Global Systematically Important Financial Institutions (G-SIFIs) METAC – USAID Regional Workshop on Basel III: Challenges and Implications Cairo – Egypt October 16 – 18, 2012

INTRODUCTION  Following the 2007/2008 financial crisis, Micro-prudential supervision remains at the core of the new regulation of the financial system  However, the crisis also underlined the risk implied by the Global Systemically Important Banks (G-SIBs) to the financial system and the real economy:  Negative externalities:  Situations in which a player is placed at a loss because of the action of a third party without any compensation;  The G-SIBs have an implied guarantee even if they maximise their individual profits through very high risk-taking.  This should lead to additional requirements. 2

INTRODUCTION  In October 2010, the Financial Stability Board fixed the direction that the systemic financial entities regulation should follow (“Reduce the GSIBs moral hazard and the cost in case of a public intervention”). These principles are approved by the G20

 The Basel Committee has been in charge of the definition of the assessment methodology (i.e. what are the indicators of a shock transmission?) which is the topic addressed in this presentation «Assessment methodology and the additional loss absorbency requirement » November 2011.

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CONTENTS 1.

Identification criteria

2.

Additional loss absorbency requirement

3.

Macro-economic Impact

4.

Public consultation

5.

Next steps

6.

D-SIFIs: an extension to domestic systematically important institutions

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1. IDENTIFICATION CRITERIA The objective of the multi indicator based approach is …

 not to : 

assess the risk that a failure can occur;

 assess the banks risk sensitive profile or  give an accurate systemic measure

 but to

appreciate, in case of distress or failure, the impact of negative externalities on the global financial system and wider (real) economy

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1. IDENTIFICATION CRITERIA •

Global, system wide, loss given default concept rather than a probability of default concept:

Evalution du risque de crédit

Probabilité de défaut Horizon d'un an

Aujourd'hui Si défaut

Expositition en cas de défaut

Perte en cas de défaut

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1. IDENTIFICATION CRITERIA The indicator-based approach in brief  5 main categories are analyzed : the size, the cross jurisdictional activity, the interconnectedness, the substitutability, the complexity  Categories are declined in 12 quantifiable weighted indicators  A bank has on each indicator a relative score representing its own systemic participation to the whole systemic banking system  Finally, the overall score of a bank is obtained by the weighted combination of the score indicators (if necessary, a supervisory judgment may as well be part of the global appreciation)  A refinement of the methodology is planned every 3 years 7

1. IDENTIFICATION CRITERIA Indicator-based measurement approach and weightings

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1. IDENTIFICATION CRITERIA Understanding the measurement approach  By construction, the banks’ synthetic scores are dependant on each other  The first calibration of this identification approach was based on a panel composed of the 73 world’s largest active banks representing 2/3 of the banking system’s total assets (this systemic universe will be reviewed every 3 years)  A systemic threshold (“cut off point”) isolated 29 banks considered as systemic and that, as a consequence, are affected by an additional loss absorbency requirement  The measures will be renewed on an annual basis implying new entries and exits 9

1. IDENTIFICATION CRITERIA G-SIFIs : For which the resolutionrelated requirements will need to be met by end-20121 Bank of America Bank of China Bank of New York Mellon Banque Populaire CdE Barclays BNP Paribas Citigroup Commerzbank Credit Suisse Deutsche Bank Dexia Goldman Sachs Group Crédit Agricole HSBC

ING Bank JP Morgan Chase Lloyds Banking Group Mitsubishi UFJ FG Mizuho FG Morgan Stanley Nordea Royal Bank of Scotland Santander Société Générale State Street Sumitomo Mitsui FG UBS Unicredit Group Wells Fargo 10

CONTENTS 1.

Identification criteria

2.

Additional loss absorbency requirement

3.

Macro-economic Impact

4.

Public consultation

5.

Recent and next steps

6.

D-SIFIs: an extension to domestic systematically important institutions

11

2. ADDITIONAL LOSS ABSORBENCY REQUIREMENT Why an additional loss absorbency ?  To encourage banks to reduce their systemic level (the loss absorbency requirement drops as the score decreases)  To cover the public sector «insurance cost» (i.e. authorities will more certainly have to act in case of a G-SIB failure than in case of a small bank)  Reduction of this implicit guarantee may indirectly improve market discipline, decrease risk-taking and competitive distortions

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2. ADDITIONAL LOSS ABSORBENCY REQUIREMENT The bucketing approach  The systemic banks are classified through a score range of 5 «buckets» (due to its high requirement level, the fifth is kept empty)  Each bucket has a minimum additional loss absorbency requirement varying from 1% to 2.5% of the RWA (the fifth being at 3.5%)

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2. ADDITIONAL LOSS ABSORBENCY REQUIREMENT The main characteristics  After analysis of the pros and cons, G-SIBs are required to meet their additional requirement only with Common Equity Tier 1 (the best and simplest effective funding)  The additional requirement is implemented as an extension of the capital conservation buffer  If a G-SIB breaches its additional requirement, it will have to present a capital correction plan and will be subject to the same limitations on dividend payout as the conservation buffer  An additional requirement should be applied within 12 months in case of a bank bucket progression 14

2. ADDITIONAL LOSS ABSORBENCY REQUIREMENT

•

A multi-criteria approach in order to identify the G-SIBs:

(source: BCBS)

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CONTENTS

1.

Identification criteria

2.

Additional loss absorbency requirement

3.

Macro-economic Impact

4.

Public consultation

5.

Next steps

6.

D-SIFIs: an extension to domestic systematically important institutions

16

3. MACRO-ECONOMIC IMPACT Expected impacts  The systemic assessment methodology, as any new regulation system, should generate a short-term cost for G-SIBs  It may affect the G-SIBs’ lending capacity to the real economy and, therefore, have a negative impact on growth  However, on the long run, the positive impacts of a stronger banking system need to be considered

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3. MACRO-ECONOMIC IMPACT Impact analysis (April 2011):  The Macroeconomic Assessment Group (MAG) and the Basel Committee’s Long-term Economic Impact (LEI) tend to show: 1) a quite small negative impact on GDP (few basis point only) during the implementation period (4 / 8 years) 2) in the opposite, an exposure reduction to systemic crises gives a substantial benefit for the economy 3) on the long-term, the G-SIBs assessment methodology combined with Basel III promote a stable and significant growth 

This results, obtained with assumptions, are naturally to consider with caution 18

CONTENTS 1.

Identification criteria

2.

Additional loss absorbency requirement

3.

Macro-economic Impact

4.

Feedback from the public consultation

5.

Recent and next steps

6.

D-SIFIs: an extension to domestic systematically important institutions

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4. FEEDBACK FROM THE PUBLIC CONSULTATION The consultation (Jul/Aug 2011) outlined numerous comments : 1)

The idea itself of an additional loss absorbency requirement was challenged by banks

2)

Some indicators (such as size) were considered as too strong penalties as well as some measurement definitions (e.g. no cancellation of intra-EU operations for the cross-border category and no netting of OTC derivatives for the complexity category)

3)

The determination process of the additional requirement levels per bucket was not clear enough

4)

Some others technical points were pointed out due to calculation or definition problems (e.g. the lack of capacity to isolate securities only hold by financial institutions or how to perceive the cross-border liabilities) 20

4. FEEDBACK FROM THE PUBLIC CONSULTATION The Basel Committee finalized the assessment methodology in September 2011: 

Some comments were not retained (e.g. the OTC derivatives on net instead on gross)



Others will be revisited (e.g. the EU viewed as a single market)



However, the committee expect to improve as much as possible the technical consistency and the feasibility of this assessment system



The rules text will certainly, therefore, be amended

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CONTENTS 1.

Identification criteria

2.

Additional loss absorbency requirement

3.

Macro-economic Impact

4.

Public consultation

5.

Recent and next steps

6.

D-SIFIs: an extension to domestic systematically important institutions

22

5. RECENT AND NEXT STEPS 

A new database (31/12/2010) will furnish updated results including a new score calibration and enhance some parameters of the methodology. This database should be upgraded on an annual basis



In November 2011, an agreement was acted by the G20 on the whole methodology, followed by the G-SIBs list publication



The final calibration is scheduled for 2014 and the gradual launch will start in 01/01/2016 (full effect in 2019)



Framework extension to domestic SIFIs …

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CONTENTS 1.

Identification criteria

2.

Additional loss absorbency requirement

3.

Macro-economic Impact

4.

Public consultation

5.

Recent and next steps

6.

D-SIFIs: an extension to domestic systematically important banks

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6. D-SIFIS: AN EXTENSION TO DOMESTIC SYSTEMATICALLY IMPORTANT BANKS  Issued for comments in June 2012  Many banks are not significant from an international perspective but could have an important impact on their financial domestic system and real economy  Degree of national discretion  More principle based  12 principles

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6. D-SIFIS: AN EXTENSION TO DOMESTIC SYSTEMATICALLY IMPORTANT BANKS  Methodology established by national authorities  Reference system is the domestic economy  Consolidated to include any of their downstream sub  Four main factors (but not the same degree of details than GSIB) :  Size  Interconnectedness  Substitutability  Complexity  Other data (bank size to GDP) 26

CONCLUSION



An inseparable methodology with Basel III



It is now obvious that such a device has real merits in the reinforcement of the banking system



It does not mean that public consultation becomes irrelevant. Some technical improvements are expected



The creation of a G-SIFIs assessment methodology will be studied carefully

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