63) (0.84) (1.05) (1.26) (1.47) (1.68) (1.89) (2.10) (2.31) (2.52) (2.73) (2.94) (3.15) (4.20)

EEMEA banks (0.18) (0.27) (0.35) (0.44) (0.53) (0.62) (0.71) (0.80) (0.88) (0.97) (1.06) (1.15) (1.24) (1.33) (1.77)

Asia-Pacific

banks

(0.14) (0.21) (0.28) (0.35) (0.42) (0.48) (0.55) (0.62) (0.69) (0.76) (0.83) (0.90) (0.97) (1.04) (1.38)

Latin America

banks

(0.32) (0.48) (0.64) (0.80) (0.96) (1.12) (1.28) (1.44) (1.60) (1.76) (1.92) (2.08) (2.24) (2.40) (3.20)

Top 100 rated

banks

(0.26) (0.39) (0.52) (0.65) (0.78) (0.92) (1.05) (1.18) (1.31) (1.44) (1.57) (1.70) (1.83) (1.96) (2.62)

Source: Capital IQ, Standard & Poor's estimates. Data is based on banks’ 2013 year-end annual reporting (for capital) and the average of

2009-2013 loan loss provisions, where available.

Chart 3


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Analysis Of The Impact On RAC Ratios Shows A Similar Picture

We also analyzed the impact of rising credit loss allowances on our RAC ratios. We define RAC as total adjusted

capital divided by risk weighted assets (see Criteria: Financial Institutions: Bank Capital Methodology And

Assumptions, published Dec. 6, 2010, on RatingsDirect). Western European banks again face the greatest hit for each

10% increase in credit loss allowances, showing a 27bps fall in RAC ratios. U.S. banks show RAC ratios falling by 9bps

for each 10% rise in allowances; Canadian banks' RAC ratios fell by less than 1bp. For Latin American banks the

impact was 20 bps; for Asia-Pacific banks, it was 13bps. While the degree to which the RAC ratio declines is lower than

the effect on core tier 1 ratios, we believe the trends are still meaningful (see chart 4).

Chart 4

Regional Differences Likely Are Attributable To Many Factors

The differences in the magnitude of the capital impact across banks in different regions result from a combination of

factors, including:

• Differences in business models. There is generally a greater level of disintermediation in U.S. banks compared with


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European banks, with the latter retaining a relatively larger proportion of loans on their balance sheets.

• Differences in asset write-off policies. Legal processes such as foreclosure tend to be slower in some jurisdictions

(such as countries in southern Europe), so it can take longer for impaired assets to be written off from the balance

sheet. Therefore, banks in such jurisdictions often carry high levels of provisioning against impaired assets for a

longer time.

The methodology we use here does not specifically adjust for these factors; e.g., because of disclosure limitations, we

have not adjusted the methodology for assets that are already substantially or fully provisioned and are thus unlikely to

attract further provisions under the new credit loss models.

The New IFRS 9 Credit Loss Model Does Not Go Far Enough

The new IFRS 9 model is an 'expected loss' model that requires companies to consider expected future losses when

estimating credit loss allowances. The model requires a dual-measurement approach, with the recognition of an initial

(day 1) credit loss allowance that represents 12 months of expected credit losses for all financial assets in the scope of

the model, updated at each reporting period. The model requires the recognition of lifetime expected credit losses, but

only when management decides the credit risk of the financial asset has significantly increased since its initial

recognition.

This means that, for assets that are performing as banks originally expected--including the vast majority of most banks'

loan portfolios--the model would only reflect a portion of expected credit losses. Management must then judge which

assets have experienced significant increases in credit risk and recognize a lifetime loss allowance for those assets.

We believe the dual-measurement approach of the IASB's expected loss model will lead to inconsistencies across

banks, because the judgments bank managements apply about whether assets have experienced significant increases

in credit risk are likely to vary and may be subject to bias (e.g., where management may be influenced by earnings

targets). It is not yet clear whether the disclosure requirements in IFRS 9 (detailed below) will help financial statement

users to identify such variances. We believe the IFRS 9 approach does not go far enough to dampen the procyclical

effects of loan losses because loan-loss allowances may start to rise only after the start of an economic downturn and

spike once the economy takes its sharpest turn for the worse.

We believe FASB's single measurement approach (i.e., lifetime losses on initial recognition of the underlying asset) is

conceptually more robust, simpler, and less ambiguous than the IASB's dual measurement approach and would

provide better information related to credit losses for our analysis (see "FASB’s Proposal Set To Revamp Accounting

For Credit Losses, But Fails To Achieve Convergence With International Accounting," July 11, 2013).

Forward-Looking Assumptions Weigh Heavily On Expected Reserve Levels, AsDo Other Factors

Managements' expectations about the future--whether credit quality indicators are getting better or worse--relative to

their historical experience likely will drive a significant part of the allowance level. However, the range of possible


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losses largely will depend on other factors, such as the composition of a bank's loan portfolio or existing accounting

policies for credit loss allowances, which could change dramatically before a bank implements these accounting

standards.

In the EU, the European Central Bank's (ECB's) comprehensive assessment of the largest Eurozone banks uses more

standardized definitions of nonperforming loans and may be stricter than those many banks use for at least some of

their portfolios. Reporting for year-end 2013 saw a number of banks in the EU recognizing higher credit loss

allowances as they positioned themselves to pass the ECB assessment (results to be published in October 2014).

In the U.S., if the FASB lifetime expected credit loss model is finalized as proposed, banks with loan books heavily

weighted toward home equity lines of credit (HELOCs) or other revolving loan commitments likely will see steeper

hikes in the allowance. These loan products may be performing well, but a significant volume have yet to reach their

end-of-draw periods. Under an expected loss approach, banks would be required to consider fully drawn and

amortizing HELOCs, in addition to forward-looking expectations and their macroeconomic views, when determining

an appropriate allowance. Similarly, this approach could also significantly affect banks with a high proportion of

Commercial and Industrial loans (C&I)--which have grown at a spectacular pace in many regions.

Regulators Likely Will Require Adjustments From Accounting Credit LossAllowances For Regulatory Capital Calculations

It is not yet clear how bank regulators will respond to the new accounting requirements for credit losses. We believe

regulators will still require banks to factor in additional credit losses in their calculation of regulatory capital.

Regulators require sufficient capital to cover expected and unexpected losses, and the new accounting is only intended

to cover expected losses. In addition, regulators may decide the new accounting does not cover expected losses

sufficiently, particularly for the initial 12-month credit loss allowance for performing assets under the IFRS model.

Regulators may also remove the tier 2 capital add-back currently allowed, where the accounting provision is higher

than the Basel expected loss amount.

For Every Accounting Action, There May Be An Equal And Opposite Reaction

As accounting rules change under IFRS and U.S. GAAP to capture banks' expected losses, it is likely many bank

managements will address the potential impact on earnings and capital. This could involve a variety of changes,

including increasing pricing on certain loan products (such as corporate loans or mortgages) to compensate for higher

loan provisions, which could counteract some of the higher expenses with higher revenues over the life of the loan.

Banks may shift loan-product strategies, favoring shorter-duration loan products over longer-term loan products. For

example, some banks--to achieve a more desirable accounting result--could add renewal options to contractual terms

to shorten the duration of certain commercial loan products. Some long-term revolving credit products, often

withdrawn on short notice, could become a smaller share of banks' loan portfolios because banks would need to

consider these loan products on a fully-drawn basis to establish reserve levels. In extreme cases, bank management

teams may decide to significantly curtail the underwriting of new loan products simply to avoid both the accounting


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consequences of establishing reserves and taking an earnings hit in a specific reporting period, particularly when

earnings are already under pressure. The effect of these rules may deter potential new market entrants, and the

outcomes could have broader economic consequences.

Major Differences Undermine Global Comparability

The lack of convergence between U.S. GAAP and IFRS means impairment analysis will be based on two markedly

different accounting approaches, creating unnecessary reporting and market confusion and undermining peer analysis.

Credit loss allowances and key metrics that are not directly comparable create significant disadvantages for investors.

In the absence of greater similarity and consistency between the IASB and FASB, we believe investors would be best

served if banks using IFRS disclosed their estimated lifetime credit losses. IFRS 9 does not specifically require this, but

in our view, bank regulators should consider mandating this type of additional disclosure to provide investors with

relevant, globally comparable information on credit losses (See appendix III for illustrative examples of disclosure

requirements mandated under IFRS 9).

In addition to the reform of credit-loss accounting, IFRS 9 serves as a single accounting standard that includes finalized

requirements for the classification and measurement of financial instruments and general hedge accounting. The rules

for classifying financial instruments for IASB purposes may differ from those in the soon-to-be released U.S. GAAP

accounting standard, which could lead to further global peer incomparability.

We Do Not Discern A Bank's Financial Strength From Capital Metrics Alone

Capital metrics do not tell the full story of a bank's financial strength. Our rating methodology provides a wider picture

by assessing whether financial reports adequately recognize and measure risks and by analyzing banks' ability to

generate capital. Indeed, many banks around the globe have accelerated their deleveraging or are implementing a

range of other options to improve capital and leverage metrics in response to more demanding regulatory

requirements under Basel III. Potentially higher credit losses and their effect on capital represent another gap that

banks must consider. However, even as banks' capital metrics improve or worsen under our definitions, we do not

view capital as a single factor triggering rating changes.

Notes:

In this article:

• The data in table 1 and chart 2 are based on banks' reported 2013 year-end reported regulatory capital figures and

2013 reported loss reserves. Increases in loss reserves are deducted from capital (the numerator in the capital ratio).

No adjustment was made for RWAs (the denominator), because the sample (top 100 rated banks, appendix I) was

assumed to be the IRB approach for the bulk of the portfolios, in which RWAs are based on gross exposures.

• The data in table 2 and chart 3 are the same as in table 1 and chart 2, but five-year average (2009-2013) loss

reserves were used, rather than just 2013 loss reserves.

• The data in chart 4 are based on banks' 2013 RAC ratios and 2013 reported loss reserves. Increases in loss reserves

were deducted from RAC (the numerator in the RAC ratio) and no adjustment was needed for our RWAs (the

denominator), because they are based on gross exposures.


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Appendices

Appendix I

Top 100 Rated Banks Reviewed In Our Sample

Country Company name

Operating company

long-term issuer credit

rating

Stand-alone

credit profile

Capital and

earnings Risk position

Netherlands ABN AMRO Bank N.V. A/Stable/A-1 bbb+ Adequate (0) Adequate (0)

China Agricultural Bank of China Ltd. A/Stable/A-1 bbb- Moderate (-1) Moderate (-1)

Ireland Allied Irish Banks PLC BB/Negative/B b+ Weak (-1) Adequate (0)

Australia Australia and New Zealand Banking

Group Ltd.

AA-/Stable/A-1+ a Adequate (0) Adequate (0)

Spain Banco Bilbao Vizcaya Argentaria, S.A. BBB/Stable/A-2 bbb+ Moderate (-1) Very strong

(+2)

Spain Banco Popular Espanol S.A. B+/Negative/B b- Weak (-1) Weak (-2)

Spain Banco Santander S.A. BBB/Stable/A-2 a- Moderate (-1) Very strong

(+2)

U.S. Bank of America Corp. A/Negative/A-1 bbb+ Adequate (0) Moderate (-1)

China Bank of China Ltd. A/Stable/A-1 bbb Moderate (-1) Adequate (0)

China Bank of Communications Co. Ltd. A-/Stable/A-2 bbb- Moderate (-1) Adequate (0)

Canada Bank of Montreal A+/Stable/A-1 a- Adequate (0) Adequate (0)

U.K. Barclays Bank PLC A/Negative/A-1 bbb+ Adequate (0) Adequate (0)

U.S. BB&T Corp. A/Negative/A-1 a Adequate (0) Strong (+1)

France BNP Paribas SA A+/Negative/A-1 a- Moderate (-1) Adequate(0)

Canada Canadian Imperial Bank of Commerce A+/Stable/A-1 a- Adequate(0) Adequate(0)

U.S. Capital One Financial Corp. BBB+/Stable/A-2 bbb+ Adequate (0) Adequate (0)

China China Construction Bank Corp. A/Stable/A-1 bbb- Moderate (-1) Moderate (-1)

China China Merchants Bank Co. Ltd. BBB+/Stable/A-2 bbb Moderate (-1) Strong (+1)

U.S. Citigroup Inc. A/Stable/A-1 bbb+ Adequate (0) Adequate (0)

Germany Commerzbank AG A-/Negative/A-2 bbb- Adequate (0) Weak (-2)

Australia Commonwealth Bank of Australia AA-/Stable/A-1+ a Adequate (0) Adequate (0)

France Credit Agricole S.A. A/Negative/A-1 a- Adequate (0) Adequate (0)

France Credit Mutuel Centre Est Europe A/Stable/A-1 a- Adequate (0) Adequate (0)

Swizerland Credit Suisse Group AG A/Stable/A-1 bbb+ Adequate (0) Moderate (-1)

Denmark Danske Bank A/S A/Negative/A-1 bbb+ Adequate (0) Adequate (0)

Singapore DBS Bank Ltd. AA-/Stable/A-1+ a Adequate (0) Adequate (0)

Germany Deutsche Bank AG A/Negative/A-1 bbb+ Adequate(0) Moderate(-1)

Norway DNB Bank ASA A+/Stable/A-1 a Adequate (0) Adequate (0)

Austria Erste Group Bank AG A/Watch Neg/A-1 bbb+ Moderate Adequate

U.S. Fifth Third Bancorp A-/Stable/A-2 a- Adequate (0) Adequate (0)

France BPCE A/Negative/A-1 a- Adequate (0) Adequate (0)

U.K. HSBC Holdings plc A+/Negative/A-1 a+ Adequate (0) Strong (+1)

India ICICI Bank Ltd. BBB-/Negative/A-3 bbb Adequate (0) Adequate (0)

China Industrial and Commercial Bank of

China Ltd.

A/Stable/A-1 bbb Moderate (-1) Adequate (0)


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Top 100 Rated Banks Reviewed In Our Sample (cont.)

Netherlands ING Bank N.V. A/Stable/A-1 a- Adequate (0) Adequate (0)

Brazil Itau Unibanco Holding S.A. BBB-/Stable/A-3 bbb Moderate (-1) Adequate (0)

U.S. JPMorgan Chase & Co. A/Negative/A-1 a Adequate (0) Adequate (0)

Russia VTB Bank JSC BBB/Stable/A-2 bb Moderate (0) Moderate (-1)

Belgium KBC Bank N.V. A-/Positive/A-2 bbb+ Moderate (-1) Adequate (0)

Korea Kookmin Bank Co. Ltd. A/Stable/A-1 a- Adequate (0) Adequate (0)

U.K. Lloyds Bank plc A/Negative/A-1 bbb+ Adequate (0) Moderate (-1)

Malaysia Malayan Banking Bhd. A-/Stable/A-2 a- Adequate (0) Adequate (0)

Japan Mitsubishi UFJ Financial Group Inc. A+/Stable/A-1 a+ Adequate (0) Adequate (0)

Japan Mizuho Financial Group Inc. A+/Negative/A-1 a Moderate (-1) Adequate (0)

U.S. Morgan Stanley A/Negative/A-1 bbb+ Adequate (0) Moderate (-1)

Australia National Australia Bank Ltd. AA-/Stable/A-1+ a Adequate (0) Adequate (0)

U.K. Nationwide Building Society A/Negative/A-1 bbb+ Adequate (0) Adequate (0)

Japan Nomura Holdings Inc. A-/Stable/A-2 bbb Adequate (0) Moderate (-1)

Germany Norddeutsche Landesbank

Girozentrale

BBB+/Negative/A-2 bbb- Adequate (0) Weak (-2)

Sweden Nordea Bank AB AA-/Negative/A-1+ a+ Adequate (0) Strong (+1)

China Oversea-Chinese Banking Corp. Ltd. AA-/Stable/A-1+ a Adequate (0) Adequate (0)

Japan Resona Bank Ltd. A/Stable/A-1 a- Moderate (-1) Adequate (0)

Canada Royal Bank of Canada AA-/Stable/A-1+ a+ Adequate (0) Strong (+1)

Korea Shinhan Bank A/Stable/A-1 bbb+ Moderate (-1) Adequate (0)

France Societe Generale Group A/Negative/A-1 a- Adequate (0) Adequate (0)

South Africa Standard Bank of South Africa Ltd. BBB/Negative/A-2 bbb Adequate (0) Adequate (0)

U.K. Standard Chartered PLC AA-/Negative/A-1+ a+ Adequate (0) Strong (+1)

U.S. State Street Corp. A+/Negative/A-1 bbb+ Adequate Strong

Japan Sumitomo Mitsui Financial Group Inc. A+/Negative/A-1 a Moderate (-1) Adequate (0)

Japan Sumitomo Mitsui Trust Bank Ltd. A+/Negative/A-1 a Moderate (-1) Strong (+1)

U.S. SunTrust Banks Inc. BBB+/Positive/A-2 bbb+ Adequate (0) Moderate (-1)

Sweden Svenska Handelsbanken AB AA-/Negative/A-1+ a+ Adequate (0) Strong (+1)

Sweden Swedbank AB A+/Stable/A-1 a- Adequate (0) Adequate (0)

U.S. The Bank of New York Mellon Corp. AA-/Stable/A-1+ a Moderate (-1) Strong (+1)

Canada The Bank of Nova Scotia A+/Stable/A-1 a Adequate Strong

U.S. The Goldman Sachs Group Inc. A/Negative/A-1 bbb+ Adequate (0) Moderate (-1)

Saudi Arabia The National Commercial Bank A+/Stable/A-1 a Strong (+1) Moderate (-1)

U.S. PNC Financial Services Group A-/Stable/A-2 a Adequate (0) Strong (+1)

U.K. The Royal Bank of Scotland plc A-/Negative/A-2 bbb Adequate (0) Moderate (-1)

Canada The Toronto-Dominion Bank AA-/Stable/A-1+ a+ Adequate (0) Strong (+1)

Turkey Turkiye Garanti Bankasi A.S. BB+/Negative/-- bb+ Adequate (0) Adequate (0)

U.S. U.S. Bancorp (The) AA-/Stable/A-1+ a+ Adequate (0) Strong (+1)

Swizerland UBS AG A/Negative/A-1 a- Strong (+1) Moderate (-1)

Italy UniCredit SpA BBB/Negative/A-2 bbb Moderate (-1) Adequate (0)

Italy Unione di Banche Italiane Scpa BBB-/Negative/A-3 bbb- Moderate (-1) Adequate (0)

Singapore United Overseas Bank Ltd. AA-/Stable/A-1+ a- Adequate (0) Adequate (0)


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Top 100 Rated Banks Reviewed In Our Sample (cont.)

U.S. Wells Fargo & Co. A+/Negative/A-1 a+ Adequate Strong

Australia Westpac Banking Corp. AA-/Stable/A-1+ a Adequate (0) Adequate (0)

Korea Woori Bank A-/Stable/A-2 bbb Moderate (-1) Moderate (-1)

Japan The Norinchukin Bank A+/Negative/A-1 a Adequate (0) Adequate (0)

Netherlands Rabobank (Coöperatieve Centrale

Raiffeisen-Boerenleenbank B.A. )

AA-/Negative/A-1+ a+ Adequate (0) Strong (+1)

Italy Intesa Sanpaolo SpA BBB/Negative/A-2 bbb Moderate (-1) Strong (+1)

Brazil Banco do Brasil S.A. BBB-/Stable/A-3 bbb Moderate (-1) Adequate (0)

Brazil Banco Bradesco S.A. BBB-/Stable/A-3 bbb Moderate (-1) Adequate (0)

India State Bank Of India BBB-/Negative/A-3 bbb- Moderate (-1) Moderate (-1)

Germany BVR (Co-operative banking sector)

Bank Germany

AA-/Stable/A-1+ aa- Strong (+1) Adequate (0)

Sweden Skandinaviska Enskilda Banken AB

(publ)

A+/Negative/A-1 a- Adequate (0) Adequate (0)

Ireland Bank of Ireland BB+/Negative/B bb Weak (-1) Adequate (0)

Austria Raiffeisen Zentralbank Oesterreich AG A/Watch Neg/A-1 bbb+ Moderate (-1) Adequate (0)

U.S. Regions Financial Corp. BBB/Positive/A-2 bbb Adequate (0) Moderate (-1)

Canada Caisse Centrale Desjardins A+/Stable/A-1 a Strong (+1) Adequate (0)

Korea Hana Bank A/Stable/A-1 bbb+ Moderate (-1) Adequate (0)

Korea Nonghyup Bank A/Stable/A-1 bbb Moderate (-1) Moderate (-1)

Spain Caixabank S.A. BBB-/Positive/A-3 bbb- Weak (-1) Strong (+1)

Spain Banco de Sabadell S.A. BB/Negative/B b+ Weak (-1) Moderate (-1)

France Dexia Credit Local BBB/Stable/A-2 b+ Moderate (-1) Weak (-2)

Korea Industrial Bank of Korea A+/Stable/A-1 bbb Adequate (0) Adequate (0)

Korea Korea Development Bank A+/Stable/A-1 bb Adequate (0) Weak (-2)

Denmark Nykredit Realkredit A/S A+/Negative/A-1 a- Adequate (0) Strong (+1)

China Shanghai Pudong Development Bank

Co. Ltd.

BBB+/Negative/A-2 bbb- Moderate (-1) Strong (+1)

Note: Data shown in the table are as of Aug. 15, 2014.

Appendix II: Methodology

Our methodology considered the potential impact on regulatory core tier 1 capital ratios and Standard & Poor's RAC

ratios from a range of higher credit loss allowances. The sample consisted of the top 100 banks we rate (see appendix

I), which we further classified based on their region:

• The U.S.;

• Canada;

• Western Europe;

• Eastern Europe, the Middle East, And Africa (EEMEA);

• Asia-Pacific; and

• Latin America.

As data points, we used:

• Core Tier 1 Capital for 2013;


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• Regulatory Risk Weighted Assets for 2013;

• Total Adjusted Capital (TAC) for 2013;

• Standard & Poor's Risk Weighted Assets (RWA) before diversification for 2013;

• Gross Loan Balances for 2013; and

• Five years' allowance for Loan Losses (i.e., 2009, 2010, 2011, 2012, 2013).

Appendix III: Illustrative quantitative disclosures for changes in credit losses and gross carryingamounts of underlying assetsTable 1

Illustrative Disclosure Of Changes In Expected Credit Losses

CU '000s

Mortgage loans--loss

allowance

12-month

expected credit

losses

Lifetime expected

credit losses

(collectively assessed)

Lifetime expected credit

losses (individually

assessed)

Credit-impaired financial

assets (lifetime expected

credit losses)

Loss allowance as of Jan. 1 X X X X

Changes due to financial

instruments recognized as of

Jan. 1:

X -- X --

--Transfer to lifetime

expected credit losses

X X X --

--Transfer to credit-impaired

financial assets

X -- X X

--Transfer to 12-month

expected credit losses

X X X --

--Financial assets that have

been derecognized during

the period

X X X X

New financial assets originated

of purchased

X -- -- --

Write-offs -- -- X X

Changes in models/risk

parameters

X X X X

Foreign exchange and other

movements

X X X X

Loss allowance as of Dec. 31 X X X X

Source: International Accounting Standards Board.

Table 2

Illustrative Disclosure Of Changes In Gross Carrying Amounts Of Assets

CU '000s

Mortgage loans--gross

carrying amount

12-month

expected credit

losses

Lifetime expected

credit losses

(collectively assessed)

Lifetime expected credit

losses (individually

assessed)

Credit-impaired financial

assets (lifetime expected

credit losses)

Gross carrying amount as of

Jan. 1

X X X X

Individual financial assets

transferred to lifetime expected

credit losses

X -- X --


transferred to credit-impaired

financial assets

X -- X X


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Table 2

Illustrative Disclosure Of Changes In Gross Carrying Amounts Of Assets (cont.)


transferred from

credit-impaired financial asets

X -- X X

Financial assets assessed on

collective basis

X X -- --

New financial assets originated

or purchased

X -- -- --

Write-offs -- -- X X

Financial assets that have been

derecognized

X X X X

Changes due to modifications

that did note result in

derecognition

X -- X X

Other changes X X X X

Gross carrying amount as of

Dec. 31

X X X X


Table 3

Illustrative Disclosure Of Credit Risk Of Financial Assets By Internal Rating Grades

CU '000s

Consumer - credit card Consumer - automotive

Gross carrying amount Gross carrying amount

Lifetime 12-month Lifetime 12-month

Internal grade 1-2 X X X X



Internal grade 7 X X X X

Total X X X X


Table 4

Illustrative Disclosure Of Credit Risk Of Financial Assets By External Rating Grades

CU '000s Corporate - equipment Corporate - construction

Gross carrying amount Gross carrying amount

Lifetime 12-month Lifetime 12-month

AAA-AA X X X X

B X X X X

BBB-BB X X X X

B X X X X

CCC-CC X X X X

C X X X X

D X X X X

Total X X X X



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Related Criteria And Research

• Global Bank Disintermediation: Filling The Corporate Borrowing Need, June 18, 2014

• Standard & Poor’s Ratings Definitions, March 21, 2014

• IASB's Proposal Set To Revamp Accounting For Credit Losses, But Fails To Achieve Convergence With U.S.

Accounting, July 16, 2013

• FASB's Proposal Set To Revamp Accounting For Credit Losses, But Fails To Achieve Convergence With

International Accounting, July 11, 2013

• Bank Capital Methodology and Assumptions, Dec. 6, 2010

Footnotes

(1) IASB Staff Paper 5B: Outreach Feedback Summary – IASB, 22-26 Jul. 2013. Available at

http://www.ifrs.org/Meetings/MeetingDocs/IASB/2013/July/05B-Impairment.pdf

(2) Fourth Global IFRS Banking Survey – Deloitte, June 2014. Available at

http://www.iasplus.com/en-gb/publications/global/surveys/fourth-global-ifrs-banking-survey/file

(3) Remarks by Thomas J. Curry Comptroller of the Currency Before the AICPA Banking Conference Washington,

D.C, Sept. 16, 2013. Available at: http://occ.gov/news-issuances/speeches/2013/pub-speech-2013-136.pdf


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