Basel III – A Global (IMF) PerspectiveVanessa Le Leslé

Role of Deposit Insurance in Bank Resolution Framework – Lessons from the Financial Crisis

November 13-16, 2011 JODHPUR, INDIA

The views expressed in this presentation are my own and do not necessarily reflect those of the International Monetary Fund

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Contents

1. Basel III – A brief overview of the state of play

Where do we stand?a) Objectivesb) Overview of select regulationsc) State of progress

What remains to be done?a) Focus on one example – Revisiting Risk-Weighted Assets

2. IMF contribution to the surveillance of the global financial sector

Overview of ways the IMF can contribute to global surveillance of the financial sector

Surveillance through Financial Sector Assessment Programs (FSAP)a) FSAPs – How do they work?b) FSAPs – Key takeaways

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The G 20 Reform Agenda The G20 Financial Regulation Reform Agenda

The Big Picture

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1a. An Overview of Basel III

Basel Headquarters, Switzerland

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What Basel III aims to do

What the problem was How Basel III aims to fix it

Some banks were allowed to meet capital adequacy ratios with very little loss absorbing common equity/retained earnings.

Common equity and Tier I portion increased; hybrid Tier I and Tier III dropped

Differences in capital definition and inadequate disclosure did not allow for comparison across institutions and countries.

Capital definition and permissible deductions better harmonized

Major on and off balance sheet risks were not captured. Risk capture of trading book exposures and capital for counter-party risks enhanced.

Banks took on excessive leverage not captured by the risk-weighted ratio. Supplementary leverage ratio introduced

Risk-sensitive capital requirements amplified procyclicality. Default statistics to be adjusted and made more ‘through the cycle’

Some banks continued to pay out dividends as usual even with depleted capital levels.

Banks to hold capital conservation buffers which must be rebuilt before loosening constraints on distribution

Latent weaknesses in asset quality and other risks may increase in the upturn and be amplified as losses in the downturn.

Countercyclical capital buffers to be built up in good times and drawn down in bad times.

Short-sighted accounting standards led to low provisioning in good times and belated loss recognition in bad times

More forward-looking provisions in the upturn

Interconnectedness of large financial firms caused their credit quality to deteriorate in tandem.

Banks to hold more capital for their exposures to large (above $100 billion in assets) regulated financial firms and to other unregulated leveraged entities

Funding liquidity evaporated suddenly in stressed periods Banks to hold high quality unencumbered liquid assets to meet the net outflow of liquidity over a 30 day period of a common stress scenario

….and exacerbated asset-liability mismatches run by banks dependent on wholesale funding models

Banks to match their sources of available liquidity with that required by their asset profile over a one year time horizon

Regulations Key features Progress

Capital Standards Higher quantity and quality capital (more robust definition of capital, including deductions)Capital Conservation Buffer in addition to minimum capital requirementsEnhanced loss-absorption clauses for non-equity capitalEnhanced market risk (including securitizations) and counterparty credit riskReview consistency of RWAs

Addressing systemic risk and reducing pro-cyclicality

Capital Surcharge for Global SIFIsCountercyclical Capital Buffer to protect banking system against excessive credit growthIntroduction of a Leverage Ratio

Liquidity Standards Liquidity Coverage Ratio (liquid assets to survive an acute 30 days liquidity stress scenario)Net Stable Funding Ratio (greater resilience of funding through better matching of assets and liabilities)Regulation of money market funds

Dealing with non-banks Expansion of the regulatory perimeter (applying bank-like rules to some non-banks)Tightening of derivatives regulations (Standardized trades move to CCP / increased transparency and disclosure)Tougher regulation of Credit Rating Agencies and greater oversight

Accounting changes Tightening standards for off-balance sheet itemsConvergence of IASB and US GAAPFair Value measurement and Hedge Accounting

Structural changes and limitation of activities

Resolution and Recovery Plans (Living Wills)Volcker rule in the US; limitations on derivatives dealing by banksVickers Commission (ICB) in the UK

Compensation &Taxes

Align better risks, compensation and governance (bonus claw-back and non-cash; capital conservation…)Bank levy

Resolution regime National rules (e.g. US, UK, Germany, …) and regional rules (e.g. European framework for bank resolution)Address cross-border banks

The crisis has prompted a broad regulatory overhaul, both domestic and international – Snapshot of select reforms

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Phase-in of capital requirements and capital buffers

4,5%

1,5%

2015

Tier 2

Additional Tier 1

Common Equity Tier 1

2016 2017 2018 2019

0,625%1,25%

1,875% 2,5%

2020

4,5%

2%

4,5%4,5%4,5%

1,5%1,5%1,5%

2%2%2%2%

2,5%1,875%

Countercyclical Buffer(if applicable;

CET1/possibly AT1)

1,25%1,25%

0,625%

1,5%

Capital Conservation Buffer

(CET1 only)

4%

8%

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Future capital structure – what it could look like

Minimum Capital Requirement

Common Equity Capital

Min. CET1 4.5%

Non-Core Tier 1 Capital1.5%

Tier 2 Capital2.0%

Total Capital 8.0%

Pillar 1 Requirement

Capital Conservation

Buffer2.5%

SIFI Buffer1-3.5%

Total Capital , with buffers11.5% - 13.0%

Basel III Standard Buffers

National Buffers

Pillar 1 Requirement

+ Standard Buffers

Counter-

Cyclical Buffer0-2.5%

Domestic Surcharge0 X 3.0%?≦ ≧Total Capital Up to 19% or 20%, with

Additional domestic buffers

Core Tier 1 Capital

Additional Tier 1 Capital

High Trigger CoCos

Tier 2 Capital

8.0%

12.0%

1.5%+

2.0%+

Potential Capital Structure including all Buffers

0 X 3%?≦ ≧

Core Tier 1 Capital

Primary Loss Absorbing

Capital

10%

7 X ≦ ≧10%?

A country example:United Kingdom

Total Tier 1: 6.0%

20%

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Liquidity Coverage Ratio and Net Stable Funding Ratio

Liquidity risk: the new metrics

Stock of High Quality Liquid Assets

Net Cash Outflows over a 30-day time period under stress

> 100%Available Amount of Stable Funding

Required Amount of Stable Funding> 100%

LCR: short-term - to ensure that a bank maintains an adequate level of unencumbered, high quality assets that can be converted into cash to

meet its liquidity needs for a 30-day time horizon under an acute liquidity

stress scenario.

NSFR: medium to long-term - a full balance-sheet metric that compares, under more prolonged but less acute stress than in the LCR, an estimate of

reliable funding sources to an estimate of required stable funding

over the 1 year horizon.

Two complementary metrics with different time horizons

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Leverage Ratio – The backstop to supplement risk-based capital

Capital to total on and off balance sheet assets

Simple, transparent, non-risk based measure

Progress of Work and Work in Progress – Some unfinished business

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1b. What remains to be done?

A stylized example Revisiting Risk-Weighted Assets

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Revisiting RWAs – Why does it matter?

What are the key concerns with regard to the banks’ risk-weighted assets (RWAs)? The opacity and complexity of internal models used by banks to compute RWAs have led

to questions about consistency and comparability of risk-weighted capital ratios across banks and jurisdictions

This also raises concerns about the adequacy of capital held by banks, even where the reported ratios look good and led to complaints of manipulation and an unlevel playing field

Addressing these concerns is important, given the critical focus of markets and the authorities globally on reported capital ratios

Key Takeaways: There are some important differences across jurisdictions in the calculation of RWAs that

need to be kept in mind when making cross country comparisons These differences are driven by a range of factors including the regulatory framework;

the accounting standards, business model and location in the business cycle The Basel Committee plans to assess the RWA practices across its membership to reduce

inconsistencies in (i) RWA measurement by banks and (ii) in supervisory practices In addition, this should be supplemented by (i) More intrusive supervision (ii) Better

bank risk management and (iii) Improved disclosure

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The Transatlantic debate

Ranking of banks by Core Tier 1 Ratio (percent) Ranking of banks by Leverage Ratio (TCE/Tangible Assets) (percent)

Source: Bloomberg; Company data – Legend: North America (red) / Asia (yellow) / Europe (blue)

The ranking of 44 Systemically Important Banks (SIB) based on Core Tier 1 Ratios (capital over risk-weighted assets (RWA)) shows no clear geographical pattern. However, the ranking based on Leverage Ratio (capital over un-weighted assets) seems to suggest that the US and Asian banks are better capitalized than European banks. In other words, the RWA/TA ratios of European banks tend to be lower than those of US and Asian banks. Are these differences justified?

0 5 10 15 20

ANAAEUNAEUAANAAEUEUANAAEUEUAEUEUEUNAEUNANANAEUEUEUNAEUEUEUEUNAAAEUNAAAAANAEU

Global Average 10.3%

0 2 4 6 8 10

ANA

AAA

NAAA

NANA

ANA

ANAEUNA

ANAEUEU

AA

EUNA

AEUEU

ANAEUEUNAEUEUNA

AEUEUEUEUEUEUEUEUEU

Global Average 4.9%

US and Asian banks

European banks

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What explains the RWA/TA differences across banks?

country-specific factors and bank-specific factors

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Supervision – macro prudential surveillance in the BCP

BCBS is revising the 2006 Core Principles and the assessment methodology

• Review and update each Core Principle, taking into consideration the lessons learnt from the crisis, the post-crisis banking and regulatory landscape, as well as consequent impact on banking supervisory approach and practices

• Supervisory implications of international regulatory standards (such as Basel III) and various supervisory guidance issued by the BCBS and other standard setting bodies which have been introduced or enhanced since the last review of the Core Principles.

• Recommendations of the Senior Supervisors Group’s report on “Risk Management Lessons from the Global Banking Crisis of 2008”, the Financial Stability Board’s report on “Intensity and Effectiveness of SIFI Supervision” and relevant reports by other international bodies.

• Review experiences gained from the International Monetary Fund’s and World Bank’s assessments of countries’ compliance with the Core Principles

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2. Contribution of the IMF to the Surveillance of the Global Financial Sector

IMF Headquarters, United States of America

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How can the Fund help? Assist Member Countries

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Surveillance through FSAP: A risk-based approach

• Assess financial sector stability and, where relevant, development needs, by the IMF and World Bank, respectively

• Joint IMF/World Bank program in LICs and EMs; Fund-only in advanced economies• Stability and developmental assessments may be done together or in separate modules• May optionally include formal assessments of compliance with financial sector standards (ROSCs)• Since 2010, stability assessments a mandatory part of IMF surveillance every 5 years for 25

countries with systemically important financial sectors

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Overview of perimeter of application of FSAPs

Country Rank

Country Rank

UK 1 India 14

Germany 2 Ireland 15

United States 3 Hong Kong SAR 16

France 4 Brazil 17

Japan 5 Russia 18

Italy 6 Korea 19

Netherlands 7 Austria 20

Spain 8 Luxembourg 21

Canada 9 Sweden 22

Switzerland 10 Singapore 23

China 11 Turkey 24

Belgium 12 Mexico 25

Australia 13

25 jurisdictions which have a systemically important financial sector

Key components of a FSAP

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The FSAP and financial sector standards: what’s covered?

FSB “Key Standards for Sound Financial Systems”

Financial Regulation and Supervision

Macroeconomic Policy and Data Transparency

Institutional and Market Infrastructure

Banking (BCP) Insurance (IAIS) Securities (IOSCO)

Monetary and financial policy transparency (IMF) Fiscal policy transparency (IMF) Data dissemination (IMF)

Payments, clearing & settlement (CPSS/IOSCO) Crisis resolution & deposit insurance (BCBS/IADI) Market integrity (FATF) Corporate governance (OECD) Accounting & auditing (IASB/IAASB) Insolvency & Creditor Rights (World Bank/UN)

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FSAP - Common findings across sectors

• Progress in implementation over time though compliance weakened in some areas in recent assessments

• Independence and sufficiency of resources continue to one of the be greatest challenge

• Legislative frameworks still have gaps but the bigger challenge is monitoring, implementation and enforcement

• Risk management oversight needs improvement

• Consolidated supervision practices still weak / evolving

• Standards becoming more complex and assessments more challenging over time

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FSAP - Main deficiencies across sectors

Banking Supervision Insurance Supervision Securities Regulation

Consolidated Supervision Corporate Governance Operational Independence and Accountability

Country and Market Risk Supervisory Authority Regulatory oversight of SROs

Risk Management Process Group-wide Supervision Supervisory Powers, Resources and Capacity

Operational Independence, Accountability and Resources

Risk-assessment and Management

Effective use of inspection, enforcement and compliance

The need to strengthen supervisory independence, authority, resources and capacity emerges as common themes across jurisdictions.

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Questions ?