From Basel II to Basel III

Nicolas Kunghehian

12th April 2011

What is new in Basel III?

Optimization
Strategy

Risk
Reporting
Monitoring

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From Basel I to Basel II

» Too simplistic
– Only 5 categories: 0%, 10%, 20%, 50%, 100%
– No link with any probability or measure of default

» Ignoring other types of risk

– Market Risk, Operational Risk
– Diversification, hedging were not taken into account

» Capital Arbitrage
– No difference between a “good” and a “bad” loan
– Securitization as an arbitrage tool

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From Basel II to Basel III

» Too much leverage

» Excessive credit growth
» Insufficient liquidity buffers
» Weaknesses of risk management systems
» Too much systemic risk

» Greater capital buffers

» Capital of higher quality
» Liquidity buffers
» More accurate measurement of risks (e.g.
market risks)
» Addressing systematically important banks

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Basel III squeezes capital !
» More strict rules on capital, lowering it (own funds review)
» Higher capital requirements (updated calculation rules increase RWA for some asset classes)
» Increased capital ratios (Core Tier 1, Tier 1, Conservation buffer, Countercyclical buffer)

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Dubai, 12th April 2011
Results of the QIS: Capital Ratios

Source: http://www.bis.org/publ/bcbs186.pdf

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Results of the QIS: Liquidity Ratios

Source: http://www.bis.org/publ/bcbs186.pdf

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 Liquidity coverage ratio (LCR)
» To ensure that banks survive a severe liquidity stress scenario for at least 1 month

» LCR = Stock of high quality liquid assets / Net cash outflow over 30-days (shall be > 100%)

» Stock of high quality liquid assets:

– Cash, central bank reserves and sovereign paper (from same country and in same currency)
– Inclusion of corporate bonds and covered bonds: haircuts 20%-40% and no more than 50% of total
stock of high quality assets

» Net cash outflow over 30 days:

– Net cash outflow under a severe stress scenario (30 day) = outflows – inflows
– Stress scenario: significant rating downgrade, partial loss of deposits, loss of unsecured wholesale
funding, increase in a) secured funding haircuts, b) collateral calls, c) calls from OBS exposures
– Under this stress scenario outflows and inflows are calculated based on regulatory factors (i.e.
minimum run-off factor of 7.5% for stable deposits)

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Liquidity coverage ratio (LCR) – example

Assets 470
Cash 50 v Stock of high quality liquid assets 150
Gov. Bonds 100
Financial Institution Bonds 50
Loans 270

Liabilities and Equity 470 Run-off Outflows* Inflows** Net

factor outflows
Stable retail deposits 100 v 7.50% 7.5
Less stable retail deposits 100 x 15% = 15 -
Unsecured Wholesale Funding (Non fin. 170 75% 127.5
Corporate with no operational relationship)
Equity 100 150.0 20 130

LCR 115%

*Additional requirements are also considered as outflow (e.g. 100% of outstanding liquidity facilities to non fin. Corporate, etc)
** 100% of planned inflows from performing assets

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Net stable funding ratio (NSFR)

» To promote more medium and long-term funding of assets and other banking activities (including OBS
exposures)

» NSFR = Available amount of stable funding / Required amount of stable funding (shall be ≥ 100%)

» Available stable funding:

– Sum of: a) Capital, b) preferred shares c) liabilities with effective maturity > 1yr d) stable deposits and
wholesale funding provided by non financial corporate (using appropriate weighting factors)

» Required amount of stable funding:

– Sum of assets and OBS exposures weighted by required stable funding factors (i.e. 0% for cash and
85% for loans to retail)

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Net stable funding ratio (NSFR) – example

Assets 470 Required stable Required stable

funding factor funding
Cash 50 0% 0
Gov. Bonds 100 5% 5
Loans (to retail) 320 85% 272
277

Liabilities and Equity 470 Available stable Available stable

funding factor funding
Stable retail deposits 100 85% 85
Less stable retail deposits 100 70% 70
Unsecured Wholesale Funding (Non fin. 170 x 50% =
Corporate with no operational relationship) 85
Equity 100 100% 100
340

NSFR 123%

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Higher costs… for a better performance

Board of Director
• Daily summary
Internal reports report
• Specific risk drivers

Regulatory reports
• Local reports
• Group reports

Risk reports
• Credit risk
• Liquidity risk
• Market risk
• Operational risk
Operational
reports
• Limit
monitoring
• P&L reports
• Budgeting
reports
• Single
portfolio
reports

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Conclusions

» More constraints for banks

– More capital of better quality
– Liquidity buffers

» A great opportunity • Modeling • Limit

• Forecasting monitoring
– Shared ownership • Action plans

– Better risk management Risk

Reporting
Calculation
– Better performance management

Optimization Strategy

• Budgeting • Planning

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Contacts

Nicolas Kunghehian

Associate Director
Moody's Analytics
436, Bureaux de la Colline
Bâtiment E - 12e étage
92213 Saint-Cloud Cedex, France

+33 (0) 4.56.38.17.05 direct

+33 (0) 6.80.63.83.34 mobile

nicolas.kunghehian@moodys.com

www.moodys.com

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