## _spn1016

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### Executive summary: key findings and context
- Objective of reforms: promote a less leveraged, less risky, and more resilient financial system that supports strong and sustainable economic growth.
- Common crisis trends: sharp increases in leverage; significant reliance on short-term wholesale funding; growth of off-balance-sheet activities; maturity mismatches; increased share of revenues from complex products and trading activities.
- BCBS capital proposals: substantial improvement in the quantity and quality of capital versus pre-crisis standards.
- Transition capacity: subject to data caveats, phase-in arrangements allow most banks to meet higher standards through earnings retention under a modest economic and earnings outlook; stronger earnings and lower dividends would accelerate rebuilding of common equity capital ratios.
- Investment-banking impact: tighter trading book requirements, new accounting rules, higher standards for securitization, derivatives, and trading businesses; LCFIs with investment banking focus can adjust strategies, but ultimate effects depend on final regulatory designs.
- Policy challenge: materially reduce systemic risk without unduly dampening financial intermediation; avoid risk shifting to unregulated sectors or less-regulated locations and coordinate reforms to prevent harmful regulatory layering.

### Scope, approach, and sample
- Analysis approach: uses publicly available data, assumes business models unchanged, combines quantitative analysis where possible with qualitative analysis from discussions with LCFIs and regulators.
- Sample composition:
  - 20 countries; 62 banks total.
  - By region: 15 from Asia; 33 from Europe; 14 from North America.
  - By business model: 34 commercial; 19 universal; 9 investment banks.
  - Sample banks account for more than $24 trillion of risk-weighted assets (RWA), and more than $2.6 trillion of Tier 1 regulatory capital as of year-end 2009.

### Weaknesses leading up to the crisis (summary)
- Trading assets rose from 20 percent in 2000 to above 40 percent in 2008 for US, European and UK LCFIs.
- LCFIs became highly interconnected domestically and globally, concentrating activity in a small core set of LCFIs.
- Shift toward shadow banking: liabilities include commercial paper, medium-term notes, asset-backed commercial paper, asset-backed securities, repurchase agreements, total return swaps, hybrid and repos/TRS conduits, ABS CDOs, ABS CDO-squareds, bonds, capital notes, and !4 NAV shares.
- Regulatory gaps: insufficient capture of market, liquidity, and funding risks and build-up of shadow banking vulnerabilities; many banks lacked adequate governance and risk management; supervision and resolution frameworks were inadequate for complex cross-border institutions.

### Main regulatory reform proposals and numeric elements
- BCBS focus areas:
  - Higher and better quality capital (mostly common equity).
  - Better risk recognition for market and counterparty risks.
  - A non-risk based leverage ratio as a backstop.
  - Tighter liquidity standards: a short-term liquidity coverage buffer and a longer term stable funding requirement.
  - Capital conservation buffers.
- Specific numeric elements (preserve source wording and precision):
  - Required minimum common equity will increase to 4.5 percent from the generally observed 2 percent under existing standards and will be complemented by an additional 2.5 percent capital conservation buffer (composed of fully loss absorbing capital—i.e., equity), which would restrict distributions in the form of dividends or bonus payments as banks approach the minimum.
  - The amount of intangible and qualified assets that can be included in capital will be limited to 15 percent.
  - The implementation period is phased in from 2013, with a gradual introduction of the deductions from 2014, to reach a common equity target at 7 percent by 2019 (including the capital conservation buffer).
  - Increased capital requirements will also apply for trading book exposures, counterparty credit risk, and exposures to other financial institutions; banks are expected to comply with revised risk recognition and capital coverage requirements by end-2011.
  - A leverage ratio of 3 percent will be introduced alongside current regulations on a trial basis starting 2013, with implementation and migration to Pillar 1 by 2018.

### Timelines and regulatory phase-in (selected schedule elements)
- Leverage ratio:
  - Supervisory monitoring, parallel run 2013-17; disclosure starts January 1, 2015; migration to Pillar 1 by 2018 (timeline elements present in source).
- Minimum common equity capital ratio and capital conservation buffer phase-in (yearly thresholds as presented in source):
  - 2013: Minimum common equity capital ratio 3.5 percent; Phase-in deductions from CET1 20 percent.
  - 2014: Minimum common equity capital ratio 4.0 percent; Capital conservation buffer 0.625; Phase-in deductions 40 percent.
  - 2015: Minimum common equity capital ratio 4.5 percent; Capital conservation buffer 1.25; Phase-in deductions 60 percent.
  - 2016: Minimum common equity capital ratio 4.5 percent; Capital conservation buffer 1.875; Minimum common equity plus buffer sequence reflects phased increases up to 7.0 percent by 2019.
  - Phased out capital instruments no longer qualifying as noncore Tier 1 or Tier 2 capital: Phased out over 10-year horizon beginning 2013.
- Liquidity ratios:
  - LCR observation period begins in 2011; introduce minimum standard in January 2015.
  - NSFR observation period begins in 2012; introduce minimum standard by January 2018.
- Phase-in schedule excerpts (All dates as of January 1 of respective year):
  - 2012: Min Common Equity Cap Ratio 3.50% ; Cap Conserv Buffer 0% ; Min Common Equity Cap Ratio + Cap Conserv Buffer 3.50%
  - 2013: 3.50% ; 0% ; 3.50%
  - 2014: 4.00% ; 20% ; 4.00%
  - 2015: 4.50% ; 40% ; 4.50%
  - 2016: 4.50% ; 0.625% ; 5.125%
  - 2017: 4.50% ; 1.25% ; 5.75%
  - 2018: 4.50% ; 1.875% ; 6.375%
  - 2019 Migration to Pillar 1: 4.50% ; 2.50% ; 7.00%
  - Parallel Run (Jan 1 2013 - Jan 1 2017); Disclosure starts Jan 1 2015; Supervisory Monitoring.

### A. Impact of the capital requirements — key findings and statistics
- Assets with weak going-concern loss-absorbency characteristics:
  - Such assets represent, on average, about 35 percent of banks’ core tier 1 capital, ranging between 5 to 60 percent of core capital across countries.
  - By region: European banks 38 percent; North American banks 33 percent; Asian banks 32 percent.
  - By business model: universal banks 45 percent of total core Tier 1; investment banks 32 percent; commercial banks 26 percent.
- Deductions and effects on capital quality:
  - Assets with low absorption capacity will be limited to 15 percent of core Tier 1 capital under new standards.
  - Based on analysis of individual LCFIs, about 24 percent of core Tier 1 of the sample LCFIs, on average, will be eliminated from the definition of regulatory capital.
  - Universal banks experience the largest deductions from capital (31 percent), compared with commercial banks (17 percent) and investment banks (21 percent).
- Impact on core Tier 1 ratios if applied immediately:
  - Proposed deductions would lower the core Tier 1 capital ratio of the average sample LCFI from 8.6 percent in 2009 to 6.7 percent, and after incorporating changes in market risk provisions, to 5.8 percent.
- Differential regional and business-model impacts:
  - New regulations would have the largest effect on European and North American banks overall, followed by Asian banks.
  - In North America, the drop in core capital would reflect the significant impact of increased market RWA.
  - In Europe, the most significant impact would come from asset deductions (large concentration of universal banks).
  - By business model, core capital ratios would move as follows (current to adjusted):
    - Investment banks: from 9.9 percent to 7.0 percent.
    - Universal banks: from 8.8 percent to 6.2 percent.
    - Commercial banks: from 7.8 percent to 7.1 percent.
- Phased implementation and capacity to close the capital gap:
  - Under baseline assumptions of modest earnings growth and without additional capital raising, the number of banks failing to meet the new target (including the 2.5 percent capital conservation buffer) would reach about 10 by 2019.
  - Under a scenario of no earnings retention, sample banks would require about $360 billion additional capital to comply with the 7 percent core capital ratio; the number of banks failing to meet the 7 percent target would increase to 48 banks by 2019 under this scenario.
- Observations:
  - Most banks in the sample should be able to meet the higher target mainly through earnings retention.
  - Consideration could be given to phasing out the permanent “15 percent allowance” for qualified and intangible assets, subject to careful analysis of implications for banks’ earnings and capital generation capacity.
  - Capital implications should be assessed as part of the overall reform package, including counter-cyclical buffers, systemic surcharges and levies, and national reform proposals.

### B. Impact of the liquidity proposals — findings
- Liquidity Coverage Ratio (LCR) — design and timeline:
  - LCR aims to ensure internationally active banks have up to 30 days of high quality liquid assets to meet short term institution specific and systemic stresses and to guard against a run on a bank’s wholesale liabilities, including secured funding.
  - Observation period begins in 2011.
  - Implemented in January 2015 after an observation period beginning in 2011.
  - LCR, defined as the ratio of Stock of High Quality Liquid Assets to Net Cash Outflows over a 30-day horizon, is required to be at least 100 percent.
  - Eligible liquid assets include Level 1 assets (cash, central bank reserves, and high-quality sovereign debt) and Level 2 assets (high-quality corporate and covered bonds and nonzero risk weighted sovereign debt subject to haircuts and a cap).
  - A carve-out can be granted to countries with structural constraints in meeting the minimum LCR because of low government debt.
- Net Stable Funding Ratio (NSFR) — design and timeline:
  - NSFR designed to promote longer term funding of assets in times of stress to reduce banks’ dependence on volatile funding sources.
  - Observation period begins in 2012.
  - Becomes a minimum standard by January 2018, after an observation period starting in 2012.
  - NSFR, defined as the ratio of Available Stable Funding (ASF) to Required Stable Funding (RSF), is required to be at least 100 percent.
- LCR impact analysis:
  - Industry estimates suggest most banks would meet LCR criteria; for banks not meeting it, the liquidity gap may be limited and manageable.
  - Staff analysis of LCR impact is difficult due to lack of publicly disclosed information on short term cash flows.
- Proxy liquidity measure (Liquid Assets to Total Assets):
  - Asian banks have the best short-term liquidity position, followed by European banks.
  - Commercial banks tend to have the lowest ratios across business models, reflecting loan portfolio duration.

### NSFR illustrative analysis and funding implications
- NSFR regional averages in sample:
  - Europe: 89 percent.
  - Asia: 112 percent.
  - North America: 127 percent.
- Regional findings:
  - European banks would be most affected by the NSFR requirement, due to greater reliance on wholesale funding and high loan-to-deposit ratios.
  - Most North American banks and some Asian banks already meet the 100 percent NSFR criterion.
- Options for banks to meet NSFR and trade-offs:
  - Change funding mix by issuing term funding (requires paying the term premium).
  - Raise more customer deposits (challenging due to competition and branch network costs).
  - Reduce assets (shrink balance sheet) (costly in terms of foregone market share and profitability).
  - Banks likely to adopt a combination of these options depending on circumstances.
- Near-term funding pressures and cost dynamics:
  - IMF (2010b) estimates nearly $4 trillion of bank debt is due to mature in the next 24 months, likely putting upward pressure on borrowing costs and making term debt issuance costlier.
  - Part of the debt maturing is government-guaranteed and likely to be refinanced at a higher cost as authorities wind-down monetary policy support measures.
  - Banks’ refinancing and restructuring could face competition from heavy government and corporate debt issuance.
  - Stronger capitalization may lower risk premiums, but increased burden-sharing of losses with bondholders could be associated with a higher cost of debt.
- Liquidity management implications:
  - Tighter liquidity requirements could decentralize operations and limit banks’ ability to move excess liquidity within groups.
  - LCR’s treatment of liquid assets less favorable for non-government securities may affect jurisdictions where banks hold such assets.
  - Increased holdings of government securities to meet LCR may raise challenges amid increased sovereign risk.

### Implications for business strategies, affected activities, and structural initiatives
- Non-neutrality of Basel package:
  - Higher direct impact on investment banking activities (trading, derivatives, securitization).
  - Long phase-in and deferred liquidity introduction should ease immediate deleveraging pressures.
  - Commercial banking–focused banks face relatively less difficulty meeting requirements than banks with major derivatives, trading, and securitization activities.
- Specific effects:
  - Securitization:
    - New accounting rules require originators to consolidate some securitized transactions onto bank balance sheets.
    - Reforms include a 5 percent risk retention requirement for originators.
    - Higher Basel risk weights expected to limit profitability and incentives for riskier securitization business.
  - Derivatives:
    - Proposals for exchange trading and CCP clearing of OTC derivatives and national initiatives (e.g., U.S. Dodd-Frank Act) will affect derivatives businesses.
  - Trading:
    - Higher Basel risk weights for the trading book and national/global reforms (e.g., the Volcker rule) reduce trading profitability.
- Universal banking and corporate structure:
  - Measures proposing break-ups or prohibitions on certain activities could reduce diversification benefits and retained earnings generation.
  - Banc-assurance groups may be pressured by combined Basel rules and Solvency II (scheduled to come into effect in late 2012).
  - Standalone subsidiarization (SAS) and living wills could establish firewalls, affecting groups’ ability to manage liquidity and capital and potentially trapping capital/liquidity locally.
- Evidence from U.S. investment banking (2009 revenues):
  - Total investment banking revenues (trading and investment income) represented 57 percent of gross revenues in investment banks and 12 percent in universal banks; commercial banks 7 percent.
  - If 10 percent of total investment banking revenues is proprietary trading in all U.S. banks, a restriction on proprietary trading would affect mostly investment and universal banks.
  - Revenues from trading in FICC amounted to 39 percent of gross revenues in investment banks in 2009.
  - U.S. caps: cannot have more than three percent of a fund’s equity after inception and cannot hold more than three percent of their Tier 1 capital in private-equity and hedge-fund investments.
  - The 5 percent risk retention requirement and accounting consolidation will reduce incentives for securitization.

### Potential unintended consequences and systemic-risk considerations
- Migration to shadow banking:
  - Regulatory costs may push some activities to less regulated shadow banking intermediaries, which typically have high leverage and maturity mismatches and lack direct access to lender of last resort.
  - Interconnectedness between banks and nonbank entities means risk could persist despite migration.
- Regulatory arbitrage and relocation:
  - Slow international consensus and divergence in national reforms may prompt relocation of activities to jurisdictions with weaker frameworks, complicating monitoring and systemic risk management.

### Policy implications and recommended safeguards
- International cooperation: ensure effective cross-border supervision of LCFIs.
- Market discipline: strengthen incentives on “too important to fail” institutions to force private-sector discipline.
- Monitoring: enhance monitoring of key markets, including the shadow banking system.
- Corrective action: implement prompt and early corrective action for weak institutions to limit systemic spillovers.
- Resolution frameworks: pursue global coordination to establish effective resolution and burden-sharing mechanisms for failed cross-border institutions.
- Guard against arbitrage: design and phase-in reforms to limit migration of risk to unregulated sectors or less-regulated jurisdictions.
- Coordinate reforms: avoid unintended layering of regulations that could unnecessarily dampen financial intermediation and the economic recovery.
- Supervision: be more intensive and proactive to prevent new cycles of leveraging and excessive risk taking before banks build buffers.
- Widening perimeter: broaden regulatory perimeter to permit monitoring of banks and nonbank institutions conducting banking activities and strengthen market infrastructure (including well-managed CCPs).
- Cross-border resolution priority: operationalizing proposals among a small set of host countries requires political commitment at the highest levels.

### Box 2 — Definition of items subject to change (July 2010 revisions)
- Assets/equity components with low absorption capacity include: goodwill; minority interests; investments in unconsolidated subsidiaries (including other financial institutions); deferred tax assets (DTA) arising from timing differences or loss carry-forwards; mortgage servicing rights (MSRs); other intangible assets.
- Partial recognition caps and rules:
  - Banks could recognize up to 10 percent of DTAs arising from timing differences as core capital.
  - Banks could recognize up to 10 percent of MSRs as core capital.
  - Banks could recognize up to 10 percent of significant investments in common shares of unconsolidated financial institutions as core capital.
  - Aggregate cap: 15 percent for the aggregate of DTAs, MSRs and significant investments in common shares of unconsolidated financial institutions.
- Minority interests treatment: deduct subsidiary capital in excess of required minimum, accounting for minority shares per July 2010 announcement.
- DTAs: deductions limited to tax losses carried forward; DTAs from timing differences allowed up to 10 percent recognition (subject to 15 percent aggregate cap).
- MSRs: up to 10 percent recognition (subject to 15 percent aggregate cap).
- Significant investments in unconsolidated financial institutions: up to 10 percent recognition (subject to 15 percent aggregate cap).
- Country variance: current regulatory rules for deductions vary; authors normalized assumptions based on common practices.

*Source: _spn1016 - Executive Summary (Executive Summary and selected sections).*

### Executive Summary

### _spn1016 - Executive Summary

### Executive summary: key findings and context
- Financial sector reforms are being considered to address the risks posed by large and complex financial institutions (LCFIs).  
- Common trends that contributed to the recent global crisis included sharp increases in leverage, significant reliance on short-term wholesale funding, growth of off-balance-sheet activities, maturity mismatches, and increased share of revenues from complex products and trading activities.  
- The key objective of the financial sector reforms is to promote a less leveraged, less risky (or better cushioned), and thus a more resilient financial system that supports strong and sustainable economic growth.  
- The recent proposals of the Basel Committee on Banking Supervision (BCBS) on capital standards represent a substantial improvement in the quantity and quality of capital in comparison with the pre-crisis situation.  
- Subject to usual caveats associated with limited data disclosures and availability, phase-in arrangements will allow most banks to move to these higher standards through earnings retention, assuming a modest economic and earnings outlook.  
- Should banks generate strong earnings in the coming years, and distribute lower dividends, they could rebuild common equity capital ratios faster than required under the current phase-in periods.  
- The new capital standards will have a significant impact on investment-banking-type activities, including through tighter requirements for trading book exposures. Investment banking activities will also be affected by new accounting rules and higher standards for securitization, derivatives, and trading businesses, as well as measures to restrain certain activities.  
- LCFIs with an investment banking focus have flexible business models and can adjust their strategies easily to mitigate the effects of the regulatory reforms; the ultimate effect on business models remains to be seen until regulations take their final shape.  
- A key challenge is to ensure tighter bank regulations achieve a material reduction in systemic risk, while not unduly dampening financial intermediation. This requires avoiding a shifting of risks to unregulated sectors or less-regulated locations and coordinating reforms to avoid layering of regulations that could weaken the financial sector’s support for the economic recovery.

### Introduction: scope and approach
- The paper analyzes implications of proposed regulatory reforms for a sample of LCFIs, using publicly available data and assuming business models remain unchanged.  
- The analysis focuses on implications for LCFIs and their business strategies and differs from confidential QIS conducted by national authorities and from macroeconomic impact assessments.  
- The paper provides both quantitative analysis (where public data allow) and qualitative analysis based on discussions with LCFIs and regulators.  
- The paper’s organization: overview of vulnerabilities and reforms; likely effects on LCFIs across regions and business models; qualitative analysis of implications for business lines; policy implications and safeguards.

### Weaknesses leading up to the crisis (summarized)
- LCFIs became larger, highly complex and leveraged, and relied increasingly on short-term wholesale funding; trading assets rose from 20 percent in 2000 to above 40 percent in 2008 for US, European and UK LCFIs.  
- LCFIs became heavily interconnected domestically and globally; cross-border interlinkages increased and financial activity concentrated in a small core set of LCFIs.  
- Financial intermediation shifted to, and became interconnected with, the nonbank (“shadow banking”) sector; shadow banking liabilities include commercial paper, medium-term notes, asset-backed commercial paper, asset-backed securities, repurchase agreements, total return swaps, hybrid and repos/TRS conduits, ABS CDOs, ABS CDO-squareds, bonds, capital notes, and !4 NAV shares (shadow bank “deposits”).  
- Regulations did not fully capture market, liquidity, and funding risks or the build-up of vulnerabilities in the shadow banking system; many banks lacked adequate governance and risk management; supervision and resolution frameworks were not sufficiently effective for complex cross-border institutions.

### Main regulatory reform proposals and quantitative elements
- BCBS proposals focus on: (i) higher and better quality capital (mostly common equity); (ii) better risk recognition for market and counterparty risks; (iii) a non-risk based leverage ratio as a backstop; (iv) tighter liquidity standards, including a short-term liquidity coverage buffer and a longer term stable funding requirement; and (v) capital conservation buffers.  
- Specific numeric elements (preserve source wording and precision):  
  - Required minimum common equity will increase to 4.5 percent from the generally observed 2 percent under existing standards and will be complemented by an additional 2.5 percent capital conservation buffer (composed of fully loss absorbing capital—i.e., equity), which would restrict distributions in the form of dividends or bonus payments as banks approach the minimum.  
  - The amount of intangible and qualified assets that can be included in capital will be limited to 15 percent.  
  - The implementation period is phased in from 2013, with a gradual introduction of the deductions from 2014, to reach a common equity target at 7 percent by 2019 (including the capital conservation buffer).  
  - Increased capital requirements will also apply for trading book exposures, counterparty credit risk, and exposures to other financial institutions; banks are expected to comply with revised risk recognition and capital coverage requirements by end-2011.  
  - A leverage ratio of 3 percent will be introduced alongside current regulations on a trial basis starting 2013, with implementation and migration to Pillar 1 by 2018.

### Implications for LCFIs and business strategies (summary)
- Capital proposals: higher quantity and quality of capital will materially affect capital ratios; phase-in arrangements and earnings retention are key channels for compliance.  
- Liquidity proposals and funding requirements will affect funding structures and may constrain business models reliant on short-term wholesale funding.  
- Investment banking activities face significant impacts from tighter trading book capital requirements, new accounting rules, and higher standards for securitization, derivatives, and trading activities.  
- LCFIs can adjust business strategies—rebalancing toward less capital-intensive or less liquidity-sensitive activities, adjusting funding profiles, or changing geographic footprint—but the final outcome depends on the final design and calibration of regulations.  
- Business-model-specific effects: commercial, investment, and universal banks will be affected differently; the paper analyzes these differences qualitatively and quantitatively where data permit.

### Policy implications and recommended safeguards
- Ensure international cooperation to enable effective cross-border supervision of LCFIs.  
- Strengthen market discipline on “too important to fail” institutions to ensure forceful private-sector incentives.  
- Enhance effective monitoring of key markets to capture emerging risks, including in the shadow banking system.  
- Implement prompt and early corrective action for weak institutions to limit systemic spillovers.  
- Pursue global coordination to establish effective resolution and burden-sharing mechanisms to deal with failed cross-border institutions.  
- Guard against regulatory arbitrage and risk migration to unregulated sectors or less-regulated jurisdictions when designing and phasing-in reforms.  
- Coordinate reforms to avoid unintended layering of regulations that could unnecessarily dampen financial intermediation and the economic recovery.

*Source: _spn1016 - Executive Summary (Executive Summary and selected sections).*

### 12. Global liquidity standards are another key element of the regulatory reform. The

### _spn1016 - 12. Global liquidity standards are another key element of the regulatory reform. The

### Global liquidity standards: LCR and NSFR
- The Liquidity Coverage Ratio (LCR) aims to ensure that internationally active banks have up to 30 days of high quality liquid assets to meet short term institution specific and systemic stresses, and to guard against a run on a bank’s wholesale liabilities, including secured funding.
- LCR implementation timeline and features:
  - Observation period begins in 2011.
  - It will be implemented in January 2015 after an observation period beginning in 2011.
  - LCR, defined as the ratio of Stock of High Quality Liquid Assets to Net Cash Outflows over a 30-day horizon, is required to be at least 100 percent.
  - Eligible liquid assets include Level 1 assets (cash, central bank reserves, and high-quality sovereign debt) and Level 2 assets (high-quality corporate and covered bonds and nonzero risk weighted sovereign debt subject to haircuts and a cap).
  - A carve-out should be granted to countries where banks face structural constraints in meeting the minimum LCR because of low government debt; rules provide for some flexibility while limiting country specific exemptions and minimizing regulatory arbitrage opportunities.
- Net Stable Funding Ratio (NSFR) design and timeline:
  - NSFR is designed to promote longer term funding of assets in times of stress to reduce banks’ dependence on volatile funding sources.
  - Observation period begins in 2012.
  - It will become a minimum standard by January 2018, after an observation period starting in 2012, and further calibration of the underlying parameters (details are provided in Annex 2).
  - NSFR, defined as the ratio of Available Stable Funding (ASF) to Required Stable Funding (RSF), is required to be at least 100 percent.

### Progress on macro‑prudential regulation and SIFI measures
- Much less progress has been made overall in developing regulations with a macro-prudential approach to dampen procyclicality and account for systemic risks, including non-banks.
- BCBS actions under consideration:
  - BCBS has requested comments on the basis for computing countercyclical risk weights and, more generally, how to construct countercyclical capital charges.
- Measures under consideration or in use to reduce systemic risk contribution of SIFIs (as listed in Table 2):
  - Measures to reduce the probability and impact of failure of SIFIs:
    - Capital and/or liquidity surcharges based on measure of systemic importance
    - More intense supervision of SIFIs
    - Risk-based levies on non-core funding (based on systemic risk contribution)
  - Measures to improve the capacity to resolve SIFIs:
    - Living wills (resolution plans)
    - Financial stability contribution linked to a credible and effective resolution scheme
    - Special resolution schemes giving supervisors power to break up banks
    - Contingent capital and bail-in proposals
    - Cross-border resolution frameworks and burden-sharing arrangements
    - Subsidiarization/ring-fencing domestic financial institutions from cross-border risks
  - Measures to strengthen core financial market infrastructure:
    - Requiring OTC derivatives to be traded through central counterparties
  - Structural measures:
    - Narrow banking restrictions
    - Other limits or restrictions on the size and/or scope of banks (e.g., Volcker rule)

### Implications of the reform initiatives for LCFIs (sample analysis)
- Sample composition:
  - 20 countries; 62 banks total: 15 from Asia, 33 from Europe, 14 from North America.
  - Business models: 34 commercial; 19 universal; 9 investment banks.
  - Sample banks account for more than $24 trillion of risk-weighted assets (RWA), and more than $2.6 trillion of Tier 1 regulatory capital as of year-end 2009.
- Scope of analysis:
  - Analysis covers impact of regulations on capital (definition and market risk) and liquidity requirements (NSFR).
  - Potential implications of the Leverage Ratio and Liquidity Coverage Ratio (LCR) are not analyzed quantitatively due to lack of detailed data.
  - Given limited publicly available data, a standard set of assumptions common to all banks were used where needed; further methodology details are provided in Annex I.

### A. Impact of the capital requirements — key findings and statistics
- Assets with weak going-concern loss-absorbency characteristics:
  - Such assets represent, on average, about 35 percent of banks’ core tier 1 capital, ranging between 5 to 60 percent of core capital across countries.
  - By region: European banks 38 percent; North American banks 33 percent; Asian banks 32 percent.
  - By business model: universal banks 45 percent of total core Tier 1; investment banks 32 percent; commercial banks 26 percent.
- Deductions and effects on capital quality:
  - Assets with low absorption capacity will be limited to 15 percent of core Tier 1 capital under new standards.
  - Based on analysis of individual LCFIs, about 24 percent of core Tier 1 of the sample LCFIs, on average, will be eliminated from the definition of regulatory capital.
  - Universal banks experience the largest deductions from capital (31 percent), compared with commercial banks (17 percent) and investment banks (21 percent).
- Impact on core Tier 1 ratios if applied immediately:
  - Proposed deductions would lower the core Tier 1 capital ratio of the average sample LCFI from 8.6 percent in 2009 to 6.7 percent, and after incorporating changes in market risk provisions, to 5.8 percent.
- Differential regional and business-model impacts:
  - The new regulations would have the largest effect on European and North American banks overall, followed by Asian banks.
  - In North America, the drop in core capital would reflect the significant impact of increased market RWA.
  - In Europe, the most significant impact would come from asset deductions (large concentration of universal banks).
  - By business model, core capital ratios would move as follows (current to adjusted):
    - Investment banks: from 9.9 percent to 7.0 percent.
    - Universal banks: from 8.8 percent to 6.2 percent.
    - Commercial banks: from 7.8 percent to 7.1 percent.
- Phased implementation and capacity to close the capital gap:
  - BCBS allowed a gradual phase-in period to avoid abrupt adjustments (see Table 1 in source).
  - During the first years of implementation, the new regulation would have minimal impact.
  - The number of banks failing to meet the new target (including the 2.5 percent capital conservation buffer) would reach about 10 by 2019 (Table 3), under baseline assumptions of modest earnings growth and without considering additional capital raising actions.
  - Under a scenario of no earnings retention, sample banks would require about $360 billion additional capital to comply with the 7 percent core capital ratio; the number of banks failing to meet the 7 percent target would increase to 48 banks by 2019 under this scenario.
- Observations and policy-relevant messages:
  - Most banks in the sample should be able to meet the higher target mainly through earnings retention, provided a modest earnings outlook; banks can issue additional capital and/or reduce dividend payments to build capital buffers.
  - An eventual phasing out of the permanent “15 percent allowance” for qualified and intangible assets might be considered to further enhance quality and comparability of capital, subject to careful analysis of implications for banks’ earnings and capital generation capacity.
  - These capital implications should be considered as part of the overall reform package, including counter-cyclical buffers, systemic surcharges and levies, and national reform proposals that introduce additional capital requirements.

### B. Impact of the liquidity proposals — findings
- Industry estimates (limited set of U.S. and European banks) suggest most banks would meet the LCR criteria; for banks that do not yet meet the criteria, the liquidity gap may be limited and manageable (Table 4, panel 1).
- Comprehensive staff analysis of LCR impact is difficult due to lack of publicly disclosed information, particularly data on short term cash flows.
- Proxy liquidity measure findings (Liquid Assets to Total Assets):
  - Asian banks have the best short-term liquidity position, followed by European banks.
  - Favorable position of Asian banks reflects simpler balance sheet structures, limited complex securities, and stronger deposit-skewed funding profiles; variation exists across countries, with some having low ratios due to structural shortage of government securities.
  - Across business models, commercial banks tend to have the lowest ratios, likely reflecting the duration of their loan portfolio.

### Timelines and regulatory phase-in (extracted schedule elements)
- Leverage ratio:
  - Supervisory monitoring, parallel run 2013-17, disclosure starts January 1, 2015, migration to Pillar 1 (timeline elements present in source).
- Minimum common equity capital ratio and capital conservation buffer phase-in (yearly thresholds as presented in source):
  - 2013: Minimum common equity capital ratio 3.5 percent; Phase-in deductions from CET1 20 percent.
  - 2014: Minimum common equity capital ratio 4.0 percent; Capital conservation buffer 0.625; Phase-in deductions 40 percent.
  - 2015: Minimum common equity capital ratio 4.5 percent; Capital conservation buffer 1.25; Phase-in deductions 60 percent.
  - 2016: Minimum common equity capital ratio 4.5 percent; Capital conservation buffer 1.875; Minimum common equity plus buffer sequence reflects phased increases up to 7.0 percent by 2019.
  - Phased out capital instruments no longer qualifying as noncore Tier 1 or Tier 2 capital: Phased out over 10-year horizon beginning 2013.
- Liquidity ratios:
  - LCR observation period begins 2011; introduce minimum standard in January 2015.
  - NSFR observation period begins 2012; introduce minimum standard by January 2018.

*Source: Excerpt from _spn1016 PDF chapter/section provided in content unit.*

### 23. An illustrative analysis of the impact of NSFR on the sample of LCFIs suggest a

### 23. An illustrative analysis of the impact of NSFR on the sample of LCFIs suggest a wide variation in banks’ ability to meet the required 100 percent level

### Estimates of NSFR across geographies and business models
- NSFR requirement under the Basel proposals: 100 percent.
- Regional average NSFRs in the sample:
  - Europe: 89 percent.
  - Asia: 112 percent.
  - North America: 127 percent.
- Key regional findings:
  - European banks would be most affected by the NSFR requirement, reflecting greater reliance on wholesale funding and high loan-to-deposit ratios.
  - Most North American banks and some Asian banks already meet the 100 percent NSFR criterion.
  - Compared to other banks in the sample, North American banks, on average, have a high share of securities on the asset side, and above average share of deposits.
- Within-region heterogeneity:
  - In Europe, a majority of sample banks does not meet the 100 percent criterion, but some banks have much lower ratios than others—especially those with large amounts of long term lending and high dependence on wholesale funding.
  - A similar structure exists in some Asian banks with high share of wholesale funding to finance long term assets.

### Options for banks to meet NSFR and associated trade-offs
- Possible responses to meet NSFR:
  - Change funding mix by issuing term funding.
  - Raise more customer deposits.
  - Reduce assets (shrink balance sheet).
- Trade-offs and constraints:
  - Issuing longer-term debt requires paying the term premium.
  - Raising deposits is challenging due to competition in local deposit markets and difficulties in building branch networks.
  - Shrinking assets may be costly in terms of foregone market share and profitability.
  - Banks will likely adopt a combination of the three options; the ultimate funding mix will depend on individual circumstances and market conditions.

### Near-term funding pressures and cost dynamics
- Increase in funding costs:
  - IMF (2010b) estimates that nearly $4 trillion of bank debt is due to mature in the next 24 months, likely putting upward pressure on borrowing costs and making term debt issuance costlier.
  - Part of the debt maturing is government-guaranteed and will likely be refinanced at a higher cost as authorities wind-down monetary policy support measures.
  - Banks’ refinancing and balance sheet restructuring could face competition from heavy government and corporate debt issuance.
- Structural shift in funding patterns and higher cost of issuance:
  - Stronger capitalization and a more robust regulatory framework should lower risk premiums, but increased burden-sharing of losses with bondholders (e.g., via instruments that convert debt to equity) may be associated with a higher cost of debt.
  - If senior bond-holders are impacted by the final regulation, banks may have to pay a greater premium to investors or face increased competition for deposits.

### Liquidity management and risk management implications
- Risk management challenges:
  - Tighter liquidity requirements could lead to greater decentralization of operations and limit banks’ ability to move excess liquidity within banking groups.
  - In jurisdictions where banks hold liquid assets other than government bonds, liquidity risk profiles may be affected because the LCR treats such assets less favorably than government securities (though some arrangements are being considered for countries with structural constraints).
  - Increased holdings of government securities to meet the LCR target may raise challenges amid increased sovereign risk.

### Implications for banks’ business strategies and affected activities
- Non-neutrality of Basel package:
  - The Basel package is not “business model neutral” and will have a higher direct impact on investment banking activities.
  - The long phase-in period for capital and deferred introduction of liquidity ratios should ease implementation, reducing immediate pressure for large-scale deleveraging.
  - Banks focused on commercial banking activities will face relatively less difficulty meeting requirements than banks with major derivatives, trading, and securitization activities.
- Specific business lines affected and regulatory drivers:
  - Securitization:
    - New accounting rules require originators to consolidate some securitized transactions onto bank balance sheets.
    - Reforms include a 5 percent risk retention requirement for originators to maintain a “skin in the game”.
    - Higher Basel risk weights are expected to limit profitability and incentives for riskier securitization business.
  - Derivatives:
    - Global proposals (e.g., exchange trading and CCP clearing of OTC derivatives) and national initiatives (e.g., U.S. Dodd-Frank Act) will affect derivatives business, particularly for banks highly active in derivatives.
  - Trading:
    - Trading business profitability is affected by higher Basel risk weights for the trading book and other national/global reforms (e.g., the Volcker rule).
- Interaction with other regulations:
  - Securitization, leverage ratio (Basel 3), accounting reforms, counterparty risk regulations, CCP clearing, systemic surcharges for SIFIs, and levies on non-core funding collectively increase capital and liquidity burdens on investment banking activities.

### Evidence from U.S. investment banking (Box 1)
- Investment banking revenues composition (U.S., 2009):
  - Total investment banking revenues—comprising trading and investment income—represented 57 percent of gross revenues in investment banks and 12 percent in universal banks in 2009; commercial banks relied much less on investment banking revenues, at seven percent of gross revenues.
  - If 10 percent of total investment banking revenues consists of proprietary trading revenues in all U.S. banks (as estimated by bank analysts), the restriction on proprietary trading would affect mostly investment and universal banks.
  - Revenues from trading in fixed income, exchange rate, commodities, and credit instruments (FICC) amounted to 39 percent of gross revenues in investment banks in 2009.
  - U.S. banks face caps on sponsorship/investment in private equity and hedge funds: cannot have more than three percent of a fund’s equity after inception and cannot hold more than three percent of their Tier 1 capital in investments in private-equity and hedge funds.
  - The 5 percent risk retention requirement and accounting consolidation will further reduce incentives for securitization.

### Impacts on universal banking and corporate structure initiatives
- Universal banking implications:
  - Groups combining commercial and investment banking activities will be affected by measures proposing to break up banks or prohibit certain activities, potentially reducing diversification benefits and retained earnings generation.
  - Banc-assurance groups (insurance and banking under one roof) could be pressured by combined Basel rules and Solvency II, which is scheduled to come into effect in late 2012 and is likely to increase insurance capital needs and reduce fungibility of insurance capital.
  - Partial recognition of insurance participations in common equity may smooth real sector implications for systems reliant on the bancassurance model.
- Structural reform initiatives:
  - Standalone subsidiarization (SAS) and living wills could establish firewalls that affect groups’ ability to manage liquidity and capital, reducing capacity to serve large customers and sustain diversified corporate structures.
  - SAS requires banking groups to be organized as constellations of self-sufficient national subsidiaries with effective firewalls; living wills map out safe wind-downs and encourage simpler corporate structures.

### Potential unintended consequences and systemic risk considerations
- Migration to shadow banking:
  - Some activities may move toward the less regulated shadow banking sector as regulatory costs rise for banks (e.g., certain loans, leases, trading, derivatives).
  - Shadow banks are intermediaries that do not accept deposits and are not subject to the same regulations as depository banks; they have high leverage and maturity mismatches and lack direct/indirect access to a lender of last resort.
  - Interconnectedness between banks and nonbank entities means risk could persist in the system despite migration.
- Regulatory arbitrage and relocation of activities:
  - Lack of careful global coordination may prompt some businesses to move to locations with weaker regulatory frameworks.
  - Slow international consensus and adoption of national regulatory reform packages (e.g., taxation and compensation regimes, U.S. Dodd-Frank Act) may encourage global banks to consider moving operations to minimize regulatory costs, complicating monitoring and management of systemic risks.

*Source: Bankscope, and staff estimates based on data for sample LCFIs.*

### 31. The current BCBS proposals on capital requirements represent a substantial

### _spn1016 - 31. The current BCBS proposals on capital requirements represent a substantial

### Assessment of BCBS proposals on capital requirements
- The proposals represent a substantial improvement in the quality, quantity, and comparability of bank capital.
- Illustrative calculations suggest that most banks can meet the more stringent capital requirements through earnings retention, provided a modest earnings outlook.
- As the global financial system stabilizes and the world economic recovery is firmly entrenched, there may be room to:
  - phase out intangible and qualified assets completely, and
  - scale back the transition period (both subject to a careful impact analysis of the possible implications).
- Further tightening would increase banking sector resilience and limit incentives to take excessive risks, but:
  - implications need to be considered as part of the overall package (including countercyclical buffers), and
  - careful assessments of the cumulative and joint impact of the overall reform package need to be conducted.

### Liquidity and funding challenges
- Some banks may face challenges in meeting the liquidity requirements in the current global environment.
- For most banks the adjustment may be manageable given multi-year implementation, but pressures on funding costs may arise from:
  - funding pressures from a large amount of debt coming due in a few years,
  - higher interest rates as authorities wind-down monetary policy support measures, and
  - competition from government debt issuance.
- The adjustment timeline: phase-in period end-2012 to end-2018, with cumulation of earnings retained.

### Systemic-risk and business-strategy risks
- A key policymaker challenge is ensuring business-strategy adjustments to tighter capital and liquidity requirements do not generate systemic risks.
- New rules are more stringent on investment banking business, which may lead banks focused on such activities to:
  - shift activities to the unregulated shadow banking sector, or
  - move businesses to jurisdictions with less onerous regulatory requirements.

### Safeguards and policy recommendations
- There is a continuing need for policymakers to restructure or resolve weak banks to ensure banks are:
  - well capitalized,
  - have access to stable funding, and
  - can earn self-sustaining profits on core activities.
  - This requires orderly and globally consistent regulatory reform; progress on macro-prudential regulation; and strengthened oversight of the financial system.
- Supervision needs to be more intensive and proactive to prevent a new cycle of leveraging and excessive risk taking, especially before banks fully build up liquidity and capital buffers; with due attention to business models and risks assumed by LCFIs.
- The regulatory perimeter needs widening to permit effective monitoring of risks by banks and nonbank institutions, regulation of all systemically important institutions that conduct banking activities, and close monitoring of markets and instruments used by financial institutions; accompanied by strengthening market infrastructure (including well-managed CCPs) and risk management capacity.
- Greater coordination of policies and implementation among national authorities and standard setting bodies is critical to:
  - maintain level playing fields,
  - contain regulatory arbitrage, and
  - ensure the cumulative impact of regulatory initiatives does not stifle financial innovation and growth.
- Agreement on cross-border resolution regimes should be a top priority; operationalizing proposals among a small set of countries that host most cross-border financial institutions requires political commitment at the highest levels.

### Key industry-view findings on potential business-model impacts (selected highlights)
- Capital Definition
  - Tighter capital definition expected to lead to scaling down or shifting out of more capital-intensive activities.
  - Deduction of minority interests: could reduce involvement of foreign global banks in emerging markets.
  - Deduction of investment in insurance subsidiaries: would affect the integrated banc-assurance model and could induce separation of insurance business.
  - Higher capital needs could induce banks to pass on costs to customers and reduce balance sheet size.
- Leverage Ratio
  - If binding, may cause further deleveraging and cuts in lending; may encourage shifts to more risky activities.
- Liquidity Coverage Ratio (LCR)
  - May induce banks to reduce lending to hold more liquid assets (mainly government securities) and affect profitability.
  - May push decentralized operations and reduce ability to move excess liquidity across borders within a banking group.
- Net Stable Funding Ratio (NSFR)
  - May limit banks’ ability to do maturity transformation and hurt retail banking’s capacity to lend to meet longer term funding requirements.
  - May increase competition for customer deposits and reduce deposit stability.
- Counterparty risk regulations and higher risk weights for trading and securitized products
  - Could reduce interbank interactions, market-making, and certain trading activities; possibly delay rehabilitation of securitization markets.
- Structural reforms (Volcker Rule, Lincoln Amendment, derivatives spin-off, CCPs)
  - May shrink proprietary trading and derivatives businesses at banks, risk shifting activity to unregulated nonbanks, and raise collateral and operational costs.
- Systemic surcharge and levies on non-core funding
  - May discourage non-core funding models and create disincentives for being a SIFI; cross-border coordination needed to avoid double taxation and level playing-field issues.
- Living wills and subsidiarization
  - May ease winding down but risk losing diversification benefits; subsidiarization could trap capital/liquidity locally and raise overall funding costs.

### Methodology and scope of capital-impact analysis (ANNEX I)
- Scope and limitations
  - Analysis explores overall impact of new BCBS capital standards for a representative group of LCFIs.
  - Based on an array of assumptions to address lack of sufficiently detailed publicly available data; a standard set of assumptions common to all banks is used where needed.
  - Exercise focuses on a limited number of banks for each country; results should not be taken as representative of a country’s banking system.
  - Some BCBS elements could not be simulated due to data gaps (e.g., defined pension assets; increase in RWA from future counterparty credit risk requirements).
- Sample and clustering
  - Sample of 62 banks.
  - As of year-end 2009, these banks held more than US$2,400 billion in total risk-weighted assets, and more than US$2.6 billion in Tier1 equity.
  - By geography: 15 Asian banks; 33 European banks; and 14 North American banks.
  - By business model: 34 Commercial banks; 19 Universal banks; and 9 Investment banks.
- Capital and market-risk adjustments applied
  - As a starting point, published “Core Tier1 Ratio” was taken as the best approximation to BCBS’ “Common Equity Capital Ratio.”
  - Market risk-weighted assets increased by three times bank by bank (following BCBS indication that market risk capital requirements will increase by an estimated average of three to four times for large internationally active banks; the analysis uses three times).
  - Capital deductions applied to Core Tier1 ratio (data as of end-2009; end-March 2010 in the case of Japanese banks): minority interests; net deferred tax assets; investments in unconsolidated subsidiaries (including the insurance business); mortgage servicing assets (for U.S. banks); and residual intangibles.
  - Partial recognition of certain items into core capital is allowed in line with BCBS amendments published July, 2010.
  - The phase-in timetable announced by BCBS in September, 2010, was used to compute the new ratios.

* _spn1016 - 31. The current BCBS proposals on capital requirements represent a substantial_*

### Box 2. Definition of Items Subject to Change in July 2010 Revisions

### Box 2. Definition of Items Subject to Change in July 2010 Revisions

### Overview
- Under the new Basel requirements, the definition of capital will contain only a limited amount of certain intangibles and qualified assets.
- Assets and corresponding equity components with a low absorption capacity include:
  - goodwill;
  - minority interests;
  - investments in unconsolidated subsidiaries (including other financial institutions);
  - the value of deferred tax assets (DTA) arising from time differences or loss carry-forwards;
  - mortgage servicing rights (MSRs);
  - other intangible assets.

### Items subject to partial recognition and treatment under the July 2010 proposals
- General cap and aggregation rule:
  - Banks could recognize up to 10 percent of DTAs arising from timing differences as core capital.
  - Banks could recognize up to 10 percent of MSRs as core capital.
  - Banks could recognize up to 10 percent of significant investments in common shares of unconsolidated financial institutions as core capital.
  - These items are also capped at 15 percent for the aggregate of DTAs, MSRs and significant investments in common shares of unconsolidated financial institutions.

- Minority Interests
  - Definition: The book value of third party shareholdings in consolidated subsidiaries within a group.
  - Treatment: Banks are required to deduct the subsidiary’s capital which is in excess of the required minimum, taking into account the respective minority shares of each subsidiary (as specified in the July 2010 announcement).

- Deferred Tax Assets (DTAs)
  - Definition: The difference between current tax charges or credits recognized by tax authorities and total taxes recorded in financial statements.
  - Composition:
    - DTAs usually relate to timing differences between financial reporting and tax recognition of specific assets or liabilities, often related to unrealized gains and losses.
    - DTAs can also relate to annual losses carried forward to offset against future taxable income.
  - Risk characteristics: DTAs relating to losses carried forward are dependent on the bank or its subsidiaries making future annual profits, so may not be available to absorb losses in stressed conditions.
  - Deduction recognition rule:
    - Deductions are limited only to tax losses that are carried forward, while excluding DTAs that arise from timing differences up to a limit.
    - Under the July 2010 proposals, banks could recognize up to 10 percent of DTAs arising from timing differences as core capital (also capped at 15 percent for the aggregate of DTAs, MSRs and significant investments in common shares of unconsolidated financial institutions).

- Mortgage Servicing Rights (MSRs)
  - Definition: Income related to the servicing of mortgages that banks have originated and sold to third parties.
  - Historical quality: Historically, MSRs tended to make a relatively good quality capital because MSRs’ value is tightly linked to the present value of the expected net future cash flows of servicing assets, and there is an active market for trading MSRs.
  - Policy response: High concentrations of MSRs in the capital base of some banks prompted their deduction from core capital.
  - July 2010 amendment: Banks could recognize up to 10 percent of MSRs, capped at 15 percent for the aggregate of DTAs, MSRs and significant investments in common shares of unconsolidated financial institutions.

- Significant investments in common shares of unconsolidated financial institutions
  - Rationale for restriction: Aimed at limiting a group from having both a bank and an insurance company under one corporate roof, given high correlation of risks between banks and insurers observed in the crisis.
  - Treatment: In line with MSRs, banks can count up to 10 percent of significant investments in common shares of unconsolidated financial institutions.

### Country variance and assumptions
- Current regulatory rules for deductions may vary on a country-by-country basis.
- The authors assumed them to be normalized based on the common practices.

### Basel III Capital Phase-in Arrangements (as proposed by BCBS) — selected phase-in figures from source text
- Phase-in schedule excerpts (All dates as of January 1 of respective year):
  - 2012: Min Common Equity Cap Ratio 3.50% ; Cap Conserv Buffer 0% ; Min Common Equity Cap Ratio + Cap Conserv Buffer 3.50%
  - 2013: 3.50% ; 0% ; 3.50%
  - 2014: 4.00% ; 20% ; 4.00%
  - 2015: 4.50% ; 40% ; 4.50%
  - 2016: 4.50% ; 0.625% ; 5.125%
  - 2017: 4.50% ; 1.25% ; 5.75%
  - 2018: 4.50% ; 1.875% ; 6.375%
  - 2019 Migration to Pillar 1: 4.50% ; 2.50% ; 7.00%
- Additional timing and supervisory notes:
  - Parallel Run (Jan 1 2013 - Jan 1 2017)
  - Disclosure starts Jan 1 2015
  - Supervisory Monitoring

*Source: Box text from the supplied PDF content.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/spn/2010/_spn1016.pdf_