Identifying top threats to Luxembourg Banks - PwC · Basel III rules are defined by the Basel...

Identifying top threatsto Luxembourg banks

7 March 20127 March 2012

Agenda

09h00 – 09h10 Welcome

09h10 – 09h30 Macro-economic environment: the biggestthreat to Luxembourg Banks

09h30 – 10h15 Identifying the other top threats toLuxembourg Banks

10h15 – 10h30 Questions and answers

10h30 – 10h45 Conclusion

Welcome andintroduction

Rima Adas, Partner, Banking Leader

Sovereign debt-crisis: amacro-economicperspective

Johannes Göldner, Senior Advisor

Exploring all alternatives

Source: Matt, The telegraph, www.thetelegraph.co.uk

The financial crisis enters its fifth year

Phases of the crisisIncreasing risks to financial

stability

Privatedebt

Subprime crisis originates in US

Source of graph: International Monetary Fund, Financial Stability Report,September 2011

Banking

Sovereign

Political

Systemic banking crisis spreads from US toEurope

European periphery sovereign debt problemsMedium term threat to advanced economies

Major political disagreements on how toassure financial stability

April September January

2011 2012 2011 2012 2011 2012 2013

France 1.6 1.8 1.7 1.4 1.6 0.2 1.0

Elevated debt and deteriorating perspectives

Debt in % of GDP Outlook real GDP growth (in %)

Germany 2.5 2.1 2.7 1.3 3.0 0.3 1.5

Greece1 -3 1.1 -5 -2 -6.1 -4.3 0.0

Ireland 0.5 1.9 0.4 1.5 - - -

Italy 1.1 1.3 0.6 0.3 0.4 -2.2 -0.6

Portugal -1.5 -0.5 -2.2 -1.8 0.7 -1.7 -0.3

Spain 0.8 1.6 0.8 1.1 - - -

G20Advanced

2.3 2.5 1.3 1.7 - - -

Source: International Monetary Fund, Fiscal Monitor, September 2011

Source: International Monetary Fund, World Economic Outlook, April &September 2011;

1 Source for January figures is baseline scenario of Debt Sustainability Analysis,IMF (Feb. 2012)

Maturing bonds & loans 2011-2013(in € billion)

Portugal + Ireland+ Greece

Italy + Spain 905

France 490

Overview maturing sovereign bonds & loans

Greece

France

France 490

Total 1.576

Source: Bloomberg, March 5th, 2012; Includes maturing bonds and loans to Government

In € billion

• Sufficient market absorption?

• Will short-term yields remain at sustainablelevels?

• Will impact of LTROs move up the yieldcurve?

0 100 200 300 400 500 600 700

Portugal

Ireland

Deposit facility

Use of the ECB’s overnight deposit facility

LTRO 1

LTRO 2

In € billion

Germany

Ireland

10 year government bonds yield development

Yields in %

15 Greece

France

Portugal

Implicit assumptionmutual liability

Onset subprime crisis

Greece admits tounderstating deficit

Overview important events Greek Bailout –an ongoing story

2010 2011 2012

Greek governmentadmits higher deficit

IMF and EU agree toassist Greece

Agreement on secondbailout of € 109 bn is

reached, later fallsthrough

Eurozone leaders agree

PwC 11

First bailout of € 110 bnlaunched

assist Greece

Adoption of EuropeanStabilisation Mechanism

Evidence reforms notimplemented fast

enough

Eurozone leaders agreeon 50% haircut, further

austerity measures

Eurozone agrees onsecond bailout of € 130

Greek Bailout – The private sector involvement

Overview creditors Key terms of voluntary exchange

• Haircut of 53,5% on principal amount of privately heldGreek government bonds

• 31,5% of principal exchanged into 20 new governmentbonds

− Maturities between 11 and 30 years− Amortisation of 5% per annum from 2023 onwards

PwC 12

Source: Statement by the Steering Committee of the Private Creditor-InvestorCommittee for Greece (PCIC), February 21st, 2012

Source: Der Spiegel, 20.01.2012, available athttp://www.spiegel.de/international/europe/bild-810420-301665.html

• 15% of principal exchanged into short-term EFSF notes

• Accrued interest on existing Greek government bonds willbe provided in short-term EFSF notes

• Coupon structure− 02/2012 - 02/2015: 2%− 02/2015 - 02/2020: 3%− 02/2020 – 02/2042: 4,3%

• Separate securities indexed to Greek GDP growth with capwill be offered to investors

IMF Debt Sustainability Analysis – The realisticcase for Greece?

Baseline scenario Alternative scenario

PwC 13

Amount of debt outstanding in % of GDP

Source: IMF, debt sustainability analysis,available athttp://ftalphaville.ft.com/blog/2012/02/21/889521/that-greek-debt-sustainability-analysis-in-full/

No reforms undertaken

Reforms initiated

•Ability to deliver structural reforms•Realisation of privatisation objectives•Success private sector involvement•Macroeconomic parameters, in particular growth and interest ratelevels

Key assumptions

The European Sovereign debt situation – Outlook

• Sufficient participation of private sector creditors not certain

• Will potential new Greek government stick to reform agreements?

• Further bailout of ~€ 50 bn necessary down the road?

• Upcoming elections in France and Germany

PwC 14

• Size and scope of ESM

• ECB and Eurobonds

Deeper European integration vs. implosion

If European crisis is resolved, shift of focus to America or Japan?

The European Sovereign debt situation – adilemma

PwC 15

Source: Matt, The telegraph, www.thetelegraph.co.uk

Identifying the other topthreats to LuxembourgBanks

Thierry López, Partner, RiskManagement Services LeaderManagement Services Leader

Agenda for today

Top 10 banking risks in Luxembourg& in the worldThierry López, Partner, Risk Management Leader

2010 2012

Political interference 1 Macro-eco environment

Capital availability 2 Profitability

Dependence on technology 3 Regulation

Liquidity 4 Credit risk

Top 10 risks for Luxembourg bankers

Liquidity 4 Credit risk

Too much regulation 5 Capital availability

Credit risk 6 Political interference

Risk management quality 7 Liquidity

Corporategovernance

8 Restructuring and changemanagement

Environmental risk 9 Corporate governance

Macro-economic trends 10 Derivatives

Top 10 risks for world bankers

Top risks for Luxembourg bankers

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the correct size, colour andlocation of the text, it isrecommended that you select.Overtype this placeholder text.Macro-economicenvironment

the correct size, colour andlocation of the text, it isrecommended that you select.Overtype this placeholder text.Profitability

Profit expectations ought to be revised

Higher capital requirements

Greater regulatory and“Every aspect of

#2 Profitability

Greater regulatory andcompliance costs

Curbs on banking activities

Political pressure to holddown prices

“Every aspect ofthe P&L is underpressure”

the correct size, colour andlocation of the text, it isrecommended that you select.Overtype this placeholder text.Regulation

Basel III - Only one aspect of the bankingsector supervision reinforcement

The wider Basel III framework

OTC derivatives markets(EMIR)

Accounting topics(IAS 39)

#3 Regulation

PricewaterhouseCoopers LLP

The “pure” Basel III framework:

Capital definition, requirements & new buffersLeverage ratioLiquidity ratios

Higher capital requirements forsystemic banks

Bank recovery & resolutionregime

The new elements in details

Areas Main Basel III Components

Capital Ratios and Targets Capital Definition

Minimum Capital Standards

Counterparty Credit Risk ( CVA / CCPs )

#3 Regulation

Leverage Ratio New Leverage Ratio

Liquidity Standards Liquidity Coverage Ratio

Net Stable Funding Ratio

Monitoring Tools

More Capital

More Liquidity

Transformation ofbusiness models, processes &

risk management practices

The solvency ratio is under strong pressure:

The eligible own funds (‘capital’) is subject to harmoniseddeductions

Adjusted own funds

The Solvency Ratio under Basel II and III

#3 Regulation

The capital requirements are increased in particular for OTCderivatives

The minimum ratios to meet are higher and become dynamic

Adjusted own fundsRatio = ------------------------------- 8%

12.5 x Capital requirements

Basel II

10.5%..13%

Basel III

the correct size, colour andlocation of the text, it isrecommended that you select.Overtype this placeholder text.Credit risk

The risk of default is increasing

• Sovereign debt is by far thebiggest concern

“Can the global

#4 Credit risk

• Consumer debt is a growingconcern, even in emergingeconomies (Turkey, China)

• In Luxembourg, households’debtload is increasing

“Can the globalbanking systemabsorb all thelikely losses?”

the correct size, colour andlocation of the text, it isrecommended that you select.Overtype this placeholder text.Capitalavailability

All entities are fighting for capital that is hard to get hold of, be it onthe financial markets or even inside a same group

Focus on Common Equity– Core Equity Tier 1 ratio

as the key ratio

The fight for capital

#5 Capital availability

as the key ratio

Harmonised regulatoryadjustments (deductions)

to be made fromCommon Equity Tier 1

Business is restrainedthrough the leverage ratio

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Dealing with political interference

• A worrying development formost respondents from the UK,Switzerland, Luxembourg, theNetherlands, Central Europe, the “Further political

#6 Political interference

Netherlands, Central Europe, theUS, China, South Africa andAustralasia

• A necessary step to reformbanks and restore public confidencefor others

“Further politicalinterference is acertainty”

the correct size, colour andlocation of the text, it isrecommended that you select.Overtype this placeholder text.Liquidity

Ratios & metrics under Basel IIIBasel III introduces two ratios and five monitoring metrics which aimto create a more resilient liquidity structure

LCRStock of high quality liquid assets

Total net cash outflows over the next 30 calendar days> 100%

#7 Liquidity

Monitoringmetrics

• Contractual maturity mismatch

• Concentration of funding

• Available unencumbered assets

• LCR by significant currency

• Market-related monitoring tools

Available amount of stable funding

Required amount of stable founding> 100%

Global progress in transposing Basel IIIBasel III rules are defined by the Basel Committee, which hasrepresentatives from the G20 but does not have any legal powers,thus it will be implemented differently across jurisdictions

#7 Liquidity

Not considered in report

Draft regulation not published

Draft regulation published

Final rule published

Final rule in force

Source: BCBS progress report on Basel III implementation, October 201136

Impact assessment of new liquidity ruleson Luxembourgish banks

Compliance of sample with LCR and NSFR requirements

#7 Liquidity

PwCSource: BCL and CSSF, Impact assessment as at Q2/201137

Distribution of banks by LCR results

#7 Liquidity

Shortfall in highly liquid assets in LCR

#7 Liquidity

Stock of highly liquid assets in LCR by business model

#7 Liquidity

Distribution of banks by NSFR results

#7 Liquidity

NSFR composition by bank size

#7 Liquidity

the correct size, colour andlocation of the text, it isrecommended that you select.Overtype this placeholder text.Restructuringand changemanagement

Change is a necessity

THE OLD WORLD - UBIQUITY THE NEW REALITY - PRECISION

GROWTH AT ANY COST

Banks were measured and rewarded performance on short-term gains rather than longer term value creation

STEWARDSHIP

A longer term view on value creation will be needed, withincentives designed to reward sustainable behaviours which

drive long term stakeholder value

OECD SUPREMACY MULTI-POLAR WORLD

#8 Restructuring and change management

OECD SUPREMACY

OECD banks and financial centers dominate globally with alarge pool of experience professionals, apparently stable

regulation and an attractive business environment

MULTI-POLAR WORLD

Emerging market banks and financial centres will grow in scaleand credibility, challenging and ultimately outgrowing their

established counterparts

INHERENT COMPLEXITY

The size of banks, geographic spread and range of productsadded complexity that made it difficult for management to fully

understand and manage risk

INDIVIDUAL AND COLLECTIVE RESILIENCE

An imperative to prevent contagion to the wider bank oreconomy will mean that operating model resilience

OVERARCHING FOCUS ON ROE

Focus on the single metric (ROE) above all else

CONSTRAINED OPTIMISATION

Optimise against multiple liquidity and capital constraints

the correct size, colour andlocation of the text, it isrecommended that you select.Overtype this placeholder text.Corporategovernance

Improving corporate governance

“Much is being done toimprove and reinforcethis at board level.

But of course the

“Without cleargovernance at boardlevel, boundaries may

#9 Corporate governance

But of course thecomplexity of matrixmanagement andoutsourcing in manylarge organisations ismaking this moredifficult.”

level, boundaries maybe crossed very soonand open the door tojust about anything.”

the correct size, colour andlocation of the text, it isrecommended that you select.Overtype this placeholder text.Derivatives

EMIR (European Market Infrastructure Regulation)objectives

OTCderivative trade

Reduce operational risk – Central Counterparty (CCP) and trade repository

#10 Derivatives

OTC flows

TradeRepository

ClientClientCounter

PartyCounter

CCPCCPTrade

Clearing

Information

Some OTC will mandatorily have to go throughCCPs and those that are not CCP-cleared will leadto extra CVA capital requirements

Strategic &operationalimpacts for banks:

Questions and answers

Conclusions

François Génaux, Partner, AdvisoryMarkets and Financial ServicesMarkets and Financial ServicesLeader

Thank you for your attention

Rima Adas François Génaux

Partner Partner

rima.adas@lu.pwc.com françois.genaux@lu.pwc.com

© 2012 PricewaterhouseCoopers S.à r.l. (Luxembourg). All rights reserved. In this document,“PwC” refers to PricewaterhouseCoopers S.à r.l. (Luxembourg) which is a member firm ofPricewaterhouseCoopers International Limited, each member firm of which is a separate legalentity.

Thierry López Johannes Göldner

Partner Senior Advisor

thierry.lopez@lu.pwc.com johannes.goldner@lu.pwc.com

Identifying top threats to Luxembourg Banks - PwC · Basel III rules are defined by the Basel...

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