Basel III and regional financial integration in emerging Europe

Transcription

1 Basel III and regional financial integration in emerging Europe EBRD Basel III workshop 21 March 2011 Alexander Lehmann, Peter Tabak (EBRD) and Micol Levi (Unicredit)

2 Four main points Europe s periphery has benefited from close integration with eurozone banks in terms of economic growth and financial stability. Main threat from Basel III to CEE subsidiaries stems from new liquidity ratios a considerable constraint in poorly developed local bond markets, could fragment banks internal capital markets. National discretion over counter-cyclical capital buffers likely under CRD IV. More is needed to stem systemic risk. Effective coordination by European agencies (ESAs/ESRB) needed to preserve benefits under new EU regulatory regime

3 Outline 1. Parent-subsidiary networks in emerging markets: growth and stability benefits 2. Basel III: key micro-prudential implications for the emerging Europe region 3. The macro-prudential dimension 4. National discretion under CRD IV, and why there will be additional national measures to stem vulnerabilities

4 Complex Western European bank presence in emerging Europe

5 In central and south-eastern Europe, financial integration has been led by foreign banking groups Foreign bank asset share, Foreign bank asset share, end-2008 Per cent 100 CEB SEE EEC Russia 80 Turkey CA Per cent Slovakia Estonia Albania CEB SEE EEC Other Lithuania Croatia Romania Czech R. Hungary Bulgaria Poland Serbia Latvia Ukraine Armenia Kyrgyz R. Russia Turkey Kazakhstan

6 Banking in the CEE primarily through subsidiaries fully integrated in group internal capital markets Lending by foreign bank subsidiaries more stable than cross-border bank lending Multinational banks transmit home-country financial shocks and absorb host-country financial shocks Lending by foreign bank subsidiaries depends on home-country business cycle During a financial crisis domestic banks tend to rein in lending, foreign bank subsidiaries less so

7 Financial integration was one of the conduits of the international crisis Change in external positions of BIS reporting banks (% of previous quarter) 20% 15% Dec-2007 Mar-2008 Jun-2008 Sep-2008 Dec-2008 Mar-2009 Jun-2009 Sep-2009 Dec % 5.9% 5% 2.7% 4.2% 3.1% 0% -5% -10% -0.4% -0.4% -1.9% -1.9% -3.5% -3.7% -5.6% -4.6% -5.9% -5.6% 0.2% -5.3% -9.8% 1.0% -7.8% -15% -15.0% -20% Source: BIS EBRD EBRD (excl. SK) Latin America Emerging Asia 2/

8 Parent-subsidiary networks brought tangible growth and stability benefits Bank presence has significant effect on economic growth Positive impact of capital openness within EU unique among emerging markets, probably due to high penetration, and sound institutions Outflows over crisis period more modest where foreign subsidiary presence was significant a key difference to other emerging market regions foreign banks buffered the EU financing shock because of commitments to subsidiaries

9 Outline 1. Parent-subsidiary networks in emerging markets: growth and stability benefits 2. Basel III: key micro-prudential implications for the emerging Europe region 3. The macro-prudential dimension 4. How EU supervision needs to adapt to preserve benefits of the integrated financial and capital market

10 Quality of capital unlikely to be an issue in CEE Original (Dec. 2009) BCBS concern that consolidated capital at group level does not reflect minority participations in subsidiaries that may not be transferred for loss absorption elsewhere A problem in CEE where history of partial privatisations and acquisitions left large number of minority bank stakes Compromise (consolidate only up to min. capital requirements in proportion to minority interest) rectifies asymmetry between consolidation of RWA but not capital Raises question of distribution and fungibility of capital within bank groups and across integrated EU financial market but between autonomous regulatory spaces Will discourage further acquisition with significant minority stakes, potentially negative for equity market liquidity and local ownership support in CEE

11 Capital adequacy overall sufficient to meet new Tier 1 criteria More demanding tier 1 capital ratios at present not a problem: with the exception of a few institutions ample capital buffers (and in some countries already enforced) Supervisors generally more conservative in demanding capital coverage, given volatile asset quality. Banks increasingly adopt more cautious capital coverage, recognizing risks from fx exposures System-wide: ample capital coverage, given more demanding regulatory requirements, and following tightening in lending standards, anaemic asset growth and (as yet) modest provisioning Risk of capital withdrawals due to shortfalls in home countries

12 Slovakia Slovenia Tier 1 Capital Ratios (%) % Tier One Austria Germany Italy Bulgaria Czech Estonia Hungary Lithuania Latvia Poland Romania Source: ECB. all banks domestic banks

13 Share of assets in banks with overall Solvency < 10% Austria Germany Italy Bulgaria Czech Estonia Hungary Lithuania Latvia Poland Romania Slovenia Slovakia Source: ECB

14 Changed capital weights: trade finance the key issue for emerging markets, though less for CEE Trade finance to face five-fold increase in capital weights); mitigation through export guarantee schemes unclear funds about 20 per cent of world trade; more important in low income countries with poor financial access, less so in CEE with generally good corporate credit access, and deep FDI presence Basel III impact on funding costs and funding availability likely more severe for less developed but open economies outside EU (e.g. western Balkans)

15 Liquidity ratios are a concern LCR already in effect in most jurisdictions, though liquid assets in effect limited to cash and government securities marketability will rightly exclude centr. bank refinancing options, though these will likely be phased out by then NSFR the key concern: few term deposits and debt securities typically very small share of overall liabilities, and at short maturities (3m-1y), Requirements will likely give incentives for further unwinding of banks long term assets, in particular in the nascent local corporate bond market, and corporate credit NBP expects shortening in average maturities of assets, growing competition for deposits and rising funding costs

16 Loan to deposit ratios underline funding gaps Austria Germany Italy Bulgaria Czech Estonia Hungary Lithuania Latvia Poland Romania Slovenia Slovakia Source: ECB

17 Poorly developed local bond markets unlikely to provide term funding

18 hence bank bond funding negligible: bonds/total liabilities (%) Austria Germany Italy Bulgaria Czech Estonia Hungary Lithuania Latvia Poland Romania Slovenia Slovakia 0 Source: ECB

19 Regulatory fragmentation of internal capital markets? CRD IV envisages national application of liquidity standards. Gives option of currency by currency requirements Intra-group (parent) funding likely treated as external funding at short maturities (deemed callable) no netting out of maturity mismatches at group level Operational costs due to rise as accounting and reporting functions replicated at subsidiary level Possibly incentives to convert to branches

20 Liquidity risks from fx exposures unaddressed in Basel III, unclear under CRD IV Money market structure in EU vs. EU-10 Swap rates and HUF in Hungary Subsidiary money market operations exposed to fx swap markets: lc deposit base swapped into fx asset base Liquidity stress quickly apparent in deterioration in fx swap markets (e.g. Q4-08-Q1-09) Margin calls in periods of local currency depreciation: credit risk swapped for liquidity risk Not covered in Basel III, though uniform treatment needed and likely through CRD IV. Sources for charts: World Bank and Bloomberg.

21 Outline 1. Parent-subsidiary networks in emerging markets: growth and stability benefits 2. Basel III: key micro-prudential implications for the emerging Europe region 3. The macro-prudential dimension 4. How EU supervision needs to adapt to preserve benefits of the integrated financial and capital market

22 Basel III: macro-prudential elements Address stability over time (pro-cyclicality): Countercyclical capital charges Through-the-cycle expected loss provisioning Capital conservation rules for stronger capital buffers Address stability at each point in time (systemwide approach): Which are the systemically important financial institutions that will attract capital surcharges? Identify inter-linkages and common exposures among all financial institutions

23 Can macro-prudential requirements dampen CEE s traditional sharp swings in credit? (y-o-y growth in credit to the private sector, 3mma) Source: IMF, WEO.

24 Limited policy scope where capital accounts are open: capital flows to CEE strongly correlated with excessive credit growth (Per cent) 90 Ukraine 90 Average credit growth between mid-2005 and mid Albania Estonia Serbia Lithuania Russia Tajikistan Bulgaria FYR BiH Croatia Slovenia Czech Rep. Hungary Poland Azerbaijan Kazakhstan Romania Moldova R 2 = Latvia Median growth of BIS lending between mid-2005 and mid-2007

25 Periods of credit boom are highly correlated (years with credit growth > 2 p.p. of GDP) 7 CEB SEE EEC and other Slovenia Croatia Estonia Latvia Poland Hungary Slovak Rep. Czech Rep. Lithuania FYR Macedonia Serbia Bulgaria Romania Albania Kazakhstan Moldova Russia Turkey Ukraine Mongolia Armenia Georgia Kyrgyz Rep

26 Countercyclical capital buffer to protect the banking sector from periods of excess aggregate credit growth that have often been associated with the build up of system-wide risk on top of minimum capital requirement and capital conservation buffer, as the latter to restrain earning distribution. Host country determines case for and size of countercyclical buffer and announces with 12 month advance notice Capital buffer of consolidated entity = weighted average of buffers in effect in each foreign subsidiary jurisdiction

27 Complications in the EU s integrated market Deviation from trend credit/gdp path unlikely to be good guide. In CEE generally short and often poor data availability. Emerging economies more prone to sharp credit cycles possibly enforcement of sound lending standard more important to stem systemic risks. Weak central banks may be unable to resist political pressure or prevent abuse of buffer as economic stimulus as opposed to macro-prudential objectives Cross-selling (from home and other CEE countries) likely to undermine effectiveness of national capital requirements. Capital charges fairly blunt: wider range of policy tools likely to be required; branches remain unregulated

28 Outline 1. Parent-subsidiary networks in emerging markets: growth and stability benefits 2. Basel III: key micro-prudential implications for the emerging Europe region 3. The macro-prudential dimension 4. How EU supervision needs to adapt to preserve benefits of the integrated financial and capital market

29 Sustaining the benefits of Europe s integrated financial market: the new supervisory agencies CEBS EBA Single rule book, harmonize practices, reduce scope for regulatory arbitrage To oversee regulatory colleges/home-host coordination Common stress tests Yet to come: ESRB to recommend macro-prudential measures, develop effective instruments In theory holistic regulation of all financial instruments and actors Supervision of systemically important institutions Complex body, political backing questionable EU Commission proposed European resolution regime to prevent national capital requirements and crisis funds (bank taxes) Ex-ante cross-border burden sharing arrangements needed to prevent destructive national bank runs