Gestión de la calidad y normas ISO 9000

TheBasel IIIaccord requires more and better capital from the banks compared to

Basel II as a buffer against solvency risk, it gives equal weight toliquidity riskregulation

and the requirements for market and credit counter party risk are increased: Contrary to Basel II not only capital but the whole balance sheet is regulated. To reduce the impact of model risk in the calculation of the risk weighted assets, which matter for the

capital charge, a model independentmaximum leverageof 3 percent is introduced for

systemic relevant banks by 2018. This means that the asset side length can be no longer 33 times the value of capital. than On the liquidity sides two measures are introduced. One reduces the probability of a liquidity stress (going concern) and the other one is used to increase the survival time once an institution is in a liquidity stress. The timeline for the implementation starts 2013 and ends 2019. More precisely the Committee - the Basel Capital Accord Committee - proposes a series of measures. These measures can act on the state variable capital (smoothing and buffer stock formation) or decision variables as provisions which can forced to be more forward looking. We have (McKinsey (2012), Deloitte (2012)):

• Changes affecting theassetside:

– New market risk and securitization framework: Introduction of a stressed

value- at-risk (VaR) capital requirement and an increase of capital require- ments for re-securitizations in both the banking and the trading book.

– Counter party credit risk: Introduction of additional charges for counter party credit exposures arising from banks’ derivatives, repo, and securities financing activities (see CVA).

– Higher Risk Weighted Assets (RWA) for financial intermediary (FI) expo-

sures: About 30 percent higher RWA for FI exposures, for example interbank exposures.

– Liquidity coverage ratio (LCR): Introduction of a global minimum short- term 30-days liquidity standard, requiring banks to reach sufficient amount of holdings of highly liquid assets. LCR is defined as:

High Quality Liquid Assets

Net Cash Outflows in 30d Period >100% .

The 30d period considered is a stress event: One assumes that the bank’s

debt is reduced by three notches using one of the official ratings, wholesale funding is complete lost, a fraction of deposits is lost, collatal posted is valued less (equivalently, the haircuts are raised, i.e. the bank has to deliver more collateral) and the lines of credit are drawed down. LCR will be monitored by both the Basel Committee and the supervisor in order to officially make it mandatory with effect from 1 January 2015.

• Changes affecting the liability side:

– Net stable funding ratio (NSFR): Introduction of a long-term structural ratio to address liquidity mismatches. This ratio is defined as:

Amount of Stable Funding

Required Amount of Stable Funding >100% .

The categories are defined as follows. The regulator defines categories of

funding for the numerator. Each funding is then attributed to a category

and multiplied by a category specific factor; the available stable funding

factor (ASF). Figure 1.18 shows the categories and the factors. NSFR will be introduced as a minimum standard as from Jan 2018.

• Changes affecting capital:

– Minimum (core) tier 1 ratio: Increase of the minimum common equity (CET1, i.e. shareholders equity and retained earnings) requirement from 2 percent to 4.5 percent. The capital ratio is defined by

Regulatory Capital

RWA > x%,

i.e. the regulatory capital has to exceed x percent of the risk weighted assets.

The figure x is discussed below. The national implementation will start on 1

minimum capital requirements expressed in risk-weighted assets: 3.5% share capital, 4.5% Tier-1 capital and 8% total capital. During the transitional period from Jan 2013 up to and including 2019, these ratios will gradually be stepped up to 4.5% share capital, 6% Tier-1 capital and 8% total capital.

– Conservation buffer: Introduction of an additional (counter-cyclical) capi-

tal conservation buffer between 0%and 2.5%to withstand periods of stress.

The buffer will be build up along gradual lines to a percentage of 2.5% from Jan 2016 through Jan 2019. Thus, banks will ultimately have to hold 10.5% of their total capital expressed in risk-weighted assets.

– Capital quality: Requirement to form tier 1 capital predominantly through common shares and retained earnings.

– Capital deductions: International harmonization of capital deductions and prudential filters. National supervisors will gradually introduce additional allowable deductions from bank capital such as deferred tax assets and invest- ments in financial institutions from Jan 2014 - Jan 2018.

– SIFI capital surcharges: Higher capital charges for systematically important

financial institutions (SIFIs).

• Changes affecting thewhole balance sheet:

– Leverage ratio: Introduction of a non-risk-based measure of capital struc- ture. The period from Jan 2013 through Jan 2017 will be a parallel run period. During this period, the development of the Leverage Ratio will be monitored. The intention is to migrate the Leverage Ratio into the Pillar 1 requirements as from Jan 2018.

– Supervisory review of newremunerationpolicies: Closer review of remuner-

ation policies, especially in case of weakening capital buffers.

For to big-to-fail banks, i.e. the SIFIs, regulation will possibly introduce acounter

cyclical buffer (CCB). The counter cyclical buffer is different than the conservation buffer which also shows some counter cyclical behavior. The goal of the CCB is increase the resilence of the banking system and to act as a damping factor in times of excessive credit lending (so called leaning against the wind): The objective of counter cyclical capital standards is to encourage banks to build up buffers in good times that can be draw down in bad ones. Buffers should not be understood as the prudential minimum capital requirement. They are unencumbered capital in excess of that minimum, so that capital is available to absorb losses in bad times. Counter cyclical capital buffer schemes can be thought of as having the objective to limit the risk of large-scale strains in the banking system by strengthening its resilience against shocks. As a model consider

Ratiot=

Creditt

GDPt

Using a statistical filter, the Hodrick-Prescott filter for example, one extracts from the Ratio the Trend at a given date. This defines the gap

Gap_t=Ratio_t−Trend_t .

The buffer add-on of the CCB is then defined as a piecewise linear function. The add-on is zero if the gap is below a given floor, the add-on increases linearly up to a maximum

level for the gap. Figure?? illustrates the impact for the UK.

Figure 1.16: Counter cyclical buffer for the UK. The upper panel shows the evolution of the

credit to GDP ratio, the trend component and the gap. The figure shows the boom periods in the 80s of last century and in the second half of the last decade up to the financial crisis. The lower panel shows the relation between the gap and the capital buffer. The buffer is largest during the boom period, where it even is often capped at its maximum level, and low or zero in periods of weak or negative economic growth.Source: BIS, UK national data, BCBS.

The methodology how regulatory capital is calculated follows the Basel II approach. But some models are changed, new models are introduced or some model free regulation (maximum leverage) is used in Basel III. First, for the different risk factors market

risk, credit risk and operational risk different approaches exist to calculate the Risk

Weighted Assets (RWA). Some are not risk sensitive, i.e. they are not derived from a statistical model. They are applied by smaller banks. Statistical models are used by larger banks. This means that larger banks can either develop own models (advanced approach for operational risk) or use internal models to generate input parameters in predefined statistical models (advanced models for credit risk). We note that it is at the national regulatory authority discretion to decide whether a bank can use a more sophisticated model or whether the bank has to. Further, internal models need to be approved by the regulatory body. If one compares a mortgage portfolio and applies to the portfolio the standardized approach (which is a non-statistical model) and then uses an advanced credit risk model for the same portfolio one typically observes:

• The RWA are lower using the advanced model if the portfolio has a good credit

risk quality compared to the standardized model.

• The opposite is true if the credit worthiness of the counter parties in the portfolio

is low.

This raises the issue of regulatory aribtrage. A bank would like to choose an advanced

model in cases where the RWA are lower compared to a non-statistical model and vice versa. But there is no such cherry picking: A bank which wants to use an advanced credit risk model has to use this theoretically for all counter parties: For the mortgage portfolio of retail clients, for the loans to corporate clients, for credit risk in the interbank market relations, for counter party risk in the derivative transactions, etc. In practice, a 100 percent fullfillment is not possible: To develop a statistical model for credit risk in start up financing is meaningless since there are no data to calibrate the parameter, to backtest the model and to see how the model would have behaved in a stress scenario - these are all requirements a bank has to fullfill in order to apply an advanced model. Therefore, the regulator will allow to treat some parts of the portolio which are not rele- vant from a solvency risk view using simpler, non-technical approaches. Finally, if a bank fails to meet the standards for a part of the portfolio the regulator will use multiplier in the calculation of the RWA.

We discuss one particular model for credit risk below. The logic of the capital re- quirement is that

Regulatory Capital

RWA > x%.

Basel III restricts the parts of capital which classify as regulatory capital: Tier 1 are common shares and retained earnings, Tier 2 is harmonized and Tier 3 is no longer allowable. All other equal the numerator decreases for an institutions which requires to raise more Tier 1 capital or to reduce risks in the RWA calculation. Second, the risk coverage will be strengthened. For example the capital requirements for counter party

credit exposures arising from banks’ derivatives transactions are strengthened or capital incentives are introduced to move OTC derivative contracts to central counter parties. This might again affect the capital level, the OTC example, or the RWA increase, see

the Section Credit Risk for details. Finally, thex%which are under Basel II8%increase

over time. This will have the effect that too risky business, i.e. business which leads to high additional capital and/or high RWA will be no longer profitable. The capital accord following Basel III and a national finalization, here the Swiss Finish for the to largest

banks UBS and Credit Suisse, are shown in Figure ??.

While the industry raised up to 80 percent of the required capital there is still much potential to reduce the RWA (Oliver Wyman 2012). RWA can be decreased either by

technical mitigation of risks or strategic exits. Since currently in Europe only 20 % of

European mid-size companies have direct access to capital markets compared to the U.S. (80 percent), it is expected that banks will first reprice their loans due to an increased capital charge and offer European corporates the possibility to issue debt for financing. Since this shift affects mid-size corporates this risk mitigation off the bank’s balance sheet can be favorable for smaller, regional banks which already have long-term lending relationship and have access to local bond markets.

Given the long period of implementation of Basel III, the existence of Basel 2.5 24

there will be confusions when capital adequacy is calculated. Confusion increases if

other capital charge definitions are used. As an example, we consider the Financial

Stability Report of the Swiss National Bank. The role of this report is:

In its Financial Stability Report, the Swiss National Bank presents its assessment of the Swiss banking sector’s and financial market infrastructures’ stability. The Bank publishes this report as part of its contribution to the stability of the financial system – a task assigned to it under the new National Bank Act. In the Financial Stability Report, the National Bank focuses on trends that are observable at the levels of the banking sys- tem, the financial market infrastructures, the financial markets and the macroeconomic environment. The main purpose of the report for the National Bank is to draw attention to strains or imbalances which could pose a threat to system stability in the short or the longer term. The Bank thus tracks developments in the banking sector from a macropru- dential perspective. This task supplements that assigned to the Swiss Financial Market Supervisory Authority (FINMA), which is responsible for supervision of the banks at the level of the individual institutions (microprudential supervision). In addition, the Finan- cial Stability Report provides information about its activities regarding the oversight of financial market infrastructures. Source: Swiss National Bank, homepage.

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’Basel III builds upon and enhances the regulatory framework adopted by Basel II and Basel 2.5, which now form integral parts of the Basel III framework: Basel II improved the measurement of credit risk and included capture of operational risk, was released in 2004 and was due to be implemented from year-end 2006. Basel 2.5, agreed in July 2009, enhanced the measurements of risks related to securitization and trading book exposures.2 Basel 2.5 was due to be implemented no later than 31 December 2011.’ Source: BIS, 2012.

Figure 1.17: Left Panel: Capital requirements for global systemically important banks (G.SIBs). An additional 1% surcharge in the additional loss absorbency buffer might be applied to provide a disincentive for banks to increase materially their global systemic importance in the future. after Basel III. Right Panel: Capital accord (Swiss Finish to Basel III) for the two large Swiss Banks UBS and Credit Suisse (status January 2012). Swiss Expert Commission requiring CET1 ratio of 10%, compared to a 8% to 9.5% ratio under Basel III. Additional buffer and progressive component capital to achieve a Total Capital ratio of 19% . A requirement which can be met with a combination of 7% high trigger and 5% low trigger contingent capital instruments. As Tier 1 and Tier 2 instruments under Basel III will require loss absorbency at the point of non-viability, they will need to include contingent capital like features.Source: BIS, Credit Suisse Group.

The report in 2012 then reports that the loss-absorbing capital of the two Swiss SIFIs UBS and Credit Suisse below the level needed to ensure sufficient resilience. The Na- tional Bank calculated the loss-absorbing figures by using all definitions of Basel III but

the low trigger contingent capital, see Figure ??. The reason is that

’... These are mainly intended for the Swiss emergency plan and the restructuring or wind-down of the remaining bank units, and are therefore not considered in this ‘going concern’ perspective. Source: Swiss National Bank’.

Although the two banks had at the end of first quarter 2012 a capital ratio following Basel III of 5.9 and 7.5 percent the loss-absorbing capital was only 1.7 and 2.7 percent respectively. The announcements of these figure put in particular Credit Suisse under pressure - both in raising new regulatory capital at a faster pace than planned and by a drop of the share price. Besides these actions, there were a lot of confusions since bankers were pointing to the good-lucking Basel III figures but central bankers focused on the lower loss-absorbing numbers.

The increased cost of capital may boostshadow banking. Strictly speaking, there

is no definition what the shadow banking area is since either an entity is a bank and regulated or it is not a bank. One considers often Credit Hedge Funds, Special Pur- pose Vehicles and Money Market Mutual Funds to be part of the shadow banking sector. There is no consensus about other entities such as Credit Card Institutions, Hedge Funds, Independent Asset Managers, Commodity Traders. The FSB (2011) released some rec- ommendations for the shadow banking sector to mitigate systemic risk and regulatory arbitrage. Basically the recommendations increase the costs of capital and liquidity for banks when they reallocate resource to the shadow banking sector and they increase the costs of operations such as increasing transparency and information requirements for the end investors.

We consider the impact of some measures in more detail.

Before the financial crisis, regulatory capital was allowed to be smaller under the then

active Basel II regime than it will be under Basel III, see Figure 1.17. This led to high

leverage, i.e the ratio between assets and capital was large. Some investment banks faced leverage ratios between 50 and 100. I.e. banks had only down to 1 percent risk buffer.

Among others, this leads to a highreturn on equity (RoE)value which in some banks

has a direct impact on compensation and the dividend policy. To show this consider two

dates 0 and T. The balance sheet reads at each date A =L+E with A the assets, L

the liabilities and E equity or capital. The Return on Assets (RoA) and the Return on

Equity (RoE) are defined by25

RoA= AT

A0

−1 , RoE= ET

E0

−1 .

λ= A_E >1defines theleverage factorandR= LT

L0 −1interest income on the liabilities.

We get26

RoE=R+λ(RoA−R) . (1.2)

Excess return on capital is proportional to excess return on assets multiplied by the

leverage factor. This is also true if we replace the quantities by expected values. LetµX

be the expected value of a random variable X. We get:

µE =R+λ(µA−R) .

Similarly for risk measured by volatilityσ:

σE =λσA. (1.3)

Hence a higher leverage factor increases both RoE and risk. The latter one increases

solvency risk, i.e. the risk that the asset value falls below the liability value (P(A < L)).

The stronger A varies, the higher the risk that E vanishes. For a RoA of 8 percent,

R= 3%and a leverage factor of 4 the expected return is

µE = 3 + 4(8−3) = 23% .

If the risk of the asset return is σA = 10, volatility of the capital increases to σE =

4×10%. Summarizing, an increasing leverage factor increasesjointlyRoE and insolvency

risk. But the story does not end here. So far, financing risk or the liability side of

a balance sheet was not considered. We analyze the relationship between interest rate risk management of the balance sheet and leverage. We assume that both assets and

liabilities depend on a single interest rate r. For small changes in the rate r uniformly

for all maturitiesMacauley duration D is a first order risk management figure. It is