Banking Regulation. Pros and Cons

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1 Certificate in Social Banking Money and Society Banking Regulation Pros and Cons Professor Dr. Gregor Krämer Chair for Banking, Finance, and Accounting Alanus University of Arts and Social Sciences, Alfter, Germany Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 1

2 Agenda 1. Some facts and recent developments in banking regulation 2. Discussion about pros and cons of banking regulation Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 2

3 Banks main risks income risk capital requirements operational risk credit risk market risk liquidity risk liquidity requirements Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 3

4 objectives of banking supervision functions of own funds protection of viability of the financial sector contributing to* loss compensation (going concern) creditor protection contributing to* liability (gone concern) * general prerequisite: permanence of provision of funds Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 4

5 Reasons for internationalisation of banking supervision expansion of banks business activities beyond national borders extensive interlocking of credit- and financial markets as well as among banks themselves introduction of the Euro in the euro-area technologicalisation of the banking and financial system increased risk of transmission of shocks securitisation und disintermediation have caused a change in banks risk structures risk of gaps in national banking supervisory regulations risk that banks will try to take advantage of supervisory arbitrage Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 5

6 Degrees of unification of different banking supervision models cooperation of national banking supervisory authorities establishment of a supranational banking super- visory authority with compre- hensive power to intervene harmonisation of banking supervisory regulations while maintaining national responsibility low unification of banking supervisory regulations high Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 6

7 Basel Committee on Banking Supervision (BCBS) establishment 1974 as Committee on Banking Regulations and Supervisory Practices (renaming in 1989) seat at the Bank for International Settlement (BIS), Basel (Switzerland) members central bank governors and heads of banking supervision from member countries member countries 27 member countries: Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, Russia, Saudi-Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, United Kingdom, USA legitimisation the BCBS is not a democratically legitimised institution; therefore its standards are not binding for any bank in any country; but many countries implement these standards into their national legal system (e.g. EU) Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 7

8 BCBS member institutions central supervisory central supervisory jurisdiction jurisdiction bank authority bank authority Argentina yes Luxemburg yes Australia yes yes Mexico yes yes Belgium yes yes Netherlands yes Brazil yes Russia yes Canada yes yes Saudi-Arabia yes China yes yes Singapore yes France yes yes South Africa yes Germany yes yes Spain yes Hong Kong yes Sweden yes yes India yes Switzerland yes yes Indonesia yes Turkey yes yes Italy yes United Kingdom yes yes Japan yes yes USA yes yes Korea yes yes Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 8

9 Key aspects of Basel I Basel I (1988) first common international regulation on capital measurement and capital standards for banks capital requirements solely for credit risk only rudimentary consideration of a debtor s credit worthiness 1996: amendment of the Basel capital accord to incorporate market risk Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 9

10 Key aspects of Basel II Basel II (2004) incorporation of operational risk improved measurement of credit risk (external/internal ratings) no changes concerning the recognition of financial instruments as own funds establishment of pillar 2 (supervisory review process) and pillar 3 (market discipline) Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 10

11 The three pillars of Basel II pillar 1 stability of the international banking and financial system Basel II (2004) pillar 2 pillar 3 minimum capital requirements supervisory review process market discipline by increased disclosure Basel I (1988) Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 11

12 Mechanism of market discipline discloses information about worsening of its risk situation bank 1 market participants lender of debt capital supplier of equity 2 respond with bank s financial situation is worsening 4 3 banks and institutional investors charging a risk premium reclaiming capital not signing a contract demanding additional collateral exerting influence on management bank is reducing its risks to an adequate level 3 Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 12

13 Key aspects of Basel III Basel III (2010) modification of regulatory capital requirements introduction of a leverage ratio introduction of a global liquidity standard raise of the quality and quantity of banks regulatory capital base introduction of a capital conservation buffer introduction of a countercyclical buffer Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 13

14 Minimum capital requirements according to Basel III total regulatory capital Tier 1 capital (going-concern capital) Tier 2 capital (gone-concern capital) Common Equity Tier 1 capital Additional Tier 1 capital must be at least 4.5 % of riskweighted assets at all times must be at least 6.0 % of risk-weighted assets at all times must be at least 8.0 % of risk-weighted assets at all times note: there will be no more Tier 3 capital Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 14

15 Capital conservation buffer designed to ensure that banks build up capital buffers outside periods of stress capital buffers can be drawn down as losses are incurred elements: Common Equity Tier 1 capital size: 2.5 % of risk-weighted assets above the regulatory minimum capital requirement Common Equity Tier 1 ratio of 7 % when capital levels fall within the range of 4.5 % to 7 % capital distribution constraints will be imposed on a bank; these constraints concern dividends, share buybacks, discretionary bonus payments to staff minimum capital conservation standards Common Equity Tier 1 Ratio Minimum Capital Conservation Ratios (expressed as a percentage of earnings) 4.5 % % 100 % > % 5.75 % 80 % > 5.75 % % 60 % > % 7.0 % 40 % > 7.0 % 0 % cf. BCBS: Basel III: A global regulatory framework for more resilient banks and banking systems, December 2010 (rev. June 2011), paragraph 131. Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 15

16 Countercyclical capital buffer enlargement of the capital conservation buffer buildup in times of excess aggregate credit growth which can lead to a rise in system wide risk elements: Common Equity Tier 1 capital (maybe also other fully loss absorbing capital) size: 0 % 2.5 % of risk-weighted assets above the regulatory capital requirement national authority will decide on the implementation of the buffer national authority will pre-announce its decision to raise the level of the countercyclical capital buffer by up to 12 months decisions to decrease the buffer will take effect immediately Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 16

17 Quantitative minimum requirements for banks regulatory capital % % Tier 2 capital 2 % Additional Tier 1 capital 2 % Common Equity Tier 1 capital Basel II minimum 8 % 0% 2.5 % countercyclical capital buffer 2.5 % capital conservation buffer 2 % Tier 2 capital 1.5 % Add. Tier 1 capital 4.5 % Common Equity Tier 1 capital Basel III minimum 8 % 13 % Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 17

18 Basic structure of the financial supervisory framework in the EU European System of Financial Supervision ESFS micro-prudential supervision by national and european supervisory authorities (ESAs) information on micro-prudential developments early warnings and recommendations for supervisory authorities macro-prudential supervision by European Systemic Risk Board ESRB early warnings and recommendations for governments EU and member states Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 18

19 Structure of the micro-prudential supervision in the EU micro-prudential supervision on EU-level Joint Committee of the ESAs European Banking Authority (EBA) European Insurance and Occupational Pensions Authority (EIOPA) European Securities and Markets Authority (ESMA) micro-prudential supervision on national level national banking authorities national insurance and occupational pensions authorities national securities and markets authorities Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 19

20 Thank you very much for your attention! questions and answers discussion about the pros and cons of banking regulation Prof. Dr. Gregor Krämer Banking Regulation Pros and Cons page 20