Basel III New Liquidity Standards and Central Bank of Egypt Applied Regulations

Mai 2013, All rights reserved.

Basel III new liquidity standards and Central Bank of

Egypt applied regulations

Submitted to: Dr. Ahmed Bahaa

Submitted by: Mai Ashmawy

ESLSCA 38A

Submitted for fulfillment of the final research project

Master of International Business Administration (MIBA)

July 13

Running head: BASEL III & CBE LIQUIDITY STANDARDS i


Acknowledgement

After my gratitude to Allah, I would like to express my appreciation to my professor, Dr. Ahmed

Bahaa, who added a lot to my knowledge and experience through this course and all other

courses I attended with him.

And I also thank my family for supporting me all the way during the completion of the research

and my MBA study.

Finally Id like to thank my work team at NBAD who always help and assist me in going on

during the tough road of gaining experience.

Without all of them Id have achieved nothing.

BASEL III & CBE LIQUIDITY STANDARDS ii


Abstract

The research provides an overview of the Basel III which was issued by the Basel Committee on

Banking Supervision, which change the capital, liquidity and leverage rules for

international banks and it explores the liquidity requirements of Basel III comparing it with the

liquidity rules currently applied in Egypt under Central Bank of Egypt regulations and

instructions.

BASEL III & CBE LIQUIDITY STANDARDS iii


List of acronyms

ABCP: Asset Backed Commercial Paper

ABS: Asset Backed Securities

ALCO: Asset-Liability Committee

BCBS: Basel Committee on Banking Supervision

BIS: Bank for International Settlements

CBE: Central Bank of Egypt

GHOS: Group of Central Bank Governors and Heads of Supervision

HQLA: High Quality Liquid Asset

LCR: Liquidity Coverage Ratio

NSFR: Net Stable Funding Ratio

PSE: Public Sector Entity

RMBS: Residential Mortgage Backed Securities

SIV: Structured Investment Vehicle

SPV: Special Purpose Vehicle

BASEL III & CBE LIQUIDITY STANDARDS iv


List of figures

BASEL III & CBE LIQUIDITY STANDARDS v


List of tables

Table 1: Basel III Phase-in Arrangements

Table 2: LCR minimum requirements

Table 3: Comparison between old and new Liquidity ratio in Egypt

BASEL III & CBE LIQUIDITY STANDARDS vi


Table of contents

Acknowledgement ...................................................................................................................... i

Abstract ..................................................................................................................................... ii

List of acronyms ....................................................................................................................... iii

List of figures ............................................................................................................................ iv

List of tables ...............................................................................................................................v

Table of contents ....................................................................................................................... vi

Chapter one: Introduction ............................................................................................................1

1.1. Problem statement .....................................................................................................2

1.2. Importance of study ...................................................................................................2

1.3. Research questions ....................................................................................................2

Chapter two: Basel Committee on Banking Supervision & Basel III standards ............................3

2.1. Basel Committee on Banking Supervision .................................................................4

2.2. Basel II ......................................................................................................................5

2.3. Financial crises & Basel III introduction ....................................................................6

2.3.1. Basel II amendment ...............................................................................................6

2.3.2. New liquidity standards..........................................................................................8

Chapter three: Central Bank of Egypt current practice ............................................................... 11

BASEL III & CBE LIQUIDITY STANDARDS vii


3.1. Liquidity ratios in Egyptian banking sector .............................................................. 12

Chapter four: Applying Basel III new standards in Egypt .......................................................... 15

4.1. Basel III impact on the banking sector generally ...................................................... 16

4.2. Applying Basel III standards in Egypt ..................................................................... 16

Chapter five: Conclusion and recommendations ........................................................................ 18

5.1. Conclusion ................................................................................................................... 19

5.2. Recommendations ........................................................................................................ 19

References ................................................................................................................................ 20

Appendix 1. Illustrative summary of LCR ................................................................................. 22

BASEL III & CBE LIQUIDITY STANDARDS 1


Chapter one: Introduction



1.1. Problem statement

Banking sector is essential for nowadays economy and the continuity of nations

prosperity, which forces the need of a base ground rules to act according to, in order to

ensure homogeneity in the global financial system & that leads us to the purpose of

establishing Basel Committee for Banking Supervision, to unify rules in banking sector

but we need to go through the Basel rules implementation in Egypt and obstacles facing

this step.

1.2. Importance of study

This study aims to define the differences between the Basel rules and the ones currently

applied in Egypt by the CBE & the impact of the Basel III which will be implemented in

2015 on the banking sector globally.

1.3. Research questions

What are Basel III new standards?

What are the differences between Basel III rules and currently applied rules in Egypt?

What is the impact of Basel III on the banking sector?



Chapter two: Basel Committee on

Banking Supervision & Basel III

standards



2.1. Basel Committee on Banking Supervision

With reference to http://www.bis.org In 1930 the BIS was established and currently it

represents the oldest international financial institution in the world, the main aim for it

was taking over the functions of collection, administration and distribution of annuities

payable which were performed before by Agent General for reparation.

After the World War II, the BIS main role was the implementation of Bretton Woodss

system, and then it focused on managing cross- border capital flows, followed by the

need for regulatory supervision of active banks globally, which was done through more

than committee: Committee on the Global Financial System, Committee on Payment and

Settlement Systems, Markets Committee, Central Bank Governance Forum, Irving Fisher

Committee on Central Bank Statistics and Basel Committee on Banking Supervision

(Emerged Basel Capital Accord in 1988 then Basel II in 2005), it currently headed by

Stefan Ingves, Governor of Sweden central bank.

BCBS mainly works through data exchange regarding supervisory issues in order to

create a common understanding developing supervisory standards.



2.2. Basel II

Basel II was created with the purpose of defining regulations of how much any bank

needs to hold to protect itself from operational and financial risks,

And since the greater the risk, the greater the reserve amount needed, The Basel II framework

has three-pillars to concentrate on which were segregated by Driga (2007) as follows:

1. Pillar I: Minimum capital requirements calculated for three components of risk.

Credit risk: This can be calculated by one of three approaches,

Standardized Approach.

Foundation Internal Rating-Based Approach.

Advanced Internal Rating-Based Approach.

Operational risk: according to Guegan & Hassani (2013) its defined as the risk

of loss resulting from inadequate or failed internal processes, people and systems

or from external events, Which can be calculated by one of three approaches,

Basic Indicator Approach (BIA).

Standardized Approach (STA).

Advanced Measurement Approach (AMA).

Market risk: This is preferred to be calculated by the Value at Risk Approach

(VAR).

Total Capital

Credit risk + Operational Risk + Market risk = Capital adequacy ratio (minimum 8%)



2. Pillar II: Supervision process, dealing with national and regional regulators.

It aims to facilitate the best tools for regulators to manage banks performance

and enables them to deal with residual risk (such as systemic risk, liquidity risk,

reputational risk, etc).

3. Pillar III: Market discipline.

It aims to set disclosure requirements allowing all market participants to evaluate

the capital adequacy of a bank.

2.3. Financial crises & Basel III introduction

2.3.1. Basel II amendment

In response to Sub-prime Mortgage Crisis and resulting from Global Financial Crisis that

hit the world in late-2007, members of Basel Committee agreed in 2010-11 to introduce

new capital requirements and risk management measures, addressing liquidity risk,

capital adequacy and stress testing within the time frame as illustrated in table 1.



Table 1



2.3.2. New liquidity standards

The Basel III introduces two liquidity ratios one to cover the short term liquidity and the

other one covering the medium to long term liquidity according to (Gromova-Schneide &

Niziolek, 2011). It will improve the banking sector's ability to absorb shocks arising from

financial and economic stress, whatever the source, thus reducing the risk of spillover

from the financial sector to the real economy.

First: Short term liquidity coverage ratio (LCR) it requires each bank to maintain

sufficient high quality liquid assets which covers its total cash outflows during the period

of 30 days components of LCR ratio are illustrated in Appendix 1.

LCR = High quality liquid assets

Net cash outflows over 30 days 100%

A) High-quality assets will be a combination of two types of assets: Level 1 and

Level 2 assets.

Where Level 1 assets are included without limit {Cash, central bank reserves, and

(if they are assigned a zero percent under the Basel II Standardized Approach to

credit risk) marketable securities representing claims on or guaranteed by

sovereigns and multi-national quasi governmental organizations} noting that these

assets can create an unlimited value of total liquid assets as they are measured at

full.



And Level 2 assets are restricted to 40 percent of the total high-quality assets.

This type is subject to a minimum 15 percent haircut, and are limited to high

grade, plain vanilla non-financial corporate bonds, covered bonds (i.e., bonds

issued by a bank and subject to special supervision designed to protect bond

holders), and marketable securities representing claims on or guaranteed by

sovereigns and multi-national quasi-governmental organizations that are assigned

a 20 percent risk-weight under the Basel II Standardized Approach for credit risk.

(Gomes & Khan, 2011)

B) The net cash outflows over 30 days will be total expected cash outflows minus

total expected cash inflows over a 30 day period. , (Lyons & Casey, 2011)

Total expected cash outflows are to be calculated by multiplying the outstanding

balances of various categories of liabilities and off-balance sheet commitments by

the rates at which they are expected to run off or be drawn down. Total expected

cash inflows are calculated by multiplying the outstanding balances of various

categories of contractual receivables by the rates at which they are expected to

flow in under the scenario up to an aggregate cap of 75% of total expected cash

outflows.

2015 2016 2017 2018 2019

Minimum LCR requirement 60% 70% 80% 90% 100%

Table 2

LCR will be implemented on gradual phases from 2015 to 2019 as shown on table

2.



Worth mentioning that GHOS agreed that, during periods of stress it would be

entirely appropriate for banks to use their stock of high quality liquid assets,

thereby falling below the minimum.

Second: Medium to long term net stable funding ratio (NSFR) goes after calculating the

proportion of long term assets funded by long term stable funding where its minimum

requirements will be introduced by 2108

NSFR = Available stable funding

Required stable funding (Weighted long term assets)

A) Stable funding includes: customer deposits, long-term wholesale funding (from

the Interbank lending market), and equity and excludes short-term wholesale

funding.

Available Stable Funding equals a banks stock of regulatory capital (both Tier 1

and Tier 2), after deductions, together with certain additional assets subject to

haircuts, It will also include preferred stock not included in Tier 2 if it has an

effective remaining maturity of one year or greater.

B) Required stable funding includes: 100% of loans longer than one year, 85% of

loans to retail clients with a remaining life shorter than one year, 50% of loans to

corporate clients with a remaining life shorter than one year, 20% of government

and corporate bonds and off-balance sheet categories.



Chapter three: Central Bank of

Egypt current practice



3.1. Liquidity ratios in Egyptian banking sector

CBE customized and adapted the usage of a monitoring system for liquidity management

in the light of the recommendations of the Basel Committee and they circulated

regulations in 2005 that each bank must maintain a policy for liquidity approved from its

board of directors.

The Asset Liability Management (ALM) is part of a comprehensive risk management

system in banks. It involves considering all assets and liabilities simultaneously on a

continuous basis in order to ensure an appropriate balance between the mobilization of

funds and their deployment with respect to their features a) Maturity, b) Cost, c) Yield, d)

Exposure to risks, etc. This includes product pricing on deposits as well as advances, and

the desired maturity of assets and liabilities.

This system was named Maturity Ladder" that has been assigned to identify any gaps

resulting from the lack of consistency maturities of assets and liabilities. It identifies

maturity gaps and ways of funding, Noting that most of the international banks use the

Maturity Ladder policy which includes expected cash in/outflow over a certain period of

time as segregated below in order to facilitate the calculation of the shortage or surplus in

each period to take the necessary action accordingly.

Next day, Less than a week. More than a week up to one month, More than a

month up to three months, More than three months up to six months, More than

six months up to one year, More than one year up to five years and More than five

years.



And the main important elements to be included in such policy are: the relative

importance of each component of inflows to the total bank obligations, matching the

Assets / Liabilities tenor in order to avoid any gaps and an emergency plan (Liquidity

Stress testing) approved by ALCO to be implemented in stress situations by preparing

different scenarios to be executed in case of shortage of liquidity to meet obligation in

case of emergency such as rush deposits withdrawals beyond the normal expectations and

this plan must include actions to be taken in each phase of the emergency according to its

severity and define the following:

i. The minimum liquid assets to be maintained to face such case.

ii. The bank ability to get more liquid assets from the local market through:

Arrangements with other banks to set limits for depositing (withdrawing) and the

possibility to liquidate a portion of the banks portfolio.

Each bank must maintain a liquidity buffer which is to be used in the unfavorable

conditions or an emergency such as loss or impairment of certain sources of funding

secured and unsecured.

The bank must take into account the cost of liquidity, benefits, risk pricing, performance

and efficiency as well as the approval procedures for new products for the bank's main

activities so that it can link between the size of the risks arising from the bank's various

activities and size of the liquidity risk for the bank as a whole.



As mentioned in Banking Sector Analysis Unified Banking Law (Guide of Regulations)

the minimum Liquidity Ratio set by CBE is 20% for local currency and 25% for foreign

currency and it can be calculated through the below equation:

Current Liquidity Ratio = Liquid Assets

Current Liabilities

A) Liquid Assets: Cash & due from central bank, treasury bills, tradable

governmental notes, bonds issued by local banks, securities issued by the

Egyptian company for mortgage refinancing, discounted commercial papers and

due from banks.

B) Current Liabilities: Due cheques, due to local banks, due to foreign banks,

customer deposits and 50% of the uncovered portion of letters of guarantee.



Chapter four: Applying Basel III new

standards in Egypt



4.1. Basel III impact on the banking sector generally

Mainly the new standards will cause changes in the relative pricing of banking products

and it will be more difficult as borrowing costs are more likely will increase since banks

will increase their capital ratio by reducing lending.

Although these changes will make banking transactions more expensive, it will make the

banking sector more stable.

On a large scale banks will have to decrease or even eliminate the activities that increase

the weight of the net cash outflow such as funds raised under ABS and ABCP programs

and committed credit and liquidity facilities provided to non-financial corporates,

sovereigns and central banks.

4.2. Applying Basel III standards in Egypt

In our case the type of research will be an applied descriptive research which are usually

carried out to solve specific, practical question as the aim of this research is to describe

the impact of the new liquidity standards in the banking sector in Egypt, the inquiry mode

will be unstructured approach as we are conducting a qualitative research.

The sample frame:

Licensed banking sector in Egypt: 40 bank as per (Banks Registered with the

Central Bank of Egypt).



The sample size: Four banks selected randomly (And it must include both local

and foreign banks to insure diversification in the sample)

Local banks: National Bank of Egypt and Banque Misr.

Foreign banks: HSBC and National Bank of Abu Dhabi.

The below table to be fulfilled to perform a comparison between the liquidity ratio before

and after the new standards.

Bank Current liquidity ratio Basel III liquidity ratio

National Bank of Egypt

Banque Misr

HSBC

National Bank of Abu Dhabi

Table 3



Chapter five: Conclusion and

recommendations



5.1. Conclusion

5.2. Recommendations



References

Banks Registered with the Central Bank of Egypt. (n.d.). Retrieved from CBE Web Site:

http://cbe.org.eg/NR/rdonlyres/2E863212-7A1D-40D3-B8D1-

CE6ED3C21A15/1903/LicensedBanks2142013E.pdf

Basel III: A New Environment for International Banks. (2011). Venulex Legal Summaries. , 1-14.

Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools. (n.d.). Retrieved from BIS

Web Site: http://www.bis.org/publ/bcbs238.pdf

BIS. (n.d.). Retrieved from BIS Web site: http://www.bis.org/

Central Bank of Egypt. (n.d.). Retrieved from Central Bank of Egypt Web site: http://cbe.org.eg

Driga, I. (2007). THE NEW BASEL CAPITAL ACCORD - AN INTERNATIONAL CONVERGENCE

OF CAPITAL MEASUREMENTS AND CAPITAL STANDARDS IN BANKING. Annals of the

University of Petrosani Economics , 129-132.

Gomes, T., & Khan, N. (2011). Strengthening Bank Management of Liquidity Risk: The Basel III

Liquidiy Standards. Financial System Review Bank of Canada , 35-42.

Gromova-Schneide, A., & Niziolek, C. (2011). The Road to Basel III -- Quantitative Impact Study, the

Basel III Framework and Implementation in the EU. Financial Stability Report (Oesterreichische

Nationalbank) , 58-61.

Guegan, D., & Hassani, B. K. (2013). Operational risk: A Basel II + + step before Basel III. Journal Of

Risk Management In Financial Institutions , 3753.



Guide of Regulations. (n.d.). Retrieved from CBE Web site:

http://www.cbe.org.eg/NR/rdonlyres/65CC5117-9954-4E6A-8AE0-D06493B91B8F/596/Book.pdf

Lyons, G., & Casey, C. (2011). Basel IIIAn Initial Piece of the Global Puzzle. Banking & Financial

Services Policy Report , 21-30.



Appendix 1. Illustrative summary of LCR

Basel III New Liquidity Standards and Central Bank of Egypt Applied Regulations

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