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more of the sources are withdrawn, and potential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
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nt
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eme
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C
an
ty m
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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
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un
g
te
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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
isimportant

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 banks 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,
bailin 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: pjackson@uk.ey.com

Regulatory capital adjustments

201418 % 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
liquiditystress.

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 201321.

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