Presented by:

Peter Went, Ph.D., CFA

Senior Researcher

GARP Research Center

September 14, 2010

GARP Webcast

Basel III Proposals:An Overview

2Strengthen the Global Financial System by Raising Capital Requirements, Increasing

Capital Levels, Improving Risk Management Practices, and Expanding Disclosure

From Basel II to Basel III Changes, Improvements, and Proposals

July 13, 2009 Package

Enhancements to the Basel II framework, Enhancements

Revisions to the Basel II market risk framework, Market Risk Revisions (Adjustments of 18 June 2010, Adjustments)

Guidelines for computing capital for incremental risk in the trading book, IRC Guidelines

December, 17 2009 Proposals

Strengthening the resilience of the banking sector, Capital Proposals

International framework for liquidity risk measurement, standards and monitoring, Liquidity Proposals

July 16, 2010 Proposals

Countercyclical capital proposal, Countercyclical Capital

July 26, 2010 Agreement

Capital and liquidity agreements

August 18, 2010 Proposals

Proposal to ensure the loss absorbency of regulatory capital at the point of non-viability

3Higher Capital Requirements in the Banking Book, Increased Supervisory Review and

Guidance, and Broader Disclosure

Pillar 1 Minimum Capital Requirements strengthen capital requirements Risk weight of resecuritization exposures Credit Conversion Factor (CCF) for liquidity facilities More rigorous credit analysis of externally rated securitization exposures Prohibition to use ratings based on self-guarantees

Pillar 2 Supervisory Review improve risk management and capital planning processes Risk oversight, risk concentrations, off-balance-sheet exposures Stress testing practices Compensation practices Reputational risk

Pillar 3 Market Discipline additional disclosure Increase transparency for securitizations, off-balance-sheet exposures and trading Reduce uncertainties about the ability to trade in volatile markets

Enhancements to the Basel II Framework Enhancements

(July 2009)

4Increase Regulatory Capital Requirements for Various Types of Securitizations

Resecuritization Risk Weights Internal Ratings Based Approach (IRB) and Standardised Approach (SA)

Senior / non-senior / granularity

Ratings Subject to Self-guarantee SA and IRB No recognition of ratings that reflect guarantees or other support provided by the bank

Operational Requirements for Credit Analysis Perform own due diligence and not simply rely on rating agency ratings

Liquidity Facilities SA and IRB CCF for liquidity facilities in the securitization framework set at 50%, regardless of maturity Clarify certain types of senior securitization exposures

General Market Disruption Lines SA and IRB Eliminate favorable capital treatment afforded general market disruption liquidity lines

Enhancements Pillar 1

5Raise Risk Management Standards and Capital Planning Process through Additional

Guidelines and Regulatory Focus

Active board and senior management oversight should immediately improve firm-wide risk oversight

The Internal Capital Adequacy Assessment Process ICAAP Stress tests The ability of regulatory capital to absorb losses during stress Capital levels throughout the economic and credit cycle

Specific risk management topics of concern Risk concentrations Off-balance sheet exposures and securitization risk Reputational risk and implicit support Valuation practices Liquidity risk management Sound stress testing practices Sound compensation practices

Enhancements Pillar 2

6Strengthen the Regulatory Framework by Enhancing Transparency through

Increased Disclosure

Disclosure requirements for securitization and re-securitization exposures, including their valuation approaches

Sponsorship of off-balance sheet vehicles Qualitative disclosures all securitization activities which the bank sponsors

Internal Assessment Approach and liquidity facilities Disclose the approach determining capital requirements

Pipeline and warehousing risks of securitization exposures Information about future securitization activities, valuation, and exposure levels

Enhancements Pillar 3

7In the Trading Book Include Incremental Risk Capital Charge (IRC) and Stressed VaR (S-

VaR) to Incorporate the Effects of Default and Migration Risk, and Market Stress

Capital requirements harmonized between the banking and the trading book

IRC considers default and migration risk

S-VaR captures potential losses that during a crisis can exceed market risk capital requirements

3 - 4 times increase in capital requirements for market risk

Changes to the Standardized Approach Capture Key Risks

Specific risk capital charge Securitization and resecuritization exposures Correlation trading portfolio Uniformly 8% for equities irrespective of level of liquidity or diversification

Revisions to the Basel II Market Risk Framework Market Risk Revisions

(July 2009)

8Changes to the Internal Measurement Approach Further Refine Risk Measurement and

Capital Adequacy Models

Factors used in pricing but not VaR calculations must be justified

VaR must capture nonlinearities, correlation and basis risk

IRC charge for default and migration risks

Market risk capital requirement VaR based on the most recent 12-month observation period S-VaR based on a12-month period of financial stress

Market Risk Revisions Market Risk Capital Requirement

One-year VaR

One-year Market

Stress VaRIRC

Market Risk Capital

Requirement

9The Incremental Risk Charge Should Capture Default and Migration Risk

Unsecuritized credit products over a one-year capital horizon at a 99.9% confidence level

Liquidity horizon to sell or hedge a position in a stressed market 3-month minimum liquidity horizon Bucketing Concentration, credit quality and other factors

Correlations between default and migration events, and issuer and market concentrations

Effects of nonlinear price sensitivities

Guidelines

Guidelines for Computing Capital for Incremental Risk in the Trading Book

IRC Guidelines (July 2009)

10

The Objective Is to Strengthen Bank-level, or Micro-prudential, Regulation

Simplifying the structure of bank capital Going-concern and loss absorbing, contingent, capital

Expanding the risk coverage of the capital base Counterparty credit risk considerations

Leverage ratio emphasizes capital quality Harmonized accounting principles better assess risk exposure

Reducing the pro-cyclicality Counter-cyclical capital and credit buffers

Systemic risk and interconnectedness

Strengthening the Resilience of the Banking Sector Capital Proposals

(December 2009)

11

The New Capital Rules Simplify the Capital Structure and Emphasize the Role of Tangible

Common Book Equity

Tier 1 Going Concern Capital absorbs losses without the institution becoming insolvent Tangible common equity evolved as the chief indicator of capital strength Contingent capital Phase out hybrid instruments (step-up, cumulative preferred, and trust preferred) Minority interests in financial institutions

Tier 2 Gone Concern Capital absorbs losses in insolvency before depositors Eliminate the distinction between lower and upper tiers Introduce contingent capital to be converted into equity during a crisis to cover losses

Tier 3 capital abolished

Harmonizing and standardizing accounting, legal, and other considerations across jurisdictions

Leverage ratio

Capital Proposals Simplifying the Structure of Bank Capital

12

The Financial Crisis Exposed the Problems of Highly Interconnected International Banks

Capital requirements for counterparty credit risk using stressed inputs Derivatives, repo and securities financing activities Risk associated with deteriorating counterparty creditworthiness 99% VaR over a 10-day period captures the impact of extreme market events

Strengthen the Risk Management Practices of Counterparty Credit Exposures

Wrong-way risk as exposures increase when the credit quality of the counterparty deteriorates

Low risk weight of central counterparty exposures

Eliminate certain cliff effects associated with credit risk mitigation practices

Capital Proposals Expanding the Risk Coverage of the Capital Base

13

All Tier 1 and Tier 2 Capital Should be Able to Absorb Losses when a Trigger Event Occurs

Convert non-debt capital to equity capital at a trigger event Inject public sector capital, support or guarantee to ensure continuing viability Write-off or convert capital to maintain ongoing viability

The decision is within regulatory discretion

Trigger events have consolidated effects across the banking group

Capital Proposals Contingent Capital

14

The Countercyclical Capital Proposal Addresses Procyclicality

Dampen any excess cyclicality of the minimum capital requirement through forward looking provisions

Capital conservation buffer to absorb banking sector losses and limit profit distributions Countercyclical buffer balance excess credit growth

The Countercyclical Capital Buffers Gives Each Jurisdiction the Ability To Define the Size

of the Buffer

Regulators would announce increasing buffers with a12-month lead Banks can meet additional capital requirements before they take effect

The geographic location determine buffer add-ons at individual exposure level

Countercyclical Capital Buffer Proposal

(July 2010)

15

Increase in Regulatory Capital Requirements and Additional Capital Surcharges to be

Implemented Gradually by 2019 to 10.5%

Common equity in Tier 1 to increase from 2% to 4.5% Capital conservation buffer of 2.5% Countercylical buffer of 0 - 2.5% Total Tier 1 requirement increases to 8.5%

New Capital Standards

(September 2010)

16

The Leverage Ratio Requirement Strengthens

the Banking Sector

Constrain the build-up of leverage in the banking sector

Avoid destabilizing deleveraging processes

Reinforce the risk-based requirements with a simple, non-risk-based backstop

A Simple, Transparent, Independent Measure

of Risk Based On Gross Exposures

Calculated in a comparable manner across jurisdictions, and adjusted for differences in

accounting standards

Staring January 2011, disclosures in January 2015, and fully implemented by January 2018

Capital Proposals Leverage Ratio

(December 2009)

Exposure Capital

17

Harmonizing Various Off-Balance Sheet Items and Assets, and Linking with Tier 1 Capital

Credit conversion factors

Netting complemented with an assessment of the potential future exposure Converted to a loan equivalent amount Computed as the average over a quarter

Increased harmonization of accounting approaches

During the parallel run phase, 2013 2016, the Tier 1 leverage ratio is 3%

Capital Proposals Leverage Ratio

18

The Interconnectedness of Many Large Banks and other Financial Institutions Ease the

Transmission of Negative Shocks across the Financial System and the Economy

Indentify systemically important institutions Potential capital surcharge for these banks Liquidity surcharge Refinements to risk weighting functions

Increase asset value correlation by 25% for large, internationally interconnected bank-groups, with assets in excess of USD 100 billion

Capital Proposals Systemic Risk and Interconnectedness

19

New Liquidity Framework Involves Short-term and Longer-term Liquidity Ratios, which

Serve as the Regulatory Standards to Ensure that Banks Maintain Sufficient Liquidity Buffers, and Monitoring to Track Liquidity

International Framework for Liquidity Risk Measurement, Standards and

Monitoring Liquidity Proposals (December 2009)

Two liquidity risk metrics as regulatory standards

Underscore the importance of holding high quality liquid assets and the need for contingency planning for stress scenarios

A short-term (30-day) ratio Liquidity Coverage Ratio LCR

A longer-term (one-year) structural ratio Net Stable Funding Ratio NSFR

Four regulatory monitoring tools to track bank liquidity

Provide greater consistency in cross-border supervisory oversight, in liquidity management

Contractual Maturity Mismatch Funding Concentration Available Unencumbered Assets Market-Related Monitoring Tools

Creating a culture of

risk awareness.TM

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