Masaryk Universi ty
Facul ty o f Economics and Admin i s t ra t ion
Field of study: Financial Management
NORMATIVE STANDARDS AND RISKS
ANALYSIS FOR BANKS UNDER BASEL III
Diploma work
Thesis Supervisor: Author:
Ing. Dagmar LINNERTOVÁ, Ph.D. BA Ekaterina GOVERT
Brno, 2014
Abstract
This work aims to investigate the core principles and standards of the Basel III
regulations. The thesis is divided into theoretical and practical parts. This work starts
with a theoretical one, by giving an introduction to the topic and briefly highlighting the
history of Basel agreements. The main theoretical part is about the Basel III accord that
brings new regulations for banks after the crisis of 2008. For this, the document itself,
common literature and available internet sources were used. The practical part includes
analysis of a given single bank with following recommendation concerning the risks,
which is based on the findings of the theory.
Keywords
Basel III, Banks, Risks, Capital, Liquidity Risk, Capital Adequacy, Market risk.
Author’s Statement
I hereby declare that I worked out the Diploma work Normative standards and risks
analysis for banks under Basel III myself, under the supervision of Ing. Dagmar Linnertová,
and that I stated in it all the literary resources and other specialist sources used according
to legislation, internal regulations of Masaryk University and internal management acts
of Masaryk University and the Faculty of Economics and Administration
Brno, 23.12.2014
hand wr i t t e n s i g na t ur e o f the a u t ho r
Acknowledgments
This thesis would not have been done without help of many people.
I would like to express my gratitude to my supervisor Ing. Dagmar Linnertová, who
offered very valuable assistance and supervision, but at the same time allowing me to
work on my own.
I would also like to thank my friends for great encouragement.
Above all, I would like to thank my family for their unconditional support and care during
the whole my studies.
Content
INTRODUCTION ............................................................................................................................ - 7 -
1. BASEL III AND THE REASONS TO CREATE SUCH A FRAMEWORK ........................ - 9 -
1.1 BASEL III OBJECTIVES ................................................................................................................... - 10 -
1.2 THE HISTORY OF BASEL AGREEMENTS ........................................................................................ - 10 -
1.2.1 The Bank for International Settlements....................................................................... - 10 - 1.2.2 Committee on Banking Supervision of the BIS .......................................................... - 11 -
2 COMPARE ANALYSIS OF BASEL II AND BASEL III .................................................... - 25 -
3 NORMATIVE STANDARDS FOR BANKS ....................................................................... - 33 -
3.1 CAPITAL MANAGEMENT ................................................................................................................ - 33 -
3.1.1 Leverage ratio ......................................................................................................................... - 40 - 3.1.2 Liquidity ..................................................................................................................................... - 43 -
3.2 NEW REQUIREMENTS ON INFORMATION DISCLOSURE ............................................................... - 59 -
3.3 CONTROL OF SYSTEMICALLY IMPORTANT FINANCIAL INSTITUTIONS ....................................... - 59 -
3.4 FULL-ON RISK COVERAGE ............................................................................................................ - 61 -
4. RISKS ANALYSIS FOR BANKS ............................................................................................ - 67 -
CONCLUSION ............................................................................................................................... - 79 -
- 7 -
Introduction
Banks as financial institutions are dealing with a lot of risk. In this case risk management
is an important activity that helps banks to maintain adequate amounts of capital and
liquidity not to forget about the liabilities that stay within the limits. For the purpose to
guarantee that banks are still reliable institutions for customers and governments there
were created special regulations and standards that can be used globally.
The global economic crisis of 2008 has provided an opportunity for a core restructuring
of the approach to risk and regulation in the financial sector. The Basel Committee on
Banking Supervision (BCBS) has reached an agreement on the changes to strengthen
global capital and liquidity rules with the goal of promoting a more resilient banking
sector, which is being referred to as “Basel III.” This is the latest accord of several of them
- so-called Basel I and Basel II accords. In Basel III includes lot of restrictions that
strengthen bank capital requirements.
This topic is very actual nowadays, as the Basel committee on Banking Supervision is
implementing the new standards for bank regulation covering some specific issues. As it
is obligatory for banks to fulfill these international rules, and therefore it is very important
to realize what Basel III is, which matters it covers and which steps should banks take to
be able to act according to these new standards. And especially in economically uncertain
times, banks need to base their decisions on good and reliable research and tools, as even
minor mistakes or incorrect risk valuation can cause huge financial problems. In addition,
these extra restrictions under Basel III regulations leave banks in unease uncertainty if
they will be able to live up all the new regulations and in the same time to maximize the
profit. The reason why it is important to understand the new standards of the accord to
know the best ways for banks to perform with new rules implemented in their activity.
The objectives of the thesis
The outcome of this thesis will be an analysis of Basel III normative standards and
possible problems of implementation in the bank activities. In order to achieve that, the
thesis will be divided into two parts.
- 8 -
The theoretical part aims to explain the main idea of the Basel III regulations, the
historical insight of Basel’s agreements and the difference between previous Basel
documents and to provide knowledge about how banks have to change organization
process to fit the new standards. In the practical part I will study the problems of
implementation on the Basel III on the example of some banks.
The main research questions are:
1. What are new regulations for banks?
2. How can a bank implement Basel III regulations in its activity and what problems
it can face?
Methods of implementation
For this thesis primary and secondary data is used. Sources vary from books and articles
to official documents from institutions involved (mainly Bank for International
Settlements). Since the area of research is very wide and questionable, especially articles
from Basel III experts and financial experts are important to consider.
The prime document “Basel III: A global regulatory framework for more resilient banks
and banking systems” and additional documents on specific questions issued by Basel
Committee on Banking Supervision are used as the primary source. For obtaining data of
the banks the Internet sources were used.
Limitations
The biggest challenge while writing this thesis lies within the fast changing economic
reality (and in some cases political) which affects the implementation of the Basel III
regulations. Also the controversial opinions on Basel III make it difficult to make a clear
view on the regulations. Even some articles might not be relevant anymore, because of
economic situation is not stable. Also each section of Basel III accord deserves the detailed
study, so it was a challenge to get deep insight into this regulation.
- 9 -
1. Basel III and the reasons to create such a framework
The first chapter will serve as an introduction into the topic.
Basel III is a regulatory standard that is spread globally and concentrates on the capital
adequacy, market liquidity risk and stress testing of banks. It was created by the Basel
Committee on the Banking Supervision in 2010-2011 and permanently revised and
changed. The implementation of the Basel III began in 2013 and is supposed to be finish
in 2018-2019. The need for the development of such a regulation came as the response to
the unsuccessfulness of the previous regulation in preventing the financial crisis of 2008.
The idea of the Basel III is to strengthen and enhance the banking regulatory framework,
which were provided in the former Basel II agreement and also it introduces requirement
for regulations on bank liquidity and a leverage ratio to fix the uncontrolled banking
activity.
Basel III builds on the Basel I and Basel II documents, and seeks to improve the banking
sector's ability to deal with financial and economic stress, improve risk management and
strengthen the banks' transparency. The focus of Basel III is to foster greater resilience at
the individual bank level in order to reduce the risk of system wide shocks.
The main idea of these standards and guidelines (Basel I, Basel II and Basel III) is to reduce
the probability for banks to face insolvency. In order to do that banks face the necessity
of reserving more capital than they might want to because reserving the capital lead to
extra costs – stakeholders are willing to get the return on equity, and increasing the
amount of capital reserved leads to less money to be earned. From the other hand there
are demands from supervisory authorities who will make it more difficult to successfully
operate without following the standards and regulations. All these elements force banks
to find the balance between profitability, liquidity and solvency. In addition the unclear
and unstable economic period we face nowadays hits the banks to concerns of survival
then to make extra profit.
- 10 -
1.1 Basel III objectives
According to the BCBS, the Basel III proposal has two main objectives:
First: to strengthen global capital and liquidity regulations with the goal of promoting a
more resilient banking sector.
Second: to improve the banking sector's ability to absorb shocks arising from financial
and economic stress, which in turn, would reduce the risk of a spillover from the financial
sector to the real economy.
To achieve such aims, the Basel III sets three proposals, the main areas of them are:
Reformation of Capital (including quality and quantity of the capital, complete risk
coverage, leverage ratio and the introduction of capital conservation buffers, and a
counter-cyclical capital buffer).
The second block is Liquidity reform (short-term and long-term ratios).
And the third is connected with other elements ranging from general improvements to
the stability of the financial system.
I will describe the novation in Basel III in details in the following chapters.
1.2 The history of Basel agreements
The timeline of Basel accords will be provided in this section. It is necessary to obtain the
understanding how the Bank for International Settlements was created as the Basel
agreements are the work of this organization. Moreover the Basel’s timeline will
dramatically show how each next accord was improved in comparison to the earlier ones.
The timeline is also illustrated graphically below in the text. (Figure 2).
1.2.1 The Bank for International Settlements
To have a full insight of the whole “universe” of Basel agreements and who creates them,
we begin with providing the information about the Bank for International Settlements
- 11 -
(BIS). This is an organization that was established in 1930 and is not controlled by any
government.
BIS is the oldest international financial organization established on 17 May 1930, for the
purpose to regulate money transactions according to the Treaty of Versailles. The main
mission of the BIS is to serve central banks in their financial stability and to improve
international cooperation in the financial sphere. (1)
Also the Bank for International Settlements serves as a bank for central banks.
It is obvious now that the BIS is a very important organization for banks because of its
regulation of capital adequacy and it insists in transparency of reserves in order to create
and keep a financial safety net.
1.2.2 Committee on Banking Supervision of the BIS
The Basel Committee on Banking Supervision has its origins in the financial market
turmoil that followed the breakdown of the Bretton Woods system of managed exchange
rates in 1973. 1 This system collapsed and many banks faced large foreign currency losses,
especially after the bankruptcy of Herstatt Bank on 26 of June 1974. This bank was a
private bank with the headquarter in Cologne, which was one of the 40 largest German
banks according to asset value in the end of 1973. The president of the USA R. Nixon
officially cancelled dollar convertibility into gold, and with this renovation he put an end
to Bretton-Wood system of fixed exchange rates. After this decision the great speculative
activity arose in money market and Herstatt Bank was also participating in these
activities. The operations of the Head of the money market department was almost out of
any control and as the result his open foreign-currency position turned out to be 80 times
higher than the established standards in 1974. The wrong strategy leaded to a loss, and
German federal authority of banking supervision revoke the license of Herstatt Bank and
foreign currency positions were closed forcefully. These events tremendously affected the
1 Bretton Woods system is a set of multilateral agreements on international economic relations, negotiated at the UN Monetary and Financial Conference held in July 1944.
- 12 -
counterparties of the bank, as they had bought USA dollars from Herstatt Bank and paid
for them with the German currency but did not received the USD currency as it was the
end of the operating day. The next day all the positions of Herstadd Bank were closed
which leaded to the bankruptcy of other banks. (2)
In response to this and other disruptions in the international financial markets, the
central bank governors of G101 countries established a Committee on Banking
Regulations and Supervisory Practices at the end of 1974, later it was renamed as the
Basel Committee on Banking Supervision. The Committee was designed as a forum for
regular cooperation between its member countries on banking supervisory matters. Its
aim was and is to enhance financial stability by improving supervisory knowhow and the
quality of banking supervision worldwide.
According to the official information provided by Bank for International Settlements
after starting life as a G10 body, the Committee expanded its membership in 2009 and
again in 2014 and now includes 28 jurisdictions. The Committee now also reports an
oversight body, the Group of central Bank Governors and Heads of Supervision (GHOS),
which comprises central bank governors and (non-central bank) heads of supervision
from member countries. The member countries are the following: Argentina, Australia,
Belgium, Brazil, Canada, China, European Union, France, Germany, Hong Kong SAR,
India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, Russia, Saudi
Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, United Kingdom
and the United States.
Countries are represented on the Committee by their central bank and also by the
authority with formal responsibility for the prudential supervision of banking business
where this is not the central bank. (3)
The primary objective of the Committee is the implementation of the unitary standards in
bank regulations sphere. With this objective in view, Committee on Banking Supervision
1 In fact there were 12 of them: Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, Great Britain, the USA and Luxembourg.
- 13 -
develops the directives and recommendations for regulatory authorities of member-
states. This recommendations are not obligatory to fulfill, nevertheless, they are reflected
in the national legal system of the member-states. The directives and recommendation
development is performed with the banks and regulatory authorities cooperation world-
wide reasoning the implementation not only in the Committee member-states but in other
states as well. So even though it is said that the regulations shall not be subject to
compulsory implementation, in reality, banks and other financial institutions cannot fully
cooperate internationally if they have not implemented the standards and requirements.
In European Union it is obligatory to follow Basel’s regulations for mutual integration of
EU member-states.
For instance, the Basel II framework was implemented in more than 100 countries.
The Basel Committee on Banking Supervision reports to the presidents of central banks
and non-central bank heads of supervision on bank activity of top ten industry-developed
countries and actively cooperates with the non-member states.
The Basel Committee core documents are considered as following:
Basel Core Principles on Effective Banking Supervision;
Basel I (1988)
The core idea which pushed the committee to create such a regulation was the
understanding that the competition in the banking sector needs to have “one set of rules”
for everyone considering owner’s equity, otherwise banks while trying to get extra profit
are going to risk the long-term well-being and preserving the money of investors. (4)
In 1988 the Basel Committee on Banking Supervision completed the Basel Capital Accord
after years of deliberations that followed the Latin American sovereign defaults of 1982
and at the same time having minimum level of owner’s capital because of sharp
competition. Basel I became that first standard on base of which other regulations for
banking supervision were created. The Basel Accord was established with two
fundamental objectives: to strengthen the soundness and stability of the international
banking system and to obtain “a high degree of consistency in its application to banks in
- 14 -
different countries with a view to diminishing an existing source of competitive inequality
among international banks.” (5) To sum up the main idea, the regulation document
establish for the banks meet a minimum capital ratio of minimum of 8% of total risk-
weighted assets.
According to this document the bank capital for regulative purposes has to be subdivided
in to two categories – the first-level capital (Tier I) and the second-level capital (Tier II).
All assets of the bank are grouped in five categories according to the credit risk. Banks
with international presence were required to have capital equal to 8 percent of the risk-
weighted assets. The only exception to the 8 percent rule was when the loan was
collateralized.
The first level capital must consist of common equity and disclosed reserves. Only this
elements of capital are capable to merge loss and going concern.
The second level capital consists of all other elements of capital, which BCBS considered
to be important, legitimate and worth to be included into capital for regulative aims:
Undisclosed reserves (the items that are not in the balance sheet or hidden, but
still are considered as an asset).
Revaluation reserves
Hybrid instruments (securities that combine two or more financial instruments of
different type, generally combining both debt and equity features).
Subordinated term debt (a loan or security that ranks below other loans or
securities taking into the account the claim on assets or earnings). It is 50% of the
first level capital with the condition to pay it not less than after 5 years with
amortization included. (4)
The deduction in the amount of business worthiness and investments in non-consolidated
bank and financial subsidiary companies is considered from the total sum of the first level
capital and the second level capital by Basel I.
BCBS considers that for the optimal indication of bank’s capital adequacy, the capital must
be compared with the risk-weighted assets. BCBS distinguish two types of risk: loan risk
- 15 -
as a risk of the counterparty’s default, and political risk. Liquidity risk and operational risk
are not taken into consideration in Basel I. There are four weights that are granted to
different class of assets: 0%, 20%, 50% and 100% as the reader can see on the table below.
Table 1: Risk weights per asset class 1
Risk weight Asset Class
0% Cash, Sovereign bonds
20% Claims on OECD banks; Claims on
municipalities
50% Residential mortgages
100% Assets involving business; Personal
consumer loans assets involving non-
OECD governments
Source: International Convergence of Capital Measurement and Capital Standards
Basel I also defines that the amount of Tier 2 capital may not exceed the amount of Tier 1
capital. That means at least 4% of the risk weighted assets should be Tier 1 capital. (5)
Basel I is now widely viewed as outmoded. The world has changed influenced by the
development of the financial conglomerates, financial innovation and risk management,
but in the 1990s it became an international standard in keeping the capital adequacy and
was implemented in more than 100 states worldwide.
Still I will highlight the most visible advantages and disadvantages of first accord.
Basel’s I advantage is that it is relatively easy to monitor and to do the calculations. The
main data for calculations of the capital adequacy is the composition and value on the
credit and trading portfolio.
The disadvantage is that the bank is seen as a very general system when the bank’s only
concern is to borrow and lend the money. It is known that in the reality bank’s operation
- 16 -
stretches out of the borders of this simple scheme, they are more dynamic and are
involved in many more occupations. As it was stated above many types of risks such as
risks associated with securities are not included in this regulation. Moreover, Basel I
offers no control over Off-Balance Sheet Instruments (OBSI) – for example, options and
other derivatives.
The absolute size of a loan is only taken into consideration - is another disadvantage.
What is more to add, Basel I does not take into consideration the borrower himself. So in
this case an unsecured loan to an AAA customer is treated the same way as an unsecured
loan to a customer that is on the bankruptcy edge. Clearly, that this omits a lot of risks and
in this connection the amount of required risk premium estimated with this very general
position can be underestimated.
Figure 1; Core Components of Basel I
Source: International Convergence of Capital measurement and capital standards, Basle Committee on
Banking Supervision
Bas
el I
(co
re p
illar
s)
Bank's Capital must be no less then 8% of risk-
weighted assets
Capital consists of 2 Tiers
Loan risk only considered
- 17 -
Basel II (published on the June 26th 2004).
Figure 2: Timeline of Basel Accords implementation.
Basel II takes into consideration a lot more spheres for regulations and supervision then
Basel I. The Basel’s II approach is based not on one, but three pillars: the minimal
requirements to the capital (based on the Basel I), supervisory review and market
discipline. Therefore, the existed from the Basel I framework on the calculation on
minimum capital adequacy, which proved its effectiveness, was improved with the
supervisory review and cooperation of banks with supervisory authorities, and the broad
system of information disclosure. The idea of three pillars to implement was to create a
mutual affect from using these pillars that leads to the increased effectiveness of all of
three.
The first pillar is for estimating the owner’s equity adequacy considering loan risk, market
risk and operational risk with the help of standardized and advanced methods.
•07.1988 Publication of Basel I
•07.1988 Publication of the capital accord to incorporate market risks
•12.1992 Implementation of Basel I
•12.1997 Implementation of methodology of measurement market risks
Basel I
•06.2004 Publication of Basel II
•06.2006 Implementation of Basel II
•12.2007 Implimentation of additional regulations of Basel II
Basel II
•07.2009 Publication of Rules of securitization and credit institution trading portfolio formation.
•12.2009 Publication of the Basel III draft
•11.2010 Confirmation of the Basel III project
•12.2011 Implementation of Rules of 07.2009
•01.2013 The beginning of implementation of Basel III
•01.2019 Accomplishment of the implementation of Basel IIIBasel III
Source: BIS history overview (1)
- 18 -
For evaluation of loan risk it may apply the standard approach and two other approaches
– Internal Rating Based (IRB-approaches). Standard approach is the approach that was
used in Basel I: assets with the concrete level of loan risk are granted with specific risk
weight (0%, 20%, 50%, 100% and plus new one – 150%) based on the external ratings of
the rating agencies. The novation is that loan derivatives, guarantees and cover funds are
widely used as they lower risks of assets. IRB-approaches are developing the
implemented in 1996 practice of market risk estimation by banks themselves, but now
the loan risk is added. Using this data bank does not need to rely only on rating agencies,
but evaluate the probability of loss and possibility of some costs. (6) This information is
the main one to figure out the capital adequacy. There are two IRB- approaches – the
standard IRB-approach (SA) (see the Table 2 below) and advanced IRB-approach (AIRB)
(see on the Figure 3 below). Which approach to use is depend of whether the bank has the
right to indicate an investor’s default risk or bank has the right to estimate other
parameters to calculate credit risk. To get the right to use both of these two approaches,
banks need to fulfill special requirements and to get approval from supervision entity.
According to IRB-approaches, minimal capital adequacy is calculated upon analysis of 5
classes of assets: corporate, banking, sovereign, retail and securities. To define assets to
one or another class it is necessary to analyze the counterparties bank has a cooperation
with. There is a special risk-measurement scale that’s indicates the most and less common
risks. When evaluating counterparty the probability of default (PD), the loss given default
(LGD) and exposure of default (EAD) and maturity date are estimated. (6)
Table 2: Basel II: Standard approach for RWA
Clients with investing rating Private sector Public sector
From AAA to AA- 20% 0%
From A+ to A- 50% 50%
From BBB+ to BB- 100% 100%
Less than BB- 150% 150%
- 19 -
Clients without investing rating
Mortgage 35%
Other mortgage loans and rent
of real estate
50%
Loans to individuals, small and
medium-sized enterprises
75%
Loans to corporate customers 100%
Source: International Convergence of Capital Measurement and Capital Standards, Basel Committee on
Banking Supervision
Advanced IRB is used by most of the European banks and 100% of American banks. This
model is developed by each bank individually and must meet the requirements of
supervisory authorities.
Figure 3: Basel II: Advanced IRB approach 1
Source: Based on the information provided in this research.
It is important that EAD and LGD can be measured solely by banks only if they use
advanced IRB-approach, in standard one these parameters are calculated and presented
by supervisory authority.
A few words about market and operational risks. The methods to evaluate market risks
remained almost unchanged in comparison with the methods that were issued in 1996.
EAD RRW RWA
- 20 -
Operational risk and its evaluation is a novel in Basel II. So what is the operational risk?
This is a form of risk that summarizes the risks a company or firm undertakes when it
attempts to operate within a given field or industry. Operational risk is the risk that
remains after determining financing and systematic risk, and includes risks that is caused
from breakdowns and mistakes in internal procedures, people and systems. (4)
The methods of distinguishing the capital tier I and capital tier II remained the same and
the final minimum capital requirements remained 8% from RWA having minimum 4% of
Capital Tier 1.
Basel III (published in 2010), which norms are being implemented from 2013 to
2018.
Basel III focuses both on micro-level (to strengthen the steadiness of particular banking
institutions) and macro-level (to prevent the incurrence of system risks and
procyclicality). Basel III contains the three main problems’ solution that were revealed
during the analysis of the crisis’s reasons.
The first issue is capital inadequacy and its low quality. The financial crisis showed that
because of the flexibility of market regulators in relation to innovative financial
instruments there were cases when the instruments had been made relate to the capital
Tier I and Tier 2 that did not have absorbing capacity of bank’s loss in the context of doing
business as a going concern and in the context of break off operation respectively.
Moreover as banks had the right to abstract regulatory revisions (mainly business
reputation) from the Capital Tier I and Tier II together, instead of core capital Tier I, they
were reporting the high level of core Tier 1 when in fact it was not true. Basel III contains
the regulations that are to get rid of these weaknesses. We will study them and following
points closely in next chapters.
The second problem that was revealed during the crisis is inadequacy of weighted ratios
while studying risk-weighted assets. There were a lot of wrongly estimated risk-weighted
assets that resulted to inconsistency of leveled regulatory capital and actual risk of a bank.
- 21 -
The third very important issue to highlight – is an imprudent manner of managing
liquidity. On the one hand, bank’s assets consist of long-term repayment instruments, on
the other hand, liabilities are lack of regular and stable
The main changes of Basel III in comparison to Basel II are in calculations of bank capital,
prudential requirements to capital and prudential requirements to liquidity. Basel III
imposed “additional capital buffers”, (i) a mandatory “capital conservation buffer” of 2.5%
and (ii) a “discretionary counter-cyclical buffer”. (7)
Summarizing the abovementioned, it is clear that in the process of developing the
regulations and standards from Basel I to Basel III BCBS was also increasing and
improving the level of understanding the demands of banking system and with each new
step was stricter to banks while realizing the importance of main bank risks. Basel I
contained the regulation on capital adequacy of banks considering the loan and country
risks then the market risk was added. Loan risk, market risk and operational risk were set
up in Basel II.
If Basel I was mainly about capital adequacy, then Basel II paid attention for the necessity
of the reasonable supervision on banks and information disclosure of financial position of
bank and risks. Basel III expanded these ideas and reflected them in the understanding of
the prevention of procyclical growth of banking sector.
Basel I was a pioneer work and could not be the document in final version as all those
experts who were involved in preparing Basel I had very different vision on it and in this
case the first regulations contained only approved by everyone rules. Basel II had already
some basis that made the issue of the new standards a bit easier. It contains more details
on regulations of different aspects of banking operation and supervision, but because of
no strong stress or urgent situations on markets or in economy in general it was not very
strict and had some lobbied parts that turned out to be the weakest ones for banks. Basel
III is considered to be an answer to the crisis in 2008 and therefore is the toughest one
among all the BCBS’s documents. It is known that huge financial institutions were trying
to lobby some of the regulations, but the document has remained almost unchanged, only
some questioned articles were allowed to change a bit.
- 22 -
Studying Basel III and its influence in banking sector without studying the core ideas and
influence of its predecessors – Basel I and Basel II – is limiting the full understanding of
the topic of this thesis. Comparative analysis of standards of all of three accords will bring
the conception of the regulatory requirements‘ progress in banking sphere. At the same
time the compare analysis of Basel II and Basel III will give us the insight of the main
standards and risks for banks under Basel III what is the main question of this research.
To sum up what was said before, there is a table that describes the core changes.
Table 3: The Comparison of Basel Accords.
Basel I Basel II Basel III
Methodology Methodological
approaches to define
and estimate the
regulatory capital
strictly defined by Basel
Committee.
Oriented on the
quantitative indicators
of capital adequacy.
Allowances of using
inner bank’s
methodology to
determine the risks.
Oriented on the
qualitative indicators.
To the quantitative
requirements it is
added the second and
the third component –
supervisory process
and market discipline.
The option of using
inner bank’s
methodology to
determine the risks is
maintained.
Introduction of norms,
the payments to owners
and to directors depend
on the fulfilment of
those norms.
Implementation of
requirements
connected with the
organization of bank
supervision on
adherence of capital
adequacy norms and
the adherence of
market discipline.
Requirements to
the capital
Differentiation of
coefficients of capital
adequacy is provided
Differentiation of
coefficients of capital
adequacy is depending
The structure change
of the stockholder
equity of banks.
- 23 -
only according to the
credit rating of the state.
on the credit risk of
each borrower.
The risk sensitivity
increases.
The increase of the
requirements to capital
adequacy.
The creation of back up
buffer
The creation of the
mechanism of
countercyclical
regulation.
Risks Coverage of only credit
risk.
Application of
standardized approach
to measure the risk,
which is determined by
Basel Committee.
Coverage of the credit
risks, market risks and
operational risks.
The possibility to
choose the approach to
measure the risks based
on the inner ratings.
The possibility to
involve independent
rating agencies to
evaluate the risks.
Coverage of credit
risks, market risks and
operational risks.
The possibility to
choose the approaches
to measure the risks
based on the inner
ratings.
The possibility to
involve the
independent rating
agencies to measure the
risks.
The necessity of
separate estimation of
risks of credit and
market portfolio of the
bank.
Transparency and
information disclosure
approach on the risk
taking of the bank and
risk management.
Source: Basel I, Basel II and Basel III accords,.
- 24 -
- 25 -
2 Compare analysis of Basel II and Basel III
In this chapter I will closely study the changes that brings Basel III agreement in
comparison to Basel II.
Basel II was released in 2004 after many issues of Basel I that showed that the regulations
must be reviewed and changed. But the financial collapse in 2008 showed that the
cornerstone conception (to avoid crisis) of Basel I and Basel II has failed and the world is
still fixing the consequences of those events.
In 2007 there were the first signs of the crisis that had its peak in September 2008 and
then transformed to the world-wide economic crisis. The epicenter of the crisis was the
mortgage loans market in the USA. While the economy was increasing American banks
started giving the mortgage loans to the borrowers of very low class of borrowing capacity
and then were securitizing a pool of loans granted (in other words, they were secure issue
of bonds with the payments flow of mortgage loans, sell them to investors and actually it
was an “exchange” of the long-term loans to liquid assets). They were expecting the price
for real estate grows permanently and in this case even unemployed borrower could pay
back the loan by selling the house. As the result rating agencies started to give the rating
AAA for all of abovementioned types of bonds (MBS and created CDO). So banks who were
investors in MBS and CDO did not reserved enough capital that was increasing the risk of
potential default of MBS and CDO. The first defaults happened in 2007 because in 1006
the price growth on real estate in the USA stopped. MBS and CDO defaults leaded to the
necessity to retain the loss by banking institutions. But banking institutions are able to do
only from their own capital, but the capital adequacy was not on the proper level. As the
result Lehman Brothers went bankrupt, Merill Lynch was bought by Bank of America,
Bear Stearns was bought by JP Morgan Chase. A lot of banks get the financial support from
the government in exchange of their shares.
There was another factor that lead for AAA rating of the mortgage bonds. The new product
was introduced to the market – credit-default swap (CDS). The idea of that product was
that in exchange to a regularly paid premium company A (for example bank) sells to
- 26 -
company B (it can be also a bank) the insurance for default in the bond that is set in the
agreement between the A and B. If default is happened with that bond, the company B
would have received the compensation from company A in the amount according to the
agreement. So we see that when company B buys CDS it can hedging itself from the risk
of borrowers default on that bond. It means that company B can consider this bond as
non-risky and not to reserve any money for the case of the default (the money reserve is
created only for company A). The market liked CDS a lot, and CDS started to be sold “in
one pack” with MBS and CDO (hedging the default risk of bonds with the mortgage
coverage, what resulted to even lower risk for the investors of MBS and CDO with this
bonds. CDA were emitted by the largest banks and insurance companies and it made the
investors of MBS and CDO to consider counterparties as the parties with minimum level
of loan risk, and again means to reserve the minimum amount of money.
In September 2008 after Lehman Brothers default that had been investing a lot in MBS
and CDO, AIG’s nationalization and the faced obstacles for most of the financial institutes
that were operating with Lehman Brothers and AIG and suffered a lot of the
consequences, the world society had a reasonable question: “Who is going to be next?”
The size of the operations, their exact amount with MBS, CDO and CDS was known only
for banks themselves because of limited disclosure of the information on operating with
that exact bonds). All these consequences lead as a result to the liquidity crisis in the
world financial crisis, as banks were afraid to provide the loans to other banks. It was
totally unexpected for who is going to default next. So even if some banks were brave
enough to give a loan, they were offering it with tremendously high interest rate. All these
events were like a domino effect. The high interest rate in bank sector lead to high interest
rates for loans in real economy sphere. Customers were not able to pay suppliers because
of no money and no possibility to take a loan in the bank; suppliers were not paying wages,
employees were not spending money on products because of no wage. In the final result
all these lead to the shock in economy globally, the decrease of manufacturing level and
enormous amount of people to be fired. Now we see how the bank crisis happen to create
the worldwide economy crisis. The governments all around the world faced the necessity
- 27 -
to get involved and to help with the “injections” of money in banking system and by
providing the guarantees to real sector of economy. But now that’s still a great question if
those actions really helped to prevent the larger losses or it was just a temporary solution,
and we can face the worse results in some period of time.
In the BCBS report to G-20 it was claimed that this financial crisis helped to figure out the
weak points of the International Convergence of Capital Measurement and Capital
Standards (Basel II) that was in force in that time. Even though these norms had the
strongest effect on banks activities in the last 20 years, the implemented changes were
not enough to prevent or at least to make less fall-out connected to global financial
turmoil. The will of banks to get more profit on speculations was not restricted with the
existing regulations. To be more specific banks had too high level of loan capital with
which they were organizing those speculations, but low level and adequacy of its own
capital, what resulted as inability to cover the losses with their own capital; moreover
there was low level of liquidity that didn’t allow banks to overcome the banking crisis of
loans. (8)
Crisis enabled regulators to see that it is necessary to direct more attention to the quality
and structure of the capital, credit portfolio diversification, standards of liquidity
management and other bank activities, including the so-called “club approach” in risk
management. As the result BCBS has developed new version of the norms – Basel III, that
have to strengthen stability of global financial system and prevention of new global
financial crisis. (In Appendix 1 there is the list of the documents that are the base of new
accord).
The new agreement does not abrogate the previous agreement (Basel II) but supplements
it, and also is oriented to dispose of the following weaknesses:
1. In terms of management and estimation of capital adequacy (Pillar I):
1.1. Non-concrete usage of terms and definitions;
1.2. Insufficient level of demands to the bank’s capital
1.3. Absence of fees for the high concentration of credit and market portfolio of
the bank
- 28 -
1.4. The absence of the correction for the state risk
1.5. Procyclicality and risk sensitivity of offered models
1.6. Allowance of subjectivity in relation to the input data;
2. In terms of implementation of prudential control standards (Pillar II):
2.1. Insufficient attention to counteragent’s risks on derivative securities
transactions;
3. In the terms of bank’s market discipline (Pillar 3)
3.1. Incorrectness of information’s disclosure requirements. (7)
The main requirements of Basel III are target bank system stability increase of the
Committee member-states in relation to the financial and economic crisis, improvement
the quality of bank risk management, increase of transparency and standards of
information disclosure for financial institutions.
Basel II was criticized due to some limits such as unclear and insufficient capital
definition, lack of liquidity monitoring and procyclical effect. Accordingly, Basel III has
carried out important reforms especially focusing on those provisions that were not
sufficient. On the graph below reader can see how the capital definition and general
understanding of this element has changed.
- 29 -
Figure 4: Capital requirements Basel II/Basel 2.5 vs. Basel III
Source: Accenture 1
In comparison with Basel II, Basel III provide a time frame during which the financial
institutions must progressively increase their capital ratios and to achieve a CET 1 capital
ratio of 9.5% and to a total capital ratio of 13% (including two capital buffers) in 2019.
- 30 -
Figure 5:Phase-in arrangements Basel III capital requirements.
Source: Accenture 2
So if to provide the structural information about the core changes in Basel III to Basel II it
is necessary to highlight the following:
1. An unclear definition of capital turns out to be more specific and in detail to
increase quality, consistency and transparency of the capital base. In Basel III Tier
I capital is going concern capital including common equity tier I capital and
additional tier 1 capital, Tier 2 capital is gone concern capital and Tier 3 capital is
eliminated.
2. The mark-to-market losses were not captured in case of counterparty default or
Credit Valuation Adjustments (CVAs) and now are fixed with the increased capital
requirements: capital charge for potential mark-to-market losses, higher
standards for collateral management and initial margining and higher capital
requirements for OTC derivatives exposures. The objective of it was to reinforce
the Counterparty Credit Risk management.
3. Basel II had a pro-cyclicality of the banking system, tending to boost the amplitude
of the business cycle. Basel III presents new capital buffers: - Capital conservation
buffer of 2.5% and Countercyclical buffer of 0-2.5% depending on macroeconomic
- 31 -
circumstances. The aim is to reduce pro-cyclicality and avoid the destabilizing
effects experienced in the last crisis.
4. New leverage ratio was introduced in Basel III, in which leverage cap of 3% is
under test and this ratio is volume based and not risk adjusted (on-and off-balance
sheet items). The ratio is necessary to constrain the build-up of leverage and to
avoid destabilizing deleveraging processes as while Basel II there were no
significant changes in the assessment of derivatives and off-balance sheet items.
5. New liquidity standard with two ratios (Liquidity Coverage Ratio (LCR) and Net
Stable Funding Ratio (NSFR) is a novel in Basel III. BCBS hopes with the help of this
new standard to promote short-term resilience of a bank’s liquidity risk profile by
ensuring that it has sufficient high quality liquid assets to survive a stress scenario
lasting one month and to promote resilience over the longer term by creating
additional incentives for a bank to fund its activities with more stable sources of
funding. Before new regulations it was a lack of monitor of funding gap between
deposits and loans.
6. The new standard requires to perform internal rating alongside external ratings
and incorporate eligibility criteria for the use of external ratings. This standard is
necessary for reduction of reliance on external rating and minimize cliff effects.
Old regulations showed over-reliance on the rating agencies to determine the
riskiness of assets.
The Table 4 below shows briefly the core changes in Basel III to Basel II and weak part of
old document and how they are fixed in new accord.
Table 4. The weak points of Basel II and their improvement in Basel III.
BASEL II BASEL III
The capital definition was not specific Now it is detailed, and with explanations
Mark-to market losses were not taken in to consideration
Fixed with stricter capital requirements
- 32 -
Pro-cyclicality tendency Countercyclicality (creating new buffers to reduce pro-cyclicality)
No significant changes in the assessment of derivatives and off-balance sheet items
Leverage ratio is introduced
Lack of monitor of funding gap between deposits and loans
creating a stable funding by ratios: LCR and NSFR
Over-reliance on the rating agencies Performance of internal rating and external rating
Source: Basel II and Basel III accords
- 33 -
3 Normative standards for banks
Now let us have a closer insight of the Basel III standards. It stands to mention that Basel
III does not intent to have more complex models (what was expected) and to withhold the
risk sensitive in the approaches that were created in Basel II. At the same time new reform
allows for requirements and definitions toughening and considers direct transition from
recommendations to provisions. That means for instance, that if bank does not accord
with new standards of capital adequacy, then the direct constraints shall apply on bank,
in the form of liability to “conserve” the certain amount of profit (40%-100%) in the
following year and decreasing the dividend payout for shareholders.
In general meaning Basel III can be divided in to two great parts: capital management and
liquidity management.
3.1 Capital management
Capital management under Basel III consists of three pillars. The first pillar is the capital
itself, the second pillar is risk coverage and the third one is market discipline.
As I were mentioning not once in this research the revealed problems during the crisis of
2008 that were reflected in new regulations. So now Basel III performs a new definition
of capital with a greater focus on common equity (the highest component of a bank’s
capital).
The capital structure got more advanced than it was described for example in Basel II
regulation. Now there are the following components of capital: Tier 1 Capital (which is
going-concern capital) consists of two elements – Common Equity Tier 1 and Additional
Tier 1; and Tier 2 Capital (gone-concern capital). As it is said in the Basel III global
regulatory framework for more resilient bank and banking systems, for “each of the three
categories above there is a single set of criteria that instruments are required to meet before
inclusion in the relevant category.” (7)
Common Equity Tier 1 must be at least 4.5% of risk-weighted assets at all the time; Tier
1 Capital must be at least 6.0% of risk-weighted assets at all the time and Total Capital
- 34 -
(equals to sum of Tier 1 Capital and Tier 2 Capital) must be at least 8.0% of risk-weighted
assets at all the time. (7)
So let us make the graphical image of what is capital look like and what is included in it:
Table 5: The capital structure according to Basel III
CAPITAL
Common Equity
Tier I
Common shares issued by the bank
Stock surplus/share premium
Retained earnings
Accumulated other comprehensive income and other disclosed reserves
Common shares issued by consolidated subsidiaries of the bank and held by third parties
Non-controlling interests
Tier 2 capital Term subordinated debt
Perpetual subordinated debt
Collective impairments provisions
Certain loans loss provisions
Revaluation reserves
Hybrid instruments
Additional Tier I
capital
Preference shares
Innovative Tier I securities
Tax on the excess of expected losses over provisions
Source: Basel III: A global regulatory framework for more resilient banks and banking system
The crisis experience showed that only capital of high quality is useful to absorb
unexpected losses. Therefore new capital definition helps banks to increase the amount
- 35 -
of high quality capital. This is not a one-moment process, and in this connection Basel III
offers a timeline for slowly increase of capital demands. Through this way banks will be
capable to work on creating a more steady capital base that will make them more loss
absorbing and more reliable and stable in the future.
The most important capital ratios are the Tier 1 capital ratio and the CET1 (common
equity tier 1) capital ratio.
The table below shows this capital transition throughout the timeline.
Table 6: Capital ratios in Basel III
RATIO YEAR Basel III
CET 1 ratio 2012
2013
2014
2015-2019
2.0%
3.5%
4.0%
4.5%
Tier 1 ratio 2012
2013
2014
2015-2019
4.0%
4.5%
5.5%
6.0%
Source: Basel III: A global regulatory framework for more resilient banks and banking system
Also note the individual bank minimum capital conservation standards that are fixed in
the following table:
Table 7: Min. capital conservation standards for individual bank.
Common equity tier 1 ratio Min. capital conservation ratio
4.5%-5.13% 100%
5.13%-5.75% 80%
5.75%-6.38% 60%
6.38%-7.0% 40%
- 36 -
>7.0% 0%
Source: Basel III: A global regulatory framework for more resilient banks and banking system.
The distribution constraints imposed on banks when their capital levels are into the range
increase as the banks’ capital levels approach the under the very minimum of the
requirements.
Basel III does not establish the direct relation of Tier 1 Capital and Tier 2 Capital, but it is
considered to set this relation through the minimal requirements to the capital adequacy
to cover the risks (7):
%5,41
RWA
capitaltierequityCommon ;
%6capital1Tier
RWA
;
%8capitalregulatory Total
RWA
To sum up the information on Basel III capital ratios there is a graph (see Figure 6) on
which it is clearly understandable how the capital ratios are implemented through the
time.
As it was said before the novel of Basel III is a Capital Conservation Buffer of 2.5%, which
has to consist of Common equity Tier1 capital. In this chapter I am going to take a closer
look to this new regulation.
Capital Conservative Buffer is necessary to set up the stability to individual and system
risks. Conservative Buffer is implemented as an extra support for banks in the periods of
“system” problems, in fact being an insurance system for banks in case of the stress with
system causes. This Basel III’s requirements are also to demolish possible imperfections
of regulations including the contagion risk. Contagion risk is the risk that “referred to as a
systemic risk and defined as a risk that financial difficulties at one or more bank(s) spill over
to a large number of other banks or the financial system as a whole”. (9) There is also
another definition of the contagion risk – when negative processes in one country lead to
- 37 -
the rating fall or credit contraction not only in that country but in other countries as well.
(10)
Figure 6: Basel III phased implementation.
Source: Basel III: An Overview of the safer's safety net, Francois van Dyk
The requirements to conservative buffer are going to be implemented step-by-step
starting in 2014. Banks have to conserve 0.5% of all risk weighted assets minimum as a
Tier 1Capital. This indicator will be increasing unless reaching 2.5% in 2018, January.
Basel III regulations set up that Capital Buffer is an obligatory capital that financial
institutions are required to hold in addition to other minimum capital requirements. The
rules for creating the adequate capital buffers are made to reduce the procyclical nature of
providing loans. Outside of stress periods banks have to keep the buffers of capital above the
regulatory minimum. There are several possibilities for banks to rebuild the buffers which
were down: to reduce discretionary distributions of earnings or, other way, raising new
capital from the private sector. (7) See the Table 8 for additional information and
comparison with Basel II.
- 38 -
Table 8: Capital buffers according to Basel II and Basel III
RATIO YEAR BASEL II BASEL III
Capital Conservation Buffer
2012-2015
2016
2017
2018
2019
______________________ _
0.625%
1.250%
1.875%
2.500%
Countercyclical buffer
2012-2019 _______________________ <2.5%(or equals)
Source: Basel II and Basel III accords
The special meaning has the Countercyclical Capital Buffer (CCB) which the main aim is
to achieve the broader macroprudential goal to protect the banking sector from periods
of excess aggregate credit growth that have often been associated with the build-up of
system-wide risk – in other words the target of this buffer is to limit procyclicality. The
CCB regime can also help to lean against the build-up phase of the cycle in the first place,
by raising the cost of credit and therefore lowing its demand. Jurisdictions will be required
to monitor credit growth in the relation to measures such as GDP and assess whether
growth is excessive and leading to the build-up of system-wide risk:
%100t
t
GDP
CREDITК , where t = period of time.
Beside the above said rules, the national supervisory entity monitors the set lowest (L) and
highest (H) boarders of the indicator. The excess of trigger set by supervisory entity is a sign
for banks to create a Countercyclical Capital Buffer. (7)
According to Basel Committee on Banking Supervision this Countercyclical Capital Buffer
will result such benefits as a) protecting the banking sector from the losses that are the result
from periods of excess credit growth followed by periods of stress; b) helping to ensure that
credit remains to be available during periods of stress; c) during the build-up phase, as credit
- 39 -
is being granted at a rapid pace, it can lead to increase of the credit cost. In this case the
buffer acts as a brake on bank lending. (7)
During the financial downturn the risk of default and bankruptcy increases and banks are
obliged to hold more capital. This also leads to the banks to provide less credit and this
stimulates the downturn even more. But on the other hand, when it is an economic boom,
banks possibly provide too much credit. I visualized the process in the figure below for
the clearer understanding. (Figure 7).
Figure 7: The process of the countercyclicality
Source: the Figure is built based on the information in the text
A more thorough description of all the novels related to the Basel III capital base and
related issues can be found in the Basel III accord. As the aim of this report is to make the
general insight of the main changes that Basel III brings to banks.
Higher risk
Higher Capital
requirementLess credit
Economic Downturn
- 40 -
3.1.1 Leverage ratio
Willing to increase the capital quality and to prevent the excess of loan capital in banking
sector, Basel Committee has created a new regulations to introduce new regulative
indicator – leverage ratio.
The leverage ratio requirement is in early stages of rulemaking in the most countries, as
many countries are waiting for BCBS to finalize definitions and calibrations before
implementing rules. The BCBS “leverage ratio definition includes both on- and off-balance-
sheet exposures in the denominator and Tier 1 transitional capital in the numerator.” (11).
The minimum leverage indicator is offered to be 2.5% for Common equity tier 1 capital
and 3% for Tier 1 capital:
%5,2А
1
total
1 capitaltierequityCommon
L ;
%0,31
2 totalА
capitalTierL .
Most jurisdictions that have rules or proposals are on the same level or even stricter than
Basel standards. See the chart below (Figure 8) on which the reader can find, that the
following countries are stricter in implementing the leverage ratio: Bermuda, US, the UK,
Swiss SIB, China Australia and India and South Africa. Note, that New Zealand does not
intend to implement the leverage ratio.
- 41 -
Figure 8: Leverage ratio implementation
Source: Moody’s national regulations.
Therefore, Committee has implemented new requirements not only to the capital
structure, but also to the general bank’s balance structure. The leverage limits are
established: the relation of Tier 1 Capital to all of its assets cannot be higher than 3%.
Experts predict that introduction of this ratio can reasonably increase the credit price for
all the loan products of banks, as this ratio is connected with the total assets value, not
risk-weighted assets. The standard is going to be implemented in 2018 with the several
phases of the adoption of the leverage ratio – Monitoring (started in January 1st, 2012),
testing (started January 1st, 2013), adjusting (starting January 1st 2017) and
Implementation (scheduled on January 1st 2018). (7)
- 42 -
Banks have a long time to estimate the real influence of this restriction for lending
profitability.
As the result of this new changes in regulations banks will face the necessity to clean up
the capital base, exclude deferred tax and equity shares of subsidiaries and at the same
time to increase the common shares and shareholders’ interest.
“Judging from current balance-sheet leverage ratios, Basel III leverage ratio
compliance is likely to be more difficult for certain regions such as Europe, where Basel
II implementation resulted in the banks’ focusing on the optimization of returns on
risk-adjusted capital and a balance-sheet leverage requirement was lacking. Regional
banks in Africa, Latin America and the Middle East exhibit low balance-sheet leverage.
US banks generally have lower leverage than European peers, in part due to greater
use of securitization to move assets off their balance sheets”. (11)
The Figure 7 depicts graphically the leverage ratios in different countries.
Figure 9: Tier 1 Leverage Ratios in different regions.
Source: Moody’s Banking Financial Metrics.
- 43 -
3.1.2 Liquidity
The strict requirements to capital adequacy are the necessary condition to stabilize the
banking sector, but they alone are not sufficient enough. The strong liquidity base with
the support of the reliable standards of supervision are important too. Nevertheless till
recent time there were no internationally negotiated standards. Therefore Basel
Committee on Banking Supervision creates its own structure of the liquidity requirements
and presents the very first internationally approved liquidity standards. These liquidity
standards similarly to the international capital standards establish the minimum
obligations and will support the equality on the international level.
The liquidity standards and monitoring system are fixed in the BCBS document under the
title “International framework for liquidity risk measurement, standards and monitoring”
published in 2009.
The Committee offers two variants of liquidity regulation that were developed to aim two
different but complimentary targets. The first target is to provide the stable and reliable
level of bank liquidity by the mean of creating the reserve of high quality liquid assets to
meet in short-term liquidity needs under a specified stress scenario (30 days). The second
target is to provide the stability in long-term by creating the additional motivation for
banks to have a stable funding.
Consequently, Basel III introduces two standards of liquidity for stability valuation: short-
term liquidity (Liquidity Coverage Ratio) and Net Stable Funding Ratio (NSFR). Both of
them are external indicators of banks’ stability in case of liquidity crisis.
Liquidity coverage ratio (LCR) allow to evaluate if bank has an opportunity to continue to
operate in the following 30 days under prescribed stress scenario. LCR is a relation of
liquidity assets to net cash outflow.
%100periodday 30 aover outflowcash Net
assetsliquidqualityhighofStock
LCR
- 44 -
To fulfil this normative standard it is necessary for relation between high quality liquid
assets (HQLA) and expected 30-days net cash outflows to be not less than 100%. Moreover
it is expected for banks to follow this standard permanently.
To determine the LCR for the bank it is necessary to calculate the amount of high quality of
liquid assets and expected net cash flow according to the stress-test. Basel III distinguish two
categories of the high quality liquid assets: Level 1 and Level 2 liquid assets. (12)
According to the BCBS document – “Basel III: The Liquidity Coverage Ratio and liquidity
risk monitoring tools”, published on January 2013 Level 1 liquid assets are the following:
Cash (coins and banknotes); reserves in central banks but those that can be withdrawn
by bank in times of stress. Note that national supervision authorities must negotiate
with their central bank that such kind if reserves are related to liquid assets of banks
and determine how and in what amount it is possible to withdraw the reserves during
the liquidity stress.
Marketable securities representing claims on or guaranteed by sovereigns, central
banks, PSEs, the Bank for International Settlements, the International Monetary Fund,
the European Central Bank and European Community, or multilateral development
banks (in this case The Basel III liquidity framework follows the categorization of
market participants applied in the Basel II Framework, unless otherwise specified).
Marketable securities must satisfy all the following conditions:
Assigned a 0% risk-weight under the Basel II Standardized Approach for credit risk;
Traded in large, deep and active repo or cash markets characterized by a low level of
concentration;
Have a proven record as a reliable source of liquidity in the markets (repo or sale) even
during stressed market conditions; and
Not an obligation of a financial institution or any of its affiliated entities.
- 45 -
Where the sovereign has a non-0% risk weight, sovereign or central bank debt
securities issued in domestic currencies by the sovereign or central bank in the country
in which the liquidity risk is being taken or in the bank’s home country; and
Where the sovereign has a non-0% risk weight, domestic sovereign or central bank
debt securities issued in foreign currencies are eligible up to the amount of the bank’s
stressed net cash outflows in that specific foreign currency stemming from the bank’s
operations in the jurisdiction where the bank’s liquidity risk is being taken. (12)
Moreover, the Group of Central Bank Governors and Heads of Supervision (GHOS)
approved the proposal to set the second level of liquid assets in 2010, which comprise
no more than 40% of the overall stock after haircuts have been applied”. The liquid
assets of this level are divided in Level 2A assets and Level 2B assets. (12)
According to the Basel III: The liquidity Coverage Ratio and liquidity risk monitoring tools
regulations, Level 2A assets are limited to the following:
Marketable securities representing claims on or guaranteed by sovereigns, central
banks, PSEs or multilateral development banks that satisfy the specific conditions set
by Basel III.
Corporate debt securities (including commercial paper) and covered bonds that satisfy
also the set requirements. Basel III specifies that these securities include only plain-
vanilla assets whose valuation is readily available based on standard methods and
does not depend on private knowledge, in other words these do not include complex
structured products or subordinated debt. Talking about the covered bonds Basel III
has also some additional notes: these bonds are bonds issued and owned by a bank or
mortgage institution and are subject by law to special public supervision deigned to
protect bond holders. (12)
In the same document that was mentioned above, level 2B assets are characterized as the
certain additional assets that can be included in Level 2 at the discretion of national
authorities. A larger haircut is applied to the current market value of each Level 2B asset
- 46 -
held in the stock of high quality liquid assets and in this category they are limited to the
following:
a) Residential mortgage backed securities that satisfy the specific conditions. And
the haircut is 25%.
b) Corporate debt securities (including commercial paper) that are subject to 50%
haircut and follow the specific requirements as well.
c) Common equity shares that satisfy all of the conditions may be included in Level
2B, subject to a 50% haircut. (12)
It is expected that the value calculation of LCR is in one currency (what is reasonable), but
banks can have HQLA in different currencies. Therefore, banks must consider when
stress-testing that the access to external currency markets can be limited, and sharp
exchange rate fluctuation can enlarge their liquidity gap. The scheme of the HQLA types
was built, (Figure 10) in which the reader can see the main features of different levels of
assets that were described above.
- 47 -
Figure 10: Categories of HQLA. Level 1 Assets
LEVEL 1 ASSETS up to 100%
LEVEL 2 ASSETS up to 40%
Source: Basel III: International framework for liquidity risk measurement, standards and monitoring, 2013
The denominator of the LCR is the total net cash outflows and has the following features:
Total net cash outflow is defined as the total expected cash outflows minus expected
cash inflows in the specified stress scenario for the subsequent 30 calendar days. Total
expected cash outflows are calculated by multiplying the outstanding balances of
Cash and central banks
reserves
SSA
SSA
Non-financial corporate
bonds
Covered bonds
-Domestic sovereign debt (non-0% risk-weight) issued on FX to the extent that this currency matches the currency needs of the bank’s operations in that jurisdiction
- 0% risk-weight under standards of Basel II
-20% risk-weight => 15% haircut
-Not issued by the bank itself or any of its affiliated entity
-High quality (rated AA- and above)
-15% haircut
-Decline of price/increase in haircut <10% over a 30-day period during a relevant period of the liquidity-test
-15% haircut
-High quality (rated AA-and above)
-Decline of price/increase in haircut <10% over a 30-day during a relevant period of significant liquidity stress
- 48 -
various categories or types 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. (12)
Total net cash outflows over the next 30 calendar days = Total expected cash
outflows – Min {total expected cash inflows; 75% of total expected cash outflows}
Also it is necessary to highlight that to indicate the total expected cash outflows the three
main group of liabilities: retail deposit, unsecured and secured corporate funding.
Moreover the retail deposits up to call and retail deposits with 30 days term are included
into retail deposits as well as long-term deposits (more than 30 days) which a depositor can
withdraw without paying any fine after the giving a notice to bank. Consequently the fixed-
term deposits (that are for more than 30 days) are excluded from the calculations in case if
a depositor has no right for pre-term withdrawal of the deposit or if the pre-term withdrawal
leads for an extra fee to pay. (12)
According to Basel III there are stable (run-off rate = 3%) and less stable (run-off rates =
10% and higher) deposits in the retail deposits category.
“Stable deposits, which usually received a run-off factor of 5%, are the amount of the deposits
that are fully insured by an effective deposit insurance scheme or by a public guarantee that
provides equivalent protection and where:
- the depositors have other established relationships with the bank that make deposit
withdrawal highly unlikely; or
- the deposits are in transactional accounts (for example accounts where salaries are
automatically deposited)”. (12)
Less stable deposits are those that have no deposit insurance system or some other public
warrant. National regulatory authorities can refer the deposits that can be withdrawn
quickly (for example internet deposits) and foreign currency deposits, deposits for VIP-
clients and deposit s with the additional options for a client. Foreign currency deposits
- 49 -
can be determined by national supervisory entities as less stable if there is a reason to
consider that such kind of deposits are more volatile than the national currency deposits.
Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools establish the
following rules for calculations:
When calculating the total net cash outflow unsecured bank’s funding is considered to
be the cash flow from the legal entities or entrepreneurs that can be withdrawn in the
term of the nearest 30 days including all the money raised with the non-fixed term.
They include:
Operational deposits generated by clearing, custody and cash management
activities: 25%
Treatment of deposits in institutional networks of cooperative banks: 25% or
100%
Unsecured wholesale funding provided by non-financial corporates and
sovereigns, central banks, multilateral development banks, and PSEs:20% or
40%
Unsecured wholesale funding provided by other legal entity customers:100%
Total net cash outflow includes the funds that were raised with the secured funding,
that is those liabilities and general obligations that are collateralized by legal rights
to specifically designated assets owned by the borrowing institution in the case of
bankruptcy, insolvency, liquidation or resolution. (12)
For all other maturing transactions the run-off factor is 100%, including transactions
where a bank has satisfied customers’ short positions with its own long inventory.
In the table below there is a summarized information about the applicable standards:
- 50 -
Table 9: Categories for outstanding maturing secured transactions and the amount to add to cash outflows.
Source: Basel III: The Liquidity Coverage Ratio and liquidity risk monitor tools, 2013
Cash inflow is also important part of the calculations. According to Basel III regulations,
“when considering its available cash inflows, the bank should only include contractual
inflows (including interest payments) from outstanding exposures that are fully performing
and for which the bank has no reason to expect a default within the 30-day time horizon.
Contingent inflows are not included in total net cash inflows.” (12) Basel III also sets the
limitations on total inflows: In order to prevent banks from relying solely on anticipated
inflows to meet their liquidity requirement and also to ensure a minimum level of HQLA
holdings, the amount of inflows that can offset outflows is capped at 75% of total expected
cash outflows as calculated in the standard. This requires that a bank must maintain a
minimum amount of stock of HQLA equal to 25% of the total cash outflows.
Whereas, when calculating the LCR to indicate the amount of cash inflow the following
operations are taken in to consideration:
1. Reverse repo and other operations to securitize assets of the first level (haircut
0%); to securitize assets of the second level (haircut of 15%); to securitize with
other assets (with the haircut 100%).
2. Operations with the current bank’s deposits in other financial institutions (with
the haircut of 0%).
- 51 -
3. Receivables from the individuals and non-financial organizations (with the haircut
of 50%).
4. Unsecured receivables from financial institutions (with the 100% haircut). (12)
The specific for banks and for the whole system stress situations for indicating the short-
term liquidity are included into the supervision scenario. The possible scenarios are
created on the base of the real events that happened during the financial crisis. The
scenario foresees the following:
The meaningful drawdown of the public credit rating of the institutions;
Partial deposit outflow;
The loss of unsecured wholesale funding
The meaningful increase in secured funding haircuts
The increase of demands to replenish the pledge for derivative financial
instruments, contractual and non-contractual off-balance sheet exposures,
including the committed credit and liquidity facilities.
Besides, the Basel III accords distinguish different types of cash outflow and cash inflow.
(12)
Type of cash outflow Type of cash inflow
Stable retail deposits Excluded cash inflows (mortgages,
credit/liquidity facilities & others)
All other retail deposits Net derivative cash inflow amount
Other unsecured retail funding Unsecured wholesale cash inflow amount
Structured transaction outflow Securities cash inflow amount
Net derivative cash outflow amount Secured lending cash inflow amount (asset
exchange)
Commitment outflow amount Broker-dealer segregated account inflow
amount
- 52 -
Collateral outflow amount Other cash inflow amounts
Collateral outflow amount (collateral
substitution)
Retail brokered deposit outflow amount
Unsecured wholesale funding amount
Debt security outflow amount
Secured funding outflow amount
Foreign central bank borrowings
Other
There are also the recommendations of application of LCR in the Basel III framework.
These issues include the frequency of banks calculating and reporting the LCR, the scope
of application of the LCR (if they apply at group or entity level and to foreign bank
branches) and the aggregation of currencies within the LCR.
This ratio must be used on an ongoing basis and at least monthly, with the operational
capacity to increase the frequency to weekly or even daily. Ideally the time lag in reporting
should be no larger than two weeks. Also banks are expected to inform supervisors on the
ongoing results of LCR. (12)
Now let us study the Net Stable Funding Ratio (NSFR). What is notable that the proposals
on the NSFR were first published in 2009 and the measure was included in Basel III
agreement in the December 2010. In January 2014 the Committee issued “the revised
standard that was changed to focus more on the riskier types of funding profile employed by
banks while improving alignment with the LCR and reducing cliff effects in the measurement
of available and required stable funding.” (13) This ratio allows to estimate the bank
liquidity in the long-term period (1 year).
According to the Basel framework:
- 53 -
the NSFR requires a minimum amount of stable sources of funding at a bank relative
to the liquidity profiles of the assets, as well as the potential for contingent liquidity
needs arising from off-balance sheet commitments. The NSFR aims to limit over-
reliance on short-term wholesale funding times of buoyant market liquidity and
encourage better assessment of liquidity risk across all on- and off-balance sheet items.
(7)
The Net Stable Funding Ratio is a relation of the amount of available stable funding to the
amount of required stable funding.
𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑠𝑡𝑎𝑏𝑙𝑒 𝑓𝑢𝑛𝑑𝑖𝑛𝑔
𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑠𝑡𝑎𝑏𝑙𝑒 𝑓𝑢𝑛𝑑𝑖𝑛𝑔≥100%
Moreover, according to Basel III,
“Available stable funding” is defined as the portion of capital and liabilities expected
to be reliable over the time horizon considered by the NSFR, which extends to one year.
The amount of such stable funding required (‘Required stable funding”) of a specific
institution is a function of the liquidity characteristics and residual maturities of the
various assets held by that institution as well as those of its off-balance sheet (OBS)
exposures. (14)
This approach can help to minimize the possibility of rapid “performance degradation” of
liquidity indicators and to prevent banks from creating the reserves of liquidity assets
with short-term funding source that have maturity date right after the normative period
established by supervisory entities.
Under the term “stable funding” BCBS understands owner’s equity and obtained funds, that
are the stable source of financing during the whole year in stress conditions. The size of such
financing for each bank is different. It depends on the liquidity level of the assets, off-balance
sheet items and (or) the activities of the bank. (14)
The document that is the part of Basel III framework - Basel III: the net stable funding
ratio sets the following rules:
- 54 -
The amount of available stable funding (ASF) is measured based on the broad
characteristics of the relative stability of an institution’s funding sources, including the
contractual maturity of its liabilities he differences in the propensity of different types
of funding providers to withdraw their funding. The amount of ASF is calculated by
first assigning the carrying value of an institution’s capital and liabilities to one of five
categories. The amount assigned to each category is then multiplied by an ASF factor,
and the total ASF is the sum of the weighted amounts. Carrying value represents the
amount at which a liability or equity instrument is recorded before the application of
any regulatory deductions, filters or other adjustments. (14)
The amount of required stable funding (RSF) is measured based on the broad
characteristics of the liquidity risk profile of an institution’s assets and OBS exposures.
The amount of required stable funding is calculated by first assigning the carrying
value of an institution’s assets to the categories listed. The amount assigned to each
category is then multiplied by its associated required stable funding factor, and the
total RSF is the sum of the weighted amounts added to the amount of off-balance sheet
activity (or potential liquidity exposure) multiplied by its associated required stable
funding factor. Note, that all the definitions mirror those outlined in Liquidity
Coverage ratio. (14)
On the Figure 11 below there are the lists of types of liability and ASF factor for it and
types of exposure and RSF factor.
- 55 -
Figure 11: NSFR ASF and RSF.
Source: Ernst & Young (15) -
- 56 -
The special feature of these standards is the implementation of stress-testing, in other
words, norms must work both in the stress situation on system level and in the stress
situation for a specific bank that was caused by inner problems.
This approach applies when the ratio of possible funding outflow is set and when the
liquidity assets and the haircut factors are indicated. Moreover, from the point of
possibility to liquidate assets the system stress prevails, and when funding the transaction
– the specific bank stress prevails.
This requirements are expected to be met by banks on their ongoing basis. The NSFR
should be reported to supervisory authorities at least each quarter.
The LCR and the NSFR are the subject to an observation period and will include a review
clause with any of unintended consequences. According to the time schedule the LCR is
going to be introduced on January 2015 and the NSFR is going to move to a minimum
standard by 1st of January in 2018.
These implementing standards on liquidity can be more than just strict for banks. But the
Basel Committee on Banking Supervision is monitoring the impact of Basel III on a sample
of banks and publishes the reports each December and June. The latest one Monitoring
Report as of 31 December 2013 was published in September 2014. In that study were
participating 227 banks, comprising 102 large internationally active banks (this group is
defined as “Group 1 banks” and includes internationally active banks that have Tier 1 capital
of more than 3 billion of euros) and 125 Group 2 banks (all the other banks). So this report
covers the Liquidity Coverage Ratio with the minimum requirement to be set initially at 60%
and then rise in equal annual steps to reach 100% in 2019. The weighted average LCR for
the Group 1 bank sample was 119% on 31 December 2013, up from 114% six month earlier.
For Group 2 banks, the average LCR remained unchanged at 132%. For banks in the sample,
76% reported an LCR that met or exceed 100%, while 92% reported an LCR at or above 60%.
The Figure 12 below shows this data on graph. (16)
- 57 -
Figure 12: Liquidity Coverage Ratio.
Source: Basel Committee on Banking Supervision.
Considering the Net Stable Funding Ration, Basel III issued a consultative document on
proposed revisions to the NSFR, and the latest update is in September 2014. The end-
December 2013 reporting period is the first data collection exercise for which a
comprehensive calculation of the revised NSFR could be conducted. The average NSFR for
the Group 1 bank sample was 111% while for Group 2 banks the average NSFR was 112%.
As of December 2013, 78% of the 208 banks in the NSFR sample reported a ratio that met or
exceeded 100%, while 88% of the banks reported an NSFR at or above 90%. (16) See the
Figure 13 and 14 for this information in graph and percentage statistic.
- 58 -
Figure 13: Net Stable funding ratio,
Source: Basel Committee on Banking Supervision. (16)
Figure 14: Liquidity Coverage ratio and Net Stable Funding ratio.
Source: Basel committee on Banking Supervision (16)
This process of achieving the set indicators for both ratios is not that simple, that is the
reason the implementation is extended for the long period of several years, as many banks
need to reconsider their business-models.
- 59 -
3.2 New requirements on information disclosure
High-profile scandals about disclosure and ratings of the largest financial institutions that
were in the edge to bankruptcy during crisis showed inadequacy of current requirements
to information disclosure: even complex and verified by auditors reports of the largest
international financial institutions did not reflect the real situation of the financial control
level and risk-management in bank. Therefore Basel committee has toughen the
requirements for information disclosure especially in calculations on capital adequacy,
securitization, off-balance sheet items and bonus and rewards payments. Moreover there
are new standards for verification of initial values and report data. These actions increase
the transparency of capital base: all elements of regulatory capital must be revealed in
relation with the financial report data of the bank – outside players must have a clear
understanding of the way bank gets a given capital adequacy level.
3.3 Control of systemically important financial institutions
Basel Committee implemented the additional requirements on the capital adequacy level
for the financial organizations that are very important for the whole system. What does it
mean? Analyzing the importance of the bank for the global financial system is held on the
basis of indicative rates in the following categories: size, connection, cannot be replaced,
the level if cross-jurisdictional activity and complexity of the business. Each of category
has an equal weight (20%) and includes some indicators. Basel Committee introduced the
first list of systemically important financial institution (SIFI or other variant is G-SIBs –
Global Systemically important banks) in 2009. It is assumed that this list is going to be
reconsidered annually. The level of importance leads to the special additional
requirements that are created for such banks considering capital Tier I adequacy (1-
2.5%). Moreover the Committee is planning to increase the additional requirements in
the nearest future. These activities are created to minimize the system risk and solving
the problem of so-called “too-big-to-fail” and make banks to reserve additional capital in
case of their importance. But we see that this reform has more quantitate then qualitative
- 60 -
effect, as these standards do not suggest to implement additional requirements to the
assets quality of such organizations.
Financial Stability Board published “2014 update of list of global systemically important
banks (G-SIBs)” on the 6th of November 2014: “The FSB and the BCBS have updated the list
of G-SIBs, using end-2013 data and the updated assessment methodology published by the
BCBS in July 2013. One bank has been added to the list of G-SIBs that were identified in 2013,
increasing the overall number from 29 to 30 (Agricultural Bank of China has been added)”.
(17) The full list is attached in the Appendix 2.
To say more: “the bucketing approach is used in that rating. The BCBS document - Global
systemically important banks: updated assessment methodology and the higher loss
absorbency requirement – sets this approach. Banks that have a score produced by the
indicator-based measurement approach that exceeds a cutoff level set by the Committee will
be classified as G-SIBs. Supervisory judgment may also be used to add banks with scores
below the cutoff to the list of G-SIBs.” (18)
On the table below the score range is provided for each bucket, according to BCBS.
Table 10: Bucketing approach.
Source: Global systematically important banks: updated assessment methodology and the higher loss
absorbency requirement, BIS
According to Financial Stability Board “the assignment of the G-SIBs to the buckets in the
updated list published today determines the higher loss absorbency requirement that will
apply to each G-SIB as these requirements begin to be phased in from 1 January 2016 (with
full implementation by 1 January 2019). The higher loss absorbency requirements for the G-
- 61 -
SIBs identified in the annual update each November will apply to them as from January
fourteen months later.” (17)
3.4 Full-on Risk Coverage
The Basel III framework implements the reasonable strictness and the increase of
requirements considering the risk coverage of portfolios, securitization transactions and
transactions with derivatives. Special attention is given to the Counterparty credit risk
value (CCR). Basel III regulations explains importance of this risk as a “need to ensure that
all material risks are captured in the capital framework in addition to raising the quality
and level of the capital base. Failure to capture major on- and off-balance sheet risks, as well
as derivative related exposures, was a key factor that amplified the crisis.” (7)
Additionally,
Banks must have a comprehensive stress testing program for counterparty credit risk
that includes several elements: for all counterparties bank have to produce (at least
on a monthly base) exposure stress testing of principal market risk factors in order to
proactively identify and in some cases reduce outsized concentrations to specific
directional sensitivities; banks must ensure complete trade capture and exposure
aggregation across all forms of counterparty credit risk at the counterparty-specific
level in a sufficient time frame to conduct regular stress testing. (7)
According to the Basel III framework, “the counterparty credit risk includes:
1. Calibration of diffusion parameters in stressed effective expected positive exposure
(EEPE) calculations;
2. Introduction of an additional capital charge to cover the risk of change in credit
valuation adjustments of a training portfolio. There are two methods for assessing
this charge are offered by BCBS.” (19) For portfolios valued by using the standard
method the formula is the following as on the Figure 15:
- 62 -
Figure 15: the formula for portfolios that use standard method.
Source: Accenture.
And for portfolios valued using IMM (and the case of banks already using an internal
model for interest rate VaR), the method is based on applying the VaR model used for
bonds to the regulatory CVA. For this cases the following formula is used as on the Figure
16:
- 63 -
Figure 16: Formula for portfolios using IMM
Source: Accenture
3. Specific wrong way risk (WWR).
Specific WWR for unfavorable correlation quantifies the negative correlation between
the risk exposure to a counterparty and its credit quality (for instance a put option
purchase on a counterparty legally bound to the counterparty issuing the underlying
instrument). When the Basel III capital requirements regulations (CRR) come into
application, transactions carrying specific WWR with unfavorable correlation will
have to be identified, isolated from the overall compensation node of origin and
assigned to a practical computation processing to calculate their exposure at default
(EAD). (19)
4. General wrong way risk. The General form of WWR arises in that case when the
credit quality of the counterparty for non-specific reasons may be connected with
different macroeconomic factors that may also impact the exposure of open
derivatives transactions. This type of risk refers to those economic factors that are
hard to find in a bank trading book and it is difficult to measure. (19)
5. Increase of the margin period of risk: the margin period of risk (MPR) is the time
period overseeing the last exchange of collateral used to cover netting transactions
with a defaulting counterparty and the resulting market risk is re-hedged. With
- 64 -
such an indicator it is possible to model the change in market value of the collateral
exchange during a theoretical date of collateral exchange and the calculation date
of subsequent exposure. In some situations (connected more to illiquid netting
sets) banks will have to move from 10 days (according to the Basel II regulations)
to 20 days of the regulatory threshold (with the possible doubling of this threshold
at least two disputes on the same set of compensation have been observed over
the last six months). (19)
6. Collateral management – type of the effective and efficient allocation of collateral
(the security that is provided by one party to another to decrease the counterparty
risk for any extension of credit or financial exposure) to reduce risk and
encompasses both supply and demand components. (19)
New requirements of calculation methods of Value-at-Risk (VaR) are brought in to focus.
The Basel II framework for market risk was reviewed and new regulations are in Basel III.
In addition to the Basel II market risk VaR (Internal Model) where under Basel II:
a) VaR computed on a daily basis.
b) At a 99% confidence level.
c) Over a 10 day holding period.
d) With an overall multiplier of 3 times VaR imposed. (20)
Moreover, banks must calculate a “Stressed Value at Risk measure” based on a 10 day
holding period, 99th percentile VaR with model inputs based on a 12 month Period (250 days)
of a period of continuous stress.” (20)
In this case the capital requirement C is equal to:
𝐶 = max{𝑉𝑎𝑅𝑡−1 ; 𝑚𝑐 ∗ 𝑉𝑎𝑅𝑎𝑣𝑔} + max {𝑠𝑉𝑎𝑅𝑡−1; 𝑚𝑠 ∗ 𝑠𝑉𝑎𝑅𝑎𝑣𝑔}
Where 𝑉𝑎𝑅𝑡−1 = VaR yesterday
Where 𝑉𝑎𝑅𝑎𝑣𝑔 = average VaR over a 60 day period
Where 𝑠𝑉𝑎𝑅𝑡−1= stressed VaR over a 60 day stress period
Where 𝑚𝑐 = multiplication factor of 3 (minimum)
- 65 -
Where 𝑚𝑠 = multiplication factor of 3 (min) (20)
Under Basel III “multiplication factor can be increased by up to 1 if model performs poorly
based on back testing by regulators as per “traffic light” system.” (20)
Now, the reader has a general impression on the Basel III accord and its specific
regulations and requirements for banks. Therefore now it is possible to apply these
theoretical knowledge while studying the specific bank.
- 66 -
- 67 -
4. Risks Analysis for Banks
In this chapter I am going to take a closer look on the analysis of the risk that are covered
by Basel III accord and take some practical examples, how to apply the theoretical
knowledge in practice.
The Liquidity risk takes a very important place in Basel III regulations. In this section I am
going to study mostly possible liquidity risk management on the example of the Russian
subsidiary of one Italian bank.
Banca Intesa is a part of Intesa Sanpaolo group that was formed by the merger of Banka
Intesa and Sanpaolo IMI. The merger brought together two major Italian banks with
shared values so as to increase their opportunities for growth. Intesa Sanpaolo is among
the top banking groups in the euro zone, with a market capitalization of 40.5 billion euro
as at 28 November 2014.
Intesa Sanpaolo has selected presence in Central Eastern Europe and Middle Eastern and
North African areas with approximately 1 400 branches and 8.4 million customers
belonging to the Group’s subsidiaries operating in retail and commercial banking in 12
countries. On the Figure 17 there is a ranking of European Banks by Bloomberg and on
that chart Intesa Sanpaolo is on 11th position.
Intesa Sanpaolo owns 100% stake in Banca Intesa. I have chosen this bank, because it is
the subsidiary bank of the large EU bank group, therefore operating in Russia despite the
orientation on the standards of the controlling company, this bank has to follow the
standards set by Central Bank of Russia. Moreover Basel III is actively implementing in
European banks and encourages the same. The parallel execution of different standards
increases the security and stability of bank’s liquidity management and fully fits the “low-
key approach” as the main principle of liquidity management in this bank.
- 68 -
Figure 17: Ranking of European Banks by Bloomberg.
Source: Intesa Sanpaolo presentation.
Generally the latest financial statement of the Intesa Sanpaolo to the date of 30th
September 2014 shows us that the profitability ratio is improving accordingly to the
business plan of 2014-2017. Group continues to strengthen what is proven by the recent
results of stress-tests held by European Central Banks for EU banks. According to the
stress-test results the CET1 ratio is above the minimum set by regulators in the beginning
of stress-test. And before in 2013 the group showed also very good results having Basel 3
common equity ratio pro-forma growth till 12.3% from 10.6% to the end of 2012, Core
Tier 1 ratio was 11.9% and Tier 1 ratio was 12.8%. Common equity ratio pro-forma after
accrued dividends in 9 months of 2014 is 13% fully loaded and 13.3% phased in.
- 69 -
As Banca Intesa says on its official web-site it plays “a key role in Russian-Italian economic
relations. The Bank successfully supports investments and commercial projects of Italian
companies working in Russia as well as Russian firms working in the Italian market.” (21)
According to Moody’s Banca Intesa has the D rating on financial stability, that means that
bank shows limited financial stability and time to time needs the outside support. I think
that the reason of assigning the D rating was the unstable and unpredictable operation
environment in which bank is functioning. Long-term ratings in foreign and national
currencies lowered till Ba1, in other words it indicates that debt obligation are under the
reasonable credit risk. And that is really true, the overdue in total loan portfolio is 10%,
what is significantly higher than average rating in this field (4%). Short-term liabilities
rating is P-3 that means that emitents are able to cover short-term liabilities.
Liquidity risk is the risk to get losses as the result of incapability to fulfil the bank’s
obligations fully. This risk arises as the result of misbalance of assets and liabilities or
when it is the necessity to pay all its liabilities by bank immediately and in all parts.
Below see the provided information on liquidity indicators of credit organizations in
Russia in recent years (Figure 18).
- 70 -
Figure 18. Liquidity indicators for banks.
Source: Central bank of Russia. The report of bank sector and bank supervision development in 2013.
The indicator of long-term liquidity in 2013, as it is seen from the data above, increased
in comparison with 2011 up to 85.5 % (the weighted structure of long-term assets of
credit organizations maintains). The maximum indicator value can be 120% that means
that banks have the possibility to provide long-term loans to the economy.
The indicator of quick liquidity increased in comparison with the small decrease in 2012
and reached the same numbers as in 2011 – 63.2%, whereas the standard value is 15%.
The common liquidity indicators are still remain higher than the standard value of 50%.
Liquidity risk management is held in the following key directions in Banca Intesa:
Main indicators;
Liquidity reserves;
The policy of short-term liquidity management (estimating of quick liquidity
indicators and common liquidity indicators);
Intraday policy of liquidity management and operational liquidity management
(methods that are applied by the Treasury);
63,259
63,2
87,581,9
84,878,3
83,5 85,5
0
10
20
30
40
50
60
70
80
90
100
2011 2012 2013
Liquidity indicators for banks
Quick liquidity Common liquidity Long-term liquidity
- 71 -
Stress-tests (are held for different scenarios and indicates the liquidity risks of
banks and the necessary reserves of liquidity assets);
Plan for liquidity management in emergency cases.
On the graph below (Figure 19) I reflected the general situation of liquidity for Bank Intesa
from the year 2007 till 2014. In Appendix 3 see the table with the data that was used to
build this graph.
Figure 19: Liquidity.
Source: Financial statements of Bank Intesa,1
The Quick liquidity ratio (Figure 20) indicates the risk when the bank loses the liquidity
during one operational day.
1 See Appendix 3.
0
0,2
0,4
0,6
0,8
1
1,2
1,4
1,6
1,8
01
.09
.07
01
.12
.07
01
.03
.08
01
.06
.08
01
.09
.08
01
.12
.08
01
.03
.09
01
.06
.09
01
.09
.09
01
.12
.09
01
.03
.10
01
.06
.10
01
.09
.10
01
.12
.10
01
.03
.11
01
.06
.11
01
.09
.11
01
.12
.11
01
.03
.12
01
.05
.12
01
.08
.12
01
.11
.12
01
.02
.13
01
.05
.13
01
.08
.13
01
.11
.13
01
.02
.14
01
.05
.14
01
.08
.14
01
.11
.14
Liquidity
Liquidity
- 72 -
Figure 20: Quick liquidity ratio of Bank Intesa.
Source: Annual financial statements.
According to the data that is presented on the graph above (Figure 21), I can provide the
conclusion that in February 2014 85.64% of demand liabilities can be fulfilled, what is
higher in 19.33% than the ratios of January 2014. And we see that this is the positive
dynamic.
The LCR indicates the liquidity risk in the nearest 30 days.
102,7
65,5
51,35
75,7
51,6
85,64
0
20
40
60
80
100
120
01.01.10 01.01.11 01.01.12 01.01.13 01.01.14 01.02.14
Quick liquidity ratio (min. 15%)
Quick ratio
- 73 -
Figure 21: Liquidity Coverage Ratio of Bank Intesa.
Source: Annual financial statements.
As it is seen in the graph above, the LCR is higher than 50%. And according to this data I
make a conclusion that in February 2014 bank was able to fulfil its obligations in the
amount of 90.35%.
Long-term liquidity ratio limits the risk of liquidity loss by bank. This ratio was 67.5% on
the date of 01.01.2013, and it was equal to 56.5% on the date of 01.01.2014. (22) The
maximum indicator value can be 120% that means that banks have the possibility to
provide long-term loans to the economy. (See the Figure 22 below). So based on this
information I come up with the conclusion that 56.5% long-range bank’s investments are
secured with long-term resources.
176,7
7985,6
91,4
77,590,35
0
20
40
60
80
100
120
140
160
180
200
01.01.10 01.01.11 01.01.12 01.01.13 01.01.14 01.02.14
LCR (min. 50%)
LCR
- 74 -
Figure 22: Long-term liquidity ratio of Bank Intesa.
Source: Annual financial statements.
All the data provided above helps us with some conclusions and recommendations for the
bank to improve its operational activity according to the standards of Basel III and
regulator’s requirements. The Bank maintains the ratios indicators on the good level and
does not allow to lower them to the critical value, thus there is a slight tendency of
performance degradation in 2014 in comparison with the year of 2013. For Bank it is very
important to pay attention to this tendency and not to allow to make it worse.
It is impossible to ignore the latest events in the geopolitical arena in Ukraine, the
implemented and planned sanctions to Russia from the western countries, gradual
devaluation of ruble and increasing outflow of capital abroad. These all again stressed the
importance of wise risk management in commercial banks. Therefore I suggest three
possible solutions for Bank Intesa to level up the risk management:
1. To negotiate with parent company the possibilities of extension of risk
management options in case of emergency;
79,9
117,1
102,4
67,5
56,5
0
20
40
60
80
100
120
140
01.01.10 01.01.11 01.01.12 01.01.13 01.01.14
Long-term liquidity ratio (max. 120%)
Long-term liquidity ratio
- 75 -
2. Implementing the payment system that allows more rapidly and riskless to make
transactions between parent company and Banca Intesa;
3. Modeling the forecasts for risk liquidity-dissolution management in the bank.
Parent company apply concrete obligations on the accounting and data reporting of its
subsidiaries in the exchange providing its subsidiaries reasonable funding and benefits of
foreign bank. Currently Banca Intesa does not have the cash settlement system CLS, which
could allow to make the payments between parent company and its subsidiaries with
minimum time spent on it and without any additional risk that is actually the realization
of the benefits of parent company.
Current information that can be used for liquidity risk management (for instance capital
adequacy ratios) has static nature and does not provide the necessary information about
the dynamic of those ratios. In the course of unpredictable behavior of the financial
markets such static data can lead to underestimation of potential risks for bank and to
limited options for well-timed management of such risks.
Another important thing for bank in our opinion is the development of forecast
instruments for modelling the potential inflows and outflows of bank liquidity. Recently
the situation appears when the co-relation between business unit of the bank and the
Treasury is almost absent that makes it more complicated to forecast the potential risks.
The collected historical data of bank’s clients’ behavior, possible money withdrawal from
deposit accounts and the requests for new credit tranche would be able to help to make
more weighted decisions for necessary fund raising on different terms to cover potential
liquidity outflow risk and as the result could minimize the liquidity risk.
The liquidity ratios analysis indicated the efficiency of applied methods for liquidity risk
management and interest rate. Nevertheless, I consider that abovementioned suggestions
will allow to take effective strategic decisions in risk management that will lead to more
determined approach in bringing in the necessary liquidity to cover the cash inflows and
outflows as well as decrease of possible loss because of interest rate fluctuations.
- 76 -
Capital adequacy is also covered in the bank’s reports. The Bank sets the primary
objectives of the bank management as following: to make the full compliance with the
capital requirements imposed by the CBR (Central Bank of Russia) and Russian
legislation; maintaining the Bank’s ability to continue as a going concern in order to
maximize shareholder value and provide economic benefits to other parties; ensuring
that the amount of capital is sufficient for business expansion and development.
The recent data for capital adequacy under Russian Legislation is as on Figure 23:
Figure 23: Bank’s CBR defined capital adequacy ratio.
Source: Annual financial statement of Bank Intesa.
In 2013 the CBR introduced a Basel III compliant framework for regulation of capital
adequacy. The CBR requires banks “to maintain a minimum capital adequacy ratio of 10%
with respect to risk-weighted assets as computed in accordance with Russian Accounting
Standards.” (23)
The Bank also applies Basel III Framework for calculation of capital adequacy using the
simplified standardized approach for credit risk measurement, the standardized
measurement method for market risk and the basic indicator approach for operational
risk estimation.
The recent data for Capital adequacy ratio under the Basel Capital Accord is as on the
Figure 24:
- 77 -
Figure 24: Bank’s Basel Accord defined capital adequacy ratio.
Annual financial statement of Bank Intesa.
The risk-weighted assets are “measured by means of a hierarchy of risk weights classified
according to the nature and reflecting an estimate of credit, market and other risks
associated with each asset and counterparty, taking into account any eligible collateral or
guarantees.” (23)
Finally, I will provide shortly the information on how the Bank deals with other types of
risks.
The Bank manages its market risk by establishing open positions limits related to financial
instruments, interest rate maturity, stop-loss limits and currency positions. The
abovementioned positions are monitored regularly and the Board of Directors is
responsible for reviewing and approving. Exposures are classified to market risk by Bank
into trading and non-trading positions. Banca Intesa calculates the same risk indicators
on the available-for-sale portfolio as for the trading portfolio. That is done for risk
management purposes. Value at Risk methodology is the main methodology for
monitoring and managing the market risk for the trading portfolio. This method reflects
the interdependency between risk variables. Other sensitivity analysis is used for
managing and monitoring of non-trading positions.
- 78 -
Operational risk is assessed in accordance with the methodology of the parent company.
Additionally, Bank creates reserves for losses from operational risk events, and calculates
the required capital to cover operational risk.
As a conclusion to this practical chapter I can say, that the Bank I were studying has a very
good positions in the financial market of Russia, along with its parent company Intesa
Sanpaolo that has very strong positions in Europe.
The analysis of statistical data and financial activity of Banca Intesa has not revealed any
negative tendencies that can affect the financial stability of the bank in future.
- 79 -
Conclusion
Basel III is a result of Basel Committee on Banking Supervision’s work that aims to make
banks to follow the standardized regulations. Nevertheless the regulations are claimed to
be not obligatory, still financial institutions worldwide are implementing the rules as it
ease the cooperation globally, additionally the requirements supposed to help banks to
be more stable during crisis period.
The good example of Basel III being not obligatory is the following: whereas Basel III
allows the gradual increase of requirements to the capital (on the regulator’s decision)
3.5% in 2013, 4% in 2014 and 4.5% in 2015, some countries were not using this
possibility. For instance, China implemented the 5% requirements for capital adequacy
and India implemented even 5.5%.
Implementation of the Basel III regulations is a difficult and time-consuming process,
member countries face obstacles while integrating the standards in their financial
activity. The USA and European Union were changing the dates when Basel III supposed
to get in force. The first deadline was the 1st of January 2013. In Argentina, Brazil and
Russia these requirements should have been implemented by the end of 2013.
Nevertheless, in Russia, Basel III is not implemented yet, and Central Bank of Russia
recently announced of another postponement of the date, from the 1st of January 2014 to
the 1st of July 2014. According to the official announcement it was caused by difficulties
to obtaining long-term resources by banks. Though analysts consider that this decision
made by Central Bank was done as the result of recent geopolitical situation, sanctions
and worsen macro economy in the country.
There is not so positive tendency in the banking system of European Union zone as well.
The European Central Bank, which tested the euro zone’s biggest banks, said 25 lenders
had failed, others only barely passed and there is a total capital shortfall of 24.6 billion of
euro. Taking account of capital raised this year, the shortfall decreases to 9.5 billion of
euro.
- 80 -
The tests, which looked at end-2013 balance sheets, were carried out by the European
Central Bank and the European Banking Authority. They were estimating how lender
investments would fare under a baseline scenario, which assumed the economy
development as expected until 2016, and a crisis scenario. The crisis scenario assumes
the EU economy would slip into a two-year recession, shrinking by 0.7% this year and
1.5% next year, and barely grow in 2016.
There is a tendency of the unemployment rate to get higher in recent years and the whole
situation of house and stock prices will be worsened. For banks not to collapse as well
and to survive, banks are required a core capital buffer that equals to 8% of risk weighted
assets for the base scenario, and 5.5% for the adverse.
Different situation is with banks who failed the stress-test. Those banks need to increase
their capital buffers either by selling new shares or divesting assets. Banks which cannot
find capital from private sources may need help from their governments. Banks that fail
only in the crisis scenario are given nine months.
The main question is if all the Basel III recommendations help to increase the steadiness
of banking system. And it is possible to answer the question in two ways.
During the normal conditions for business operations, when banks are able to evaluate
the risks, less level of capital is needed for banks’ sustainable operating. But from the
other point of view, if risks are estimated wrongly, the increase of capital pillar according
to Basel III will not be enough. For instance, if there is a bank that was not even operating
with mortgage loans that collapsed the financial system in 2007-2009, it still can easily
face the sharp increase of loan default percent.
Therefore, Basel III protects banking system from small cyclical risks. But it is important
to note that it protects only from cyclical risks, it is hardly to happen that Basel III can
protect from the crisis or debt crisis in EEC (Greece).
The negative points of Basel III are the following.
- 81 -
First of all, banks may need a huge amount of money for share capital inflow in the
following 8 years. And it is still unclear where banks can gain such a financial resources
in the conditions of very slow global economy growth.
Secondly, the increase of capital means the increase of cost of capital that leads for banks
to increase the profit at least twice. As a chain reaction, these processes are leading to the
growth of the interest rate for loans. This growth of interest rate will not be large (not
more than 0.25% annually) but even this small growth can damage the economy.
Thirdly, it is more likely that the banking system will face M&As especially in European
Union. M&As will decrease the amount of banks, competition in banking sector and the
stability of the whole system (as the less players are on market, the less stable is the whole
system).
Nevertheless, Basel III regulations support banks, because all the ratios and standards
help to improve risk analysis and to see the weak parts. The bank that was analyzed in the
practical part of this paper can serve a good example of this.
- 82 -
- 83 -
Bibliography
1. BIS. About BIS- History - Overview. Bank for International Settlements. [Online] BIS, June 29, 2003. [Cited: November 15, 2014.] http://www.bis.org/about/history.htm.
2. Basel Committee on Banking Supervision. Working paper No.13. Basel : Bank for International Settlements, 2004. ISSN 1561-8854.
3. BIS. About BIS. Bank for International Settlements. [Online] BIS, October 17, 2014. [Cited: December 30, 2014.] http://www.bis.org/about/.
4. Ozdemir Bogie, Miu Peter. Basel II implementation: a guide to developing and validating a compliant internal risk rating system. New York : McGraw-Hill, 2009. ISBN 978-0-07-159132.
5. Basel Committee on Banking Supervision. International Convergence of Capital Measurement and Capital Standards. Basle : BIS, 1988.
6. —. Basel II: International Convergence of Capital Measurement and Capital Standards:A Revised Framework - Comprehensive Version. Bank for International Settlements. [Online] June 2006. [Cited: June 19, 2013.] www.bis.org/publ/bcbs128.pdf.
7. —. Basel III: A global regulatory framework for more resilient banks and banking systems. Basel : Bank for International Settlements, 2010. ISBN web: 92-9197-859-0.
8. Settlements, Bank for International. The Basel Committee's response to the financial crisis: report to the G20. [Online] Bank for International Settlements Communications, October 2010. [Cited: December 7, 2014.] http://www.bis.org/publ/bcbs179.pdf. ISBN 92-9197-851-5.
9. Schoenmaker, Dirk. Contagion Risk in Banking. [Online] [Cited: November 20, 2014.] http://www.imes.boj.or.jp/cbrc/cbrc-03.pdf.
10. U.A., Anisimova. Models of financial instruments hedging on the energy market/Модели хеджирования финансовых рисков на рынках электрической энергии (мощности). [Vektor Nauky of Togliatti State University/Вектор науки Тольяттинского государственного университета №3 (21)] Togliatti : Tolliatty, 2012.
11. Moody's. 1-Basel III Implementation in Full Swing - Global Overview and Credit Implications. Moody's investor service. [Online] Moody's, August 04, 2014. [Cited: December 15, 2014.] http://www.btinvest.com.sg/system/assets/27262/Basel%20III%20Implementation%20in%20Full%20Swing%20-%20Global%20Overview%20and%20Credit%20Implications%204Aug14.pdf.
12. Basel Committee on Banking Supervision. Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools. Basel : Bank for International Settlements, 2013. ISBN 92-9197-912-0.
- 84 -
13. Bank for International Settlements. Basel III: the net stable funding ratio. Bank for International Settlements. [Online] Bank for International Settlements. [Cited: December 6, 2014.] http://www.bis.org/bcbs/publ/d295.htm.
14. Basel Committee on Banking Supervision. Basel III: the net stable funding ratio. Basel : Bank for International Settlements, 2014. ISBN 978-92-9131-960-2.
15. EY Basel III liquidity requirements and implications - Required stable funding (RSF) and available stable funding (ASF) - EY - Global. EY. [Online] Ernst&Young, 2014. [Cited: November 27, 2014.] http://www.ey.com/GL/en/Industries/Financial-Services/Banking---Capital-Markets/Basel-III-liquidity-requirements-and-implications---Required-stable-funding--RSF--and-available-stable-funding--ASF.
16. Basel Committee on Banking Supervision. Basel III Monitoring Report as of 31 December 2013. Bank for International Settlements. [Online] Bank for International Settlements, september 10, 2014. [Cited: december 6, 2014.] http://www.bis.org/publ/bcbs289.htm.
17. Financial Stability Board. 2014 update of list of global systemically important banks (G-SIBs). [Online] November 6, 2014. [Cited: December 8, 2014.] http://www.financialstabilityboard.org/wp-content/uploads/r_141106b.pdf.
18. Basel Committee on Banking Supervision. Global systematically important banks: updated assessment methodology and the higher loss absorbency requirement. [Online] July 2013. [Cited: December 8, 2014.] http://www.bis.org/publ/bcbs255.pdf. ISBN 92-9197-947-3.
19. Accenture. Counterparty Credit Risk and Basel III. A framework for successful implementation. s.l. : Accenture, 2013. 13-3568.
20. Saunders, Professor Anthony. Basel III: The reform propolsals summary. 2011.
21. Profile. About the bank, Banca Intesa. Banca Intesa. [Online] [Cited: December 24, 2014.] http://www.bancaintesa.ru/en/about/today/.
22. Banca Intesa. Banca Intesa, Interim Condensed Consolidated Financial Statements. Moscow : Banca Intesa, 2014.
23. CJSC Banca Intesa. Interim Condensed Consolidated Financial Statements. Moscow : Banca Intesa, 2014.
24. S.N., Vasilenko. Оценка влияния Базель III на Российский банковский сектор/Basel III influence estimation on the Russian Bank sector. [Article]
25. Steinhauser, Gabriele. The Wall Street Journal. Market & Finance: The Wall Street Journal. [Online] Dow Jones & Company, Inc., October 26, 2014. [Cited: December 26, 2014.] http://blogs.wsj.com/moneybeat/2014/10/26/how-the-european-stress-tests-worked/.
26. Dendrinou, Viktoria. Markets&Finance The Wall Street Journal. The Wall Street Journal. [Online] Dow Jones & Company, Inc., October 26, 2014. [Cited: December 26,
- 85 -
2014.] http://blogs.wsj.com/moneybeat/2014/10/26/here-are-the-european-banks-that-failed-the-stress-test/.
27. Intesa Sanpaolo. Italian Leader with a European Scale. http://www.group.intesasanpaolo.com. [Online] December 22, 2014. [Cited: 12 27, 2014.] http://www.group.intesasanpaolo.com/scriptIsir0/si09/contentData/view/Brochure_istituz_en.pdf?id=CNT-04-00000000418CF&ct=application/pdf.
28. Dyk, Francois van. Basel III: An Overview of the safer's safety net. s.l. : Official Magazina of the South African Institute of Financial Markets, the South African Institute of Financial Markets, 2014.
29. Rodriguez, L.Jakobo. Banking Stability and the Basel Capital Standards. Cato Institute. [Online] 2003. [Cited: November 27, 2014.] http://object.cato.org/sites/cato.org/files/serials/files/cato-journal/2003/5/cj23n1-12.pdf.
30. Basel Committee on Banking Supervision. Fact Sheet - Basel Committee on Banking Supervision. Bank for International Settlements. [Online] [Cited: June 15, 2013.] www.bis.org/about/factbcbs.htm.
- 86 -
List of figures
Figure 1; Core Components of Basel I .............................................................................................. - 16 -
Figure 2: Timeline of Basel Accords implementation................................................................ - 17 -
Figure 3: Basel II: Advanced IRB approach 1 ................................................................................ - 19 -
Figure 4: Capital requirements Basel II/Basel 2.5 vs. Basel III .............................................. - 29 -
Figure 5:Phase-in arrangements Basel III capital requirements. ......................................... - 30 -
Figure 6: Basel III phased implementation. ................................................................................... - 37 -
Figure 7: The process of the countercyclicality ........................................................................... - 39 -
Figure 8: Leverage ratio implementation ...................................................................................... - 41 -
Figure 9: Tier 1 Leverage Ratios in different regions. ............................................................... - 42 -
Figure 10: Categories of HQLA. Level 1 Assets ............................................................................. - 47 -
Figure 11: NSFR ASF and RSF. ............................................................................................................ - 55 -
Figure 12: Liquidity Coverage Ratio. ................................................................................................ - 57 -
Figure 13: Net Stable funding ratio,.................................................................................................. - 58 -
Figure 14: Liquidity Coverage ratio and Net Stable Funding ratio. ...................................... - 58 -
Figure 15: the formula for portfolios that use standard method. ......................................... - 62 -
Figure 16: Formula for portfolios using IMM ............................................................................... - 63 -
Figure 17: Ranking of European Banks by Bloomberg. ............................................................ - 68 -
Figure 18. Liquidity indicators for banks. ...................................................................................... - 70 -
Figure 19: Liquidity. ............................................................................................................................... - 71 -
Figure 20: Quick liquidity ratio of Bank Intesa. ........................................................................... - 72 -
Figure 21: Liquidity Coverage Ratio of Bank Intesa. .................................................................. - 73 -
Figure 22: Long-term liquidity ratio of Bank Intesa. ................................................................. - 74 -
Figure 23: Bank’s CBR defined capital adequacy ratio.............................................................. - 76 -
Figure 24: Bank’s Basel Accord defined capital adequacy ratio. ........................................... - 77 -
- 87 -
List of tables
Table 1: Risk weights per asset class 1 ........................................................................................... - 15 -
Table 2: Basel II: Standard approach for RWA ............................................................................ - 18 -
Table 3: The Comparison of Basel Accords. .................................................................................. - 22 -
Table 4. The weak points of Basel II and their improvement in Basel III. ........................ - 31 -
Table 5: The capital structure according to Basel III ................................................................. - 34 -
Table 6: Capital ratios in Basel III ..................................................................................................... - 35 -
Table 7: Min. capital conservation standards for individual bank. ...................................... - 35 -
Table 8: Capital buffers according to Basel II and Basel III .................................................... - 38 -
Table 9: Categories for outstanding maturing secured transactions and the amount to add to cash outflows. ...................................................................................................................................... - 50 -
Table 10: Bucketing approach............................................................................................................ - 60 -
- 88 -
- 89 -
List of Appendices
Appendix 1. The list of BCBS documents to form the Basel III accord.
Appendix 2. G-SIBs as of November 2014 allocated to buckets corresponding to required
level of additional loss absorbency.
Appendix 3. The data for Bank Intesa.
Appendix 1.
The list of BCBS documents to form the Basel III accord.
1. July 2011 Global systematically important banks: Assessment methodology and
the additional loss absorbency requirement – consultative document
2. July 2011 Pillar 3 disclosure requirements for remuneration.
3. July 2011 Basel III framework for liquidity - Frequently asked questions
4. July 2011 Basel III definition of capital - frequently asked question
5. June 2011 Basel III: A global regulatory framework for more resilient banks and
banking systems - revised version June 2011
6. May 2011 Range of Methodologies for Risk and Performance Alignment of
Remuneration
7. Jan 2011 Final elements of the reforms to raise the quality of regulatory capital
issued by the Basel Committee
8. Dec 2010 Capitalisation of bank exposures to central counterparties - consultative
document
9. Dec 2010 Basel III: International framework for liquidity risk measurement,
standards and monitoring
10. Dec 2010 Guidance for national authorities operating the countercyclical capital
buffer
11. Dec 2011 Results of the comprehensive quantitative impact study
12. Aug 2010 Proposal to ensure the loss absorbency of regulatory capital at the point
of non-viability - consultative document
13. Oct 2010 Principles for Enhancing Corporate Governance
14. Jul 2009 Guidelines for computing capital for incremental risk in the trading book
- final version
15. Jul 2009 Revisions to the Basel II market risk framework - final version
16. Jul 2009 Enhancements to the Basel II framework
17. Apr 2009 FSF Principles for Sound Compensation Practices
18. Jun 2006 Basel II: International Convergence of Capital Measurement and Capital
Standards: A Revised Framework - Comprehensive Version
Appendix 2
G-SIBs as of November 2014 allocated to buckets corresponding to required level
of additional loss absorbency.
Bucket G-SIBs in alphabetical order within
each bucket.
5
(3.5%)
(empty)
4
(2.5%)
HSBC JP Morgan Chase
3
(2.0%)
Barclays BNP Paribas Citigroup Deutsche Bank
2
(1.5%)
Bank of America Credit Suisse Goldman Sachs Mitsubishi UFJ FG Morgan Stanley Royal Bank of Scotland
1
(1.0%)
Agricultural Bank of China Bank of China Bank of New York Mellon BBVA Groupe BPCE Group Crédit Agricole Industrial and Commercial Bank of China Limited ING Bank Mizuho FG Nordea Santander Société Générale Standard Chartered State Street Sumitomo Mitsui FG UBS Unicredit Group Wells Fargo
Appendix 3
DATE Assets of Bank Intesa (thousands rub.)
Bank equity (thousands rub.) Liquidity Category
01.11.14 78 794 174 11 330 617 0.66 High liquidity
01.10.14 73 374 995 11 336 915 0.69 High liquidity
01.09.14 75 558 530 11 729 082 0.54 High liquidity
01.08.14 76 698 957 11 672 834 0.7 High liquidity
01.07.14 76 470 026 11 612 079 0.57 High liquidity
01.06.14 79 022 285 11 708 464 0.66 High liquidity
01.05.14 83 704 748 11 674 296 0.88 Very high liquidity
01.04.14 88 319 044 11 934 200 0.75 High liquidity
01.03.14 73 530 123 11 954 966 0.46 Moderate liquidity
01.02.14 76 352 750 11 923 023 0.47 Moderate liquidity
01.01.14 71 236 984 11 919 738 0.46 Moderate liquidity
01.12.13 90 085 363 11 931 940 0.76 Very high liquidity
01.11.13 2 953 103 1 793 499 0.45 Moderate liquidity
01.10.13 84 629 108 11 933 855 0.47 Moderate liquidity
01.09.13 84 827 905 11 919 749 0.51 High liquidity
01.08.13 83 245 444 12 003 707 0.47 Moderate liquidity
01.07.13 81 700 437 11 990 311 0.48 Moderate liquidity
01.06.13 80 153 694 11 944 456 0.46 Moderate liquidity
01.05.13 79 394 930 11 818 264 0.54 High liquidity
01.04.13 80 262 578 12 615 078 0.6 High liquidity
01.03.13 84 079 571 12 493 452 0.68 High liquidity
01.02.13 81 021 485 12 471 947 0.5 Moderate liquidity
01.01.13 82 585 301 12 531 712 0.65 High liquidity
01.12.12 86 141 408 12 742 327 0.41 Moderate liquidity
01.11.12 87 941 179 12 733 758 0.55 High liquidity
01.10.12 87 364 248 12 776 916 0.47 Moderate liquidity
01.09.12 82 553 087 12 695 373 0.56 High liquidity
01.08.12 85 298 306 12 535 536 0.58 High liquidity
01.07.12 89 887 751 12 650 572 0.6 High liquidity
01.06.12 85 933 583 11 960 413 0.48 Moderate liquidity
01.05.12 84 994 658 12 067 932 0.33 Average liquidity
01.04.12 84 994 658 12 067 932 0.33 Average liquidity
01.04.12 89 904 182 12 188 642 0.49 Moderate liquidity
01.03.12 86 887 769 11 994 749 0.42 Moderate liquidity
01.02.12 87 629 690 11 824 136 0.41 Moderate liquidity
01.01.12 93 750 887 11 648 011 0.45 Moderate liquidity
01.12.11 89 594 043 11 971 554 0.4 Moderate liquidity
01.11.11 87 580 443 11 813 897 0.53 High liquidity
01.10.11 93 378 681 11 986 290 0.47 Moderate liquidity
01.09.11 96 577 927 11 940 376 0.49 Moderate liquidity
01.08.11 95 323 156 11 700 338 0.48 Moderate liquidity
01.07.11 93 550 895 11 619 113 0.45 Moderate liquidity
01.06.11 91 377 021 11 513 620 0.64 High liquidity
01.05.11 88 923 463 11 440 785 0.56 High liquidity
01.04.11 84 158 864 11 318 488 0.57 High liquidity
01.03.11 83 713 424 11 244 943 0.45 Moderate liquidity
01.02.11 87 040 013 11 242 416 0.47 Moderate liquidity
01.01.11 87 166 568 11 151 029 0.58 High liquidity
01.12.10 80 455 000 11 043 772 0.41 Moderate liquidity
01.11.10 81 263 931 10 857 468 0.38 Average liquidity
01.10.10 74 107 395 10 960 595 0.46 Moderate liquidity
01.09.10 69 555 092 11 187 212 0.4 Moderate liquidity
01.08.10 76 395 587 11 102 268 0.4 Moderate liquidity
01.07.10 76 406 763 11 126 402 0.21 Low liquidity
01.06.10 75 228 613 11 052 976 0.41 Moderate liquidity
01.05.10 73 854 193 10 968 115 0.41 Moderate liquidity
01.04.10 72 587 217 11 094 570 0.62 High liquidity
01.03.10 71 850 665 10 918 634 0.74 High liquidity
01.02.10 73 471 591 10 957 134 0.46 Moderate liquidity
01.01.10 64 715 596 6 569 211 0.91 Very high liquidity
01.12.09 63 495 711 6 951 336 0.62 High liquidity
01.11.09 61 968 363 7 053 047 0.7 High liquidity
01.10.09 60 984 610 7 084 066 0.62 High liquidity
01.09.09 61 532 027 7 131 419 0.69 High liquidity
01.08.09 61 467 253 7 142 814 0.94 Very high liquidity
01.07.09 62 061 414 7 339 300 0.74 High liquidity
01.06.09 65 165 315 5 704 576 1.34 Very high liquidity
01.05.09 67 650 188 5 671 451 1.63 Very high liquidity
01.04.09 69 023 468 5 875 808 0.55 High liquidity
01.03.09 71 914 360 6 287 846 0.55 High liquidity
01.02.09 72 317 900 6 709 748 0.5 Moderate liquidity
01.01.09 72 005 710 7 107 268 0.7 High liquidity
01.12.08 73 081 655 7 069 196 0.36 Average liquidity
01.11.08 69 968 101 7 171 594 0.38 Average liquidity
01.10.08 68 851 755 7 214 188 0.78 Very high liquidity
01.09.08 65 837 557 7 429 910 0.16 Low liquidity
01.08.08 61 736 530 4 593 065 0.23 Low liquidity
01.07.08 57 900 357 4 525 170 0.38 Moderate liquidity
01.06.08 54 553 314 4 528 183 0.5 Moderate liquidity
01.05.08 52 579 767 4 536 772 0.49 Moderate liquidity
01.04.08 51 141 926 4 318 416 0.36 Moderate liquidity
01.03.08 45 677 433 4 425 887 0.46 Moderate liquidity
01.02.08 43 804 429 4 503 684 0.42 Moderate liquidity
01.01.08 43 615 445 4 271 435 0.48 Moderate liquidity
01.12.07 40 133 779 4 513 898 0.46 Moderate liquidity
01.11.07 38 035 389 4 463 666 0.44 Moderate liquidity
01.10.07 36 932 547 4 319 677 0.45 Moderate liquidity
01.09.07 36 882 941 4 482 690 0.5 Moderate liquidity
List of Abbreviations.
ASF - Available Stable Funding
BCBS - Basel Committee on Banking Supervision
CCB - Countercyclical Capital Buffer
EAD - Exposure of default
GHOS - The Group of Central Bank Governors and Heads of Supervision
G-SIB - Global Systematically Important banks
HQLA - High quality liquid assets
IMM - Internal Monitoring Model
LGD - Loss given default
LCR - Liquidity Coverage Ratio
MPR - Margin period of risk
NSFR - Net Stable Funding Ratio
OBSI - Off-Balance Sheet Instruments
PD - Probability of default
PSE - Public sector entity
SIFI - Systematically Important Finance Institution
SPE - Special purpose entity
WWR - Wrong Way Risk
