Identifying top threats to Luxembourg Banks - PwC · Basel III rules are defined by the Basel Committee, which has representatives from the G20 but does not have any legal powers,
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Identifying top threatsto Luxembourg banks
7 March 20127 March 2012
Agenda
09h00 – 09h10 Welcome
09h10 – 09h30 Macro-economic environment: the biggestthreat to Luxembourg Banks
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09h30 – 10h15 Identifying the other top threats toLuxembourg Banks
10h15 – 10h30 Questions and answers
10h30 – 10h45 Conclusion
Welcome andintroduction
Rima Adas, Partner, Banking Leader
Sovereign debt-crisis: amacro-economicperspective
Johannes Göldner, Senior Advisor
Exploring all alternatives
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Source: Matt, The telegraph, www.thetelegraph.co.uk
5
The financial crisis enters its fifth year
Phases of the crisisIncreasing risks to financial
stability
Privatedebt
Subprime crisis originates in US
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Source of graph: International Monetary Fund, Financial Stability Report,September 2011
Banking
Sovereign
Political
Systemic banking crisis spreads from US toEurope
European periphery sovereign debt problemsMedium term threat to advanced economies
Major political disagreements on how toassure financial stability
6
April September January
2011 2012 2011 2012 2011 2012 2013
France 1.6 1.8 1.7 1.4 1.6 0.2 1.0
Elevated debt and deteriorating perspectives
140
160
180
200
Debt in % of GDP Outlook real GDP growth (in %)
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Germany 2.5 2.1 2.7 1.3 3.0 0.3 1.5
Greece1 -3 1.1 -5 -2 -6.1 -4.3 0.0
Ireland 0.5 1.9 0.4 1.5 - - -
Italy 1.1 1.3 0.6 0.3 0.4 -2.2 -0.6
Portugal -1.5 -0.5 -2.2 -1.8 0.7 -1.7 -0.3
Spain 0.8 1.6 0.8 1.1 - - -
G20Advanced
2.3 2.5 1.3 1.7 - - -
7
Source: International Monetary Fund, Fiscal Monitor, September 2011
0
20
40
60
80
100
120
2011
2012
2013
Source: International Monetary Fund, World Economic Outlook, April &September 2011;
1 Source for January figures is baseline scenario of Debt Sustainability Analysis,IMF (Feb. 2012)
7
Maturing bonds & loans 2011-2013(in € billion)
Portugal + Ireland+ Greece
181
Italy + Spain 905
France 490
Overview maturing sovereign bonds & loans
Greece
Spain
France
2012
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France 490
Total 1.576
8
Source: Bloomberg, March 5th, 2012; Includes maturing bonds and loans to Government
In € billion
• Sufficient market absorption?
• Will short-term yields remain at sustainablelevels?
• Will impact of LTROs move up the yieldcurve?
0 100 200 300 400 500 600 700
Portugal
Italy
Ireland
2013
2014
8
500
600
700
800
900
Deposit facility
Use of the ECB’s overnight deposit facility
LTRO 1
LTRO 2
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0
100
200
300
400
9
In € billion
9
20
25
30
Germany
Ireland
10 year government bonds yield development
Yields in %
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0
5
10
15 Greece
Spain
France
Italy
Portugal
10
Implicit assumptionmutual liability
Onset subprime crisis
Greece admits tounderstating deficit
10
Overview important events Greek Bailout –an ongoing story
2010 2011 2012
Greek governmentadmits higher deficit
IMF and EU agree toassist Greece
Agreement on secondbailout of € 109 bn is
reached, later fallsthrough
Eurozone leaders agree
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First bailout of € 110 bnlaunched
assist Greece
Adoption of EuropeanStabilisation Mechanism
Evidence reforms notimplemented fast
enough
Eurozone leaders agreeon 50% haircut, further
austerity measures
Eurozone agrees onsecond bailout of € 130
bn
11
Greek Bailout – The private sector involvement
Overview creditors Key terms of voluntary exchange
• Haircut of 53,5% on principal amount of privately heldGreek government bonds
• 31,5% of principal exchanged into 20 new governmentbonds
− Maturities between 11 and 30 years− Amortisation of 5% per annum from 2023 onwards
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Source: Statement by the Steering Committee of the Private Creditor-InvestorCommittee for Greece (PCIC), February 21st, 2012
Source: Der Spiegel, 20.01.2012, available athttp://www.spiegel.de/international/europe/bild-810420-301665.html
• 15% of principal exchanged into short-term EFSF notes
• Accrued interest on existing Greek government bonds willbe provided in short-term EFSF notes
• Coupon structure− 02/2012 - 02/2015: 2%− 02/2015 - 02/2020: 3%− 02/2020 – 02/2042: 4,3%
• Separate securities indexed to Greek GDP growth with capwill be offered to investors
12
IMF Debt Sustainability Analysis – The realisticcase for Greece?
140
160
180
200
220
240
140
160
180
200
220
240
Baseline scenario Alternative scenario
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Amount of debt outstanding in % of GDP
Source: IMF, debt sustainability analysis,available athttp://ftalphaville.ft.com/blog/2012/02/21/889521/that-greek-debt-sustainability-analysis-in-full/
100
120
100
120
No reforms undertaken
Reforms initiated
•Ability to deliver structural reforms•Realisation of privatisation objectives•Success private sector involvement•Macroeconomic parameters, in particular growth and interest ratelevels
Key assumptions
13
The European Sovereign debt situation – Outlook
• Sufficient participation of private sector creditors not certain
• Will potential new Greek government stick to reform agreements?
• Further bailout of ~€ 50 bn necessary down the road?
• Upcoming elections in France and Germany
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• Size and scope of ESM
• ECB and Eurobonds
Deeper European integration vs. implosion
If European crisis is resolved, shift of focus to America or Japan?
14
The European Sovereign debt situation – adilemma
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Source: Matt, The telegraph, www.thetelegraph.co.uk
15
Identifying the other topthreats to LuxembourgBanks
Thierry López, Partner, RiskManagement Services LeaderManagement Services Leader
PwC
Agenda for today
Top 10 banking risks in Luxembourg& in the worldThierry López, Partner, Risk Management Leader
2010 2012
Political interference 1 Macro-eco environment
Capital availability 2 Profitability
Dependence on technology 3 Regulation
Liquidity 4 Credit risk
Top 10 risks for Luxembourg bankers
19
Liquidity 4 Credit risk
Too much regulation 5 Capital availability
Credit risk 6 Political interference
Risk management quality 7 Liquidity
Corporategovernance
8 Restructuring and changemanagement
Environmental risk 9 Corporate governance
Macro-economic trends 10 Derivatives
Top 10 risks for world bankers
High
20
Low
Top risks for Luxembourg bankers
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the correct size, colour andlocation of the text, it isrecommended that you select.Overtype this placeholder text.Macro-economicenvironment
Top risks for Luxembourg bankers
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Profit expectations ought to be revised
Higher capital requirements
Greater regulatory and“Every aspect of
#2 Profitability
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Greater regulatory andcompliance costs
Curbs on banking activities
Political pressure to holddown prices
“Every aspect ofthe P&L is underpressure”
23
Top risks for Luxembourg bankers
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Basel III - Only one aspect of the bankingsector supervision reinforcement
The wider Basel III framework
OTC derivatives markets(EMIR)
Accounting topics(IAS 39)
#3 Regulation
PricewaterhouseCoopers LLP
The “pure” Basel III framework:
Capital definition, requirements & new buffersLeverage ratioLiquidity ratios
Higher capital requirements forsystemic banks
Bank recovery & resolutionregime
25
The new elements in details
Areas Main Basel III Components
Capital Ratios and Targets Capital Definition
Minimum Capital Standards
Counterparty Credit Risk ( CVA / CCPs )
1
2
3
#3 Regulation
PricewaterhouseCoopers LLP
Leverage Ratio New Leverage Ratio
Liquidity Standards Liquidity Coverage Ratio
Net Stable Funding Ratio
Monitoring Tools
4
5
More Capital
More Liquidity
Transformation ofbusiness models, processes &
risk management practices
6
7
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The solvency ratio is under strong pressure:
The eligible own funds (‘capital’) is subject to harmoniseddeductions
Adjusted own funds
The Solvency Ratio under Basel II and III
#3 Regulation
PricewaterhouseCoopers LLP
The capital requirements are increased in particular for OTCderivatives
The minimum ratios to meet are higher and become dynamic
Adjusted own fundsRatio = ------------------------------- 8%
12.5 x Capital requirements
Basel II
10.5%..13%
Basel III
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Top risks for Luxembourg bankers
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The risk of default is increasing
• Sovereign debt is by far thebiggest concern
“Can the global
#4 Credit risk
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• Consumer debt is a growingconcern, even in emergingeconomies (Turkey, China)
• In Luxembourg, households’debtload is increasing
“Can the globalbanking systemabsorb all thelikely losses?”
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Top risks for Luxembourg bankers
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All entities are fighting for capital that is hard to get hold of, be it onthe financial markets or even inside a same group
Focus on Common Equity– Core Equity Tier 1 ratio
as the key ratio
The fight for capital
#5 Capital availability
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as the key ratio
Harmonised regulatoryadjustments (deductions)
to be made fromCommon Equity Tier 1
Business is restrainedthrough the leverage ratio
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Top risks for Luxembourg bankers
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Dealing with political interference
• A worrying development formost respondents from the UK,Switzerland, Luxembourg, theNetherlands, Central Europe, the “Further political
#6 Political interference
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Netherlands, Central Europe, theUS, China, South Africa andAustralasia
• A necessary step to reformbanks and restore public confidencefor others
“Further politicalinterference is acertainty”
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Top risks for Luxembourg bankers
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Ratios & metrics under Basel IIIBasel III introduces two ratios and five monitoring metrics which aimto create a more resilient liquidity structure
LCRStock of high quality liquid assets
Total net cash outflows over the next 30 calendar days> 100%
#7 Liquidity
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NSFR
Monitoringmetrics
• Contractual maturity mismatch
• Concentration of funding
• Available unencumbered assets
• LCR by significant currency
• Market-related monitoring tools
Available amount of stable funding
Required amount of stable founding> 100%
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Global progress in transposing Basel IIIBasel III rules are defined by the Basel Committee, which hasrepresentatives from the G20 but does not have any legal powers,thus it will be implemented differently across jurisdictions
#7 Liquidity
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Not considered in report
Draft regulation not published
Draft regulation published
Final rule published
Final rule in force
Source: BCBS progress report on Basel III implementation, October 201136
Impact assessment of new liquidity ruleson Luxembourgish banks
Compliance of sample with LCR and NSFR requirements
#7 Liquidity
PwCSource: BCL and CSSF, Impact assessment as at Q2/201137
Impact assessment of new liquidity ruleson Luxembourgish banks
Distribution of banks by LCR results
#7 Liquidity
PwCSource: BCL and CSSF, Impact assessment as at Q2/201138
Impact assessment of new liquidity ruleson Luxembourgish banks
Shortfall in highly liquid assets in LCR
#7 Liquidity
PwCSource: BCL and CSSF, Impact assessment as at Q2/201139
Impact assessment of new liquidity ruleson Luxembourgish banks
Stock of highly liquid assets in LCR by business model
#7 Liquidity
PwCSource: BCL and CSSF, Impact assessment as at Q2/201140
Impact assessment of new liquidity ruleson Luxembourgish banks
Distribution of banks by NSFR results
#7 Liquidity
PwCSource: BCL and CSSF, Impact assessment as at Q2/201141
Impact assessment of new liquidity ruleson Luxembourgish banks
NSFR composition by bank size
#7 Liquidity
PwCSource: BCL and CSSF, Impact assessment as at Q2/201142
Top risks for Luxembourg bankers
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Change is a necessity
THE OLD WORLD - UBIQUITY THE NEW REALITY - PRECISION
GROWTH AT ANY COST
Banks were measured and rewarded performance on short-term gains rather than longer term value creation
STEWARDSHIP
A longer term view on value creation will be needed, withincentives designed to reward sustainable behaviours which
drive long term stakeholder value
OECD SUPREMACY MULTI-POLAR WORLD
#8 Restructuring and change management
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OECD SUPREMACY
OECD banks and financial centers dominate globally with alarge pool of experience professionals, apparently stable
regulation and an attractive business environment
MULTI-POLAR WORLD
Emerging market banks and financial centres will grow in scaleand credibility, challenging and ultimately outgrowing their
established counterparts
INHERENT COMPLEXITY
The size of banks, geographic spread and range of productsadded complexity that made it difficult for management to fully
understand and manage risk
INDIVIDUAL AND COLLECTIVE RESILIENCE
An imperative to prevent contagion to the wider bank oreconomy will mean that operating model resilience
OVERARCHING FOCUS ON ROE
Focus on the single metric (ROE) above all else
CONSTRAINED OPTIMISATION
Optimise against multiple liquidity and capital constraints
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Top risks for Luxembourg bankers
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Improving corporate governance
“Much is being done toimprove and reinforcethis at board level.
But of course the
“Without cleargovernance at boardlevel, boundaries may
#9 Corporate governance
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But of course thecomplexity of matrixmanagement andoutsourcing in manylarge organisations ismaking this moredifficult.”
level, boundaries maybe crossed very soonand open the door tojust about anything.”
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Top risks for Luxembourg bankers
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EMIR (European Market Infrastructure Regulation)objectives
OTCderivative trade
Reduce operational risk – Central Counterparty (CCP) and trade repository
#10 Derivatives
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OTC flows
TradeRepository
TradeRepository
ClientClientCounter
PartyCounter
Party
CCPCCPTrade
Clearing
Information
Some OTC will mandatorily have to go throughCCPs and those that are not CCP-cleared will leadto extra CVA capital requirements
Strategic &operationalimpacts for banks:
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Questions and answers
Conclusions
François Génaux, Partner, AdvisoryMarkets and Financial ServicesMarkets and Financial ServicesLeader
Thank you for your attention
Rima Adas François Génaux
Partner Partner
rima.adas@lu.pwc.com françois.genaux@lu.pwc.com
© 2012 PricewaterhouseCoopers S.à r.l. (Luxembourg). All rights reserved. In this document,“PwC” refers to PricewaterhouseCoopers S.à r.l. (Luxembourg) which is a member firm ofPricewaterhouseCoopers International Limited, each member firm of which is a separate legalentity.
Thierry López Johannes Göldner
Partner Senior Advisor
thierry.lopez@lu.pwc.com johannes.goldner@lu.pwc.com
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