The new international standard for banking regulation "Basel-3" was introduced after the crisis of 2007-2008. Its main task is to reduce the risks of the banking sector. However, the accelerated introduction of the new standard in Russia in itself carries significant risks.
Petr Rushailo
System of measures and weights
The Basel Committee on Banking Supervision was established in 1974 on the basis of the Bank for International Settlements, its main task was to develop standards that would improve the stability of the banking system. Almost a decade and a half later, in 1988, the first international standard appeared, called "Basel-1". It determined the methodology for calculating bank capital and its minimum level - at least 8% of the amount of risk-weighted assets.
The Basel-1 methods were corrected several times, but they underwent a truly serious modernization only 16 years later, in 2004, when the Basel-2 standard was introduced. By that time, the financial market had seriously changed: the sectors of derivative financial instruments and corporate bonds grew very strongly, complex structured products appeared - mortgage bonds, credit notes, that is, instruments for which the assessment of credit and market risks required completely different approaches than when assessing risks of an individual issuer or borrower.
With such a complex and dynamic market, moreover, a global one, it was rather difficult for regulators to react to its conjuncture by promptly changing asset valuation standards and capital adequacy requirements. Therefore, it was decided to give the largest banks "freedom of choice." They were given the right, in agreement with their national regulators, to use estimates based on their own models instead of standard risk assessments. When applied to credit risk, this practice has been referred to as the Internal Rating Approach (IRA).
Bankers took advantage of the chance that fell to their lot - over the next couple of years, the growth rate of lending accelerated significantly. And not only in Europe, where "Basel-2" was introduced, but also in the USA, where the process of credit expansion was due to various kinds of derivative instruments and inflation of banks' off-balance sheet liabilities. As a result, the monetary authorities started talking about the danger of another bubble forming and tried to prevent the market from overheating by increasing the value of money. How it ended is well known: the rise in interest rates in the United States led to the collapse of a weak link - a relatively small segment of subprime mortgages, after which it turned out that no one really understands the real risks embedded in structured financial products consisting of sets of various securities and instruments , as well as the volume of bank investments in such products. A crisis of confidence began, which instantly grew into a liquidity crisis, the market stopped, and only the heroic issuance efforts of central banks and cash infusions of governments managed to save most of the large banks.
“One of the main reasons that the economic and financial crisis turned out to be so severe was that the banking sectors of many countries allowed an excessive imbalance between their own funds and assets and off-balance sheet liabilities (excessive leverage). This was accompanied by a gradual decrease in the size and quality of banks' own funds "At the same time, many banks held insufficient liquidity. The banking system was thus unable to withstand the resulting systemic losses on commercial transactions and loans, and also could not withstand the immobilization of capital for large off-balance sheet risks that arose in the shadow banking system" , the Basel Committee later concluded.
It became clear that the risk management system in banks is still far from perfect. As a result, in 2009, the Basel 2.5 interim package was released, which tightened the requirements for assessing the risks of derivatives, and immediately after that, the Basel 3 standard, approved at the G20 summit in 2010.
"Basel-3" significantly tightens the principles of regulation prescribed in "Basel-2". First of all, the concept of the capital of the first level is specified, that is, the capital that must amortize losses in the period until the bank has yet been brought to bankruptcy. The concept of basic capital (ordinary shares and retained earnings) is introduced, for which separate adequacy ratios are established. Other forms of Tier 1 capital (subordinated loans, options, and others) are included in Tier 1 capital only under certain conditions (in particular, subordinated loans must be perpetual and contain conditions for conversion into ordinary shares). In addition, capital buffers are being introduced: a conservation buffer (accumulated during favorable periods to compensate for losses during unfavorable ones) and a countercyclical buffer (introduced by the regulator to protect the market from overheating).
New liquidity ratios are also being introduced - instant, short-term and long-term - and new methods and approaches to measuring and assessing risks. Tighter banking supervision standards, increased disclosure requirements and risk management are designed to keep new system. And in addition to this control system, a leverage indicator will also be introduced - the maximum ratio of the amount of assets, excluding risk weights, to capital.
The Basel-3 standard is being implemented in stages, the corresponding program is designed until 2019. Implementation timeline in different countries specific regulatory requirements and approaches vary, depending on the specifics of national regulation and the state of the country's economy. And in this regard, it seems that Russia, as always, will have a special path.
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Total limit on related persons (banking and non-banking): 15-75% of Tier 1 capital depending on the rating
Own arshin
Russia started the implementation of Basel-3 without actually implementing the main approaches of Basel-2 - domestic banks were not given the opportunity to evaluate all the benefits of self-assessment of risks within the framework of this standard.
On the one hand, this probably slowed down the pace of their development in the pre-crisis period, on the other hand, it may have made the crisis less painful: the majority were able to survive it by receiving unsecured refinancing from the Central Bank (not counting, of course, investment banks that were looking for bailouts in batches through sales to large universal banks both in our country and in the West; Bank of Moscow and Mezhprombank can also be ignored - these seem to be stories that have little to do with the crisis). It may have also played its role that the equity capital adequacy ratio in Russia was higher than that stipulated by Basel II—10% against 8% of risk-weighted assets.
True, their ability to handle market risks Russian banks ry nevertheless demonstrated - in the repo market, which almost completely stopped after the collapse in the stock market and it was necessary to unravel non-payments there with no less energy than after the 1998 default; This story cost the investment bank "KIT Finance" its life.
Nevertheless, the absence of a "golden" period according to Basel-2 may now create certain problems for Russian banks when implementing Basel-3. More precisely, not the standard itself, but advanced approaches related to the introduction of their own risk assessment systems.
The introduction of such systems, we recall, is voluntary. The bank may choose to operate the old way, using the "standard approach", i.e. the standard risk ratios corresponding to different types assets. And the transition to "individual plans" is a rather expensive procedure, it requires not only the development and implementation of appropriate methods, management procedures and IT support, but also mandatory certification by the Central Bank, which actually implies an external audit of the risk management system by the Central Bank. Not to mention increased transparency, the bank has to disclose much more information about its activities.
In Russia, the implementation of the IWR approach will become possible only from next year. That is, already after the introduction of Basel-3, which establishes more stringent requirements in terms of capital formation and risk assessment. Hence, to benefit significantly from self-assessments risks for Russian bankers will be much more difficult.
Moreover, Russia is also introducing more stringent requirements than those stipulated by the "global" Basel-3 standards, both for the minimum basic capital (5% versus 4.5% of the amount of risk-weighted assets) and for the total banks' capital (10% vs. 8%). It is not yet clear, however, whether the Bank of Russia will follow Western regulators into gradually creating a capital conservation buffer as early as 2016, but this will not change the essence of the matter: Russian requirements will remain stricter than global ones.
Another difference in Russian and foreign regulation according to Basel is the approach to accounting for loans issued to "related parties". The Bank of Russia treats such loans as high-risk instruments and introduces tighter concentration limits on transactions with "related parties". At the same time, most foreign regulators allow such transactions to be interpreted by analogy with loans provided to "ordinary" borrowers, provided that such loans are provided to counterparties on market terms (see the box "Overview of Additional Direct Restrictions (Limits) on Transactions with "Related Parties"). "").
In addition, the approach of the Central Bank in terms of assessing credit risk on participation in the capital of third parties, that is, the purchase of shares, including those traded on the stock exchange. In terms of such investments, "Basel-2" makes it possible to choose one of three approaches - either use fixed risk weights, or use one of two options for internal models. In the Russian version, the banks that have chosen the IVR for the assessment credit risks have the opportunity to apply only fixed risk weights, twice as high as those set for banks operating within the framework of standard risk assessment standards, that is, theoretically having a less advanced risk management system.
Moreover, this is hardly an oversight: the Central Bank in every possible way demonstrates attention to the opinion of market participants and submits for discussion documents related to the introduction of Basel-3. And also corrects them if necessary.
So, for example, it was originally planned that the minimum requirement for Tier 1 equity capital would be 5.6% of the amount of risk-weighted assets, but in the middle of last year, the Central Bank decided that the corresponding standard, introduced from 2014, would be 5%. "In accordance with KPMG studies of the impact of new capital adequacy requirements, conducted on the basis of open data, the initial estimate of the capital deficit of the top 50 banks in the amount of 304 billion rubles was reduced to 3.1 billion rubles," the consulting company commented on this decision then. KPMG in its review.
The Central Bank consistently "plays for its own" in another important issue related to the ratings of liabilities and issuers. This problem is quite acute: the Basel standards provide, for example, that when assessing the risk of a loan, the presence of a guarantee is taken into account only if the guarantor has a rating of at least A- on the S&P scale or similar on another scale. But the Bank of Russia decided to allow replacing the probability of default of the borrower with the probability of default of the guarantor, despite the limitation on the external rating. Since there are no companies with such high ratings in Russia (and due to the recent downgrade of the country rating of the Russian Federation and the complete uncertainty with the further development of the geopolitical situation, they are unlikely to appear soon), the decision of the Central Bank looks quite logical and very useful for large holdings acting as guarantors for loans their "daughters". A similar approach to ratings can probably be expected with the introduction of Basel liquidity standards - in the international version, they are also focused on the presence of high-rated portfolios of securities in banks.
If we also take into account that the Central Bank has set very high (50%) discounts on shares when calculating capital requirements, the following picture emerges. By implementing Basel 3 under the conditions of high capital requirements, the Central Bank reasonably believes that the IRR will be applied only largest banks For the rest it will be simply unprofitable. At the same time, advanced approaches to risk management imply more thorough control, which will allow for tight supervision of these banks by the regulator. These banks will also be protected from unnecessary risks from the stock market.
Thus, it is possible that it will really be possible to form in Russia a kind of backbone of large "highly reliable" banks. The only question is: how will such a system develop?
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*The data on capital buffers are given according to the publications of the Central Bank and at the time of the compilation of the table are not official requirements.
*** There are no banks in Russia classified as global SIBs.
****Set by national regulator.
*****Not including buffer for SSB.
******Not including buffer for SSB.
First, a little history. Established in 1974, the Basel Committee on Banking Supervision under the Bank for International Settlements introduced the first set of banking regulatory standards, called Basel I, back in 1988. Basel II was adopted in 2004. The purpose of these two documents was to increase the reliability and transparency of banking systems. However, the new requirements and standards did not save the global financial system from a severe crisis that began in 2007 in the mortgage segment and then spread to other financial and non-financial industries.
After the crisis, in 2010, the Basel Committee developed new, even more stringent measures - Basel III, the purpose of which was to prevent a new financial catastrophe. In 2012, the implementation of these rules was approved by the leaders of the G20 countries. In Russia, the new standards came into force on January 1, 2014. By 2019, a complete transition of Russian credit organizations to the Basel III standards. Are banks ready for this, and how will the tightening of standards affect the country's economic growth?
Basel III: what is it about?
Basel I introduced the rules for calculating the bank capital adequacy ratio, taking into account the quality of assets and the risks associated with them. According to the rules, adequacy is checked for Tier 1 capital and Tier 2 capital. Tier 1 capital is equity capital and retained earnings. This capital represents the protection of the bank against possible unforeseen losses. Tier 2 capital consists of additional, less reliable capital - asset revaluation reserves, reserves to cover possible losses on loans, subordinated loans, etc. Under Basel I, Tier 2 capital must not exceed Tier 1 capital.
Basel II introduced a new, more sensitive, risk assessment system for calculating capital adequacy ratios, which involves the use of international credit ratings or independent calculations by the bank itself. In addition, oversight has been tightened and measures have been introduced to improve risk management and improve the disclosure system.
Basel III was developed in response to the global financial crisis, so the new document meant tightening capital requirements and creating special buffers to maintain capital adequacy in the event of a systemic economic downturn. The new requirements also introduced the calculation of liquidity ratios. This is necessary in order for banks to maintain a sufficient amount of highly liquid resources and be able to survive in the event of instability.
In Russia, the transition to Basel III began even before the full transition to Basel II was completed. Since January 1, 2014, Russian credit institutions have been calculating not only the capital adequacy ratio H1 (now N1.0), which has remained at the same level of 10%, but also two more standards - H1.1 and H1.2. For the first, the norm is set at 5%, for the second - 5.5% for 2014 and 6% - from the beginning of 2015. It was previously planned that Russian banks would switch to the new capital requirements on October 1, 2013, but after requests from banks to postpone the deadlines, and due to the fact that the United States and Europe planned to introduce new rules only on January 1, 2014, the deadlines were transferred to Russia. Also, at the request of bankers in Russia, capital adequacy levels were lowered.
In general, the Basel rules are very or even too universal, so countries can adapt them to their reality. That is, in fact, slightly different versions of the rules are adopted in different countries.
Basel risks
The world and Russian professional communities are actively discussing not only aspects of the transition to Basel III, but also how this transition will affect economic development. Many experts come to the conclusion that the introduction of new rules will improve the reliability of banking systems. Although, of course, Basel III should by no means be regarded as a vaccine that can protect countries from new banking crises. As with vaccines, banking viruses can change rapidly, and predicting these changes in advance is quite difficult.
At the same time, "grafting" can lead to a slowdown in economic growth, since a more cautious attitude to risks and the diversion of capital from lending to ensure reliability will reduce lending. As a result, fewer companies will be able to receive funding. Profits may decrease banking, which will reduce the attractiveness of shares of credit institutions for investors and increase the costs of banks to attract financing, and hence increase interest rates for borrowers. All this can lead to attempts by bankers to act "bypassing" the new restrictions and, accordingly, give impetus to the development of shadow banking.
Also, the time chosen by the world community for the implementation of the new Basel rules is not entirely successful. The economies of many countries around the world, including Russia, are not in the best condition, and more stringent requirements can not only become a burden on banks, but also have a negative impact on already weak economic growth.
In Russia specifically, there are also fears that the implementation of Basel III rules will strengthen the dominance of state-owned banks. Large private banks may not be something to worry about. As noted on the website of the online conference recently held on the website of the news agency Marina Musiets, Deputy Director for Banking Ratings "Expert RA", average value of H1.1 for the largest state banks as of March 1, 2014 is about 8.5%, and for the largest private banks - 9.0%; for private banks, the average value of H1.0 is also higher – by 0.5 percentage points.
However, small banks will have a hard time. In addition, if small and medium-sized private banks become less risky, more borrowers may turn to state-owned banks, traditionally considered much safer in Russia.
In general, the development of lending in Russia is likely to slow down in the near future, but this will be associated not only or even not so much with the introduction of Basel III, but with the general economic slowdown. Thus, at the end of May 2014, the Bank of Russia lowered its growth forecast for Russia's gross domestic product (GDP) to 0.5% from 1.5–1.8%, which was expected back in February of this year. The Ministry of Economic Development does not rule out that in the second quarter of 2014 the Russian economy may find itself in a technical recession. Conservative development scenario Russian economy The Ministry of Economic Development also assumes that in 2014 the increase will be 0.5% (basic - 1.1%).
You can expect a decrease in margins banking business. The need to hold a more significant amount of highly liquid assets and the need to replace short-term sources of funding with long-term ones will also contribute to the margin decrease, which can lead to their rise in price. In general, the bank is likely to cost its shareholders more than before, at least in the process of implementing the new rules.
It should be recognized that Basel III was developed by developed countries and is primarily aimed at limiting the use of hybrid instruments by banks in their capital, as well as encouraging the use of a system of capital buffers. In Russia, according to Natalia Orlova, chief economist at Alfa-Bank, the structure of bank capital in most cases is simple: share capital and retained earnings. Additional tools for its replenishment are used only by very large Russian banks that have access to world markets and practice international approaches to managing financial indicators. Therefore, the introduction of Basel III in Russia actually concerns only a very small number of banks, mainly the largest ones. Most of the smaller banks are unlikely to be strongly affected by the new regulations in the near future. Rather, Basel III is being introduced in Russia as a pre-emptive measure for the future.
Transition and waiting issues
According to Karina Artemieva, head of the analytical department of the National Rating Agency (NRA), in the transition to Basel III, the key problem is the ability of owners not only to increase the capitalization of their banks, but also to ensure the required quality of the capital structure. The regulator, no doubt, will conduct a strict monitoring of the actions of the owners and the instruments that are used to increase the banks' own funds.
Central bank, in general, has already demonstrated its intention to treat the stability of the banking system with all severity. According to Anton Soroko, analyst of the investment holding "FINAM", the latest activity of the Bank of Russia, in particular, is associated with the implementation of Basel III standards. “We can say that in this way the regulator wants to prevent possible problems banking sector if too many banks fail to cope with the tightening of regulations,” commented Soroko.
The Basel standards are not only new indicators of capital adequacy and liquidity, but also a set of specific and detailed requirements for processes and systems. According to Stanislav Volkov, Head of the Credit Institutions Ratings Department at Expert RA, the transition to Basel standards will primarily affect the restructuring of the business model, as well as an increase in costs in terms of compliance. For example, the introduction of new standards will require banks to improve their risk management and IT systems, which is associated with additional costs. This, according to the expert, in the face of declining profitability of the banking business, will be the main problem for banks.
In general, experts, of course, have a positive attitude towards the transition to Basel III, but do not have particularly positive hopes in this regard. For example, there is an opinion that the application international standards can reduce the cost of capital for Russian banks abroad, as well as the cost of conducting some cross-border transactions. However, in practice, in order to translate these hopes into reality, much more will have to be done beyond the implementation of international rules.
Also, as noted Alexander Murychev, Vice-President of the Russian Union of Industrialists and Entrepreneurs (RSPP), Chairman of the Board of the Association of Regional Banks of Russia, the transition to new requirements is unlikely to provoke shifts in the development of the Russian banking system, especially given that it is based on state-owned banks, and their the main clients are companies close to the state or controlled by it. Also, according to the expert, one should not rush with the transition, since the new regulations are still an additional burden on banks, and more stringent requirements for the quality of capital can reduce lending.
Nevertheless, the introduction of Basel III standards is expected to improve the banking segment, increase its homogeneity and improve the quality of management of credit institutions or the withdrawal of some players from the market. Among the remaining banks, the quality of risk management may increase; for those who have already implemented international standards relating to risk management, only new benchmarks will be added. Thus, banks will become more reliable for customers; systemic risks will be reduced. It is possible that as a result of the implementation of all these "pluses" of the introduction of new rules, the population's confidence in credit institutions will also increase.
Are banks ready?
According to Alexander Murychev, in general, Russian banks are not ready to switch to all the "advanced" requirements of both Basel II and Basel III. True, no one is demanding this from them right now. “The main reason for the unpreparedness of our banks to apply the Basel II and Basel III approaches is currently associated with a lack of interest in competition for the borrower and consumer financial services, the expert commented. – The inaccessibility for a large number of end users of all the financial instruments and financial innovations that are present in modern banking also plays a role here. Influenced by insufficient financial literacy how individuals and business representatives. As for the latter, they are not always able to qualitatively manage the risks of their company and conduct a joint search for ways to increase the efficiency of their business with credit institutions.”
Another significant limitation, according to Murychev, is the complexity in the field of telecommunications in Russia, which prevent the massive penetration of remote methods of interaction between customers and banks at an accessible, reliable and secure level. Given this, many, if not all, Russian banks still have serious work to do in the field of information technology and the organization of internal business processes.
According to Stanislav Volkov, at the end of 2013, Russian credit institutions did a lot of work to meet the new capital adequacy requirements (N1.0, N1.1, N1.2 standards). In particular, agreements on attracting subordinated loans included a condition on their conversion into shares under certain conditions. As a result, in less than half a year, the number of banks having difficulty maintaining N1.0, N1.1, N1.2 at the required level has decreased by an order of magnitude (from 70 to 7-10 organizations). Nevertheless, for many banks, the values of the new indicators are on the verge, so the Central Bank decided not to revoke licenses for violating the new capital adequacy requirements during 2014. Until January 1, 2015, the issue of revoking a license for a credit institution will be resolved using the calculation of capital in accordance with Regulation No. 215-P “On the Methodology for Determining Equity (Capital) of Credit Institutions”. The easing of the regulator's position gives banks more time to reallocate assets towards lower risk.
Experts are somewhat concerned about the introduction of the liquidity ratio at the beginning of 2015. Thus, banks may have difficulty finding highly liquid assets that meet the new requirements if the Central Bank's refinancing system is not completed with “contractual liquidity lines”.
Among the largest banks, especially among the TOP-30 banks, no one expects significant problems with the implementation of the new rules. Smaller banks may have difficulty. Thus, about fifty Russian credit institutions do not meet or hardly meet the standards introduced on January 1, 2014. Another difficulty, including for small and regional banks, is the need to introduce a large number of new documents, which will increase the bureaucratic burden on them and, accordingly, increase their costs.
Despite the fact that Russian banks are not ready for the transition to Basel III, according to Alexander Murychev, there are no grounds for fear yet, and there is still enough time to prepare. A sharp reduction in the number of banks, especially in connection with the introduction of new regulations, should not be expected. There will be a reduction, but it will have a smooth character. There will be as many banks as the market needs. Maybe.
Vasily Anatolyevich, today the banking community is of considerable interest to issues related to new international requirements for the quality and capital adequacy of the bank, enshrined in the document of the Basel Committee on Banking Supervision (hereinafter referred to as the Committee) Basel III.
The main requirements of Basel III are aimed at increasing the resilience of the banking systems of countries that are members of the Committee in relation to financial and economic crises, improving the quality of risk management and assessment, increasing transparency and disclosure standards by financial institutions.
Basel III does not cancel previous capital agreements (under Basel I and Basel II), but supplements them and is aimed at eliminating the shortcomings of existing regulatory standards recognized by the international community, such as insufficient level of capital requirements for a bank, the ability to include hybrid instruments in capital without obligations their conversion or write-off for losses, procyclicality of regulation, underestimation of the risk on securitized assets and the risk on the counterparty on transactions with derivatives; insufficient disclosure of information by banks.
What are the main parts of Basel III?
Firstly, Basel III significantly tightens the requirements for the structure and quality of a bank's capital: new minimum requirements are introduced for the adequacy of Tier 1 capital and its constituent part - core capital, the recognition of hybrid instruments in capital is gradually being discontinued, and the list of regulatory deductions from capital is being specified.
Tier 1 Common Equity Tier 1 capital includes ordinary shares (or their equivalent for non-equity companies), as well as retained earnings and share premium on ordinary shares.
Thereafter, regulatory adjustments will be made for the purposes of calculating core capital, such as intangible assets deferred tax assets, direct or indirect investments of the bank in ordinary shares and participation interests, own shares acquired at the expense of the bank, loss received during the year, and other deductions. As a result, the minimum value of basic capital according to Basel III standards is 4.5%.
The Basel Committee allows a gradual increase in the requirements for basic capital (at the discretion of the national regulator): 3.5% in 2013, 4% in 2014 and 4.5% in 2015.
It is worth noting that not all countries have taken advantage of this option of progressively increasing requirements. For example, China immediately introduced a capital adequacy requirement of 5%, and India - 5.5%.
Tier 1 surplus capital includes: hybrid instruments that meet a single conversion and write-off criterion and additional criteria such as perpetuity, as well as share premium from instruments accounted for in surplus capital, subject to regulatory adjustments. For example, participation in additional capital of subsidiaries, subordinated loans provided to subsidiaries, and other deductions.
Compared to Basel I and II, Basel III places the bulk of the deductions on Tier 1 core capital. Basel III does not limit the amount of additional Tier 2 capital to the amount of Tier 1 core capital, but establishes minimum requirements for the adequacy of capital components to cover risks.
A gradual increase in Tier 1 capital requirements is also allowed: 4.5% in 2013, 5.5% in 2014, 6% in 2015.
The Basel Committee allows a gradual increase in the requirements for basic capital at the discretion of the national regulator
Is the second part of Basel III about capital allowances?
Yes. The new standards provide for the creation of two capital buffers: a conservation buffer and a countercyclical buffer range.
The main purpose of forming a conservation buffer, a “simple” premium to minimum requirements, is to maintain capital adequacy at a certain level in order to cover bank losses during a systemic economic downturn. In order to maintain a conservation buffer, banks will be limited in the distribution of profits (so that it goes into capital).
This indicator will increase from 2016 by 0.625% annually until it reaches 2.5% by January 1, 2019.
Limitation of excessive lending activity of banks is regulated by the formation of a countercyclical buffer.
Why is a countercyclic buffer needed?
The countercyclical buffer is designed to contain the lending activity of banks during periods of economic recovery and stimulate it during periods of recession.
It is important to note that capital buffers are formed from instruments that meet the criteria of Tier 1 basic capital, i.e. instruments with the greatest ability to absorb losses.
What does the third element mean?
Proposals have been developed to introduce a new regulatory indicator "leverage ratio" - this is the ratio of all bank assets (without risk weighting to its Tier 1 capital). The minimum leverage ratio is proposed to be set at 3% for Tier 1 capital:
So far, all countries are monitoring this indicator, however, some have already announced expected values above the minimum.
Basel III does not cancel previous capital agreements (under Basel I and Basel II), but supplements them
Is the fourth part about liquidity management?
Yes. To assess the stability of banks, Basel III introduces two liquidity ratios: the liquidity coverage ratio (LСR) and the net stable funding ratio (Net Stable Funding Ratio, NSFR), which should become external indicators of banks' stability in case of a liquidity crisis.
The short-term liquidity ratio (or liquid coverage) LCR, which measures whether a bank has the ability to continue its operations over the next 30 days, is the ratio of liquid assets to net cash outflow. In 2013, we plan to provide banks with a methodology for calculating LCR, but you should immediately pay attention to the fact that the methodology for calculating this indicator is largely an estimate, as it includes individual inflow-outflow ratios and specifics of decision-making regarding securities of the trading and treasury portfolios.
The NSFR Net Stable Funding Ratio measures a bank's liquidity with a 1-year time horizon. NSFR is defined as the ratio of stable sources of funding available to the amount of stable funding needed. This indicator must be above 100%. The supervisory authority may establish additional thresholds net stable financing ratios, which will be an indicator for the application of appropriate measures.
Are there any new changes in the standards?
Yes, they are about calculating the risk of assets. This is an increase in capital requirements for counterparty credit risks (counterparty credit risk - CCR) for transactions with derivative financial instruments, repo transactions and asset securitization transactions. The document defines an approach to assessing this type of risk through the CVA (Credit Value Adjustment) indicator. Unlike credit risk on a loan, CCR creates a two-sided risk of loss: market price of a given transaction can be positive or negative with respect to each of the parties to this transaction, and the market value is an uncertain value and may vary over time as underlying market factors change.
Also, for investments in securitized assets, a weighting factor of 1250% (equal to 100% regulatory capital coverage) is set instead of deductions from Tier 1 and Tier 2 capitals 50/50 according to Basel II.
The calculation of credit risk for claims to the central counterparty is changing. Under the standardized approach, requirements for a CCP are weighted by at least 2% (previously not weighted at all).
Additionally (within the framework of the IRB approach), the correlation coefficient is increased (by 25%) to calculate the credit risk of large financial institutions (banks, brokers/dealers, Insurance companies with assets over $100 billion). In fact, this is a change in the requirements for the parameters of the model.
Regulatory capital
Introduction to the mandatory requirements (standards) of the leverage indicator:
Liquidity ratios:
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The Basel III accord is a set of financial reforms that was developed by the Basel Committee on Banking Supervision (BCBS), with the aim of strengthening regulation, supervision, and Systemic risk Systemic risk can be defined as the risk associated with the collapse or failure of a company, industry, financial institution or an entire economy. It is the risk of a major failure of a financial system, whereby a crisis occurs when providers of capital lose trust in the users of capital within the banking industry. Due to the impact of the 2008 Global Financial Crisis on banks, Basel III was introduced to improve the banks’ ability to handle shocks from Cost of debt The cost of debt is the return that a company provides to its debtholders and creditors. Cost of debt is used in WACC calculations for valuation analysis. Learn the formula and methods to calculate cost of debt for a company based on yield to maturity, tax rates, credit ratings, interest rates, coupons, and and strengthen their transparency and disclosure.
Basel III builds on the previous accords, Basel I and II, and is part of a continuous process to enhance regulation in the banking industry. The accord prevents banks from hurting the economy by taking more risks than they can handle.
The BCBS was established in 1974 by the Federal Reserve (the Fed) The Federal Reserve, more commonly referred to as The Fed, is the central bank of the United States of America and is hence the supreme financial authority behind the world’s largest free market economy. governors of the Group of Ten (G10) countries, as a response to disruptions in financial markets. The committee was set up as a forum where member countries can deliberate on banking supervisory matters. BCBS is responsible for ensuring financial stability by strengthening regulation, supervision, and banking practices globally.
The committee was expanded in 2009 to 27 jurisdictions, including Brazil, Canada, Germany, Australia, Argentina, China, France, India, Saudi Arabia, the Netherlands, Russia, Hong Kong, Japan, Italy, Korea, Mexico, Singapore, Spain, Luxembourg, Turkey, Switzerland, Sweden, South Africa, the United Kingdom, the United States, Indonesia and Belgium.
The BCBS reports to the Group of Governors and Heads of Supervision (GHOS). Its secretariat is located in Basel, Switzerland, at the Bank for International Settlements (BIS) . Since it was established, the BCBS has formulated the Basel I, Basel II, and Basel III accords.
The Basel III accord raised the minimum capital requirements for banks from 2% in Basel II to 4.5% of common equity, as a percentage of the bank’s risk-weighted assets. There is also an additional 2.5% buffer capital requirement that brings the total equity to 7%. Banks can use the buffer when faced with financial stress, but doing so can lead to even more financial constraints when paying dividends.
As from 2015, the Tier 1 capital requirement increased from 4% in Basel II to 6% in Basel III. The 6% includes 4.5% of Common Equity Tier 1 and an extra 1.5% of additional Tier 1 capital. The requirements were to be implemented starting in 2013, but the implementation date has been postponed several times, and banks now have until March 31, 2019, to implement the changes.
Basel III introduced a non-risk based leverage ratio to serve as a backstop to the risk-based capital requirements. Banks are required to hold a leverage ratio in excess of 3%. The non-risk based leverage ratio is calculated by dividing Tier 1 capital by the average total consolidated assets of a bank.
To conform to the requirement, the Federal Reserve Bank of the United States fixed the leverage ratio at 5% for insured bank holding companies, and 6% for Systematically Important Financial Institutions (SIFI).
Basel III introduced two liquidity ratios – the Liquidity Coverage Ratio and the Net Stable Funding Ratio. The Liquidity Coverage Ratio requires banks to hold sufficient high-liquid assets that can withstand a 30-day stressed funding scenario as specified by the supervisors. The Liquidity Coverage Ratio was introduced in 2015 with 60% requirements and is expected to increase by 10% each year till 2019 when it takes full effect.
On the other hand, the Net Stable Funding Ratio (NSFR) requires banks to maintain stable funding above the required amount of stable funding for a period of one year of extended stress. The NSFR was designed to address liquidity mismatch and will start being operational in 2018.
The requirement that banks must hold a minimum capital of 7% will make banks less profitable. Most banks will try to maintain a higher capital to cushion themselves from financial distress, even as they lower the number of loans issued to borrowers. They will be required to hold more capital against assets, which will reduce the size of their balance sheets.
A study by the Organization for Economic Cooperation and Development (OECD) in 2011 revealed that the medium-term effect of Basel III on GDP would be -0.05% to -0.15% annually. To stay afloat, banks will be forced to increase their lending spreads as they pass the extra cost on to their customers.
The introduction of new liquidity requirements, mainly the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR), will affect the operations of the bond market. To satisfy LCR liquid-asset criteria, banks will shy away from holding high run-off assets such as Special Purpose Vehicle (SPV) A Special Purpose Vehicle/Entity (SPV/SPE) is a separate entity created for a specific and narrow objective, and that is held off-balance sheet. SPV is a and Structured Investment Vehicle (SIV)A structured investment vehicle (SIV) is a non-bank financial entity set up to purchase investments designed to profit from the difference in interest rates - known as the credit spread - between short-term and long-term debt..
The demand for secularized assets and lower-quality corporate bonds will decrease due to the LCR bias towards banks holding government bonds and covered bonds. As a result, banks will hold more liquid assets and increase the proportion of long-term debts to reduce maturity mismatch and maintain minimum NSFR. Banks will also minimize business operations that are subject to liquidity risks.
The implementation of Basel III will affect the derivatives markets, as more clearing brokers exit the market due to higher costs. Basel III capital requirements focus on reducing counterparty risk, which depends on whether the bank trades through a dealer or a central clearing counterparty (CCP). If a bank enters into a derivative trade with a dealer, Basel III creates a liability and requires a high capital charge for that trade.
On the contrary, derivative trade through a CCP results in only a 2% charge, making it more attractive to banks. The exit of dealers would consolidate risks among fewer members, thereby making it difficult to transfer trades from one bank to another and increase systemic risk.
The Institute of International Finance, a 450-member banking trade association located in the United States, protested the implementation of Basel III due to its potential to hurt banks and slow down economic growth. The study by OECD revealed that Basel III would likely decrease annual GDP growth by 0.05 to 0.15%.
Also, the American Bankers Association and a host of Democrats in the U.S. Congressd argued against the implementation of Basel III, saying that it would cripple small U.S. banks by increasing their capital holdings on mortgage and SME loans.
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