evolving banking regulation nov 2010
TRANSCRIPT
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FINANCIAL SERVICES
EvolvingBanking
RegulationA marathon or a sprint?
November 2010
kpmg.com
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Editorial team
Giles Williams
Partner
Financial Services
Risk and Regulatory
Center o Excellence
EMA region
KPMG in the UK
Jim Low
Partner
Financial Services
Risk and Regulatory
Center o Excellence
Americas region
KPMG in the US
Simon Topping
Partner
Financial Services
Risk and Regulatory
Center o Excellence
ASPAC region
KPMG in China
About this report
This report was developed by KPMGs
network o regulatory experts. The
insights are based on discussions with
our frms clients, our proessionals
assessment o key regulatory
developments and through our links
with policy bodies.
Special thanks
We would like to thank members o the
editorial and project teams who have
helped us develop this report:
Kara Cauter, KPMG in the UK
Clive Briault, KPMG in the UK
Alexandra Dean, KPMG in the UK
Amber Stewart, KPMG in the UK
Meghan Meehan, KPMG in the US
Karen Staines, KPMG in the US
2010 KPMG International. KPMG International is a Swiss cooperative. Member fr ms o the KPMG network o indep endent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor do es KPMG International have any such authority to obligate or bind any member frm. All rights reserved.
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Contents
Foreword 2Executive Summary 4
1. Capital
Perspectives: ASPAC 8
2. Liquidity
Perspectives: Europe 12
3. Systemic risk 16
4. SupervisionPerspectives: US 20
5. Governance and remuneration 26
6. Customer treatment 30
7. Traded markets 34
8. Accounting and disclosure 40
Acknowledgements 44
2010 KPMG International. KPMG International is a Swiss cooperative. Member frms o the KPMG network o independ ent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor does KPMG International have any such authority to obligate or bind any member frm. A ll rights reserved.
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Foreword
When we released our frst Evolving Banking Regulation report in
November 2009, there was still signifcant uncertainty around the
eventual shape o banking regulation. What a dierence a year makes.
Policy makers in every region have sprinted ahead with new rules or
banks. The Basel Committee has fnalized new principles or capital
and liquidity. The United States has passed the Dodd-Frank Act,
which touches on virtually every aspect o its fnancial sector.
Proposals have been put orward by global, regional and national
policy setting bodies which will change the structure, supervision and
governance o fnancial services. But we are nowhere near the fnish
line regulatory change remains on the G20 agenda and will continue
so or years to come, as we enter the much longer marathon towards
implementation and transormation o the industry.
Working through the enormous volume
o policies and proposals which have
been issued this year, I am struck by
how much uncertainty remains. High
level proposals are still subject to
detailed rulemaking and implementation
guidelines and I have no doubt the
devil will be in the detail. All stakeholders
agree on the need or a sae, eective
inancial sector. But how we strike thebalance between sae and eective
or there will be trade os remains
a contentious issue, as evidenced in
some o the announcements in the
lead up to the G20 summit in Seoul in
November. Tensions and competing
priorities between nations will, in the
end, inluence the tone and detail o
how changes are inally implemented
on a local level. Outcomes look
increasingly likely to dier by region,
and indeed by country, but by how much?
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Despite commitment to a level playing
ield rom the G20, the IMF, the FSB
and other major players, the reality is
very dierent. Major jurisdictions are
taking dierent paths over issues
including systemically importantinancial institutions, governance,
remuneration and supervision. This is
partly driven by very dierent starting
points countries that emerged
relatively unscathed rom the inancial
crisis are reluctant to implement costly
measures to improve saety and
resilience. Timelines or implementation
will also diverge both by geography,
and within that by institution as larger
cross-border banks race ahead to
demonstrate their stability and position
themselves or opportunities.
Saety and soundness dominate
the policy agenda in Europe. We are
seeing the end o light touch
supervision in avor o a multi layered
intensive supervision with potential
knock on consequences or Europes
competitiveness in the global inancial
markets. In the US, compliance with
Dodd-Frank will require liaison with
new and reconigured regulatory
entities, operational redesign, and
vigilant attention to one o the largestrule-making exercises in the history o
the country. But the accelerated time
line to inalize rules increases the risk o
unintended consequences which will
have an eect on all markets globally.
Asia Paciic is not a homogenous
region, there is signiicant variation in
the approach to inancial services
regulation; however overall the Asia
Paciic banks were relatively unscathed
by the crisis. Nevertheless, there is
signiicant work to be done to developthe inrastructure, governance and
risk management required to manage
businesses which will become more
complex and global in outlook.
Given these developments, I believe
our themes are likely to have the
greatest impact on the inal shape o
the new rules as we move into the core
implementation phase:
Stakeholder expectations must be re-adjusted to relect capital and liquidity
constraints banking will be a more
costly business both or institutions
and or their customers. How these
changes play out between nations
is likely to vary, in some cases
signiicantly, which will increasingly
make some markets more attractive
to do business in.
Systemic risk will be a key ocus,
but sharp national dierences on
insolvency law and economic
imperatives will continue to complicate
a cross-border approach to supervision,
crisis management and resolution,
as central bankers try to balance the
need or market saety with political
pressure to create a ramework or
economic growth.
Demonstrable change in how banks
govern their businesses with much
greater weight given to risk-adjusted
returns, and a signiicant increase in
the accountabilities o management,
the Board, and on supervisors toassess the eectiveness o these
changes. There are signiicant
consequences or attracting and
retaining sta, and developing markets.
Increased ocus on the customer and
core banking services added capital,
liquidity and operational costs will
make trading business less attractive
and lead to reduced capital allocation
to these businesses. Banks will
reocus on retail and commercial
banking, and core services such aspayment and custody. But this area
too has challenges increasing
regulatory ocus on consumer
protection means banks must
simpliy oerings and increase
transparency, which risks stiling
innovation and choice at a time when
state pensions and investment and
savings returns, are diminishing.
Development o the regulatory
paradigm is clearly having a signiicant
impact on the industry, and around the
world. Regulators are under pressure
to get the mix right between a sae
and eective inancial system by
establishing a new ramework o rules
or local supervisors to implement, but
the success will only be evident some
way down the track. Leading global
inancial institutions are acing the
challenge to implement critical changes
in capital and liquidity well ahead o
stated timetables, in order to meet or
exceed market expectations. But many
national inancial institutions are not yet
in a position to respond to the ull
implications o these changes and the
journey to ull compliance will be long
and intensive.
So is it a sprint, or a marathon?
I believe it will be both and it is the
inancial institutions that plan and
prepare early, embedding the new
requirements in how they govern anddirect the business, who will be best
positioned or success.
2010 KPMG International. KPMG International is a Swiss cooperative. Member frms o the KPMG network o independ ent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor does KPMG International have any such authority to obligate or bind any member frm. A ll rights reserved.
Jeremy Anderson
Global Chairman
KPMGs Financial Services practice
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Executive Summary
2010 KPMG International. KPMG International is a Swiss cooperative. Member fr ms o the KPMG network o indep endent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor do es KPMG International have any such authority to obligate or bind any member frm. All rights reserved.
The journey towards a re-shaped fnancial sector is now well under
way. Policy bodies are moving towards the fnal stages o rule making
around the core objectives o the agenda or regulatory change set
out by the G20. Signifcant changes are inevitable or every acet
o the banking industry and indeed the wider fnancial services
industry. But how this change will play out or dierent business
models and in dierent jurisdictions looks set to be very dierent.
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Capital and liquidity have been a primary
ocus o the inancial press since the
crisis. The new bank capital and liquidity
requirements agreed by the Basel
Committee on Banking Supervision
(BCBS), and supported by G20governments, will strengthen the
resilience o inancial irms. We argue in
our chapters on Capital and Liquidity
that these changes will cause a systemic
reduction in banking proits, resulting in
a undamental re-shaping o the sector.
Changes may make banking saer
but could also limit the diversity and
innovation which has underpinned
economic expansion.
The G20 summit in Seoul supported
an emerging ocus on inancial
institutions deemed globally systemic
(G-SIFIs). As we discuss in our chapter
on Systemic Risk these institutions
are likely to be subject to additional
layers o regulatory and supervisory
scrutiny. While the G20 has approved a
ramework or a consistent international
approach to G-SIFIs, it leaves scope or
additional national supervisory add-ons
or G-SIFIs and application o dierent
rules or local SIFIs. This could result
in a very unlevel playing ield or large
cross-border institutions.Imposing new regulations will require
a signiicant step up in supervisory
authority and scrutiny, which has been
in evidence or some time in major
markets. Our chapter on Supervision
sets out the signiicant structural changes
to the supervisory ramework in Europe
and the US, which will add urther
complexity. As we argue in our chapter
on Governance and Remuneration,
supervisors are also using expanded Board
and senior management accountabilities
to shine the light on governance and
remuneration. Changes in these areas
are proving extremely challenging or
banks in all regions, and may prove moreso in Europe where new rules rather
than principles are under discussion.
Customer treatment receives a
renewed ocus by policy bodies. The
G20 in Seoul re-emphasized the need or
customer protection, and as we observe
in our chapter on Customer Treatment
we expect a move towards simpliied
retail oerings which may enhance
transparency but could limit choice.
Traded markets is an area which has
received relatively little mainstream
press. Yet changes in the capital
requirements and market structure
around securities and in particular
derivatives trading will drive a major shit
in the sector. As we argue in our chapter
on Traded Markets, many product
oerings will no longer be economically
viable. These changes may weed out
some o the purely speculative trading
o the past, but could limit useul inancial
market innovation.
The level o new capital requirements
will be inextricably linked to theaccounting bases associated with
inancial assets and liabilities, an area
subject to signiicant revision in the
coming years. The eort continues,
at the G20s urging, to create an
internationally harmonized set o
accounting standards but dierences
add urther uncertainty and complexity
to banks eorts to plan or the new
regulatory ramework.
The new bank capital and liquidity
requirements agreed by the
Basel Committee on Banking
Supervision (BCBS), and
supported by G20 governments,
will strengthen the resilience
of nancial rms. We argue
in our chapters on Capitaland
Liquiditythat these changes
will cause a systemic reduction
in banking prots, resulting in
a fundamental re-shaping of
the sector.
2010 KPMG International. KPMG International is a Swiss cooperative. Member frms o the KPMG network o independ ent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor does KPMG International have any such authority to obligate or bind any member frm. A ll rights reserved.
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Table 1: Regulatory Pressure Index
Regulatory reform Europe North
America*
Asia
Pacific
Regulatory drivers
Capital 4 4 2 All banks will eel the impact o higher charges, regulators in the US andparticularly in key European markets are already indicating they may levy higher
charges than global minimums. Global SIFIs will ace the highest charges,
but mid tier banks ace particular challenges to meet new requirements at
a cost consistent with adequate returns.
Liquidity 5 4 4 Liquidity requirements will bite hard across the industry, but particularly indeveloped markets where the added cost o unding will reduce margins and
curtail more complex (and higher return) product lines, while at the same
responding to supervisory expectations, particularly in Europe, o local liquiditysel suiciency. In Asia Paciic banks will have to make major changes to how
they look at liquidity, and in some markets there may be issues with the quantity
o high quality liquid assets available.
Systemic Risk 5 5 1 Large cross border banks, based predominantly in Europe and the US, willsuer the brunt o eventual proposals or systemic institutions, with European
markets subject to multiple layers o macro-prudential supervision which could
add urther to their compliance burden.
Supervision 4 5 2 Supervisory intensity is already increasing substantially in the US and Europe,and this will add signiicantly to the compliance burden o irms in these regions,
whereas the shit in ASPAC is less marked given more conservative approaches
already in place in many markets.
Governance 4 4 4 New guidance on governance, and enhanced supervisory scrutiny, will drive asigniicant step up or inancial institutions in every region, and equipping boards,
management and sta to ulil their obligations is a signiicant challenge. In Asia
it is recognized that improving corporate governance is an important issue, likely
to be given additional impetus by recent events.
Remuneration 4 3 1 Remuneration is relatively lower proile in Asia Paciic, and not a ocus.Despite public outcry in the US, regulators are taking a measured but
pragmatic approach. The EU is considering the introduction o additional
regulation which could set the most restrictive pay criteria with knock on
eects or its attractiveness to high quality sta.
Customer
Treatment
3 4 1 Now prominent on the regulatory agenda, customer treatment will be a
particular step change in the US with the introduction o a dedicated agencyto write and police consumer issues, but igures only marginally in Asia Paciic
where Australia has traditionally set a strong standard or consumer protection
and other markets are still ocussed on a basic suite o retail products.
Traded Markets 4 4 1 The US and Europe will be most aected by capital charges given the sizeo trading activity, but the US has proposed additional restrictions which could
drive a proportionately bigger reduction there.
Accounting
and Disclosure
3 3 3 Uncertainty over the inal outcome o new rules and the scale o convergencebetween IASB and FASB will complicate planning or banks, but the general
thrust o change in key areas like valuation, recognition and impairment is
expected to increase the base or calculation o regulatory capital requirements
even urther.
2010 KPMG International. KPMG International is a Swiss cooperative. Member fr ms o the KPMG network o indep endent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor do es KPMG International have any such authority to obligate or bind any member frm. All rights reserved.
* The US is currently subject to its rule making phase: approximately 240 rules by 14 ederal agencies needs to be created over
the next 12 months in order to implement Dodd-Frank.
Key: 5 = signiicant pressure 3 = moderate pressure 1= low pressure
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2010 KPMG International. KPMG International is a Swiss cooperative. Member frms o the KPMG network o independ ent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor does KPMG International have any such authority to obligate or bind any member frm. A ll rights reserved.
Table 1: Regulatory Pressure Index
sets out our assessment o the scale o
the challenge posed by key areas o
inancial sector reorm or three major
regions the United States, Europe and
the Asia Paciic region (ASPAC). This isbased on discussions with our irms
clients in each o these regions, as well
as on our proessionals assessment o
key regulations and discussion papers.
The accumulation o additional costs
driving out o regulatory change will drive
a systemic reduction in returns or all
banks. Changes to capital and liquidity
are a major actor, but so too are the
costs associated with expanded
compliance requirements around
reporting, monitoring, documenting, data
capture and modelling. The challenge
around retaining talent could lead to less
innovation, with uncertain impacts or
national economies and their objectives to
increase private savings and investment
and underpin economic growth.
However, taking account o the
practicalities o addressing the issues on
institutions, we expect Europe to eel the
most signiicant pressure overall, with
the US close behind. Both the EU and
the US are going through signiicant step
ups in supervisory intensity, and theconcentration o cross border systemically
important inancial institutions will pose
additional challenges or some o their
biggest banks. Large proprietary trading
books, which were a major driver o
proits or some banks in these regions
pre crisis, are already being wound down
in avour o a ocus on less capital hungry
banking services.
However, taking account of
the practicalities of addressing
the issues on institutions, we
expect Europe to feel the most
signicant pressure overall,
with the US close behind
Challenges in the ASPAC region
will differ by country, but overall
much of the transition to more
intensive and conservative
supervision was embedded after
the Asian crisis of the late 1990s.
Challenges in the ASPAC region will
dier by country, but overall much o
the transition to more intensive and
conservative supervision was embedded
ater the Asian crisis o the late 1990s.
The pressure is on and or manythe journey has already started. Eective
compliance, and more importantly,
successul positioning or growth in this
changing environment, requires careul
planning and a steady pace which can
adapt to new rules and approaches that
continue to emerge. Are you out o the
starting blocks yet?
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01
CapitalRaising the bar
Basel III undoubtedly sets a higher standard or banks to maintain
more robust cushions o capital against their risks. However its
impacts on the shape and diversity o the banking market are yet to
be properly explored. While the large cross-border banks will be hit
the hardest overall, they are also generally in a better position to adapt,
because o their size, diversity and access to investors and customers.
It may be the mid tier banks and investment houses that will fnd it
harder to implement the changes: the ormer fnding it difcult to raise
capital in a constrained market without government subsidy, and the
latter fghting to maintain returns in an environment where many
strategies are no longer viable. Impacts on the competitive landscape
will be o concern to those who see innovation and diversity as
important to a healthy system. All banks will ace higher costs
and signifcant changes to the processes which underpin the
management, measurement, monitoring and reporting o capital
the cost and complexity o which may drive urther all out among
more marginal players.
2010 KPMG International. KPMG International is a Swiss cooperative. Member fr ms o the KPMG network o indep endent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor do es KPMG International have any such authority to obligate or bind any member frm. All rights reserved.
Since the previous Evolving Banking
Regulation publication last year, the
BCBS has announced and inalized its
ramework or strengthening capital
standards. Although some particularly
diicult issues are still subject to
consultation and inal calibration, the
revised capital requirements and the
transition path to them were agreed
by the G20 at its meeting in Seoul inNovember. Increased requirements
or trading book capital in particular
may drive signiicant re-shaping o many
businesses, as we discuss in chapter 7
(Traded Markets). The key requirements
rom the BCBS are summarized in Table
2: Capital Requirements. The emphasis
on common equity and retained earnings
to meet new minimum regulatory capital
requirements is a major shit or many
inancial institutions, particularly or
developed markets where there had
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2010 KPMG International. KPMG International is a Swiss cooperative. Member frms o the KPMG network o independ ent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor does KPMG International have any such authority to obligate or bind any member frm. A ll rights reserved.
been higher penetration o innovative
capital instruments to satisy
requirements. In addition, banks will
be subject to a minimum leverage ratio
o tier 1 capital o at least 3 percent
o (unweighted) total assets including
o-balance sheet items.
The European Commissions (EC)
process is running in parallel with the
BCBS roadmap. Changes to trading book
capital were passed through amendments
to the Capital Requirements Directive
(CRD), in September 2010, the so-calledCRD 3. In early 2010, the EC launched
an initial public consultation on urther
possible changes to the CRD or banks
and investment irms (CRD 4). These
proposed changes are closely aligned with
the Basel III requirements or capital and
liquidity. A urther consultation is expected
in Q1 2011 relecting a more inal version
o Basel III.
The Dodd-Frank Act in the US echoes
international regulatory pronouncements
on capital by calling or all inancial
institutions to hold more and better
quality capital, initially ocusing on larger
bank and non-bank inancial institutions.
The Federal Reserve (Fed) has been given
powers to set higher capital and liquidity
standards or large, interconnected bank
holding companies with total consolidated
assets o US$50billion or more, and or
non-bank inancial companies deemed
to be suiciently systemically signiicant
to warrant Fed supervision. Several
speciic provisions also aim to impose
higher capital on risky activities, to limitproprietary trading (the Volcker rule)
and to shit some swaps activity into
separately capitalized ailiates.
US regulators are expected to
incorporate certain eatures o Basel III
(conservation buer, countercyclical
buer, and liquidity coverage ratio)
in advance o the agreed-upon
implementation schedule. In the
meantime, the US is continuing to
implement Basel II or mandatory
and opt-in institutions.
Key Implications
Common equity requirements or
banks will jump rom a minimum o
2 percent to a minimum o 7 percent
under Basel III, including the capital
conservation buer. While many banks
already have common equity ratios
above 7 percent the proposals will be
more o a challenge than might irst
appear as current calculations are based
on Basel II deinitions. A tight deinition
o qualiying capital, higher deductions
rom capital, and increased capitalrequirements or the trading book will
make a 7 percent capital ratio much
more challenging. In addition some
national regulators may impose higher
requirements than these minimums,
either to all institutions or on a case-by-
case basis.
Europe
Although many cross-border UK banks
are well positioned to meet these higher
core tier 1 capital requirements, having
already started the process o bolstering
their capital base, government supported
banks and continental European banks
ace tougher challenges. Basel III is
stricter than Basel II in its treatment o
tax-deerred assets and mortgage-
servicing rights, which could reduce
capital ratios or some continental
European banks by up to one percentagepoint. German banks may be among
those hardest hit as capital components
such as silent participations and
subordinated loans, which were
commonly used or tax reasons in the
past, will need to be veriied on a case
by case basis to assess to what extent
Table 2: Capital Requirements
CoreTier 1
TotalTier 1
TotalCapital
Notes
Minimum
requirement
4.5% 6% 8% Core tier 1 represents the
highest orm o loss absorbing
capital (share capital and
retained earnings)
Capital Conservation
buffer
2.5% Must comprise common
equity, bringing total common
equity requirement to 7%
Countercyclicalcapital buffer
0 2.5% Current proposal:Added by national supervisors
depending on local
circumstance
Additional
Systemically
Important Financial
Institution (SIFI)
capital requirement
To be determined
by the BCBS
Still under consideration at a
global level. Expected to be set
in the region o an additional
minimum possibly 5% or
G-SIFIs and 23% or domestic
SIFIs, as a combination o
common equity and contingent
capital
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2010 KPMG International. KPMG International is a Swiss cooperative. Member fr ms o the KPMG network o indep endent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor do es KPMG International have any such authority to obligate or bind any member frm. All rights reserved.
they can still be treated as capital under
the new regime. The leverage ratio will
also have signiicant implications or
some banks in the UK and Europe,
where these banks carry large amounts
o low risk-weighted and o-balance
sheet assets. The greater emphasis
likely to be placed by host country
supervisors on the adequacy o locally
held capital will also have an impact
on total capital requirements or
international banking groups.
ASPAC
In the ASPAC Perspective on page 11,
Simon Topping explains that Asian banks
generally remained well capitalized
throughout the crisis. Many commentators
have questioned the appropriateness o
the Basel III package or a region whose
business ocus is local and is conducted
largely by way o retail and small
business and commercial lending.
Additionally, an upcoming KPMG/Oracle
survey Evolving Regulatory Reforms:
Impact on Asia Pacific Financial
Institutions, highlights concerns over
the implications o Basel III or growth in
the region. The ocus o regulators and
banks in Asia is more likely to be on the
liquidity requirements orming part o
the Basel proposals, risk management
and governance, and the challenges o
bolstering the expertise and availability
o internal resources, data quality and
inormation technology capabilities.
North AmericaIn general, North American banks are
considered to be well capitalized to meet
the Basel III standards as many o these
banks have been accumulating capital
since the inancial crisis, and were
unwilling to release this capital during
the uncertainty o the legislative phase
o the Dodd-Frank Act. To the extent
that leading banks are in eect over-
capitalized, they may release unds
towards lending and acquisitions.
Further capital changes are expected.Systemically Important Financial
Institutions (SIFIs) will be subject to
urther capital requirements both under
eventual global standards, and in some
cases under super-equivalent national
standards, as discussed in chapter 3
(Systemic Risk).
Impact on core banking activities
Requiring banks to hold greater capital
buers to absorb potential losses could
lead to a urther tightening in the price
(interest margins and higher collateral
requirements) and availability o bank
lending. The relatively easier and cheaper
access o larger banks to capital and the
impact o regulatory costs more generally,may result in smaller banks being
acquired by larger banks or choosing to
leave the market. This will raise signiicant
issues about the impact o regulatory
reorm on competition in the banking
sector. For this reason, there are long
implementation periods being allowed,
to try to ensure that this potential
tightening o availability o credit does
not occur.
The stated implementation dates
o Basel III extend to 2018, but in the
regulatory race, supervisory pressure
ocusing on capital planning and stress
testing by banks and market discipline
are likely to push banks towards much
earlier implementation. Many banks
are thereore preparing or the new
capital regimes well in advance o theirproposed implementation dates, and
aiming or core tier 1 capital ratios
comortably above 7 percent, rather
than risk supervisory sanctions on
earnings distribution and remuneration
or market censure.
Issues to consider
Banks should begin by thinking
strategically about what impact the
new capital requirements will have
on the shape o their business:
Have you carried out appropriate
scenario planning and impact
assessments to ensure the
development o a successul
capital strategy?
Which businesses have the most
attractive undamentals which
businesses in your portolio should
you be considering exiting,
growing or divesting?
Is your organization geared up toeectively and consistently deliver
real time measurement,
management and reporting o your
capital position?
How will you address the pricing
implications arising rom changes
in the capital requirements or
certain products?
Can the same business models
continue under a dierent structure,
minimizing capital requirements?
(eg branch versus subsidiary)
Are you prepared to meet timescales
which eectively may be shorter
than the announced starting dates?
Have you considered the strategic
advantages/disadvantages o these
timescales?
Have your capital planning and
capital management processes
been reviewed in light o the new
requirements?
Will you set your capital targetwith reerence to the regulatory
requirements, or will you use other
means (economic capital, ICAAP)
to determine the appropriate level?
Have you considered the optimum
capital mix in this new environment,
including possibly replacing existing
capital with higher quality capital?
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Perspectives:ASPACViews on Basel III
When you cut through all the complexity,
Basel III is really very simple its about
making banks more resilient to stress,
through stronger capital and liquidity
positions and enhanced risk management.
Basel II was a move in the rightdirection, in that it helped encourage
banks to make use o more sophisticated
risk management techniques, and made
capital requirements more risk-sensitive,
but one o the problems with Basel II was
that it wasnt suiciently comprehensive.
It was silent on key issues such as
liquidity, deinition o capital, and leverage.
Basel III redresses this. It also gives
increased emphasis to some important
areas such as stress-testing and capital
management, which were present, but
underplayed in Basel II.
Banks in Asia Paciic generally ared
much better during the inancial crisis
o the last ew years than those in the
US and Europe, and so a question some
are asking is whether Basel III is really
necessary or them. But it would be
very short-sighted to take such a view
its always important to learn rom others
experience. Certainly, there are some
key messages that all should take on
board, and three in particular:
First is the need to make the riskmanagement process more
sophisticated, more comprehensive
and better integrated; to consider all
types o risk, not just credit and market
risk, and how they are related and
interact. Second, to make greater use
o stress-testing o risk positions, o
capital, and o liquidity and to develop
well-articulated contingency plans or
responding to adverse scenarios, both
o an institution-speciic and a system-
wide nature. Third is the need to ensurethat the banks strategy, business
model and risk appetite are well thought
through, and that the capital planning/
management process is consistent
with this.
Maybe it will be a surprise to some that
I havent identiied the requirement or
a greater amount and higher quality o
capital as a key issue or banks in Asia
Paciic. Certainly there will be some or
which this will be an issue but, generally
speaking, banks in Asia Paciic already
operate at considerably higher ratios than
is the norm in the US and Europe, and a
high proportion o this is typically in the
orm o common equity, so it is generally
o high quality too. So you could say,
Basel III endorses what has been thenorm or many in Asia Paciic or some
time. Similarly, I dont see the new
leverage ratio as being a big issue or
most in Asia Paciic. Business models
here have generally not involved the
build-up o excessive leverage. Likewise,
the longer-term liquidity ratio, the net
stable unding ratio, shouldnt generally
be a problem, as regulators have tended
to discourage mismatching short-term
unding and long-term lending.
What could well prove the most
problematic area, however, is the shorter-
term 30 day liquidity coverage ratio.
This is basically a good idea that a bank
should hold enough liquidity to see it
through a stress period but the problem
is that 30 days is probably not the right
time horizon in many Asia Paciic
jurisdictions. Once a bank gets into
diiculty, things tend to happen rather
quickly, and so ive or seven days may be
more appropriate. Local regulators seem
likely thereore to stick with this much
shorter time horizon, possibly in additionto the 30 day ratio.
Another issue associated with the new
liquidity requirements is where all this
liquidity is going to come rom, as many
Asian jurisdictions simply do not issue
suiciently large enough amounts o
government debt to satisy the likely
demand. The BCBS acknowledged this
issue in its July 2010 press release
detailing broad agreement on the Basel
Committee capital and liquidity reorm
package, and some lexibility is likely.No doubt these details will be ironed
out over time. Hopeully the issue o
provisioning will also be made clearer.
Again, this is an area where many banks
in Asia Paciic are relatively well-prepared,
as regulators have in many cases required
banks to hold provisions in excess o
the amount suggested by the impaired
loss model, in eect pre-empting the
move to provisioning on an expected
cash low basis.
So, in many important ways, banks in
Asia Paciic are perhaps better-placed to
meet the new capital and liquidity numbers
under Basel III than many banks elsewhere.
For them, the challenge may be more on
the risk management side, and it is here
that, in my view, the emphasis needs tobe on systems and people resources
rather than inancial resources.
O course, Asia Paciic is a very
diverse region, with both advanced and
less advanced economies and inancial
systems. Some have very well developed
supervisory capabilities; others are urther
down the learning curve. Some have
implemented Basel requirements (such
as Basel II) on the same timetable as
other major jurisdictions, while others are
still in the process o doing so. But i there
is one thing that is a common actor in
most Asia Paciic jurisdictions, and which
perhaps dierentiates Asia Paciic rom
the US and Europe, it is that both bank
managements and regulators have
consistently tended to be relatively
conservative in relation to risk-taking,
innovation, and capital and liquidity
positions. This innate conservativeness
possibly a cultural eature, possibly a
response to having gone through the
Asian inancial crisis in the late 1990s
has served Asia Paciic institutions wellin the recent crisis.
Simon Topping
Head o Financial Risk Management,KPMG in China and Head o the Risk
and Regulatory Center o Excellence
or ASPAC region
Formerly Executive Director (Banking
Policy), Hong Kong Monetary Authority
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02
LiquidityA steep incline
Although capital grabs the headlines, the new liquidity requirements
in Basel III will be at least as signifcant, i not more, or many banks
and their customers. Maintaining higher liquidity buers may depress
banks margins and ultimately reduce the range o products they
oer customers. Banks will have to make signifcant investments
to monitor and manage liquidity more eectively in an increasingly
constrained and heavily supervised landscape, and to respond to the
increasing demands o some host supervisors or branches to meet
local liquidity requirements.
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One key contributor to the ailure or
near-ailure o many banks during the
crisis was a lack o liquidity and the
consequential impact o a loss o
depositor conidence. Given the nature
o the banking business model and
the key role banks play in maturity
transormation, a perceived liquidity
shortall can rapidly escalate into a
run with collateral damage acrossthe system. Since the crisis, regulators
have been ocusing much more attention
on ensuring and deending adequate
liquidity standards and reducing the
moral hazard generated by public
support or banks and their depositors.
The BCBS has proposed two new
minimum liquidity requirements,
designed to enhance both the ability
o banks to repay their liabilities as
they all due and the maturity matching
o banks balance sheets. There is aparticular emphasis on moving banks
away rom relying too heavily on short-
term wholesale unding:
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Liquidity coverage banks must hold
suicient high quality liquid assets
(cash, government bonds, covered
bonds and highly rated corporate
bonds) to enable them to withstand
or 30 days the loss o a proportiono their retail deposits and an inability
to roll over any corporate and
wholesale deposits.
Net stable unding banks must hold
suicient stable sources o unding
to match their lending o over one
year maturity.
Both the BCBS and national regulators
have also emphasized the importance
o the boards o banks understanding
liquidity risk, taking a close interest in
setting a risk appetite, and satisying
themselves that these risks are properly
monitored and controlled; the need or
banks to run a range o stress tests,
covering both bank-speciic and market-
wide vulnerabilities; and or banks to
have adequate systems, data, reporting
and management inormation to enable
continuous management o liquidity.
These quantitative and qualitative
requirements are expected to be
implemented in the EU through the
CRD. In the US detailed liquidityrequirements will emerge rom the rule
making currently being undertaken by
various US ederal banking regulators.
As with capital, some national
regulators may set additional standards
to those in Basel III. The UK has already
implemented new liquidity arrangements
which are, in many respects, more
restrictive than those proposed by the
BCBS and are likely to remain so.
Key implicationsUnder the new liquidity regime proposed
by the BCBS, banks will be aced with
higher requirements or liquidity buers.
One key contributor to the failure
or near-failure of many banks
during the crisis was a lack of
iquidity and the consequential
mpact of a loss of depositor
condence Since the crisis,
regulators have been focusing
much more attention on ensuring
and defending adequate liquidity
standards and reducing the moral
hazard generated by public support
for banks and their depositors.
The costs o liquidity will increase
sharply, as a larger amount o liquid
assets will need to be held in low risk,
low return assets such as government
bonds, and as banks shit rom short-
term wholesale deposits to retail andlong-term wholesale deposits. In
combination, there will be a signiicant
drag on liquidity reducing proitability. As
Clive Briault discusses in the Europe
Perspective on page 15, this could be
urther reinorced while all banks seek
to increase their reliance on a limited
pool o retail and longer-term wholesale
deposits. It may be hard to re-price other
businesses to compensate, especially
at a time when aggressive moves to
migrate customers to alternative, more
proitable, products will be under greater
political and competition authorities
scrutiny. This is likely to drive a long-term
shit in balance sheet planning rom
an asset-based approach to a liability
management strategy, reducing the
probability o signiicant balance sheet
expansion.
Banks will also need to put in place
stronger systems and controls or
managing liquidity and liquidity risk.
Senior management has a clear
obligation to monitor perormance andto deliver signiicantly enhanced and
more requent reporting o liquidity
positions. In the UK, the Financial
Services Authority (FSA) is already
moving to make daily reporting part o
a regular regime. It also intends to drill
down more deeply into individual banks
positions; and at the same time quantiy
aggregate industry risk positions on a
regular basis. Meeting these requirements
will place enormous strains on banks
data and systems which may in manycases be inadequate to the task.
Major investment will be necessary.
In Germany, the latest consultation
l
i
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papers are moving closer to the UK and
US requirements that banks run regular
stress tests and take proper account o
the results in assessing the adequacy
o their liquidity buers.
For international banks the deinitiono individual liquidity pools will become
a critical and contested area. This
relects both the demands o some host
national supervisors that the branches
o oreign banks should be sel-suicient
in terms o their local liquidity; and the
dominance o the legal entity driver in
the approach o some supervisors,
orcing legal entity simpliication and the
matching o liquidity pools with each
legal entity.
With the increasing requirements on
liquidity, it is clear that liquidity transer
pricing will be an issue or banks,
aecting their pricing and thereore
their business model. Many complex
structures will struggle to demonstrate
adequate return in this environment.
In October 2010 the Committee o
European Banking Supervisors (CEBS)
inalized its Guidelines on Liquidity Cost
Beneit Allocation. According to CEBS,
liquidity management has to include
adequate unds transer pricing policy
that considers all relevant liquiditycosts (direct and indirect), beneits and
risks. Implementation is expected by
mid-2011.
Issues to consider
Do you understand your current
liquidity position in suicient detail
and know where the stress pointsare e.g. how sticky are your retail
and wholesale deposits?
Have you considered the impact o
new liquidity rules on proitability
has liquidity risk/cost been
actored into key business
processes and priced internally?
Is liquidity planning, governance
and modeling in line with leading
industry practice?
Are systems, data and
management reporting adequate
to meet the new requirements?
How do you determine what an
appropriate series o stress tests
is and how these will change
over time?
Are you aware o the likely
implementation timetable or
dierent elements o the global
and national rameworks being
proposed?
Have you assessed your liquidity
strategy in light o the existing legal
and regulatory structure o yourorganization? Have you considered
the uture liquidity requirements
o overseas subsidiaries/branches
and how these might be met?
Have you reviewed your liquidity
contingency plan? Have you set
up Key Risk Indicators to give early
warning o impending liquidity
problems?
Are all areas o your business aware
o the implications o the new
requirements? What impact will
this have on your business model?
Have you considered the interaction
between the new liquidity and
leverage requirements?
Have you discussed with your
supervisor their plans/intentions
regarding providing liquidity to the
market/individual institutions,
including in times o stress?
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03
Systemic riskPart of the bigger picture
The fnancial crisis continues to expose the political and economic
impacts o major disruption in fnancial services. Policy makers are
establishing new rameworks to deal with both systemic institutions
and systemic risks. Detailed proposals on additional capital
requirements and other add-ons or systemically important fnancial
institutions (SIFIs) are in progress, but a lack o clarity between global
and national SIFIs gives rise to the risk o an unlevel playing feld.
Large cross-border banks are likely to bear the brunt o the
additional regulatory burdens and changing prudential supervisory
relationships, and ace a period o considerable uncertainty. Many
argue that it is the approach to risk rather than the size o the
institution that should be the determining criteria or additional
systemic requirements and supervisory arrangements. In any case,
the monitoring o systemic risk does not guarantee the identifcation
and prevention o the next crisis. Some threats to fnancial stability
may not be identifed, while even identifed threats may not be
addressed in the context o other, political imperatives.
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The inancial crisis highlighted two major
shortcomings in how the authorities
dealt with systemic risk. First, the threat
to the system arose in part rom the
collective actions o inancial institutions
(or example the combined rapid growth
o asset prices and collateralized credit,
a slackness in loan origination), and the
use o securitizations and credit
derivatives to spread risk. But supervisorshad ocused mainly on the risks acing
individual regulated irms, and not
enough on system-wide risks. Second,
many governments had to commit public
unds to support SIFIs, rather than risk
the inancial instability, loss o key
inancial unctions and damage to the
real economy that would have resulted
rom their ailure.
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The policy response has been aimed at
achieving our core objectives:
Reduce the risk o ailure o SIFIs.
Increase the powers o the authorities
to resolve a ailing SIFI without
disruption to the inancial systemand without taxpayer support.
Instil greater market discipline through
a more credible threat o loss to
shareholders and creditors.
Intensiy the monitoring o systemic
risk, both across the system and
within individual institutions.
Global policy setting bodies have
proposed a series o measures in varying
stages o implementation to meet these
objectives, as outlined below.
More capital, and better quality capital
and higher liquidity
The risk o the ailure o a SIFI can be
reduced in part through the capital and
liquidity buers or all banks as set
out in Basel III, and in part through the
imposition o additional capital and
liquidity buers or SIFIs. Additional
capital buers could include both
contingent capital which would convert
to equity at an early stage when a SIFI
began to experience diiculties, andthus help the SIFI to continue as a going
concern and bail in capital which
would convert to equity just beore a
SIFI ailed, thereby spreading losses
to creditors and reducing the need or
public support.
The BCBS is developing its own
proposals to address systemic issues,
including higher capital and liquidity
requirements, additional loss absorbency
through contingent capital and enhanced
supervision, but details are not expecteduntil mid-2011.
In the US the Dodd-Frank Act requires
SIFIs to be subject to higher capital,
leverage and liquidity requirements,
and to meet enhanced requirements on
disclosures, rigorous risk management,
concentration o exposures, and
resolution plans. In Switzerland, the
Swiss National Bank has proposed a
total capital requirement o 19 percent
on its two largest banks, to be made upo core tier 1 capital o 10 percent and a
urther 9 percent o capital in the orm o
two dierent types o contingent capital.
Enhancement o resolution and
insolvency regimes
Clearly, SIFIs would be less o an issue
i eective resolution, in the event o
their ailure, were possible. However,
many question the likelihood o an
eective globalresolution and insolvency
regime being developed and agreed.
Requirements are already in place in
some jurisdictions or SIFIs to ormulate
recovery and resolution plans (sometimes
known as living wills or uneral plans),
which would assist the authorities in
resolving ailing SIFIs in an orderly
manner, thereby reducing the contagion
impact o any such ailure. Similarly,
some countries have implemented, or
are planning to implement, enhanced
powers or the authorities to intervene
to resolve a ailing SIFI by replacing the
management o the SIFI and transerringor selling parts o its business in order to
maintain core inancial services. The
US, UK and some other countries are
pushing hard or improving national
resolution regimes.
Under the Dodd-Frank Act, the FDIC
has extended powers to manage the
resolution o SIFIs. The International
Monetary Fund (IMF) is seeking progress
on a cross-border resolution regime.
The EU is also examining its approach
to resolution and crisis managementwith the intention o creating consistent
crisis management tools or inancial
services. This could include cross-border
cooperation, recovery and resolution
plans, resolution unds supported by
Clearly, SIFIs would be less of
an issue if effective resolution,
in the event of their failure,
were possible. However, many
question the likelihood of an
effective global resolution
and insolvency regime being
developed and agreed.
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national bank levies and eventually
greater harmonization o legal resolution
rameworks across the EU. However,
some countries remain unconvinced
that these regimes will be capable o
resolving a ailing SIFI and so place moreemphasis on preventing ailure (and
ensuring that in the event o a ailure
the losses do not all on taxpayers) as
the best way orward.
Supervision
The Financial Stability Board (FSB) has
recently set out proposals or more
intensive supervision o SIFIs, an
approach already well under way in
major developed markets, to allow or
early identiication and prevention o
issues. More intensive and challenging
supervision, along with additional
disclosures on risk, are expected to be
the norm. Many countries, including
Australia and the US, have also taken
speciic steps to extend the remit
o supervisors to capture previously
under regulated entities such as
hedge unds and investment advisers,
discussed urther in chapter 4
(Supervision).
Structural change in the industryProposals in some jurisdictions would
limit the size o banks and the activities
they are allowed to undertake. In the
US, the Volcker rule limits proprietary
trading and investments in private pools
o capital. The UK has set up an
Independent Commission on Banking
which is exploring multiple options
intended to support a stable and
competitive banking sector, including
limits on activities and mandatory
disposals to reduce balance sheetsand risk. Proposals in both the EU and
the US to move the bulk o over the
counter (OTC) derivatives trading to
central counterparties are intended to
minimize market instability arising rom
counterparty ailure.
It remains to be seen whether policy
makers will ultimately determine that big
banks should be broken up. The
argument goes both ways. On the onehand, big banks pose a concentration (or
systemic) risk, on the other, big banks
have generally been regarded as
providing strength and stability to
inancial systems.
Taxation
Bank levies have been implemented
in some countries, notably the UK,
Germany, and France, and proposed
by others including the US and across
the EU. The orm and purpose o these
levies vary between jurisdictions
some are intended to cover the costs o
resolution, some to establish a und to
meet uture resolution costs, and others
to lessen government deicits. Opponents
o resolution unds argue that they would
reinorce moral hazard by creating the
expectation that the unds would be used
to support ailing banks in the uture.
Systemic overview
Various existing and newly created
national and international bodies havebeen tasked with macro-prudential
oversight, including the European
Systemic Risk Board (ESRB) in the EU,
the Financial Stability Oversight Council
(FSOC) in the US, and the Financial
Policy Committee (FPC) in the UK. Their
role is to identiy risks to inancial stability
including credit and asset price growth
and vulnerabilities in payment, clearing
and settlement systems and to take or
recommend actions to mitigate these
risks.
Key Implications
While the high level objectives around
the regulation o SIFIs are broadly
accepted, this masks some signiicant
ault lines over the detailed measures
being proposed. These ault lines
include the deinition o SIFIs, and the
eectiveness in practice o applying
resolution plans and contingent capital with many skeptics doubting that either
would avoid the need or government
support o a ailing SIFI.
Global versus Local SIFIs
Views dier on how dangerous SIFIs
are. The US, UK and Switzerland are
the most concerned, given the size and
concentration o their SIFIs relative to
their GDP. In contrast, many in ASPAC
and parts o Europe whose banks were
less entangled in the crisis, view the
size and business model o their largest
banks as a source o strength and
stability.
The most recent statements rom the
FSB and the G20, which distinguish
between global (G-SIFIs) and national
SIFIs, relect these diering levels o
concern, but risk creating an unlevel
playing ield on a number o ronts,.
Global minimum standards or additional
capital, liquidity and supervisory
requirements look increasingly likely to
be targeted at G-SIFIs. National SIFIs(i.e. those which are systemic only at a
national level) could then be set lower
additional requirements by their national
supervisors. Implementation may not
be consistent, with some jurisdictions
choosing to gold-plate the minimum
standards.
These developments will put pressure
on global banks to reconsider how they
operate and whether they can take a
group-wide approach to capital and
liquidity. Uneven implementation o SIFIstandards may cause some to consider
restructuring themselves and relocating
parts o their operations to take
advantage o less onerous regulation.
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Resolution regimes
Contrasting views across countries on
the potential eectiveness o resolution
regimes, raise questions about the
proper balance between preventing
ailures o SIFIs through additional capitaland liquidity requirements and relying
on an orderly resolution regime to limit
the impact o a ailing SIFI. Again, this
could lead to an unlevel playing ield
or SIFIs subject to dierent national
regimes. The eectiveness o
supervisory colleges in resolving issues
with cross-border institutions has yet
to be tested and may ultimately be
constrained by national insolvency law.
Signiicant dierences in national
resolution powers and the speed o
contagion in the inancial sector may
undermine the eectiveness o
resolution powers or cross-border
institutions. Large cross-border
institutions have grown complex, and
in many cases unwieldy, business and
legal entity structures. Eective
resolution plans will require that these
are thoroughly reviewed and rationalized
as part o the process o writing recovery
and resolution plans (RRPs).
Practicality o contingent capitalIt is by no means certain that contingent
capital can be raised in the volume which
is implied in recent proposals. Nor is it
clear that contingent capital will meet its
objective. Depending on where trigger
levels are set, the act o the conversion
could add urther stress through a loss o
conidence in individual banks and in the
inancial system more generally.
Both contingent capital requirements
and government insistence that bail
outs will no longer be available, willsigniicantly increase unding costs
or large banks as investors seek
compensation or added risk. The risk
premium required may undermine the
viability o contingent capital as an option,
in which case these banks will need to
raise even more common equity.
Systemic overview
Although various new bodies are beingestablished, it remains to be seen how
eective they will be in identiying and
addressing risks to inancial stability.
In particular, little progress has been
made outside Asia in designing the
macro-prudential toolkit o measures
that could be taken and in determining
the conditions under which the
measures would be deployed. Financial
institutions thereore ace considerable
uncertainty over the national and
international measures that might be
taken, and in planning or the impact
o these measures on their businessstrategies and on the capital they
need to hold. There is also considerable
scope here or uneven choice and
use o measures across countries
and across dierent types o inancial
institution G-SIFIs, national SIFIs
and other banks.
Issues to consider
Does management understand
which aspects o the business
are systemically important?
Does your business and/or
management structure need to be
reorganized to acilitate resolution
planning?
How ar will unding proiles shit
given the push to ensure that
private creditors bear any losses?
Have you begun to understand
how to develop a resolution plan,
including multiple levels within
your organization? Can you collect
the inormation you need to satisy
multiple requests?
Being designated a SIFI may impose
greater costs (in terms o increased
capital etc) but it may also bring
beneits (e.g. in terms o lower
unding cost because o the
perception o having been identiied
as systemically important. Have
you considered how you might be
aected by this (whether or not
you are a SIFI)?
Have you considered the pros and
cons o being located in dierent
jurisdictions?
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04
SupervisionApplying the rules of the game
Banking supervision is changing signifcantly. Reducing the likelihood
and severity o uture fnancial crises through stronger regulation
and supervision is an agreed priority or most governments and policy
makers. Stronger supervision will mean not only more intensive
reviews o activities diving deep into individual business areas, but
also more challenge o banks strategies and business models.
Larger cross-border frms will have to rely on eective cooperation
between colleges o supervisors to prevent duplicate and inconsistent
supervisory requirements.
The precise tone o supervision, and the balance between
supervisory discipline and market discipline remain to be determined.
This will depend as much on politics as on the organizational structure
o supervisory agencies, with both the supervisors o individual banks
and the macro-prudential supervisors o the overall fnancial system
acing a fne balancing act between eective supervision and
pressures to deliver a broader political and economic agenda.
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The substance and execution o
banking supervision in key inancial
markets aces substantial changes
(in both structure and policy). There
are six broad themes:
Implementation o the tougher and
more extensive regulations being
introduced under the G20 regulatory
reorm agenda.
More intrusive, intensive andchallenging supervision.
Expansion o the scope o
supervision to capture additional
actors in the supervisory net.
Increased cooperation and
coordination among supervisors
to improve the scrutiny o cross-
border activities.
New and expanded supervisory
powers in relation to the capital
conservation buer and
countercyclical buer. New supervisory structures and
the allocation o responsibilities or
macro-prudential oversight.
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Evolving Banking Regulation | November 2010 | 21
The substance and execution
of banking supervision in
key nancial markets faces
substantial changes (in both
structure and policy).
2010 KPMG International. KPMG International is a Swiss cooperative. Member frms o the KPMG network o independ ent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor does KPMG International have any such authority to obligate or bind any member frm. A ll rights reserved.
The implementation o these changes
will depend in part on local political
and economic developments. The
common element will be more
intensive and challenging supervision,
within a more rigorous, risk-based andorward-looking approach. This change
is already being experienced by
regulated irms in areas such as the
eectiveness o corporate governance,
remuneration, the riskiness o
business models, stress testing,
enterprise-wide risk management,
systems and controls, liquidity, and
tighter ring-encing o the local branches
and subsidiaries o overseas irms.
Europe
The current Level 3 Committees
(CEIOPS, CEBS and CESR)1 will
become European Supervisory
Agencies (ESAs) rom 1 January 2011,
with greater regulatory and legal
powers. Initially the ESAs will be
relatively small and will require support
rom key national supervisors in
developing policy but their size
and inluence could be increased
signiicantly ater three years when
the success o the new structure is
set or review.The ESAs will be able to write
policy, with the aim o creating a
single European rulebook, subject to
adoption by the European Commission
(EC). In some evolving areas, ESAs
may gain a primary role. For example,
the European Securities and Markets
Authority (ESMA) is lined up to play a
key role in the registration and
supervision o credit rating agencies
and central counterparties though
with support rom national supervisorsplaying host to these bodies. They will
also have a mandate to ensure the
consistent application o Directives by
national supervisors. The ESAs will
have the power to mediate and
mandate actions where there are
disagreements or inconsistencies
between national supervisors in
how they apply these rules.
In practice, this system o peer
review should minimize (but noteliminate) the scope or national
variation, and highlight weaker
supervision practices. In both cases,
there could be signiicant impacts or
the local approach to supervision it
limits the scope or national supervisors
to take a more competitive approach
to political issues, as seen recently
with the remuneration debate urther
discussed in chapter 5 (Governance
and Remuneration) and the Alternative
Investment Fund Managers Directive
(AIFMD), even i it still leaves scope
or local regulators to apply super-
equivalent rules.
A European Systemic Risk Board
(ESRB) will look at emerging macro-
prudential risks. Its role will include
carrying out market-wide stress tests
to help determine the systems
sensitivity to shocks as discussed in
chapter 3 (Systemic Risk). Its main
interaction with irms will be in issuing
risk warnings (public and private) and in
recommending (but not mandating)mitigating action on such risk warnings.
UK
The UK arrangements are diverging
rom the wider European model. Unlike
the ESA structure, planned supervisory
changes will separate prudential rom
market and conduct o business
regulation and supervision, with
signiicant implications or UK regulated
irms in dealing with multiple supervisory
agencies. The Bank o England willdischarge its responsibilities or the
prudential regulation and supervision o
banks and insurance companies through
a subsidiary agency, the Prudential
Regulatory Authority (PRA). One major
1. CEIOPS: Committee o European Insurance and OccupationalPensions SupervisorsCEBS: Committee o European Banking SupervisorsCESR: Committee o European Securities
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22 | Evolving Banking Regulation | November 2010
Managing multiple relationships
and the changing supervisory
spheres of inuence, may cause
some rms to consider changing
their structures and business
models to achieve the most
effective balance of supervisory
oversight.
2010 KPMG International. KPMG International is a Swiss cooperative. Member fr ms o the KPMG network o indep endent frms are afliated with KPMG International. KPMG International provides no client services. Nomember frm has any authority to obligate or bind KPMG International or any other member frm vis- -vis third parties, nor do es KPMG International have any such authority to obligate or bind any member frm. All rights reserved.
driver or these changes is to ensure
the eective coordination o macro-
prudential oversight with the prudential
regulation and supervision o individual
irms. Thus the Bank o England will also
have a Financial Policy Committee (FPC)to assess threats to inancial stability,
including the growth o credit and o
asset prices.
Meanwhile, the Consumer Protection
and Markets Authority (CPMA) will ocus
on consumer and market protection and
act as a single conduct o business
regulator and supervisor or both retail
and wholesale irms. The implications o
this is outlined in chapter 6 (Customer
Treatment). This division o regulatory
responsibilities relects a historically
greater ocus on consumer protection in
the UK than in much o the rest o Europe.
However, ways o working and the
boundaries between micro and macro
issues, between prudential and conduct
o business issues, and between market
supervision and market stability issues,
remain to be determined. Teething
problems may cause diiculties or
supervised irms.
US
The Dodd-Frank Act eectively expandsthe ramework o inancial services
regulation to a variety o new irms,
products and regulators. The core
regulatory ramework or insured
depository institutions (banks and thrits)
is not substantially dierent, but there
are our key exceptions:
The creation o the Financial Stability
Oversight Council (FSOC).
The creation o the Consumer
Financial Protection Bureau (CFPB).
Increased powers or the Fed whereinstitutions (both inancial and non-
inancial) are deemed to be
systemically important.
The long anticipated elimination o the
Oice o Thrit Supervision (OTS),
with the reallocation o its powers
and duties to the other ederal bank
regulatory agencies (OCC, the Fed
and FDIC).
The FSOC will undertake macro-
prudential supervision within the US.
Working through the Fed, it has
signiicant powers to review and modiy
the strategy and activities o institutions
deemed to be systemically important.
The impact o more supervision on these
irms, their strategies and their business
models is likely to be substantial.
The consumer protection unctions
o the OTS, OCC, FDIC and the Fed
will be largely transerred to the CFPB on
or around July 2011. The CFPB will have
all consumer protection rule-making
authority in addition to supervisory
responsibility or insured depository
institutions with assets in excess o
US$10billion, as well as their ailiates
and service providers. The CFPB will
also have supervisory responsibility or
non-bank inancial companies that
provide consumer inancial services
and products. Smaller institutions stay
under the purview o their primaryederal regulator while also being subject
to the rule-making authority o the CFPB.
Finally, the OCC will now supervise
ederally-chartered thrits in addition
to national banks and has rule-making
responsibility or all thrits. The Fed has
authority over thrit holding companies.
Thrits are likely to ind themselves
subject to much more rigorous
supervisory standards under the OCC,
eliminating a regulatory arbitrage
opportunity to take advantage o themore lexible approach o the OTS.
Industrial banks, credit card banks
and trust banks are likely to be subject
to enhanced regulatory scrutiny in
areas such as governance and risk
management.
There are a number o other changes in
the authority o individual regulators: The FDIC gains authority to act as
receiver or certain systemically
important institutions that ail
(including bank holding companies
and non-bank inancial companies).
The Securities Exchange Commission
(SEC) and CFTC will share supervisory
responsibility or OTC derivatives,
subjecting this market or the irst
time to coordinated oversight o its
activities and risks.
Investment advisers to private pools
o capital (including private equity,
hedge unds and certain real estate
unds) are also pulled in to the
regulatory net by requiring registration
by July 2011 and will then be
regulated by the SEC.
As Hugh Kelly discusses in the US
Perspective on page 24, the scale o
supervisory change brings signiicant
risks o an outcome which is rushed and
uncoordinated.
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Evolving Banking Regulation | November 2010 | 23
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ASPAC
As noted earlier in this report, regulators
in ASPAC have generally adopted quite
a conservative approach, relecting
the less developed nature o some
jurisdictions, plus the lessons learnedrom the Asian Financial Crisis.
Regulators in ASPAC never went in
or light touch or principles-based
regulation, and thereore have less back-
tracking to do. Generally they have been
more rules-based, more prescriptive, and
have required banks to hold conservative
buers and maintain conservative limits.
As a consequence, there may be a less
dramatic change in the style o regulation
and supervision in many ASPAC
jurisdictions compared with elsewhere.
Similarly, there is likely to be ar less
organizational change in the supervisory
set-up.
Key Implications
More supervision
Financial institutions are already acing
more intensive and intrusive supervision,
more coordinated supervision among
supervisory agencies and a widening
o the regulatory net. Larger and more
complex irms ace a balancing act to
manage relationships with multiplesupervisors who may ind themselves
pulled in dierent directions, not only
by regulatory initiatives but also broader
political and economic imperatives.
This will drive increased cost and
changes to compliance. Managing
multiple relationships and the changing
supervisory spheres o inluence, may
cause some irms to consider changing
their structures and business models to
achieve the most eective balance o
supervisory oversight.
Unknown quantities
The tone, style and demands o new
agencies have yet to be established.
Firms are gearing up or another wave
o rule making and supervisory scrutiny,
as new bodies come on line and lookto establish their authority. This will
have implications or data, systems and
reporting requirements, and provide
scope or disruption or irms as the lines
o demarcation between the new bodies
take shape. The rise o the ESA structure
in Europe is likely to mean less scope
or local variation in the implementation
o EU-wide requirements this may
even the race, but could reduce the
competitiveness o larger and more
international irms and markets.
The macro-prudential overlay
Financial institutions will be subject
to both micro and macro supervisory
action irm-wide level supervisory
requirements will be supplemented
with actions