Risk & Capital Management under Basel III

Transcription

1 Risk & Capital Management under Basel III London, 15 Draft

2 Agenda Impact of Basel III changes on banks and the economy What are banks doing to address the challenge? Some quantitative examples: - Return on Equity - Pricing 2

3 What is the impact of the changes on the economy? What the Basel Committee says... Transitional impact on the macro-economy: Capital: 1% increase in required capital ratio = c. 0.19% decline in GDP after 4½ years. Liquidity: 25% increase in holding of liquid assets + extension of the maturity of banks wholesale liabilities = c. 0.14% increase in lending spreads + fall in lending volumes of 3.2% after 4½ years + a decline of c. 0.08% in GDP. BCBS Interim Report August 2010 Assessing the macroeconomic impact of the transition to stronger capital and liquidity requirements. 3

4 What is the impact on banks? Overall impact on risk based capital requirements for: Group 1 banks - Gross CET1 ratio falls from 11.1% to 5.7%. Capital shortfall: 165bn (4.5% CET1 target) 577bn (7.0% CET1 target) 2009 PTP = 209bn Group 2 banks - Gross CET1 ratio falls from 10.7% to 7.8%. Capital shortfall: 8bn (4.5% CET1 target) 25bn (7.0% CET1 target) 2009 PTP = 20bn LCR: shortfall of 1.73 trillion NSFR: shortfall of 2.89 trillion BCBS December 2010 Results of the comprehensive quantitative impact study. 4

5 What is the world saying about banks? The new rules will force banks to set aside more capital for their fixed-income operations, and would have reduced the average returns on equity by 5.7 percentage points from 14% to 8.3% in 2010, while the return from equities would have fallen by 2.6 percentage points from 19.1% to 16.5 %, they said. Huw van Steenis, 17 January 2010 Morgan Stanley 5

6 What is the world saying about the banks? We expect dividend contributions to be curtailed until capital bases are restored to required levels, in 2015, for the sector. Philip Richards and Gert van Rooyen, 4 Société Générale 6

7 Never again the response of regulators But will requirements keep rising? Bank of England Discussion Paper No Optimal bank capital: We conclude that: even proportionally large increases in bank capital are likely to result in a small long-run impact on the borrowing costs faced by bank customers. even if the amount of bank capital doubles our estimates suggest that the average cost of bank funding will increase by only around 10-40bps substantially higher capital requirements could create very large benefits by reducing the probability of systematic banking crises. We use data from shocks to incomes from a wide range of countries over a period of 200 years to assess the resilience of a banking system to these shocks and how equity capital protects against them. In the light of the estimates of costs and benefits we conclude that the amount of equity funding that is likely to be desirable for banks to use is very much larger than banks have had in recent years and higher than targets agreed under the Basel III framework. 7

8 It s more than compliance - the rules challenge banks on capital, funding & profitability (1/2) Event Impact Resulting in... Increased competition for deposits. Changes to repo market dynamics. More competition for funds in the bond markets - from insurers; corporates Need to look for alternative (more expensive) funding. Potential for reduced NII margin. Higher haircuts and more encumbered assets. Need to look for alternative (more expensive) funding especially if bank credit ratings fall. Cost of funding NII / P&L Cost of funding Availability of liquid assets Cost of funding Availability of funding 8

9 It s more than compliance - the rules challenge us on capital, funding & profitability (2/2) Event Impact Resulting in... CCR requirements force trading books to become the preserve of hedge funds. Need to maintain a portfolio of high quality liquid assets. Changes to the definition of capital. Another potential source of income is challenged. Lower returns on larger portfolio of high quality assets (potentially with more limited availability to drive returns down further). Capital growth limited and becoming scarcer and more expensive. P&L NII / P&L + Opportunity cost Cost of capital Availability of capital Contingent convertibles and bail in bonds Need to find buyers for riskier capital instruments. Huge volume of capital to be replaced Cost of capital Availability of capital 9

10 In summary - what are the rules telling us to do? How to respond: invest to comply? Capital and liquidity management: - RWA optimization and mitigation - Monitoring available liquidity and liquid assets - Funding and transfer pricing Collateral management Stress testing: risk management tool or regulatory requirement Trading book: - Monitoring and managing counterparty credit risk - Embedding stressed VaR limits Contingency plans recovery in times of stress; resolution on death Rebuild the structure and booking models 10

12 What are the banks saying? UBS may have to change its structure and move some capital- intensive investment banking businesses, such as securitization, into subsidiaries in other jurisdictions with lower capital requirements. The bank currently operates through branches in other countries and holds almost all capital in Switzerland while booking 80 percent of assets elsewhere. Oswald Gruebel, 8 Chief Executive Officer, UBS 12

13 What are the banks saying? I think we re going to have to move to a regime of booking more business in fully capitalized subsidiaries, especially in the U.K., which is our European Union hub, and the U.S. John Cryan, 8 Chief Financial Officer, UBS 13

14 What is the world saying? We have to be a little more selective both in relation to the potential profitability of those business lines but also in relation to the capital they use, We will de-emphasize some businesses that look as though we can t make them profitable or they use too much capital for the profit potential. John Cryan, 8 Chief Financial Officer, UBS 14

15 How to respond: invest to comply... or refresh what I do? Banks are transitioning from a post-crisis focus to preparing for the new world of stringent regulation. Can they successfully change their playing field, or will others do it better? - Low capital/liquidity businesses become more valuable - Move trading books out into hedge funds - Reshape deposit base to longer maturities - Review maturity transformation - longer term lending (property?) - Consider balance between banking and insurance Basel III vs. Solvency II? - Review options in shadow banking private equity, money market, property and other funds 15

16 What is the world saying about the banks?... and the effect is? Banks are already adapting business models to offset the expected impact, and extra pricing power should enhance sector profitability. Philip Richards and Gert van Rooyen, 4 January 2011 Société Générale 16

18 Possible effects on bank profitability : present rules (1/2) Total assets RWA % RWA Liabilities Cash 10 0% 0 Current and deposit accounts 47,12 Government bonds 10 0% 0 Bonds 47,12 Loans to banks 10 20% 2 Tier 2 instruments 2,88 Loans to customers % 60 Other tier 1 instruments 1,44 Other assets % 10 Equity 1,44 Total assets Capital structure Tier 1 - in % RWA 4,0% 2,88 Tier 2 - in % RWA 4,0% 2,88 Minimum requirement 5,76 - o/w Equity - in % RWA 2,0% 1,44 Equity - CCB 0,0% 0,00 A simplified Balance Sheet and a capital structure consistent with the present minimum regulatory requirement is assumed as a starting point. The minimum equity value is equal to 1,44. 18

19 Possible effects on bank profitability : present rules (2/2) Interest rates Government bonds 3,0% Loans to banks 1,0% Loans to customers 7,0% Current and deposit accounts 1,0% Bonds 4,0% Tier 2 instruments 6,0% Other tier 1 instruments 7,5% Risk cost (EL) 1,0% General expenses (as a % of revenues) 50,0% Profit & loss Interest received 4,60 Interest paid -2,64 Interest margin 1,96 General expenses -0,98 Risk cost (EL) -0,60 Gross profit 0,38 Net profit (@ 40%) 0,23 RoE 15,90% Considering the data of the table on the right, the RoE is equal to 15,9%. 19

20 Possible effects on bank profitability: incoming rules (1/2) Total assets RWA % RWA Liabilities Cash 10 0% 0 Current and deposit accounts 46,22 Government bonds 10 0% 0 Bonds 46,22 Loans to banks 10 20% 2 Tier 2 instruments 1,44 Loans to customers % 60 Other tier 1 instruments 1,08 Other assets % 10 Equity 5,04 Total assets Capital structure Tier 1 - in % RWA 6,0% 4,32 Tier 2 - in % RWA 2,0% 1,44 Minimu requirement 5,76 - o/w Equity - in % RWA 4,5% 3,24 Equity - CCB 2,5% 1,80 According to the new rules the minimum equity is equal to 5,04. 20

21 Possible effects on bank profitability: incoming rules (2/2) Interest rates Government bonds 3,0% Loans to bank 1,0% Loans to customers 7,0% Current and deposit accounts 1,0% Bonds 4,0% Tier 2 instruments 6,0% Other tier 1 instruments 7,5% Risk cost (EL) 1,0% General expenses (as a % of revenues) 50,0% Profit & loss Interest received 4,60 Interest paid -2,48 Interest margin 2,12 General expenses -1,06 Risk cost (EL) -0,60 Gross profit 0,46 Net profit (@ 40%) 0,28 RoE 5,49% Considering the same conditions as in our initial example, the RoE decreases to 5,49% 21

23 Possible effects on pricing: present and future situation Pricing (present situation) Amount financed 100,00 Interest rate 5,12% Interest received 5,12 Cost of funding -2,64 Interest margin 2,48 General expenses -1,24 Risk cost (EL) -1,00 Gross profit 0,24 Net profit 40%) 0,14 Cost of -0,14 Value 0,00 Pricing (Basel III) Amount financed 100,00 Interest rate 6,12% Interest received 6,12 Cost of funding -2,48 Interest margin 3,64 General expenses -1,82 Risk cost (EL) -1,00 Gross profit 0,82 Net profit 40%) 0,49 Cost of -0,50 Value -0,01 A simple one-year bullet loan is assumed. Interest is paid in arrears. The interest rate to be paid to achieve break-even will increase from 5,12% to 6,12%. 23

24 Conclusions The aim of the Committee s proposals is to create a more stable financial system The Basel Committee s proposals tend to enhance some areas of Basel 2 framework The parameter calibrations and the transition periods are two important factors that will determine the impact of the new proposals on the banking system. But as we all know the devil is in the detail. The new measures should be implemented consistently as part of a global framework. To this end, most of the specific parameters used in the new metrics should be harmonised internationally Most of the proposals will have relevant impact on bank profitability and pricing 24