European regulatory reforms crd IV

CRD IV – Implementing BASEL III reforms in Europe A Reference guide to understand the framework and Banking Implications

By Megha Gupta

Email: [email protected]

CRD IV Framework

Contents

CRD IV Framework

Capital Requirements Liquidity Rules Leverage Ratio Supervisory Review Disclosure Large Exposures

IT Implications

Transitional Changes Appendix

• Introduction of new Capital Buffers

• Minimum Capital Requirements and Capital ratios Capital Requirements

• Introduction of two new liquidity ratios

• Liquidity Coverage requirement (LCR)

• Net stable Funding Requirement (NSFR)

Liquidity Rules

• Introduction of leverage ratio to encourage firm’s asset s to be inline with Capital thus containing build up of leverage within banking system Leverage Ratio

• Supervisory processes aimed to enhance link between institution’s risk profile, its risk management, risk mitigation systems and capital

• Internal Capital Adequacy assessment process (ICAAP)

• Supervisory Review and Evaluation Process (SREP)

Supervisory Review

• Country by Country reporting requirements (CBCR)

• COREP ( up to 60 additional returns)

• FINREP ( up to 30 additional returns) Disclosure

• Requires bank and Investment Firms to monitor and control their large exposures and entails reporting on large exposures

• Large exposure limits for connected Clients/ Institutions Large Exposures

Post 2008-2009 European crisis, Basel Committee of Banking supervision proposed BASEL III . The proposal has been implemented through 2 legislative instruments – Capital requirements Directive (CRD IV) and Capital requirement Regulation (CRR) collectively known as CRD IV package. The new rules have been applicable post Jan 2014 with key focus on following areas : 1. Improvisation of quality and quantity of capital base 2. Improvisation of short term and long term liquidity standards 3. Reduce Leverage in banking systems 4. Enhancing risk coverage 5. Disclosure requirements

Capital Requirements

Contents

CRD IV Framework


IT Implications

Transitional Changes

Appendix

Capital Ratio and Minimum Capital Requirement

• Under Basel III, bank’s capital consists of Tier 1 and Tier 2 Capital. • Tier 1 capital : Used to absorb losses without ceasing business operations • Tier 2 capital : supplementary and less reliable than Tier 1.

• Shareholder’s equity • Retained Earnings

Tier 1 Capital

Tier 1 Capital ratio > = 6 % = Bank’s Tier 1 capital

Total Risk Based Assets

Tier 2 Capital

* Supplementary Capital

Tier 2 Capital ratio > = 2% = Bank’s Tier 2 capital

Total Risk Based Assets

Minimum Capital ratio required as 8 %

Introduction of new Capital Buffers

Capital Conservation Buffer Common Equity Tier 1 equivalent to 2.5 % of total risk exposure

Counter Cyclical Capital Buffer

• Sufficient capital base during periods of credit growth. • Common equity Tier 1 capital from (0 – 2.5%) of Risk weighted assets (RWA)

Systemic important institution Buffer ( SII)

• Additional loss absorption capacity of Institutions deemed as systematically important • Mandatory G-SII surcharge - from 2016 between 1- 3.5 % of RWA • Optional other – SII surcharge - up to 2% of RWA from 2016

Systemic Risk Buffer Additional Buffer to mitigate long term non-cyclical systemic or macro prudential risk. Must be atleast 1% of common equity tier 1

Liquidity Rules

Contents

CRD IV Framework

Capital Requirements

Liquidity Rules Leverage Ratio Supervisory Review Disclosure Large Exposures

IT Implications


Appendix

Liquidity Coverage Ratio (LCR) Net Stable Funding Ratio (NSFR)

Cash, central bank reserves, liquid marketable securities qualifying for 0% risk weight

• Available stable funds eg: Tier 1 /Tier2 capital after deductions, preferred stock, secured/unsecured borrowing with maturity < 1 yr • Highly liquid assets assigned zero weights in RSA

• Strengthen short – term liquidity profile • Time Horizon : 30 days • Monthly reporting frequency with operational capacity to report weekly/daily • Implementation date : phased-in gradually , starting at 60 % in 2015 and reaching 100% in 2018

• Strengthen medium to long term liquidity profile; Incentivizes institutions to use stable sources of funding • Time Horizon : 1 yr • Quarterly reporting frequency • Implementation date : Scheduled for 2018

Stock of highly Liquid assets > = 100 % Net cash outflows over 30-day horizon

Available amount of stable funding (ASA) > = 100 % Required amount of stable funding (RSA) (Assets) * Stable funding: Portion of those types of equity and liability financing expected to provide reliable sources of funds over a •one year

Highly Liquid Assets

> = 60 % Level 1 assets < = 40 % Level 2 assets

Corporate bonds (AA- rating), Covered bonds (AA – rating) , liquid marketable securities qualifying 20% risk weight)

Introduction of two new Liquidity Ratios

Leverage Ratio

Contents

CRD IV Framework

Capital Requirements Liquidity Rules

Leverage Ratio Supervisory Review Disclosure Large Exposures

IT Implications


Appendix

Jan’ 13 Jan’ 15 Jan’ 17 Jun’ 17 Jan’ 18

Institutions to publically disclose their leverage ratios and components

Start of parallel run period; Monitoring interaction between risk based capital requirement and leverage ratio

Parallel run phase ends

Final adjustments to definition and calibration

Full Implementation

Time Lining

• Exposures and commitments of bank do not exceed a certain multiple of capital. • Leverage ratio will be set at 3% limit during the testing phase (known as ‘Parallel run’ period) • Banks are required to report their leverage ratio on consolidated basis from 1st Jan 2015 Frequency : Concurrent to financial statement (quarterly or half yearly) Total Exposure

Derivative exposure comprising PFE (potential future exposure)

Unfunded Lending commitments

Stand by letters of credit and other

guarantees Additional Exposure

Off Balance sheet assets

On Balance sheet Assets

Tier 1 Capital > = 3% Total Exposure * Tier 1 capital comprises of shareholder’s equity and retained earnings

CRD IV introduced Leverage ratio requirement

Supervisory Review

Contents

CRD IV Framework

Capital Requirements Liquidity Rules Leverage Ratio

Supervisory Review Disclosure Large Exposures

IT Implications


Appendix

Internal capital Adequacy assessment process (ICAAP) Supervisory review and Evaluation process (SREP)

• Banks to conduct Internal capital Adequacy assessment process ( ICAAP) to demonstrate they have conducted sufficient procedures to ensure adequate capital resources • Regulatory authorities have to conduct Supervisory review and Evaluation process (SREP ) to assess soundness of bank’s ICAAP and take appropriate actions

• Clear Organisational structure • Effective risk management processes • Adequate Internal control mechanism • Sound administration and accounting procedures • Adequate remuneration policies and practices

Remuneration policies Credit and Counterparty Risk

Securitisation Risk Operational Risk

Treatment of Risks Residual Risk

Market Risk Liquidity Risk

Internal approaches for calculating Capital requirements

Concentration Risk IRR in banking book

Leverage Risk

• Institution arrangements, strategies, processes and mechanisms will be reviewed • Risks to which institutions are or might be exposed will be evaluated • Risks that an institution poses to financial system will be evaluated

Stress Test results Own funds held for securitised assets

Stress Test results carried out by

bank

Concentration risks

Exposure, measure and management of liquidity risk

Geographical location of exposures

Application of policies and procedures

Impact of diversification effect

Business Model of the Institution

FINREP COREP CBCR

There is a significant impact on organizations in implementation of disclosure requirements as several new datasets have been introduced for the first time, with increased requirement of granularity of data and mandatory reporting in XBRL format. The restrictive timelines have forced institutions to implement tactical approach however the need for strategic solution remains intact in changing regulatory framework and stricter norms on bank’s internal process reviews.

Disclosure

Contents

CRD IV Framework

Capital Requirements Liquidity Rules Leverage Ratio Supervisory Review

Disclosure Large Exposures

IT implications


Appendix

Institutions will be required to report following information on consolidated basis annually. • Name(s), nature of activities, geographical location • Turnover • Number of employees on full time equivalent bases. • Profit or loss before tax • tax on profit or loss and • public subsidies received

• Detailed reporting requirements, unprecedented level of granularity in fully standardized format • COREP reporting effective from 1st Jan 2014 • Volume of reporting required as below

Capital Adequacy ( 6 templates) ; Quarterly Group Solvency ( 1 template) ; Quarterly Credit and counterparty credit risk (12 templates) ; Quarterly Operational risk (2 templates) ; Quarterly Market risk (8 templates) ; Quarterly Large exposure (6 templates) ; Quarterly Leverage ratio (7 templates) ; Quarterly Liquidity ratios (3 templates) ; Monthly

• Requirement of granular data relating to income statement and balance sheet most likely requiring sourcing from general ledger, finance source systems • Requirement of 53 new forms with around 6500+ data fields on quarterly basis. • FINREP implementation date : 1 July 2014, first reporting date 30th Sep 2014

CRD IV implemented Country by Country reporting (CBCR) to give a clearer picture of company’s tax position.

Common Reporting (COREP) is European Banking Authority’s (EBA) prudential reporting framework in accordance with CRR/CRDIV

Financial reporting (FINREP) covers financial reporting for supervisory purposes based on IAS/IFRS. Applicable to all credit institutions in EU.

CRD IV increased reporting volumes of banks and Investment firms by 9 times

All aspects of large exposure framework must be implemented in full by 1 Jan 2019. Banks must adjust their exposures to abide by the large exposure limit by that date since no grandfathering will be arranged for existing exposures.

Large Exposures

Contents

CRD IV Framework

Capital Requirements Liquidity Rules Leverage Ratio Supervisory Review Disclosure

Large Exposures

IT implications


Appendix

• Information to be reported on each large exposure atleast twice a year

• Identification of Clients or group of connected clients

• Exposure before credit risk mitigation

• Exposure after credit risk mitigation

CRD IV attempts to prevent risk arising from large exposure to individual clients or group of connected clients by limiting its value

Large Exposure Upper Limits

Exposure to counterparty, group of connected clients or connected counterparties

<= 25%

Small Institutions having exposure to other institutions in excess of 25%

Cap limit : min (100% eligible Capital, 150m )

Large exposure Lower Limits : Ring fencing

Lower limit of 15% until June 2015 post which lower limit set at 10%

Data

Processes

Technology

• Direct implications on how bank handles data with need to demonstrate traceability • Capabilities to handle adhoc regulatory reporting requests • Need of high quality, consistent data due to inter-related, detailed reporting requirements • Need of sourcing cross product, cross functional data requiring high data integrity • Compliance of new processes for risk data aggregation and risk reporting by 2016

IT Implications

Contents

CRD IV Framework


IT implications


Appendix

BASEL III and CRD IV IT impact

Processes

Data Technology

•`Impact on monitoring processes of Intra-day LCR and NSFR • Business processes to handle new rules and standards

• Capability to produce integrated reports • Remove dependency on legacy systems and implement more flexible solutions • Extensive reconciliation capacity • Capability to handle real time data to meet intra-day monitoring requirements • Capability to integrate third party, in-house risk calculation applications

Data Sources Collection Preparation and Calculation Reporting

Implementation chain

Operations and Monitoring

Data historisation and Archiving

*Need of external and Internal Data sets

*Collection and transformation of data, Quality control, correction, Validation

*Calculation of technical provisions, aggregation and

consolidation

* XBRL conversion, Internal and External reporting, Validation of

reports

Implementing voluminous changes in tight timelines have resulted in adoption of Tactical solutions by IT. Permanent strategic solutions will however be needed to handle evolving requirements in long run.


Contents

CRD IV Framework


IT implications


Appendix

Leverage

Timeline 2014 2015 2016 2017 2018 2019 2020 2021

Parallel run

Disclosure

Introduce Minimum standards

Common Equity

4 %

4.5%

Conservation buffer

0.625% 1.25%

1.875% 2.5%

Countercyclical Buffer

0.625%

1.25% 1.875%

2.5%

Tier 1 Capital

5.5%

6 %

Phase out of Capital instruments

Begin 2014 until Dec 2021

Liquidity Capital ratio Introduce min requirement of 60%, increase to 100% by 2018

Observation period

Net stable funding ratio Introduce min standard Observation period

Implementation of legislative framework has commenced since 1 Jan 2014 with required full implementation to be completed by 2021. The transitional period is accompanied with multiple changes in technical standards of reporting required by EBA on industry consultation and review

* Percentage of Tier 1 capital

* Common equity Tier 1 Capital as a percentage of risk weighted assets of bank

• Common equity Tier 1 Capital as a percentage of risk weighted assets of bank

* Percentage of Risk weighted assets of bank

Appendix

Contents

CRD IV Framework


IT implications


Appendix

Annexure of ITS on Supervisory reporting

Article of ITS No of Templates

Reporting Frequency First Remittance dates 2014

Annex I solvency reporting on own funds (“COREP”)

5 – 8 29 Quarterly 30 June at individual and consolidated level for Q1

Annex III Financial information for IFRS banks “FINREP”)

9 – 10 31 Quarterly 11 Nov consolidated level for Q3

Annex IV Financial information for national GAAP banks (“FINREP”; NB! At Supervisory discretion)

11 31 Quarterly 11 Nov at consolidated level for Q3

Annex VI real estate Losses 12 1 Semi- annually 11 Aug (Q2);

Annex VIII Large Exposures 13 4 Quarterly 30 June at individual and consolidated level for Q1

Annex X Leverage Ratio 14 7 Quarterly 30 June at individual and consolidated level for Q1

Annex XII Liquidity Coverage Ratio 15 4 Quarterly

30 June for the months March, April and May. June till December 30th calendar day after end of the month

Annex XII Liquidity Net Stable Funding Ratio

16 2 Quarterly

30 June at individual and consolidated level for Q1

References

• McKinsey &Company - Basel III and European banking: Its impact, how banks might respond, and the challenges of implementation; 2010 • PWC- Smart implementation:Reining in the risk and cost of regulatory change in banking • EBA’s Single rulebook : ITS on supervisory reporting • KATALYSYS LTD – Overview of COREP • KPMG – Internal Capital adequacy assessment process • Allen & Overy CRD IV – Capital Buffers • JP Morgan – Leveraging the leverage ratio • AFME – Leverage ratio • AFME – Liquidity Coverage ratio • AFME – Net Stable Funding ratio • Allen and Overy – CRD 4 framework – Liquidity requirements • Allen and Overy - Capital and Capital Adequacy • Allen and Overy – CRD 4 – Introduction to regulatory capital and liquidity • Deloitte – IT implications for BASEL III and CRD IV • A cierco Consulting special report – CRD IV • KPMG – BASEL III : Issues and implications • EY – EU CRD IV country by country reporting – Aug 2013 • Deloitte : BASEL III and CRD IV : the impact for investment firms • CFA institute : Capital requirements directive IV • Invoke Financial reporting : The state of Data – How financial institutions are rising to the challenge of CRD IV reporting • Official journal of European Union • CELEX – 32013R0575