Basel III Ernst & Young approach
Leverage ratio A leverage ratio will be introduced as a supplementary measure to the Basel II risk-based framework.
• Capital distribution constraints will be imposed on
any bank not fully meeting the capital conservation buffer.
• The country-specific countercyclical buffer will be
interests within consolidated capital is being introduced.
Market and counterparty credit risk requirements
2012
Market risk
New stressed VaR, incremental risk capital charge, comprehensive risk capital charge for certain correlation trading portfolios, and additional securitization requirements
Regulatory capital adjustments Deductions for CET1 calculation
• Examples include goodwill, deferred tax assets (DTAs)
• A limit of 15% of CET1 capital has been set on the combined capital contribution from DTAs from temporary differences, significant investments in the common shares of unconsolidated financial institutions and mortgage servicing rights.
Counterparty credit risk • Effective expected positive exposure (EEPE) with
financial institutions
• New standards for the capitalization of exposures to
Total capital
Tier 1 capital
6%
6%
6%
6%
Required amount of stable funding
4.5%
4.5%
4.5%
2.5%
• To ensure the optimum legal entity structure to avoid trapped liquidity and capital as well as manage impact of IFRS changes
8% 4.5%
6%
Recession
RWAs
Models
Capital calculations
Counterparty risk
Liquidity calculations
Leverage calculations
Internal reporting
Regulatory reporting
Bank levy calculations
ICAAP
Stress testing
Remuneration policies
Data quality
Capital calculation
Given pressures on capital, banks must make sure usage is optimum. • Changing strategy where needed • Legal entity rationalization • Ensuring the capital requirement calculations are efficient: • Recognizing collateral • Other data issues are dealt with
Ernst & Young liquidity risk management approach
Concentration of funding
• Identifies the potential gaps between the contractual inflows and outflows of liquidity for defined time periods
• Analyzes concentrations of wholesale funding provided by significant counterparties, instruments and currencies
• E.g., overnight, 7 days, 14 days, 1, 2, 3, 6 and 9 months; 1, 2, 3, 5 and 5+ years
• Useful in assessing funding liquidity risk, if one or more of the sources are withdrawn, and potential exposure to currency exchange risk • No prescribed concentration limits; however, reporting expectations by time horizon
Available unencumbered assets
Market-related monitoring tools • Provides early-warning indicators in monitoring potential liquidity concerns
Jan 2019
n tio a iz im t p lo nt ti a p eme g a a C an ty m i d i Liqu
LCR
• Useful in assessing overall health of the market, industry or specific institution
sk Ri
e nc a rn ve o g
Specific requirements for reporting will be set by regulators and at the EU level by the European Banking Authority.
Reg ula tor y r Co epo rtin un g te rp ar ty ris k
Description Liquidity diagnostic tool
Governance • Operating model • Policies design • Enhanced ALCO
Stress testing • Business and regulatory stress test design • Stress test production • Quantitative stress factor development • Stress assumption validation • ILAA production and review
Liquidity risk systems and data program Support end-to-end liquidity risk systems and data enhancement programs: • PMO office • Target operating model • Business requirements definition • Vendor assessment and selection • Data management road map • Implementation planning • Implementation support • Business benefit measurement • Post-implementation review • Development of common data warehouses
Risk systems/data
R NSF
• No specific metrics are specified or required; however, guidance prescribes that accurate interpretation of liquidity impact of metrics is important
Gap analysis • Liquidity diagnostic • Best practice benchmarking
g tin es st res St
• No prescribed liquidity haircuts; however, monetization value is expected to be reported net of expected haircuts
Ca pi ta l
Liqu idit y
• Measures the amount of unencumbered assets a bank has which could potentially be used as collateral for secured funding • Useful in comparing ability to raise additional funds
Ernst & Young tools and accelerators Tool
The LCR by specific currency will track potential currency mismatch issues that could arise in a time of stress.
NSFR final amendments
Jan 2018
Recovery and resolution planning
Ernst & Young has extensive experience in helping banks in this area and has been instrumental in finding multibillion-dollar capital savings for individual firms.
Contractual maturity mismatch
LCR final amendments
Jan 2017
Counterparty credit risk
• Calculations are risk sensitive
petite Risk ap
Introduce NSFR minimum standard
Jan 2016
Stress testing
Liquidity
Boom
Leverage
NSFR minimum standard
Introduce LCR minimum standard
Jan 2015
Capital optimization
Capital ratio
4.5%
• No behavioral adjustments
NSFR observation period
Legal entity optimization
• To minimize regulatory pressure
Minimal capital (CET1)
There is a common set of liquidity monitoring metrics that capture specific information related to a bank’s cash flows, balance sheet structure, available unencumbered collateral and certain market indicators.
• Useful in indicating how much liquidity a bank would potentially need to raise if all cash outflows occurred at the earliest possible date
LCR observation period
Risk appetite
2%
>100%
LCR minimum standard
Strategic forecasting
Allowable capital Tier 1 + Tier 2 — shortfall and other deductions
4%
funding, but this is 65% for qualifying residential mortgages.
Bank reporting to regulators starts
• Capital/liquidity • Tax • Supervisory intensity
Legal entity optimization
• To make recovery and resolution planning easier
4.5%
• Controls • MI • Risk transparency • Risk-based remuneration
3.5%
outflow minus cumulative expected cash inflow over a 30-designated-day period (using specified stresses).
Jan 2014
8%
• Growth • Assets • Liabilities • Capital • Leverage
Business processes and practices
Optimum legal entity structure
Systems and operating models need to be fit for purpose to deal with all these areas
Boom
4%
• The net cash outflow is the cumulative expected cash
Basel III liquidity timeline
8%
N ► ot all banks will be subject to the same pressures — the new business model will not be the same for all.
Optimal risk governance
Liquidity target operating model
Liquidity conceptual framework
Regulatory reporting and assurance • Reporting build support • Tactical reporting tools • Reporting UAT support • Reporting assurance — process and control reviews, GL reconciliation
CFP and recovery and resolution planning • CFP action framework • Early-warning indicators
Detailed business requirements
Vendor selection
Contractual cash flow reporting tools
FTP and liquidity buffer costs • FTP benchmarking • Methodology development • Liquidity buffer pricing methodologies
Optimization
Liquidity conceptual technology architecture
• Minimizing the size
of the liquid assets buffer • Managing the structure of funding • Managing collateral and contingent items
Framework for liquidity reporting assurance reviews ►
LCR calculation engine
►
Basel definitions
The user can get further information by navigating via the linked arrows
LCR calculator, QIS reporting tools
BCBS 188 “Basel III: International framework for liquidity risk measurement, standards and monitoring “
The calculated LCR will be verified and analysed in the Reporting ►
Reporting
►
Scenario analysis
Global strengthening of regulatory regimes. Global increase in focus on stress testing and governance.
Liquidity risk
Stress testing
Adjustment because of countercyclical buffers
Trading books
Systemic importance
More focus on stress testing
Risk appetite
Regulatory stress tests and anchor scenarios
Systemically important financial institutions (SIFIs): intensive supervision; higher capital, bail‑in and CoCos; and recovery and resolution planning
• There is clear regulatory pressure following the crisis to enhance risk appetite and controls to deliver it. But boards and senior management are similarly focused on the need to improve risk appetite, risk transparency and controls to improve long-run profitability. • The boards of the firms that had the largest losses were not aware of the size of the risks being taken. A survey by Ernst & Young for the Institute of International Finance highlights that improvements in risk appetite continue to be high on the list of changes that many banks see as essential. ERM stress testing
Group liquidity
Risk appetite design
Capital and liquidity allocation
Governance
• Risk types
Topdown risk appetite statements Quantified hard limits and metrics
Iterative process
Capital
qualitative
• Aggregation • Consultation • Profit and growth • Contingency • RWAs
• Limits and controls • Targets • Incentives • Concentrations
Reverse stress testing Stress testing products
Stress test training
• Escalations and responsibilities • MI • Technology and data • Risk transparency
CVA modeling
CCRM
Stress EEPE modeling
Integrated balance sheet stress testing
Individual portfolio stress tests
Data quality
2013
• Develop robust statements of risk appetite through Ernst & Young-led board discussion workshops
• Designing the overarching framework
• Enhancing governance and controls
• Integrated strategic forecasting models
• Addressing data and process challenges
• Model the forward-looking business impacts of your strategy
• Design of macroeconomic stress tests
• Aligning IMM models with stressed market risk approaches
• Provide methodologies to allocate risk appetite down to business units as part of the firmwide business planning process
• Stress testing approaches for business portfolios
• Developing risk management processes and strategies for CVA
• Rigorous reverse stress testing approaches
• Supporting data quality initiatives
• Implementation of programs to embed risk appetite into business targets, limits, controls, reporting and remuneration schemes
2014
2015
2016
2017
2018
2019
Global contact
Minimum capital requirements
Patricia Jackson
3.5% CET1, 4.5% Tier 1, 8% total capital
UK
4% CET1, 5.5% Tier 1, 8% total capital
Tel: +44 (0)20 7951 7564
4.5% CET1, 6% Tier 1, 8% total capital
Email:
[email protected]
Regulatory capital adjustments 2014–18 % of total new deductions applied in the year increases 20% each year from 2014 to 100% in 2018. New capital buffers Countercyclical buffer
RWA
Capital conservation buffer
0%-0.625%
0%-1.25%
0%–1.875%
0%–2.5%
0.625%
1.25%
1.875%
2.5%
Market and counterparty credit risk requirements 2011 — Market risk requirements go live 2013 — Counterparty credit risk requirements go live
Leverage
Leverage ratio 2011 — Supervisory monitoring 2013 — Parallel run 2015 — Disclosure starts 2018 — Pillar 1 requirements Liquidity
Liquidity
Timeline
Integrated stress test design
Embed
Risk appetite
Stakeholder expectations • Regulators • Investors • Customers
2012
Allocate
Governance and controls
Macroeconomic outlook • 1, 3 and 5 years • Global, regional and country Historic loss data • Divisions • Geography
Structured approach to Pillar II
2011
Design
• Framework • Quantative and • Strategy linkage
Counterparty credit risk Macroeconomic stress testing
Governance
Enterprise-wide stress testing
National discretion and unlevel playing fields
Stress testing
ure ult dc an
Regulatory focus/ intensive supervision
Risk appetite
tes tin g
Intensified in many countries
Under intensive supervision requirements, regulators’ approaches will be reviewed by peer regulatory colleges
Risk awareness
En ter pri se -w ide str ess
Intensive supervision and enhanced Pillar II
Governance/risk
Forward regulatory agenda
Ernst & Young has extensive experience and tools to support the development of effective approaches.
ng ini Tra
Governance
Calculation results of the underlying scenario analysis will be displayed in the Reporting
Liquidity risk management
Available amount of stable funding
• 100% of illiquid assets need to be backed with stable
Jan 2013
1.875%
2.5%
rs ffe Bu
Liquidity
8%
1.25%
7%
• Improving finance models to assess the benefits of different strategies
Optimal balance sheet management
• Core portfolios • Core geographies • Core products
0%–2.5%
• Higher quantitative and qualitative requirements for
• It aims to ensure that each institution maintains
Jan 2012
2019
4.5%
The net stable funding ratio (NSFR) is designed to provide incentives for banks to seek more stable forms of funding.
Jan 2011
2018
• Optimizing strategy across three dimensions: capital, liquidity and leverage
Additional requirement for systemically important firms to be decided
5.5%
central counterparties (CCPs)
The liquidity coverage ratio (LCR) will prescribe the quantity of high-quality liquid assets a bank must have at any given time.
2 x further QIS
2017
8%
8%
NSFR: net stable funding ratio
an adequate level of unencumbered, high-quality assets that can be converted into cash to meet its liquidity needs for 30 days under a specified acute liquidity stress.
0.625%
8%
(WWR)
• Higher asset value correlation multiplier for large
2016
8%
• New explicit Pillar 1 capital charge for wrong way risk
CET 1 capital
≥100%
2015
0%–0.625% 0%–1.25% 0%–1.875%
• New credit valuation adjustment (CVA) charge
testing and model validation)
Total net cash outflows over the next 30 calendar days
2014
Countercyclical buffer
collateralized transactions
Stock of high-quality liquid assets
2013
Capital conservation buffer
stressed parameters
• Higher operational requirements (backtesting, stress
LCR: liquidity coverage ratio
Capital conservation buffer – stops profit being distributed
Optimum business strategy
Comply/minimize
(other than from temporary differences), intangibles, certain holdings in other unconsolidated financial institutions, shortfall of the stock of provisions to expected losses, defined benefit pension fund assets and investments in own shares.
arrangements will apply in the calculation of the exposure measure.
Strateg ic forec Le asting ga l en tity op tim iza tio n
• A new stricter approach to the inclusion of minority
0%-2.5%
applied to overheating markets. This buffer will vary between 0% and 2.5% of CET1.
• Tier 3 capital (available to cover market risk) is being eliminated. Innovative hybrid capital instruments with an incentive to redeem will be phased out. The phaseout period is 2013–21.
• The minimum Tier 1 leverage ratio is set at 3% for the observation phase.
• I► dentifying areas of business which are no longer profitable
assets. Data will also be collected during the observation period using total capital and CET1.
Risk awa reness
and a focus on CET1.
Non-allowable capital
• Basel II treatment of counterparty credit risk for OTC derivatives and cross-product netting
Setting strategy poses particular challenges in the new regulatory environment — given the substantial increases in required capital and liquidity buffers:
9.5%
• The ratio will require a minimum percentage of Tier 1 to gross on- and off-balance-sheet
Pil lar II
• In addition, there is a new tighter definition of Tier 1
will be added to the minimum CET1 level of 4.5%, bringing total CET1 to 7%. It will be built up in “good times” and can be drawn upon in “bad times.”
Indicative
of risk-weighted assets (RWA) but the proportion accounted for by Tier 1 is being increased. By 2015, the minimum level for common equity Tier 1 (CET1) will increase to 4.5% of RWA and Tier 1 to 6% of RWA.
Capital optimization
Strategic forecasting
Countercyclical buffer
Client issue
New capital buffers • A capital conservation buffer, of 2.5% of CET1,
Strategy
Minimum capital requirements • The minimum level for total capital will remain at 8%
Optimize
Capital
Timeline and requirements
2011 — Observation period LCR 2015 — LCR goes live 2011 — Observation period NSFR 2018 — NSFR goes live
© 2011 EYGM Limited. All Rights Reserved. 1132438.indd (UK) 06/11. Creative Services Group. EYG: EK0054
