Adrian Docherty, Head of Bank Advisory, BNP Paribas

International Association of Credit Portfolio Managers (IACPM), Berlin, 19 May 2017

The Capital Odyssey Contemporary perspectives on bank risk and capital management

Disclaimer

The views expressed in this presentation are the author’s personal views, not the views of BNP Paribas S.A.

Disclaimer

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January 2017 2

Odyssey: The Epic Journey

January 2017 4

Focus on Risk and Capital Management

Today’s Focus

Brand Logistics

Risk Capital

What are the Key Components of Banking?

January 2017 5

The Odyssey: Where We’ve Been

2007

January

2017

May Basel III

More Capital

Resolution

CET1 Levels: Mission Accomplished?

3.7

13.1

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016e

Prevailing Rules

Basel III fully loaded equivalent

Regulatory CET1 Ratio for European Banks (%)

Source: BNP Paribas

January 2017 6

Significant balance sheet restructuring

and recapitalisation

CET1 ratios rising at c.1pp p.a.

Recent slowdown in solvency increase

January 2017 7

The Odyssey: What Lies Ahead

2007

January

2017

May Resolution

Capital

Basel IV

Expected Loss

Provisioning

Even More

Capital?

Basel III

More Capital

Resolution

A

B

C

D

A. Even More Capital?

Have we passed the point of “optimisation”?

6 79

13 14 1418 20 22

15

Nguyen 2014 Yan et al 2012 Basel LEI 2010 BoE 2015 Mendicino et al

2015

Martinez-Miera &

Suarez 2014

European Actuals

FY 2016

Miles et al 2011 Firestone et al

2017 (US Fed)

Kashkari Plan

(Minneapolis Fed)

Authoritative estimates of solvency levels beyond which value destruction occurs (ie. economic costs > economic benefits)

(fully loaded Basel III, % of RWAs)

Source: Basel Committee, Federal Reserve and academic studies; BNP Paribas estimates, assumptions and conversions to fully-loaded Basel III

January 2017 9

B. Resolution Capital: The Lifeboat

Resolution Capital

January 2017 11

Q. How Much Solvency is Enough?

A. Twice As Much As You Need

Target ratios roughly double reg-cap (20-25-30% of RWAs as a norm)

€800bn of instruments to be issued in the next few years

FR / UK / CH / US: €80bn already and well received

EU harmonisation around credit hierarchy and French-style Senior Non-Preferred

C. Basel IV

Basel IV: A Matter of Principle

January 2017 13

Basel II’s risk-sensitivity in question:

“flat capital requirements are better”

Maximum harmonisation doctrine,

focusing on low RW businesses

Dec 2014: Basel proposes floor to IRB

capital requirements

H2 2016: European fightback

End-2016 deadline missed

Op Risk: AMA/SMA out, SA instead

Floors lead to (terminal?) rifts in Basel

Interregnum while Tarullo is replaced

Improving IRB supervision (eg. TRIM)

Background State of Play

D. Expected Loss Provisioning

IFRS 9: Serious and Soon

tinyurl.com/ELcartoon or goo.gl/sGB6p6

Expected Loss Accounting Video

March 2017 15

(in bp of RWAs)

Source: EBA, Exane BNP Paribas, BNP Paribas

59 75

100+

Average Top 20% Outliers?

Solvency Impact of IFRS 9

Volatility

Buffer

150?

IFRS 9: A Process Error

January 2017 16

EL provisioning is a bad development

↑ Complexity

↑ Procyclicality

↑ Subjectivity

No impact study

Move from incurred loss to EL provisions = need for Basel rethink

Official response: 5-year phasing not temporary neutralisation

IFRS 9: Scope for Unintended Negative Consequences

Financial Resource Allocation:

Steering Between Scylla and Charybdis

Capital Allocation = Competitive Advantage

March 2017 19

Economic Profit

Zero Capital Profit

Net Revenues

Gross Revenues

LIABILITIES

Equity

Debt Capital

Funding

Credit Losses

OpEx

ASSETS

Liquid Assets

Risk Assets

Customer

Services

Overhead Target Horizons

Interest

income

Fee income

Cost of Capital

Cost of

Funding

Cost of

Liquidity

Cost of ECL

OpEx

Contribution

Contribution Confidence,

timeframe

Strategic Threats: Fragile Macro

Actual and Latent Risks: The “Dirty Dozen”

January 2017 21

Rates, QE, tapering

Deglobalisation, Brexit

Trump administration

Market liquidity drain

Greece et al.

Precautionary recapitalisations

Banks shrinking

Asset bubbles

Indebtedness

Conflicts

Rise of the machines

Disruption & obsolescence…

Markets Unflustered by Latent Risks

January 2017 22

0

8

16

24

32

40

48

56

64

72

80

0

200

400

600

800

1000

1200

1400

1600

1800

2000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Market indices this century

Equities (MCSI)

Volatility (VIX)

Strategic Threats: Disruption & Obsolescence

January 2017 24

Risk and Capital Management: The Basis for Competitive Advantage

Disintermediation of

balance sheet resources

(=CPM!)

Brand Logistics

Risk Capital

What are the Key Components of Banking?

Smooth apps and end-

to-end automation Fresh new and/or non-

bank providers

Increased role for

experts. Scope for “big

data”

Unmet needs

Broader franchises

Modern approach

Better businesses

January 2017 25

Evolving Role of CPM

2017

May Basel III

More Capital

Resolution

Fragile Macro

Disruption &

Obsolescence

Resolution

Capital

Basel IV

Expected Loss

Provisioning

Even More

Capital?

Capital Allocation

Active Balance Sheet

Disintermediation

Capital Velocity

Portfolio Risk

Management

The Odyssey Continues