G.Georgakopoulos International Waves Of Regulation The Cost To The Economy 19 06 2012 Final

International waves of regulation

The cost for banks and the economy

4th Risk Management & Compliance Forum

Athens,

June 19th 2012

George Georgakopoulos

Executive Vice President – Bancpost

President of the BOD – EFG Retail Services

[email protected]

Introduction and Summary

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� A wide set of international reforms, as well as many nation–specific changes are being introduced, aimed at

improving the stability of the global financial system.

� The prevailing regulatory rationale is micro-prudential, attempting to stabilize the financial system through

higher capital & liquidity requirements.

� Banks are four years into what will probably be a decade–long phase of adjustment to tougher regulatory

standards.

� Tougher regulations might increase capital needs , for Euro area banks only, by 700 bn euro, and long–term

debt issuance by 300 bn. by 2015.

� These funding demands will likely lead to an increase in bank lending rates of about 364bps over the next

five years.

� Much of the adjustment to date has occurred through de–leveraging, which has been an impediment for the

global economy.

� Higher lending rates will likely reduce the level of real GDP of the Euro area by about 3% up to 2015, or by

about 0.7% per year.

� CEE economies will be affected more, since they rely heavily on bank financing

� This would lead to about 2.8 million fewer jobs being created over the next four years.

� Alternatives to pro-cyclical regulation such as macro-prudential measures, or mitigators such as direct

support from governments and central banks to ensure lower cost of funding for banks, and, therefore,

more lending, might well come to the forefront of the public policy debate in the near future.

Key Areas of Regulatory Changes

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Regulatory Changes

Internationally agreed-on measures Nation-specific measures

Capital related measures Liquidity related measures

• Internationally capital agreed-on measures may include the following:

� higher core ratios

� re-definition of capital

� changes in risk-weighting

� capital surcharges

e.g. Romania:

• additional capital and liquidity rules

• consumer protection

• restriction on credit expansion

The Regulatory Agenda Facing Financial Firms

4Source: IIF “The Cumulative Impact on the Global Economy of Changes in the Financial Regulatory Framework” _ Sept 2011

CAPITAL Liquidity

� Liquidity coverage ratio

� Net stable funding ratio

� Liquid asset definition

� Role of central bank

� Local restrictions

� Off-balance sheet commitments

� Treatment of financial institutions

� Money market fund regulation

� New minimum capital levels

� Capital conservation buffer

� Counter-cyclical buffer

� Revised definition of capital

� Trading book capital

� Counterparty credit risk charge

� Contingent capital

� Leverage ratio

Basel III Minimum Capital Ratios and Phase-in Plans

5Source: BCBS

2011 2012 2013 2014 2015 2016 2017 2018 2019

1. Minimum Common Equity

Capital Ratio2% 2% 3.50% 4% 4.50% 4.50% 4.50% 4.50% 4.50%

2. Capital Conservation Buffer 0.625% 1.25% 1.875% 2.5%

3. Total (1+2) 2% 2% 3.5% 4% 4.5% 5.125% 5.75% 6.375% 7%

4. Phase-in of deductions from core Tier

1equity due to capital redefinitions20% 40% 60% 80% 100% 100%

5. Phase-out of instruments that non longer

qualify as non-core Tier 1 or Tier 2 capital10% 20% 30% 40% 50% 60% 70%

Memo:

Minimum Tier 1 Capital 4% 4% 4.5% 5.5% 6% 6% 6% 6% 6%

Minimum Total Capital 8% 8% 8% 8% 8% 8% 8% 8% 8%

What Changes Occurred since the Crisis Started? (I)

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� Many financial institutions across the world have been either liquidated or merged; whole sectors

of the financial industry have disappeared or been reformed; market mechanisms and transparency

have improved; and, perhaps most importantly, Industry behavior has been radically changed by the

experiences of 2007 – 2008.

� Among the key changes already registered have been significant efforts by banks to boost capital

and liquidity ratios (like Basel II)

� The crisis has made bank managers themselves far more conservative in their behavior & in the

desired structure of their balance sheets. “Fortress balance sheets” have become desirable and

attractive to regulators, bank managements and investors

What Changes Occurred since the Crisis Started? (II)

7

� Supervisors have begun to enforce higher capital and liquidity ratios well ahead of the

implementation of globally agreed-on norms. In some cases, this reflects the introduction of new, local

specific norms (in Switzerland, where banks were required to raise capital and liquidity ratios in 2008).

� In the United States, the stress test of early 2009 (otherwise known as the Supervisory Capital

Assessment Program, or SCAP ) showed that under an adverse scenario, 10 of the 19 SCAP banks

would need to raise a total of $75 billion in capital in order to have the capital buffers that were

targeted under the SCAP.

� In Europe, the publication of the results of the 2011 European Banking Authority (EBA ) stress

test exercise revealed that several banks had made substantial efforts to improve their capital position

in the first half of the year, largely in anticipation of the exercise itself.

� Many banks are adjusting as rapidly as possible to new international norms for both capital and

liquidity well ahead of their formal timetable introduction.

How Regulatory Reforms Impact the Economy?

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Globally Coordinated Reforms Distance for banks to adjust National reforms

Time for implementation

Economy’s dependence on banks for credit intermediation

Other factors shaping banking health

Impact on economy

Costs of Additional Equity and Debt Funding will Define the Impact on the Economy

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Cost of Bank

Equity Capital

Perceived riskiness of

banking sector

Near term

supply

Ability of banks to

deliver on investors’

expectations

Cost of Long-

Term Bank

Debt

Increased demand for bank

debt will increase the

spreads, however the

stronger capital ratios will

reduce the risk of bank

bond-holders

All 3 are likely to

work negatively for

SE Europe in the

near term

Perceived riskiness

of the region might

well disadvantage

SEE banks

The Bank of England already announced on June 14th that it is looking to give to banks cheap funding for several years as to ensure bank lending in periods of extended uncertainty.

0.0

1.0

2.0

3.0

4.0

5.0

Mar

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Jun-

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p-08

Dec

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Mar

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Jun-

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Dec

-09

Mar

-10

Jun-

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Dec

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Mar

-11

Jun-

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p-11

Dec

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-12

RZB Unicredit Erste EFG Eurobank Alpha Bank NBG

The Price to Book Ratios though Indicate Low Appetite for Equity Investment in Banks

10Source: Bancpost internal estimates; Reuters

Price to book = Market Capitalization / Tangible Book

Tangible Book = Total Equity – Intangibles - Goodwill

Regulatory Reforms will Have an Impact on the Real Economy

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Regulatory

Change

Impact on banks Lower credit supply

Impact on non-bank credit intermediation

Higher bank lending rates

Higher private sector borrowing costs

Higher non-bank lending rates

Lower aggregate

demand

Estimated Costs for Economies & Banks

Higher lending rates will reduce the level of real GDP by about 3% up to 2015, or by about 0.7%/ year for the Euro area. This would lead to about 2.8 million fewer jobs being created over the next five years.

Sources: International sources and IIF report _ Sept 2011 12

� By 2015, banks are projected to need to raise about 1.8 trillion USD.

� The impact of reform is to reduce avg. GDP (of the 5 regions) by 0.7 pp / year for the next 5 years. This leads to a lower GDP by 3 pp than where it would otherwise be.

� In 2015, employment impact implies that governments would make a dent for the 17 mil shortfall registered between Q3 ’08 & Q1 ’10.

Change in real GDP & employment

-3.0%

-2,825

-0.6%

What About the Impact of the international Regulation Reform

on Eastern Europe?

The impact on the GDP of the CEE between 2011 and 2015 is likely to be higher than the 3% of the

Euro area because of:

1. Higher cost of equity capital, driven by higher credit risks in the CEE

2. Higher cost of debt funding, driven by higher CDS rates

3. The reliance on banks as the main financing option in the region

4. Local measures in the region which further accentuate slow-down in lending (e.g. regulatory

ceilings of indebtedness, regulation on tenors, etc)

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Benefits of Regulatory Reform

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� Higher capital and liquidity requirements will lead to a greater degree of shock absorbency. This will make the banking system more resilient to costly future financial crisis.

� One can consider current regulatory changes as an insurance premium in view of future crisis.

� Higher capital ratios provide insurance to banks against business decisions going wrong, but also against issues caused by economic volatility.

� The higher capital and liquidity ratios might convince investors that it is attractive to invest in banks across the economic cycle since their capital is safer

Are There Alternatives to Micro-Prudential Regulation?

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I expect alternative approaches to the current path of regulatory reform to get stronger support in the future, and specifically measures that do not slow-down lending in the recession or post crisis:

• Time varying capital requirements

• Higher quality capital

• Corrective action targeted at Euro amounts – not capital ratios

• Regulation of debt maturity

• Regulation of the shadow banking system (ABS funded short term)

Source: Hanson, Kahyap and J Stein, A macro-prudential approach to Financial Regulation

Conclusions

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� Following the financial crisis, regulators have introduced requirements for additional capital and liquidity – an adjustment process that will last for several more years

� The key argument in favor is that such regulation is that it will protect the economy in future crises

� However, it is equally expected that such regulation will impact GDP and employment in the short & medium term, due to the increase in lending rates and contraction of demand

� The negative impact is likely to be higher in Eastern Europe, since the costs of equity and debt capital will be higher

� Micro-prudential regulations have been criticized as untimely. Alternative macro-prudential regulations are likely to get more support in the future

� Central banks and governments are likely to consider the plans of the Bank of England to provide cheap long term funding to banks so that they do extend lending in uncertain times