## 1. Conceptual Difference between ‘Traditional’ Stress Test and Stress Tests Taking Into Account Group Structures

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### Conceptual difference
- Traditional consolidated-group stress tests implicitly assume:
  - Free flow of capital and liquidity within each banking group (full intra-group mobility).
  - Uniform regulatory treatment across countries (ignores country-by-country regulatory differences, e.g., minimum total capital adequacy ratios).
- Key limitations highlighted:
  - Consolidated statements obscure geographic structure of international banking groups.
  - Home/host regulators may limit or obstruct intra-group flows—assumption invalidated during the crisis.
- Paper contribution:
  - Presents a straightforward conceptual approach to combine unconsolidated and consolidated balance sheet data to reflect geographical structure of banking groups.
  - Approach applied in the 2011/12 Czech Republic FSAP for solvency and liquidity stress tests and financial stability analysis.
- Illustrative impact:
  - Estimates based on banks’ 2010 data from the June 2011 EBA exercise indicate up to 3 percentage points of additional Core Tier I capital needs for banks under very strict forms of ring-fencing from outside EU countries.
  - This magnitude is comparable to Basel III’s proposed (up to 2½ percent) Common Tier I capital adequacy surcharge for G-SIBs.
- Policy implication:
  - A credible international framework for resolution of cross-border banking groups would help avoid unilateral, costly solutions.
  - In absence of such cooperation (including burden sharing), larger capital buffers for international banks to account for potential ring-fencing could be a second-best option.

### Annex I – Mapping Bank Groups: I. INTRODUCTION
- Focus:
  - Limitations of stress tests that use consolidated banking group balance sheets and income statements for international banking groups.
- Implicit assumptions in consolidated-group stress tests:
  - Ignore regulatory differences across countries, e.g., minimum total capital adequacy ratios often set higher in many (emerging) countries, e.g., at 10-12 percent rather than at the Basel minimum of 8 percent.
  - Basel III and other regulatory initiatives will potentially add cross-country differences (countercyclical buffers, systemic risk charges for large banks, additional liquidity and leverage regulations).
  - Assume free flow of capital and liquidity within each banking group, i.e., do not consider that home/host regulators might limit or fully obstruct intra-group flows.
- Evidence and necessity:
  - Combining consolidated and unconsolidated data is necessary because of potential implications of “ring fencing” (partially or fully limiting cross-border groups’ ability to re-allocate funds).
  - Illustrative estimate: up to 3 percentage points additional Core Tier I capital needs under strict ring-fencing scenarios (2010 EBA data).

### Annex I – Mapping Bank Groups: II. THE RECENT EVOLUTION IN BANK STRESS TESTS
- Progress:
  - Expanded focus beyond solvency to integrate liquidity and contagion risks; improved capture of systemic aspects and some dynamic/non-linear effects.
  - Data improvements in breadth, detail and quality.
- Remaining challenges:
  - Important data gaps for global systemic risk analysis because many banks publish only consolidated financial statements that obscure geographic structure.
  - Key challenge: devising consistent global scenarios to translate macro shocks into country-specific financial impacts.
  - Stress tests can suffer from poorly calibrated scenarios and omitted shocks, yielding a false sense of stability (example: pre-crisis Iceland stress tests).
  - Confidentiality of bank-level data in several advanced European countries limits use of host-country affiliate data for unconsolidated mapping.

### Annex I – Mapping Bank Groups: III. A COMBINED UNCONSOLIDATED/CONSOLIDATED STRESS TEST APPROACH
- Conceptual rationale:
  - Traditional consolidated top-down stress tests assume full intra-group capital/liquidity mobility; unconsolidated approach treats parent and foreign-incorporated subsidiaries as single entities for entity-specific simulation.
- Key advantages of unconsolidated approach:
  - Forces design of a consistent global macro scenario broken down to entity/country levels.
  - Improves understanding of banks’ business models and how shocks/policy actions affect different parts of the group.
  - Reveals relative soundness of specific entities and informs contingency planning.
- Data availability options:
  - Best Case: actual bank data on parent and individual subsidiaries (internal bottom-up tests; supervisory data).
  - Available Alternative: compile publicly available subsidiary data (burdensome); use proxies such as residuals from group data minus major subsidiary data.
  - Trade-off: low value-added for mostly domestic systems; high value-added where international banks are significant.
- Introducing ring-fencing into scenarios:
  - After projecting solvency/liquidity impacts per subsidiary and accounting for national regulations (hurdle rates), define assumptions on transfers of profits, excess capital and/or liquidity within the group.
  - Three illustrative transfer assumptions:
    1. No ring-fencing: parent profits and subsidiaries’ excess liquidity and excess capital buffers can be used to cover shortfalls in any subsidiary.
    2. Partial ring-fencing: parent profits and subsidiaries’ profits and/or excess liquidity can be reallocated, but not subsidiaries’ excess capital.
    3. Full ring-fencing: no transfers between any group affiliates (including parent to subsidiaries).
  - Scenarios may limit proceeds from asset sales; effectiveness depends on macro environment and market conditions (fire-sale valuation issues).
- Behavioral and practical considerations:
  - Banks’ ability to overcome ring-fencing (e.g., selling subsidiaries) can be limited during severe stress; historical examples where announced sales were delayed (Dexia, NBG, BCP).
  - Market adverse reactions and valuation uncertainty (lemon problem) can hinder asset-sale remedies.

### Annex I – Mapping Bank Groups: IV. QUANTIFYING THE POTENTIAL BIAS OF NOT USING A COMBINED APPROACH
- Illustration and caveats:
  - Illustration uses June 2011 EBA stress test figures as base case (no-ring-fencing).
  - Two adjustments—partial and full ring-fencing—calculated to assess effects of non-EU host regulators ring-fencing foreign deposit-taking affiliates.
  - Not a full unconsolidated stress test due to data limitations; EBA projections and bank structures have changed since 2010.
- Key quantitative benchmark:
  - Up to 3 percentage points of additional Core Tier I capital needs under very strict external ring-fencing scenarios (based on 2010 EBA data projections).
  - Comparison context: Basel III additional loss absorbency for G-SIBs proposed magnitude of up to 2½ percent Common Tier I (Basel III calibration described as producing additional loss absorbency generally in the range of around 1% to 8% of risk-weighted assets in Common Equity Tier 1 equivalent, with a central tendency of around 2% to 4%).
- Implication:
  - Ring-fencing risk can materially increase capital needs for cross-border banks; consolidated-only stress tests may understate vulnerabilities under plausible ring-fencing scenarios.

### Box 1. Arguments For and Against Ring-Fencing — Key Points
- Arguments for centralized cross-border bank structures and against ring-fencing:
  - Efficiency and financial stability considerations (benefits of diversification when country-specific shocks hit).
  - Free re-allocation of funds across affiliates essential for cross-border banks’ efficiency.
  - Centralized structures may benefit host economies by providing subsidiaries with better access to capital and liquidity (internal capital market).
  - Absence of ring-fencing facilitates diversification and can stabilize the group against home-country shocks.
- Arguments for ring-fencing:
  - Host regulators may impose ring-fencing to protect domestic banking systems from negative spillovers.
  - Ring-fencing can increase domestic reserves when impending output collapse and bank losses abroad are uncertain.
  - Tradeoff exists between global and host-country objectives; not always present if ring-fencing preserves stability during large inflows.

### Box 1. Banks’ geographical characteristics (EBA sample analysis)
- Coverage and mapping:
  - For 51 banking groups of the 91 included in the EBA June 2011 stress test, operations outside EU were mapped.
  - “EU countries” includes the 27 EU member countries, plus Switzerland and Norway.
  - Outside EU profits included only banking related activities (excluding non-banking subsidiaries).
  - Five year 2006-10 averages of net income used to reduce volatility.
- Sample highlights:
  - A selected sample of 22 large international banks (with more than EUR 100 billion and 2 percent or more profit share from outside EU) shows substantial heterogeneity in geographical structure.
  - About 2/3 of the banking groups operate almost exclusively within the EU; their income, capital and assets outside the EU are below 5 percent.
  - 15 percent of the banking groups have a large presence outside the EU, many with more than 20 percent of their profits and capital from bank-deposit affiliates located outside the EU.
  - Shares of capital and income outside the EU were generally larger than shares of assets, indicating non-EU operations require more capital and are more profitable.
  - No close relation between share of non-EU activities and home country of the parent bank; heterogeneity across countries (examples: Spanish, Italian, Austrian, UK, Greek banks).
  - Two business models:
    - Traditional, retail-oriented banks: more substantial presence outside the EU (about 20 percent or more of profits).
    - Other banks (including some with sizeable investment business): overall lower share of deposit-taking affiliates’ assets, profits and capital outside the EU.

### Box 1. Ring-fencing adjustment estimates (EBA scenarios)
- EBA projections:
  - Two main projections for a two year horizon (2011-2012): a baseline scenario and a double dip (adverse) scenario.
- Partial ring-fencing adjustment:
  - Deducts from EBA profit projections the share of profits generated outside the EU.
  - Results: EBA baseline scenario overestimates banks' Core Tier I capital ratios by 0 to 0.7 percentage points.
  - Impact depends on share of profits from outside the EU and importance of stress test profit projections on capital buffers.
- Full ring-fencing scenario:
  - Assumes both profits and excess capital buffers of non-European affiliates cannot be re-allocated to Europe.
  - Impact tends to be larger than partial ring-fencing; adjustment could be up to 3 percent of core Tier I capitalization in Europe.
  - Full ring-fencing mostly affects banks with meaningful income and capital outside the EU.
  - Ring-fencing adjustments in the EBA adverse scenario are similar in size to those in the baseline, but final adjusted Core Tier I capital levels are lower in the adverse scenario because lower EBA projected profits compound the effect.

### Conclusions and policy implications (from Annex I and Box 1)
- Methodological:
  - Unconsolidated approach extends best-practice stress tests and can yield materially different outcomes than consolidated top-down tests when accounting for ring-fencing.
  - Explicitly accounting for business structure of international banks provides better understanding of vulnerabilities of single large banks and systemic financial risks.
- Policy recommendations:
  - Establish a credible framework for resolution of cross-border banking groups to avoid unilateral and likely more costly solutions (in terms of capital requirements); reduce incentives for ring-fencing.
  - In current absence of fully-fledged resolution and burden-sharing mechanisms, set minimum capital requirements for cross-border banking groups that take into account potential ring-fencing risks.
    - More work is needed estimating different ring-fencing scenarios across international banks to assess additional capital buffer needs and whether Basel III proposed G-SIB surcharges already cover them.
    - Although ring-fencing is not formally included as a factor in Basel III proposed G-SIB surcharges, the top bucket level (2½ percent additional Tier I buffer) and G-SIB classification based on global cross-jurisdictional activity implicitly account for drivers of ring-fencing risks.
  - Larger capital buffers and sound liquidity levels would:
    - Provide buffers against ring-fencing.
    - Reassure host regulators that subsidiaries can withstand ring-fencing, reducing pre-emptive ring-fencing actions.
    - Reduce hosts’ incentives to ring-fence well-capitalized foreign subsidiaries.
  - Geographic distribution matters:
    - Not only size of capital buffers but geographical location of those buffers within the group is important.
    - Need for higher capital buffers could increase if reform proposals trigger higher levels of ring-fencing—even among OECD countries.
    - Significant changes in geographical distribution of capital buffers (due to regulatory reforms) could prompt host regulators to increase subsidiaries’ capital requirements.
  - International cooperation is essential to avoid undesired outcomes from ring-fencing and geographical redistribution of capital buffers.

*Source: _wp12288 — Annex I – Mapping Bank Groups; Box 1. Arguments For and Against Ring-Fencing (excerpts).*

### 1. Conceptual Difference between ‘Traditional’ Stress Test and Stress Tests

### 1. Conceptual Difference between ‘Traditional’ Stress Test and Stress Tests Taking into Account Group Structures

### Conceptual difference
- Title: "Conceptual Difference between ‘Traditional’ Stress Test and Stress Tests Taking Into Account Group Structures"
- Page reference: 8

### Banks’ Geographical Distributions
- Title: "Banks’ Geographical Distributions"
- Page reference: 13

### Banks’ share of Profits and Capital Outside EU
- Title: "Banks’ share of Profits and Capital Outside EU"
- Page reference: 13

### Partial and Full Ring Fencing Adjustments
- Title: "Partial and Full Ring Fencing Adjustments"
- Page reference: 15

### References
- Page reference: 18

*Source: _wp12288 - 1. Conceptual Difference between ‘Traditional’ Stress Test and Stress Tests Taking Into Account Group Structures*

### Annex I – Mapping Bank Groups ..........................................................................................

### Annex I – Mapping Bank Groups

### I. INTRODUCTION
- Focus: limitations of stress tests that use consolidated banking group balance sheets and income statements, especially for international banking groups.
- Implicit assumptions in consolidated-group stress tests:
  - They ignore regulatory differences across countries, for example:
    - minimum total capital adequacy ratios often set higher in many (emerging) countries, e.g., at 10-12 percent rather than at the Basel minimum of 8 percent.
    - Basel III and other regulatory initiatives will potentially add cross-country differences (countercyclical buffers, systemic risk charges for large banks, additional liquidity and leverage regulations).
  - They assume free flow of capital and liquidity within each banking group, i.e., do not consider that home/host regulators might limit or fully obstruct intra-group flows—an assumption invalidated to some degree during the crisis.
- Paper contributions:
  - Presents a straightforward conceptual approach to combine unconsolidated and consolidated balance sheet data to reflect banking groups’ geographical structure; approach applied in the 2011/12 Czech Republic FSAP for solvency and liquidity stress tests and financial stability analysis.
  - Provides evidence, within existing data limitations, that combining consolidated and unconsolidated data is necessary because of potential implications of “ring fencing” (partially or fully limiting cross-border groups’ ability to re-allocate funds from subsidiaries with excess capital/liquidity to those in need).
- Illustrative magnitude of impact:
  - Estimates based on banks’ 2010 data from the June 2011 EBA exercise indicate up to 3 percentage points of additional Core Tier I capital needs for banks under very strict forms of ring-fencing from outside EU countries.
  - This magnitude is comparable to Basel III’s proposed (up to 2½ percent) Common Tier I capital adequacy surcharge for G-SIBs.
- Policy implication highlighted:
  - A credible international framework for resolution of cross-border banking groups would help avoid unilateral, costly solutions. In the absence of such cooperation (including burden sharing), larger capital buffers for international banks to account for potential ring-fencing could be a second-best option.

*Source: Annex I – Mapping Bank Groups (excerpts).*

### II. THE RECENT EVOLUTION IN BANK STRESS TESTS
- Progress and remaining challenges:
  - Expanded focus beyond solvency to integrate liquidity and contagion risks, and improved capture of systemic aspects and some dynamic/non-linear effects.
  - Data improvements in breadth, detail and quality, but important gaps remain for global systemic risk analysis because many banks publish only consolidated financial statements that obscure geographic structure.
  - Key challenge: devising consistent global scenarios to translate macro shocks into country-specific financial impacts; EU stress test 2011 used a macroeconomic model as one approach, and benchmark rules of thumb have been proposed for solvency and liquidity.
- Specific observations:
  - Stress tests can suffer from poorly calibrated scenarios and omitted shocks, yielding a false sense of stability (example: pre-crisis Iceland stress tests).
  - Confidentiality of bank-level data in several advanced European countries limits use of host-country affiliate data for unconsolidated mapping.

*Source: Annex I – Mapping Bank Groups (excerpts).*

### III. A COMBINED UNCONSOLIDATED/CONSOLIDATED STRESS TEST APPROACH
- Conceptual rationale:
  - Traditional consolidated top-down stress tests implicitly assume full intra-group capital/liquidity mobility and may partially capture geographic exposures only when macro scenarios include foreign-country assumptions.
  - Unconsolidated (bottom-up) approach treats parent and foreign-incorporated subsidiaries as single entities, allowing granular simulation of entity-specific solvency and liquidity under country-specific scenarios and ring-fencing assumptions.
- Key advantages of unconsolidated approach:
  - Forces design of a consistent global macro scenario broken down to entity/country levels.
  - Improves understanding of banks’ business models and how shocks/policy actions affect different parts of the group.
  - Reveals relative soundness of specific entities (e.g., subsidiaries) and informs contingency planning for policymakers and banks.
- Data availability options:
  - Best Case: obtain actual bank data on parent and individual subsidiaries—available to banks (internal bottom-up tests) and supervisors if detailed supervisory data are provided.
  - Available Alternative: compile publicly available data on subsidiaries (burdensome), use proxies such as residuals from group data minus major subsidiary data.
  - Trade-off: compare the burden of data assembly against expected insights; low value-added for mostly domestic banking systems, high value-added where international banks are significant.
- Introducing ring-fencing into scenarios:
  - After projecting solvency/liquidity impacts per subsidiary and accounting for national regulations (hurdle rates), define assumptions on transfers of profits, excess capital and/or liquidity within the group.
  - Three illustrative transfer assumptions:
    1. No ring-fencing: parent profits and subsidiaries’ excess liquidity and excess capital buffers can be used to cover shortfalls in any subsidiary (approximates standard consolidated assumptions while allowing for country regulation differences).
    2. Partial ring-fencing: parent profits and subsidiaries’ profits and/or excess liquidity can be reallocated, but not subsidiaries’ excess capital.
    3. Full ring-fencing: no transfers between any group affiliates (including parent to subsidiaries).
  - Scenarios may also limit proceeds from asset sales as a means to overcome ring-fencing; effectiveness depends on macro environment and market conditions (fire-sale valuation issues).
- Behavioral and practical considerations:
  - Banks’ ability to overcome ring-fencing (e.g., selling subsidiaries) can be limited during severe stress; historical examples where announced sales were delayed (Dexia, NBG, BCP).
  - Market adverse reactions and valuation uncertainty (lemon problem) can hinder asset-sale remedies.

*Source: Annex I – Mapping Bank Groups (excerpts).*

### IV. QUANTIFYING THE POTENTIAL BIAS OF NOT USING A COMBINED APPROACH
- Illustration using June 2011 EBA stress test figures:
  - Base case (no-ring-fencing) is given by EBA figures.
  - Two adjustments—partial and full ring-fencing—are calculated to assess effects of non-EU host regulators ring-fencing foreign deposit-taking affiliates.
- Caveats:
  - The cross-country example is illustrative and not a full unconsolidated stress test due to data limitations; EBA projections and bank structures have changed since 2010 (many banks raised capital or sold subsidiaries).
- Key numerical benchmark:
  - Up to 3 percentage points of additional Core Tier I capital needs under very strict external ring-fencing scenarios (based on 2010 EBA data projections).
  - Comparison: Basel III additional loss absorbency for G-SIBs proposed magnitude of up to 2½ percent Common Tier I (Basel III calibration described as producing additional loss absorbency generally in the range of around 1% to 8% of risk-weighted assets in Common Equity Tier 1 equivalent, with a central tendency of around 2% to 4%).
- Implication:
  - The estimated adjustment magnitude suggests that ring-fencing risk can materially increase capital needs for cross-border banks and that current consolidated-only stress tests may understate vulnerabilities under plausible ring-fencing scenarios.

*Source: Annex I – Mapping Bank Groups (excerpts).* 

*Source document: Annex I – Mapping Bank Groups (excerpts).*

### Box 1. Arguments For and Against Ring-Fencing

### Box 1. Arguments For and Against Ring-Fencing

### Arguments for centralized cross-border bank structures and against ring-fencing
- Rely on efficiency and financial stability considerations (e.g., benefits of diversification when country-specific shocks hit).
- From a cross-border bank’s perspective, the ability to freely re-allocate funds across its affiliates is essential for achieving the most efficient outcome.
- Centralized cross-border bank structures may yield benefits for host country economies:
  - De Haas and van Lelyveld (2010) show that the ability of international banks to attract liquidity and raise capital allows them to operate an internal capital market, which provides their subsidiaries with better access to capital and liquidity than what they would have been able to achieve on a stand-alone basis, and hence may help to reduce the pressure to scale back lending during economic downturns.
- For both home and host authorities, the absence of ring-fencing facilitates diversification and can make the group as a whole more stable, for example, against shocks in the parent home country.

### Arguments for ring-fencing
- Host country regulators may impose ring-fencing driven by macro-financial stability considerations:
  - Protect the domestic banking system from negative spillovers from the rest of the group.
  - Increase reserves for the whole domestic banking system when the magnitude of the impending output collapse and bank losses associated with a crisis abroad are uncertain.
- There is a clear tradeoff between cross-border/global and host countries' objectives, especially if host countries have not been fully affected by the crisis.
- Note: There is not always a tradeoff between global and individual country objectives. For example, there may not be such a conflict when ring-fencing/capital controls are implemented when a banking system is receiving substantial inflows in order preserve financial stability.

### Banks’ geographical characteristics (EBA sample analysis)
- Coverage and mapping:
  - For 51 banking groups of the 91 included in the EBA June 2011 stress test, operations outside EU were mapped.
  - Country coverage under “EU countries” includes the 27 EU member countries, plus Switzerland and Norway.
  - Outside EU profits included only banking related activities (profits in affiliates that operate as banks), but not subsidiaries that perform non-banking activities.
  - To reduce income volatility, five year 2006-10 averages of net income were used.
- Sample highlights (Figure 2 and Figure 3 insights):
  - A selected sample of 22 large and international banks (with more than EUR 100 billion and 2 percent or more profit share from outside EU) shows substantial heterogeneity among large European banking groups in terms of geographical structure.
  - About 2/3 of the banking groups operate almost exclusively within the EU and the portion of their income (average of 2006-2010), capital and assets outside the EU are below 5 percent.
  - 15 percent of the banking groups have a large presence outside the EU, with many having more than 20 percent of their profits and capital from bank-deposit affiliates located outside the EU.
  - Shares of capital and income outside the EU were generally larger than the shares of assets, indicating that operations outside the EU require more capital than within the EU and are more profitable.
  - No close relation between share of non-EU activities and home country of the parent bank; large heterogeneity exists across countries (examples: Spanish, Italian, Austrian, UK, Greek banks).
  - Two business models highlighted:
    - Traditional, retail-oriented banks: more substantial presence outside the EU (about 20 percent or more of profits) independently of size.
    - Remaining banks (including some with sizeable investment business): overall lower share of deposit-taking affiliates’ assets, profits and capital outside the EU.

### Ring-fencing adjustment estimates (EBA scenarios)
- EBA tests provided two main projections for a two year horizon (2011-2012): a baseline scenario and a double dip (adverse) scenario.
- Adjustment approaches:
  - Partial ring-fencing adjustment:
    - Deducts, from the EBA profit projections, the share of profits generated outside the EU.
    - Results indicate that the EBA baseline scenario overestimates banks' core Tier I capital ratios by 0 to 0.7 percentage points.
    - Impact is a function of the share of profits from outside the EU and the importance of stress test profit projections on bank capital buffers.
    - Several banks with sizeable profit buffers partly earned outside the EU exhibit the largest adjustments to their Core Tier I capital ratios.
    - Long-term (5-year) profit averages have been used to avoid drawing conclusions based on overly favorable or unfavorable figures; EBA reported profit projections are only available on the aggregate, so calculations are conservative.
  - Full ring-fencing scenario:
    - Assumes both the profits and the excess capital buffers of non-European affiliates cannot be re-allocated to Europe (i.e., subsidiaries cannot be sold without incurring book losses).
    - The impact for the European part of the international banking group tends to be larger than in the partial ring-fencing context.
    - The adjustment could be up to 3 percent of their core Tier I capitalization in Europe.
    - Full ring-fencing mostly affects banks with meaningful income and capital outside the EU.
    - Theoretically, under full ring-fencing, if a larger share of bank capital buffers are within EU than outside, the European part could end up with a higher core Tier I capital ratio in full ring-fencing calculations than in no ring-fencing.
    - Ring-fencing adjustments in the EBA adverse scenario projections are not much different in size from those calculated with the EBA baseline scenario figures, but final adjusted Core Tier I capital levels in the adverse scenario are lower since both the ring-fencing adjustments and lower EBA projected profits interact together.

### Conclusions and policy implications
- Methodological insight:
  - The unconsolidated approach extends best-practice stress tests to better understand risks faced by international banking groups; outcomes can differ considerably from consolidated top-down stress tests when accounting for different degrees of ring-fencing.
  - Explicitly taking into account the business structure of international banks provides a better understanding of vulnerabilities of single large banks and financial risks more generally.
- Policy implications:
  - Establishment of a credible framework for the resolution of cross-border banking groups would help avoid unilateral and likely more costly solutions (in terms of capital requirements); such frameworks could reduce incentives for, and incidence of, ring-fencing by home/host authorities.
  - In the current context of non-fully-fledged resolution and burden-sharing mechanisms (even among EU members), setting minimum capital requirements for cross-border banking groups should take into account potential risks of ring-fencing, especially during crisis times.
    - More work estimating different ring-fencing scenarios across international banks is needed to assess potential additional capital buffer needs and/or whether they are already covered by the Basel III proposed capital G-SIB surcharges.
    - Although ring-fencing has not been formally included as a factor in Basel III proposed capital G-SIB surcharges, the proposed top bucket level (2½ percent additional Tier I buffer) and the fact that G-SIB classification across buckets would be a function of banks’ global cross-jurisdictional activity and bank size implicitly accounts for both estimated capital adjustment needs and drivers (bank size, international outreach) of ring-fencing risks.
  - Larger capital buffers—together with sound liquidity levels—would:
    - Provide capital buffers in the potential presence of ring-fencing.
    - Reassure host country regulators that the banking group has enough capital buffers to withstand ring-fencing by other host regulators, thereby avoiding pre-emptive actions.
    - Reduce host regulators’ incentives to ring-fence well-capitalized foreign subsidiaries in anticipation of impacts when other host regulators ring-fence.
  - Geographic distribution matters:
    - Not just the size of a banking group’s capital buffers, but the geographical location of those buffers within the group matters.
    - Need for higher capital buffers for cross-border banking groups could be larger if reform proposals (e.g., separating UK retail business and increasing capital buffers on those operations) trigger higher levels of ring-fencing—even among OECD countries.
    - Even without a crisis, significant changes in the geographical distribution of capital buffers (due to regulatory reforms) could prompt host country regulators to increase subsidiaries’ capital requirements.
  - International cooperation is essential to avoid undesired outcomes arising from ring-fencing and changes in geographical distribution of capital buffers.

*Source: Box 1. Arguments For and Against Ring-Fencing, _wp12288 - Box 1. Arguments For and Against Ring-Fencing*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2012/_wp12288.pdf_