Basel 3: A new perspective on portfolio risk management Tamar - - PowerPoint PPT Presentation
Basel 3: A new perspective on portfolio risk management Tamar JOULIA-PARIS October 2011 1 Content Basel 3 1. A complex regulatory framework With possible unintended consequences Consequences on 2. Main banking products and
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Tamar JOULIA-PARIS October 2011
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A complex regulatory framework
With possible unintended consequences
2.
Main banking products and business models
Risk management
Portfolio and balance sheet management
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Amount and quality of Capital were inadequate to absorb extreme losses, forcing for some banks bail-out
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Some risks were not adequately recognised : counterparty risk, rating agencies, securitizations, excessive growth, procyclicality, etc
systemic risks, were underestimated.
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Banks did not have enough liquidity buffers.
systems and global economy required state aids in US and Europe. New rules are being implemented at country level as of Jan 2013: Basel III → CRD IV (EU) → Country laws.
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(For illustration : EU framework)
new independent body, for all financial sectors & guarantee schemes, responsible for macro-prudential oversight at the level of the EU.
actors who ensure the micro-prudential supervision of EU financial system:
the European Banking Authority (EBA); the European Insurance and Occupational Pensions Authority (EIOPA); the European Securities and Markets Authority (ESMA) ; the Joint Committee of the European Supervisory Authorities (ESA); the competent or supervisory authorities in the Member States; the European Systemic Risk Board.
Rem: Basel III (banks) and Solvency II (Insurers) have similar objectives but different
approaches, with possible unintended consequences.
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Solvency ratios
Risk based (Tier I) : Eligible Capital / RWA > 8%, 3 capital buffers, 2 tiers Purpose : Increase risk coverage (2013-2018) and quality of capital Non risk based (Leverage) : Capital > 3% of total on/off balance-sheet Purpose : Constrain leverage build-up
Liquidity ratios
Liquidity Coverage ratio (LCR): 30 days net outflow / Liquid assets < 100% Purpose : Ensure high quality liquid assets can fund 30 days stressed outflows Net Stable Funding Ratio (NSFR): Available stable (LT) funding /
Required stable (LT) funding > 100%
Purpose : Ensure illiquid assets can be funded during one year with a minimum
amount of stable financial resources
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2011 2012 2013 2014 2015 2016 2017 2018 Jan 2019
Common equity ratio
3.5% 4% 4.5%
Conservation buffer
0.625% 1.25% 1.875% 2.5%
Common equity+conservation 3.5%
4% 4.5% 5.125% 5.75% 6.375% 7%
Tier 1 capital ratio
4.5% 5.5% 6%
Total capital ratio (unchanged)
8%
Total capital + conservation
8% 8.625% 9.125% 9.875% 10.5%
Countercyclical buffer
0 to 2.5 %
Uneligible capital instruments
Phased out over 10 yrs starting 2013
LCR ratio
Observation Introduction
NSFR ratio
Observation Introduction
Leverage ratio
Monitoring Parallel run + disclosure (2015) Pillar I
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On Products :
banks ROE On Business models :
trading activities, but challenge the bank’s transformation role On Risk Management
On Portfolio and Balance-Sheet management:
require a new framework for balance-sheet optimization
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More favorable Less favorable
Tier 1 ratio
Low risk assets (mortgages, govt debt) Trading activities Financials, securitization, wrong-way risk High risk assets, re- securitization
Leverage ratio
High risk assets Central clearing
Low risk assets, undrawn commitments
LCR
(short term liquidity)
Cash, central bank reserves, govt bonds Low risk corporate and covered bonds Unsecured bank bonds
NSFR
(long term funding)
Term deposits > 1 yr Stable savings Wholesale savings Funding from Financials LT debt, high quality bonds Low LTV mortgages High LTV mortgages Liquidity facilities
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Increased amount & cost of capital, combined with additional cost of liquid assets & long term funding, will make some banking products more expensive and reduce banks ROE
a) The business context:
Limited growth perspectives
Customer behavior transformation
Continued exposure to systemic risks
Cost cutting programs
Large technology programs
Uncertainties in interest rate, tax and regulations
Mismatch between shareholders expectations & regulatory requirements
etc
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The business context is not so exciting for Financial Institutions in developed markets….
b) The Business consequences of Basel III:
Increased cost of holding a balance-sheet
Downsizing of activities severely impacted by Basel III
Increased competition for customer deposits (LCR) and granular high yield assets (SME loans)
Challenge of banks maturity transformation role (NSFR)
Development of new products combining loans and deposits
Less incentive for talented people to work for banks
Balance between short term and long term management
etc
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…. and Basel 3 favors traditional banking versus complex trading activities, while also challenging the bank’s transformation role
Growing importance of stress tests
Sensitivity analyses (unconditional stress tests), “Probable” scenarios for business, finance and risk planning, “Stressed” scenarios for capital, liquidity and appetite for risk management.
Focus on governance and risk appetite:
Tolerance defined at the top, and aligned with group strategy, Cascading down via KRI’s per business line (value) and risk type (concentrations) KRI’s connected to KPI’s (Capital, Liquidity, Earnings, Growth).
Internal emphasis on regulatory requirements
Break-up of silo risk management at portfolio level
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The famous “new” risk paradigm, managing risk together with return on a pro-active basis….
a) The business context of CPM activities
Reduced activity in support of tier I ratio (RWA release) Lower incentive to originate or retain investment grade loans Limited liquidity in credit markets, CDS and mainly securitizations, Challenge of the value of straightforward « diversification » Priority on funding and management of liquidity ratios High recognition as experts in combining business, market, risk,
finance and regulatory knowledge.
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The competences of CPM teams (clients, products, models, markets, accounting, regulations, etc) are leveraged for complementary purposes ….
b) The change in credit portfolio functions
Front end CPM integrated with funding for new loans Back end CPM integrated with balance-sheet management Migration towards a more holistic internal transfer pricing Priority on liquidity, more than credit or capital management Management of client/business value at balance-sheet level
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The combined management of capital, leverage & liquidity ratios will require a new infrastructure for balance-sheet optimization (Capital management, Treasury, ALM, CPM)
B/S
Capital
Risk
Models Scenarios Treasury Liquidity
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Financial institutions should prepare for an active balance-sheet management, by … 1) Understanding the combined effect of all financial risks on pricing and on financial performance
Technology : Collecting & stressing Risk & Finance cash flow information;
Risk management : Combining top-down management of financial risks (Credit,
ALM, and liquidity);
Risk and finance Planning :
Combining scenarios/stress tests on P/L, balance sheet and cash flows;
Benchmarking KPI’s and KRI’s with performance targets and appetite for risk;
Combined contingency plans on funding and capital;
Single internal performance benchmark : new fund transfer price.
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2) Developing solutions to transfer granular long term loans to investors with a more adequate liability profile, i.e.
Revive a different loan securitization market, complementary to covered bonds, allowing for eligibility as HQLA and lower RWA %,
Set up independent but regulated Utilities, acting as providers of fiduciary services to facilitate risk transfers, mainly between regulated institutions,
Allow long term investors to invest in a regulatory accepted form, reducing their exposure to inflation risk while supporting the economy.
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Due to
the increased and continuous systemic risks,
the necessity to actively manage the retained balance-sheet,
the technology & knowledge required to manage B/S risks, Basel 3 might gradually encourage for new organization, with
An independent B/S Management function, ultimately reporting to the CEO,
A separation between commercial and balance sheet activities, the latter acting like an internal (or external ?) asset manager.
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No, Systemic risks seem to be part of our day-to-day life…..
squeezed without capacity to off-load balance sheet risks,
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Yes :
their balance-sheet,
sensitive to inflation and sovereign risks,
systemic institutions.
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