BIS Outlines Basel III

The Bank for International Settlements has announced:

the oversight body of the Basel Committee on Banking Supervision, met on 26 July 2010 to review the Basel Committee’s capital and liquidity reform package. Governors and Heads of Supervision are deeply committed to increase the quality, quantity, and international consistency of capital, to strengthen liquidity standards, to discourage excessive leverage and risk taking, and reduce procyclicality. Governors and Heads of Supervision reached broad agreement on the overall design of the capital and liquidity reform package. In particular, this includes the definition of capital, the treatment of counterparty credit risk, the leverage ratio, and the global liquidity standard. The Committee will finalise the regulatory buffers before the end of this year. The Governors and Heads of Supervision agreed to finalise the calibration and phase-in arrangements at their meeting in September.

The Basel Committee will issue publicly its economic impact assessment in August. It will issue the details of the capital and liquidity reforms later this year, together with a summary of the results of the Quantitative Impact Study.

The Annex provides vague details, vaguely:

Instead of a full deduction, the following items may each receive limited recognition when calculating the common equity component of Tier 1, with recognition capped at 10% of the bank’s common equity component:

  • Significant investments in the common shares of unconsolidated financial institutions (banks, insurance and other financial entities). “Significant” means more than 10% of the issued share capital;
  • Mortgage servicing rights (MSRs); and
  • Deferred tax assets (DTAs) that arise from timing differences.

A bank must deduct the amount by which the aggregate of the three items above exceeds 15% of its common equity component of Tier 1 (calculated prior to the deduction of these items but after the deduction of all other deductions from the common equity component of Tier 1). The items included in the 15% aggregate limit are subject to full disclosure.

There’s at least some recognition of the riski of single point failure:

Banks’ mark-to-market and collateral exposures to a central counterparty (CCP) should be subject to a modest risk weight, for example in the 1-3% range, so that banks remain cognisant that CCP exposures are not risk free.

1-3%? Not nearly high enough.

The Committee agreed on the following design and calibration for the leverage ratio, which would serve as the basis for testing during the parallel run period:

  • For off-balance-sheet (OBS) items, use uniform credit conversion factors (CCFs), with a 10% CCF for unconditionally cancellable OBS commitments (subject to further review to ensure that the 10% CCF is appropriately conservative based on historical experience).
  • For all derivatives (including credit derivatives), apply Basel II netting plus a simple measure of potential future exposure based on the standardised factors of the current exposure method. This ensures that all derivatives are converted in a consistent manner to a “loan equivalent” amount.
  • The leverage ratio will be calculated as an average over the quarter.

Taken together, this approach would result in a strong treatment for OBS items. It would also strengthen the treatment of derivatives relative to the purely accounting based measure (and provide a simple way of addressing differences between IFRS and GAAP).

When it comes to the calibration, the Committee is proposing to test a minimum Tier 1 leverage ratio of 3% during the parallel run period.

A leverage of 33x on Tier 1? It’s hard to make comparisons … the definition of exposures appear to be similar to Canada’s, but Canada uses total capital with a leverage pseudo-cap of 20x – this can be increased at the discretion of OSFI, without disclosure by either OSFI or the bank as to why the increase is considered prudent and desirable.

I suspect that Canadian banks, in general, will have about the same relationship to the new leverage cap as they have to the extant leverage cap, but will have to wait until those with access to more data have crunched the numbers.

US comparisons are even harder, as their leverage is capped at 20x Tangible Common Equity, but uses only on-balance-sheet adjustments.

The vaguest part of the Annex is:

In addition to the reforms to the trading book, securitisation, counterparty credit risk and exposures to other financials, the Group of Governors and Heads of Supervision agreed to include the following elements in its reform package to help address systemic risk:

  • The Basel Committee has developed a proposal based on a requirement that the contractual terms of capital instruments will allow them at the option of the regulatory authority to be written-off or converted to common shares in the event that a bank is unable to support itself in the private market in the absence of such conversions. At its July meeting, the Committee agreed to issue for consultation such a “gone concern” proposal that requires capital to convert at the point of non-viability.
  • It also reviewed an issues paper on the use of contingent capital for meeting a portion of the capital buffers. The Committee will review a fleshed-out proposal for the treatment of “going concern” contingent capital at its December 2010 meeting with a progress report in September 2010.
  • Undertake further development of the “guided discretion” approach as one possible mechanism for integrating the capital surcharge into the Financial Stability Board’s initiative for addressing systemically important financial institutions. Contingent capital could also play a role in meeting any systemic surcharge requirements.

The only form of contingent capital that will actually serve to prevent severe problems from becoming crises is “going concern” CC – which is regulator-speak for Tier 1 capital. The “conversion at the point of non-viability” “at the option of the regulatory authority” is merely an attempt by the regulators to short-circuit the bankruptcy process and should be considered a debasement of creditor rights.

There are a number of adjustments to the proposals for the Liquidity Coverage Ratio and the Net Stable Funding Ratio on which I have no opinion – sorry folks, I just plain haven’t studied them much!

Bloomberg comments:

France and Germany have led efforts to weaken rules proposed by the committee in December, concerned that their banks and economies won’t be able to bear the burden of tougher capital requirements until a recovery takes hold, according to bankers, regulators and lobbyists involved in the talks. The U.S., Switzerland and the U.K. have resisted those efforts.

Update, 2010-07-27: The Wall Street Journal fingers Germany as the dissenter:

Germany refused—at least for now—to sign on to parts of an agreement on the latest round of an evolving international accord on bank-capital standards being negotiated by the Basel Committee on Banking Supervision, according to officials close to the talks.

But a footnote to the news release said: “One country still has concerns and has reserved its position until the decisions on calibration and phase-in arrangements are finalized in September.” That one country wasn’t identified in the release by the Basel Committee.

One Response to “BIS Outlines Basel III”

  1. […] PrefBlog Canadian Preferred Shares – Data and Discussion « BIS Outlines Basel III […]

Leave a Reply

You must be logged in to post a comment.