risk & capital management under basel iii · pdf filepwc icaap – impacted by basel...

Risk & Capital Managementunder Basel III

London, 15 February 2011

www.pwc.com

Draft

PwC

Agenda

• The ICAAP under Basel III

• Challenges for capital management

• Interaction of Risk & Finance

• Conclusions

February 2011Slide 2

Risk & Capital Management under Basel III

PwC

ICAAP – Impacted by Basel III?



Components of ICAAP

Pillar 2

SupervisoryReview Process

Internal CapitalAdequacy

Assessment Process(ICAAP)

Supervisory Reviewand EvaluationProcess (SREP)

Governance over the ICAAP

Risk assessment

Internal capital assessment

Risk strategy

Capital planning

Stress testing

Use test

PwC

ICAAP – Impacted by Basel III?



Capital planning

• Conservation buffer

• Uncertainty on countercyclical buffer

• Transition period to 2019: lengthening the capitalplanning period

PwC

Available total capital (illustrative)

Available Core Tier 1 (illustrative)

3.5%

4%

4.5%

5.125%5.75%

6.375%

Non-core T1 instruments phase out 2013 - 2022New deductions phase in 2014 - 2019

T1 and T2 instruments phase out 2013 – 2022New deductions phase in 2014 – 2019

8%

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

4.5% minimum -- 1/1/15

7% (includingConservationBuffer) – 1/1/19

New available CT1

10.5% includingConservationBuffer – 1/1/19

Capital ratio%

Minimum Total Capital

Minimum Core Tier 1(common equity)

2%

New total capital

Basel III – putting the squeeze on capital



Basel IIminimum(2.0%)

1.TTC adjustments.

2. Basel III RWAs

Basel IIIminimum(4.5%)

6. Systemic buffer (tbc)

Basel III

3. Definition change

10. Impact of future accounting changes

7.Economic growth buffer

8. Market buffer

5. Countercyclical buffer (0.0% - 2.5%)

11.Volatility buffer

4.Conservation buffer (2.5%)

TargetCT1ratio

9. Management buffer

Basel III and otherregulatory changes

Additionalconsiderations in settingtarget CT1 ratio

Basel III: the outlook for capital and liquidityPwC 6

The approach to buffers is complex and candouble-count

PwC

Agenda




• Conclusions



PwC

Four main themes will dominate bank capital managementpractices going forward.

Capital Optimization and Mitigation will be critical to reset businessmodels and become integral part of decision making – e.g. strategicplanning & budgeting, new business, and performance evaluation.

1.

Capital Structures will emphasize high quality equity, discouragehybrids, and allow for entrance of new instruments such as CoCos.

2.

Capital Analytics and Measures will rely less in statistical models andcombine forward looking stress testing and risk measures with enhancedcoverage.3.

Capital Contingency Planning will be integrated with liquidity riskmanagement and corporate recovery / resolution planning processes.

4.February 2011

Slide 8Risk & Capital Management under Basel III

PwC

Capital is increasingly becoming an explicit component of alldecision making processes.

• Culture• Committee Structure• Roles and Responsibilities• Policies and Procedures

AnalyticsBusiness Processes and Controls

Risk AppetiteStrategicPlanning

Budget andForecast

New Product /New Business /

M&A

PerformanceMeasurement

ReportingIncentives &

CompensationDisclosure

Strategic &BusinessPlanning

Execution

PerformanceEvaluation

Infrastructure

PricingModels

RiskMeasures

Stress Testing

CapitalMeasures

PerformanceMeasures

ControlIndicators

• Technology• Data• Resources

FrontOffice

RiskMgmt.

Finance

Controls

P&L Production& Attribution

Liquidity &Funding

CapitalEvaluation

ContingencyPlanning

RiskIdentification

RiskMeasurement

Stress TestingRisk Monitoring

& Limits

Origination &Pricing

ExecutionP&L and Risk

AnalysisSupervisory

Controls

Governance &Organization

Integrated Capital ManagementFramework

Bu

sin

ess

Reg

ion

Leg

al

En

tity

ComplianceInternalControls

ModelValidation

Internal Audit

Capital Considerations



PwC

In the area of capital measures and analytics, more emphasisto stress testing will be placed relative to economic capital.

• Economic capital failed inmost instances to capturefat tail risks

• Stress testing techniquesto be combined witheconomic and regulatorycapital measures

• Need for global stresstesting practices levelplaying field

• Economic capitalmeasures to convergewith regulatory capitalcalculations

Comparison of Economic Capital and Actual/Stressed Losses

0.0 50.0 100.0 150.0 200.0 250.0

BofA

Citi

JPMC

Wells

Goldman

Morgan Stanley

Barclays

DB

CS

UBS

07-08 Actual Losses Stress Test Losses Economic Capital



PwC

Upgrades in capital planning are necessary, including capitalcontingency plans that link to recovery plans and living wills

Capital Measures-Regulatory-GAAP-Economic Capital

Assessment Scenarios-Forecast under specificcurrent forecast (base case)

-Forecast under stressedscenarios (unexpectedevents)

Early Warning Triggers-Market Perception-Capital Change-Liquidity Impact

Capital Crisis Level

Level 1 – Normal

Level 1B – Normal with HeightenedCapital Concerns

Level 2A – No Crisis but Potential forCrisis Above Normal

Level 2B – No Crisis but Potential forCrisis is More Probable

Level 3 – Capital Crisis That Shouldnot Threaten the Bank’s Survival

Level 4 – Capital Crisis That MayThreaten the Bank’s Survival

Mobilizing Plan-Testing & Communication-Monitoring & Activation

Capital Response Actions-Increase Available Capital-Reduce Required Capital-No Actions

Key Considerations-Response Time & OperationalReadiness

-Magnitude-Type of Capital-Stakeholder Reaction

1. PerformPeriodic

Assessment

2. DetermineCapital

Crisis Level

3. Select andImplement

Capital ResponseActions

KeyComponents

KeyProcesses

Capital Contingency Planning Overview



PwC

Enterprise-wide initiatives like recovery and resolutionplanning emphasize the need for integrating capital andliquidity contingency planning

Integration of Capital and LiquidityContingency Planning

Inputs, results, and actions• Common early warning triggers• Impact of liquidity specific stress test results

on capital position and vice versa• Impact of liquidity response actions on

capital position and vice versa

Enterprise-wide applications• Enterprise-wide stress testing• Recovery and resolution plans• Dividends and other earning retention/

distribution decisions• Ongoing risk management

CapitalContingency Plan

• Capital measures• Early warning triggers• Specific stress scenarios• Crisis levels• Capital response actions• Communication and

escalation

LiquidityContingency Plan

• Liquidity measures• Early warning triggers• Specific stress scenarios• Crisis levels• Funding response actions• Communication and

escalationFebruary 2011

Slide 12Risk & Capital Management under Basel III

PwC

Bringing it all together – the overarching capitalchallenge

Banks: cost of equity vs. return on equity

-20

-15

-10

-5

0

5

10

15

20

25

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2010 2011 2012

Time

Pe

rc

en

tag

e

Source: Capital IQ; PwC analysis – UK banks

CoE

RoE

2009



PwC

Agenda




• Conclusions



PwC

Liquidity and capital constraints force risk &finance to work together

• Management is forced to have a much sharper focus on capital andfunding (and therefore risk) management

• Resource allocation decisions are top of the agenda – both in terms ofcapital and liquidity

• Liquidity risk function will need to get sole control over stock ofliquid assets under Basel III liquidity rules

• Increased disclosure of capital and liquidity management approachesand measures to investors and other external stakeholders

• Valuation of illiquid instruments, products and collateral remains acritical issue

• CEO and Board insist on better decision support, managementinformation and data consistency



PwC

In addition, there are internal drivers pushing inthe same direction ...

Internal drivers Implications for risk and finance

Strategic choices require anintegrated assessment of riskperspectives

• Risk needs to be integrated at the front end of strategy andbusiness planning processes.

• Risk appetite needs to be formulated clearly, communicatedand monitored

• Economic capital and risk-adjusted performance measurementare no longer optional extras

Performance challengesrequire improved operationalefficiency

• Increased appetite for simplified, integrated IT and dataplatforms

• Finance and transactional activities increasingly standardisedand off-shored or outsourced

• Assessment of opportunities to apply similar approaches to riskactivities

Attracting and retaining talent • CROs and CFOs both seen as leaders with seats at the top table• Organisation models that provide challenging career paths

across risk and finance• Well-defined, proactive commercial roles for risk and finance

personnel, partnering with middle and front office colleagues



PwC

Linking risk & finance



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Aligned risk & finance structure



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Agenda




• Conclusions



PwC

Capital management is an integral process,touching a number of organisational functions

• Risk appetite is set by the Board and cascaded through theorganisation through limits, etc.

• Risk measurement is undertaken by the respective risk functions andreported to decision makers

• Finance produces planning and budgeting figures, which have to besupplemented with the relevant risk estimates

• Stress tests applied to forecasts are a joint endeavour of businesslines, risk and financial planning

• Management (committees) decide on actions to be taken as a resultof forecasts

• Execution of capital management actions is the responsibility ofTreasury



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