Basel III HandbookTable of ContentsFiguresTablesAbbreviations1 Introduction2 Definition of capital and capital buffers2.1 New definition of capital2.2 Components of capital2.2.1 Common Equity Tier 1 capital2.2.2 Additional Tier 1 capital2.2.3 Tier 2 capital2.3 Prudential filters and deductions2.3.1 Prudential filters2.3.2 Deductions from CET 1 capital2.3.3 Exemptions from and alternatives to deduction from CET 1 items2.3.4 Deductions from Additional Tier 1 capital2.3.5 Deductions from Tier 2 items2.4 Minority interests2.4.1 Minority interests that qualify for inclusion in consolidated CET 1 capital2.4.2 Qualifying Additional Tier 1, Tier 1, Tier 2 capital and qualifying own funds2.5 Institutional networks2.6 Capital buffers2.6.1 Capital conservation buffer2.6.2 Countercyclical capital buffer2.7 Enhanced disclosure requirements44561214161618192020212222232424242425252525262828292929293 Counterparty Credit Risk3.1 Effective Expected Positive Exposure3.2 Credit valuation adjustment3.3 Wrong way risk3.4 Asset value correlation3.5 Central counterparties3.6 Enhanced CCR management requirements24 Leverage ratio4.1 Definition and calibration30323437384042454546484850525353535457585 Global liquidity standard5.1 Liquidity Coverage Ratio5.1.1. Definition of high quality liquid assets5.1.2. Definition of net liquidity outflows5.2 Net Stable Funding Ratio5.3 Monitoring tools5.4 Institutional networks6 Enhanced governance and sanctions6.1 Enhanced governance6.2 Sanctions7 Other topics7.1 Systemically Important Financial Institutions7.2 Overreliance on external ratings7.3 Small and Medium-Sized Entity7.4 Basel I limit8 ConclusionBibliographyAppendix3FiguresFigure 1: From Basel 2.5 to Basel IIIFigure 2: Capital requirements Basel II/Basel 2.5 vs. Basel IIIFigure 3: Phase-in arrangements Basel III capital requirementsFigure 4: Leverage Ratio within Basel IIIFigure 5: Liquidity risk management (LRM) frameworkFigure 6: Liquidity Coverage RatioFigure 7: LCR: High quality liquid assetsFigure 8: LCR: Net liquidity outflowsFigure 9: LCR: High quality liquid assets and net liquidity outflowsFigure 10: Net Stable Funding RatioFigure 11: NSFR: Available stable fundingFigure 12: NSFR: Required stable fundingFigure 13: AVC: Risk-Weights for large financial institutions Basel II vs. Basel III9151532363739404143434460TablesTable 1: Flexibility of member states within the single rule bookTable 2: Prudential filters Basel IIITable 3: Deduction from CET 1 capital in Basel IIITable 4: Deduction from Additional Tier 1 capital in Basel IIITable 5: Deductions from Additional Tier 2 capital in Basel IIITable 6: Options on corporate governanceTable 7: Basel III Summary TableTable 8: AVC: Risk-Weights for large financial institutions Basel II vs. Basel IIITable 9: Indicator-based measurement approach G-SIBSTable 10: Ancillary indicators for assessment G-SIBS102021222349586061614AbbreviationsASFBCBSCIUCCPCCRCEMCET1CRDCVAEBAEPEFSBFYG-SIBsIMMLCRMDANSFROTCPDPSERSFRWSIBsSIFIsSMSMESSPEVaRAvailable Stable FundingBasel Committee on Banking SupervisionCollective Investment UndertakingCentral CounterpartyCounterparty Credit RiskCurrent Exposure MethodCommon Equity Tier 1Capital Requirements DirectiveCredit Valuation AdjustmentEuropean Banking AuthorityExpected Positive ExposureFinancial Stability BoardFinancial YearGlobal Systemically Important BanksInternal Model MethodLiquidity Coverage RatioMaximum Distributable AmountNet Stable Funding RatioOver-the-CounterProbability of DefaultPublic Sector EntityRequired Stable FundingRisk-WeightSystemically Important BanksSystemically Important Financial InstitutionsStandardized MethodSmall and Medium-Size EntitySecuritization Special Purpose EntityValue-at-Risk51Introduction67Recent financial crises have demonstrated numerousweaknesses in the global regulatory framework andin banks risk management practices. In response,regulatory authorities have considered various measuresto increase the stability of the financial markets andprevent future negative impact on the economy. Onemajor focus is on strengthening global capital andliquidity rules.Basel III addresses this, with the goalof improving the banking sectorsability to absorb shocks arising fromfinancial and economic stress. InDecember 2010 the Basel Committeeon Banking Supervision (BCBS)published the Basel III documentsBasel III: A global regulatoryframework for more resilient banks andbanking systems (a revised versionwas published in June 2011) and BaselIII: International framework for liquidityrisk measurement, standards andmonitoring.With this reform package, the BCBSaims to improve risk managementand governance as well as strengthenbanks transparency and disclosure.Basel III is also designed to strengthenthe resolution of systemicallysignificant cross-border banks.It covers primarily the followingaspects1:Definition of capitalIntroduction of a new definitionof capital to increase the quality,consistency and transparency ofthe capital base. As the recent crisisdemonstrated that credit losses andwrite-downs come out of retainedearnings, which is part of bankstangible common equity base, underBasel III common equity (i.e., commonshares and retained earnings) must bethe predominant form of Tier 1 capital.Further, the reform package removesthe existing inconsistency in thedefinition of capital by harmonizingdeductions of capital and by increasingtransparency through disclosurerequirements.Enhanced risk coverage/Counterparty Credit RiskThe reforms to the Basel II frameworkby the BCBS in 2009 and theamendments made in the EuropeanCapital Requirements DirectiveIII (CRD III)2 increased capitalrequirements for the trading bookand complex securitization positionsand introduced stressed value-at-riskcapital requirements and higher capitalrequirements for re-securitizationsfor both in the banking and tradingbook. Basel III now adds the followingreforms: calculation of the capitalrequirements for counterparty creditrisk (CCR) based on stressed inputs;introduction of a capital charge forpotential mark-to-market losses (i.e.,credit valuation risk); strengtheningstandards for collateral managementand initial margining; higher capitalrequirements for OTC derivativesexposures; raising CCR managementstandards.8Leverage ratioIntroduction of a leverage ratio asa supplementary measure to therisk-based framework of Basel II. Theobjective is to constrain the build-upof leverage and avoid destabilizingdeleveraging processes.Global liquidity standardA new liquidity standard is introducedto achieve two objectives. The firstobjective, pursued by the LiquidityCoverage Ratio (LCR), is to promoteshort-term resilience of a banksliquidity risk profile by ensuring thatit has sufficient high quality liquidassets to survive a stress scenariolasting one month. The secondobjective is to promote resilience overthe longer term by creating additionalincentives for a bank to fund itsactivities with more stable sourcesof funding. The Net Stable FundingRatio (NSFR), with a time horizon ofone year, should provide a sustainablematurity structure of assets andliabilities. Basel III also introduces acommon set of monitoring tools. Thenew requirements complement thePrinciples for Sound Liquidity RiskManagement and Supervision3 whichare included in the CRD II.4 The CRDII requirements, implemented intonational law by the EU Member States,became effective December 31, 2010.Reducing procyclicality andpromoting countercyclical buffersIntroduction of measures to makebanks more resilient to procyclicaldynamics and avoid the destabilizingeffects experienced in the last crisis.The main objectives of these measuresare: dampen any excess cyclicalityof the minimum capital requirement;promote more forward-lookingprovisions; conserve capital to buildbuffers at individual banks and inthe banking sector that can be usedin periods of stress testing; achievethe broader macro-prudential goal ofprotecting the banking sector fromperiods of excess credit growth.This handbook provides a detailedoverview of the major changes ofBasel III corresponding to the EU rules.It focuses on aspects related to banks.Amendments regarding supervisoryauthorities in the context of enhancedsupervision are not covered in detail.The status of topics currently underdiscussion is included here, as aredifferences between the EU rulesand the Basel III documents fromthe BCBS.The enhancements of the capitalframework within Basel 2.5 (CRDII and CRD III in the EU), which arealready in force or become applicablebeginning in 2012 are not withinthe scope of this manual. Nor arethe challenges banks face withthe implementation of the Basel IIIrequirements.5Figure 1: From Basel 2.5 to Basel IIIBasel 2.5Legal basis (EU) CRD (2009/111/EC) published in theOfficial Journal (Nov.2009) (CRD II) Transposed intonational lawBasel III CRD (2010/76/ "CRD IV (package of two legal instruments: directive and regulation)EU) published in theOfficial Journal (Dec.2010) (CRD III) Partiallytransposed intonational law "Basel III published by the BCBS in Dec. 2010 (rev. version of capital framework June 2011) Directive and Regulation published by the European Commission in July 2011; discussed by Parliament and Council in autumn 2011/beginning of 2012 Directive: to be translated into national law till Dec. 31, 2012; Regulation: no national translation requiredComing intoforceTopics Dec. 31, 2010 Large exposures Securitization Hybrid capital instruments Liquidity risk management Cross border supervision Dec. 31, 2011 Re-securitization Disclosure securitization risks Trading book Remuneration policies Jan. 1, 2013 (with transition periods till 2019)Regulation Definition of capital Liquidity risk Counterparty credit risk Leverage ratio Single rule book (through Regulation)etivDric Capital buffers Enhanced governance Sanctions Enhanced supervisionStatusEuropean/nationalimplementationSource: Accenture9Basel II and the reform packages ofBasel 2.5 are implemented throughdirectives in the EU (CRD, CRD II,CRD III). That is, the rules need tobe transposed into national lawwith several options and discretionsat the national level. Basel III isintroduced through two differentlegal instruments.6 Most of the keytopics, such as the new definition ofcapital and the new liquidity ratios,are implemented through a Regulation(a directly applicable legal act, withno further national implementationneeded). The objective is to create alevel playing field (single rule book).Other aspects, including capitalbuffers and enhanced governance,are implemented through a Directive.Following the European legislativeprocess, the next step is for the legaldocuments published by the EuropeanCommission (the proposed Regulationsand Directives) to be discussed withinthe European Parliament and Council.Despite the single rule book, MemberStates will retain some flexibility inspecific areas which are summarizedin Table 1:Table 1: Flexibility of Member States within the single rule bookType of MeasureEU Macro-prudential MeasuresPillar 1Does not preclude the measurebeing specifically targeted to certainregional exposuresPower for the Commission to tightenthe requirements temporarily acrossthe board for specific activities andexposures. Special urgency procedureis possible for swift response tomacro-prudential developments.Measure is embedded in the SingleRule Book. It uniformly applies to allinstitutions across Europe that havethe type of exposure concerned.Compatible with Single RuleBook?National MeasuresCapital requirements for real estatelendingSpecial procedure in the Regulationunder which Member States can bothraise capital requirements and tightenloan-to-value limits for loans securedby commercial and/or residentialproperty.Member States can set an additionalbuffer requirement to dampen excesslending growth more generally. This isto protect the economy/banking sectorfrom any other structural variablesand from the exposure of the bankingsector to risk factors related tofinancial stability.National supervisors can impose awide range of measures, includingadditional capital requirements, onindividual institutions or groups ofinstitutions to address higher-than-normal risk.Measure is embedded in the SingleRule Book. The requirements set bycountry A apply also to institutions incountry B that do business in A.Measure is embedded in the SingleRule Book. The requirements set bycountry A apply also to institutions incountry B that do business in A. This"reciprocity" is mandatory only up to2.5%.Countercyclical bufferPillar 2"Pillar 2" measuresMeasures are included in the Directive.They must be justified in terms ofparticular risks of a given institutionor group of institutions, including riskspertaining to a particular region orsector. Further convergence of suchmeasures will be sought over time.Source: CRD IV Frequently Asked questions (July 2011), European Commission found at EUROPA - Press Releases - CRD IV Frequently Asked Questions10112Definition of capital andcapital buffers12132.1 New definition of capitalThe financial crisis showed that notall institutions did hold sufficientcapital and that the capital wassometimes of poor quality and notavailable to absorb losses as theymaterialized. Basel III introduces based on the amendments madeunder the CRD II with regard to hybridcapital instruments a new definitionof capital to increase the quality,consistency and transparency of thecapital base. It also requires highercapital ratios. Key elements of therevision include7: Raise quality and quantity of Tier 1capital; Simplification and reduction of Tier2 capital; Elimination of Tier 3 capital; More stringent criteria for eachinstrument; Harmonization of regulatoryadjustments; Enhanced disclosure requirements; Introduction of a new limit systemfor the capital elements.According to the new definition,capital comprises the followingelements: Going-concern capital (Tier 1capital);- Common Equity Tier 1 capital (CET 1capital): Common equity (i.e., commonshares and retained earnings) must bethe predominant form of Tier 1 capital- Additional Tier 1 capital Gone-concern capital (Tier 2 capital).While going-concern capital (Tier1) should allow an institution tocontinue its activities and help preventinsolvency, gone-concern capital (Tier2) would help ensure that depositorsand senior creditors can be repaid ifthe institution fails.The own funds requirements underBasel III are the following (as apercentage of risk-weighted assets,RWA): CET 1 capital ratio of 4.5%; Tier 1 capital ratio of 6%; Total capital ratio of 8%.Total capital ratio will remain 8% ofRWA. CET 1 capital ratio increasesfrom 2% to 4.5%. Additional Tier 1capital ratio is 1.5%, leading to a Tier1 capital ratio of 6%. The importanceof Tier 2 capital decreases by reducingthe ratio to 2% of RWA.Apart from these changes, Basel IIIwill introduce two new capital buffers:a capital conservation buffer of2.5% and a countercyclical buffer of0-2.5% depending on macroeconomiccircumstances (see section 2.6 for adetailed description of the buffers). Forboth buffers, an extra cushion of CET1 capital needs to be held leading to aCET 1 capital ratio of up to 9.5%.Additional capital surcharges between1% and 2.5% (extra cushion of CET1 capital) for systemically importantfinancial institutions (SIFIs) depending on the systemic importanceof the institution are currently indiscussion.On top of these own fundsrequirements, supervisory authoritiesmay require extra capital to coverother risks following Pillar 2 (as it isalso under the current framework).Basel III foresees a transition periodbefore the new capital requirementsapply in full. The going concern(Tier 1) capital requirements willbe implemented gradually between2013 and 2015; the capital buffersbetween 2016 and 2019. The newprudential adjustments will beintroduced gradually, 20% a yearfrom 2014, reaching 100% in 2018.Grandfathering provisions over 10years would also apply to capitalinstruments that are currently usedbut do not meet the new rules. Theyare phased out over a 10-year periodbeginning in 2013 (10% a year). Whilethe proposals of the BCBS require thatthese instruments were issued priorto the date of agreement of the newrules by Basel (September 12, 2010),instruments issued after this cut offdate would need to comply with thenew rules or would not be recognizedas capital as of January 1, 2013. Theproposals of the EU Regulation set thecut off date "as the date of adoptionof the proposal by the Commission,when the Commission as a Collegeagreed to legally implement BaselIII in the EU. Setting a cut off dateprior to this policy decision wouldneither be legitimate nor legallysound, as it would apply the new rulesretroactively.8The latest proposals from the BCBSfollow a principles-based approachin regard to capital, with the focuson the substance of the capitalinstruments. They also ensure that thenew rules are capable of being appliedto the highest-quality capital itemsof non-joint stock companies, such ascooperative banks. Through a set ofprinciples, the EU standard specifiesin greater detail the applicationof the new definition of capital toinstruments issued by non-jointstock companies to ensure they holdcomparable levels of high quality Tier1 capital. Like the BCBS proposals,it imposes 14 strict criteria thatinstruments need to meet.14Figure 2: Capital requirements Basel II/Basel 2.5 vs. Basel III16%14%12%10%8%6%4%2%0%Basel ll/Basel 2.5CET 1 capital (certain Tier 1 items)Tier 2 capitalCapital conservation bufferSIBs surcharge (in discussion 1-2.5%)Additional Tier 1 capital (hybrid capital)Tier 3 capitalBasel IIICountercyclical capital buffer (0-2.5%)Tier 3 capitalTier 2 capitalmax. 100% ofTier 1 capitalTier 1 capitalSIBs capital surcharge(in discussion)Countercyclical capital bufferextra cushion of CET 1Capital conservation bufferextra cushion of CET 1Lower Tier 2 capitalmax. 50% Tier 1 capitalUpper Tier 2 capitalMax. 50% of Tier 1 capital innovativehybrid capital max. 15% of Tier 1 capitalTotal capitalSource: Accenture, based on Basel III Leitfaden zu den neuen Eigenkapital- und Liquiditittsregeln fr Banken (2011), Bundesbank and CRD IV Frequently Asked Questions(2011), European Commission.Note: The treatment of hybrid capital instruments was amended within the CRD II (harmonization of the eligibility criteria and limits of hybrid capital instruments); furtheramendments follow within Basel III.Figure 3: Phase-in arrangements Basel III capital requirements14%12%1.875%10%8%6%4%2.0%2%2.0%0%Until 2012CET 1 capitalCapital conservation buffer201320142015201620172018From 20193.5%4.0%4.5%4.5%4.5%4.5%4.5%4.0%3.5%1.0%2.5%1.5%2.0%1.5%0.625%0.625%2.0%1.5%1.25%1.25%2.0%1.5%1.875%2.0%1.5%2.5%2.0%1.5%2.5%Additional Tier 1 capitalCountercyclical capital bufferTier 2 capitalSource: New proposals on capital requirements (July 2011), European Commission.152.2 Components of capital2.2.1 Common EquityTier 1 capitalA key aspect of the stricter definitionof capital is that Common EquityTier 1 (CET 1) instruments mainlycommon shares (or comparableinstruments) and retained earnings must be the predominant formof Tier 1 capital. According to theproposed EU Regulation, CET 1 itemsconsist of the following:9a) Capital instruments, provided theconditions laid down in Article 26 ofthe proposed EU Regulation are met;b) Share premium accounts related tothe instruments referred to in point a;c) Retained earnings;d) Accumulated other comprehensiveincome;e) Other reserves;f) Funds for general banking risk.CET 1 items of mutuals, cooperativesocieties or similar institutionsinclude capital instruments by aninstitution under its statutory termsprovided the following conditions aremet:a) The institution is of a type thatis defined under applicable nationallaw and which competent authoritiesconsider to qualify as a mutual,cooperative society or a similarinstitution;b) The conditions laid down inArticles 26 and 27 of the proposed EURegulation are met;c) The instrument does not possessfeatures that could cause thecondition of the institution to beweakened as a going concern duringperiods of market stress.The European Banking Authority(EBA) has the mandate to developdraft regulatory technical standardsto specify the points previouslymentioned. These include featuresthat could cause the condition of aninstitution to be weakened as a goingconcern during periods of marketstress.According to Article 26 of theproposed EU Regulation, capitalinstruments need to meet all of thefollowing conditions to qualify asCET 1 items:10a) The instruments are issueddirectly by the institution with theprior approval of the owners ofthe institution or, where permittedunder applicable national law, themanagement body of the institution;b) The instruments are paid up andtheir purchase is not funded directly orindirectly by the institution;c) The instruments meet all thefollowing conditions as regards theirclassification:i) They qualify as capital within themeaning of Article 22 of Directive86/635/EEC;ii) They are classified as equitywithin the meaning of the applicableaccounting standard;iii) They are classified as equity capitalfor the purposes of determiningbalance sheet insolvency, whereapplicable under national insolvencylaw;d) The instruments are clearly andseparately disclosed on the balancesheet in the financial statements ofthe institution;e) The instruments are perpetual;f) The principal amount of theinstruments may not be reducedor repaid, except in either of thefollowing cases:i) The liquidation of the institution;ii) Discretionary repurchases of theinstruments or other discretionarymeans of reducing capital, wherethe institution has received the priorconsent of the competent authorityin accordance with Article 72 of theproposed EU Regulation;g) The provisions governing theinstruments do not indicate expresslyor implicitly that the principal amountof the instruments would or mightbe reduced or repaid other than inthe liquidation of the institution, andthe institution does not otherwiseprovide such an indication prior to orat issuance of the instruments, exceptin the case of instruments referredto in Article 25 of the proposed EURegulation, where the refusal by theinstitution to redeem such instrumentsis prohibited under applicablenational law;h) The instruments meet the followingconditions as regards distributions:i) There are no preferentialdistributions, including in relationto other Common Equity Tier 1instruments, and the terms governingthe instruments do not providepreferential rights to payment ofdistributions;ii) Distributions to holders of theinstruments may be paid only out ofdistributable items;iii) The conditions governing theinstruments do not include a cap orother restriction on the maximum levelof distributions, except in the caseof the instruments referred to inArticle 25 of the proposed EURegulation;16iv) The level of distributions is notdetermined on the basis of the amountfor which the instruments werepurchased at issuance, and is nototherwise determined on this basis,except in the case of the instrumentsreferred to in Article 25 of theproposed EU Regulation;v) The conditions governing theinstruments do not include anyobligation for the institution to makedistributions to their holders and theinstitution is not otherwise subject tosuch an obligation;vi) Non-payment of distributions doesnot constitute an event of default ofthe institution;i) Compared to all the capitalinstruments issued by the institution,the instruments absorb the firstand proportionately greatest shareof losses as they occur, and eachinstrument absorbs losses to the samedegree as all other Common Equity Tier1 instruments;j) The instruments rank below all otherclaims in the event of insolvency orliquidation of the institution;k) The instruments entitle their ownersto a claim on the residual assets ofthe institution, which, in the event ofits liquidation and after the paymentof all senior claims, is proportionateto the amount of such instrumentsissued and is not fixed or subject to acap, except in the case of the capitalinstruments referred to in Article 25 ofthe proposed EU Regulation;l) The instruments are not secured, orguaranteed by any of the following:i) The institution or its subsidiaries;ii) The parent institution or itssubsidiaries;iii) The parent financial holdingcompany or its subsidiaries;iv) The mixed activity holdingcompany or its subsidiaries;v) The mixed financial holdingcompany and its subsidiaries;vi) Any undertaking that has closelinks with the entities referred to inpoints (i) to (v);m) The instruments are not subjectto any arrangement, contractual orotherwise, that enhances the seniorityof claims under the instruments ininsolvency or liquidation.Capital instruments issued bymutuals, cooperative societies andsimilar institutions need to meetthe conditions mentioned in Article26 of the proposed EU Regulation(see above) as well as the followingconditions as with respect to theredemption of the capital instrumentsto qualify as CET 1 instruments:a) Except where prohibited underapplicable national law, the institutionshall be able to refuse the redemptionof the instruments;b) Where the refusal by the institutionof the redemption of instruments isprohibited under applicable nationallaw, the provisions governing theinstruments shall give the institutionthe ability to limit their redemption;c) Refusal to redeem the instruments,or the limitation of the redemption ofthe instruments where applicable, maynot constitute an event of default ofthe institution.The EU also addresses the topic ofsilent partnership, pointing out thatit is a generic term covering capitalinstruments with widely varyingcharacteristics (e.g., in terms of abilityto absorb losses). Whether or not silentpartnership would qualify as a CET 1item depends on the characteristicsof the instrument. The items must beof extremely high quality and able toabsorb losses fully as they occur.11The CET 1 capital should includeCET 1 items after the application ofregulatory adjustments, deductionsand exemptions and alternatives.172.2.2 Additional Tier 1capitalAdditional Tier 1 instruments include:a) instruments where the below-mentioned conditions of Article 49 ofthe proposed EU Regulation are met;and b) the share premium accountsrelated to these instruments.According to Article 49 of theproposed EU Regulation, capitalinstruments need to meet all of thefollowing conditions to qualify asadditional Tier 1 capital items:a) The instruments are issued andpaid up;b) The instruments are not purchasedby any of the following:i) The institution or its subsidiaries;ii) An undertaking in which theinstitution has participation in theform of ownership, direct or by way ofcontrol, of 20% or more of the votingrights or capital of that undertaking;c) The purchase of the instruments isnot funded directly or indirectly by theinstitution;d) The instruments rank below Tier2 instruments in the event of theinsolvency of the institution;e) The instruments are not secured, orguaranteed by any of the following:i) The institution or its subsidiaries;ii) The parent institution or itssubsidiaries;iii) The parent financial holdingcompany or its subsidiaries;iv) The mixed activity holdingcompany or its subsidiaries;v) The mixed financial holdingcompany and its subsidiaries;vi) Any undertaking that has closelinks with entities referred to in points(i) to (v);f) The instruments are not subjectto any arrangement, contractual orotherwise, that enhances the seniorityof the claim under the instruments ininsolvency or liquidation;g) The instruments are perpetual andthe provisions governing them includeno incentive for the institution toredeem them;h) Where the provisions governingthe instruments include one or morecall options, the option to call may beexercised at the sole discretion of theissuer;i) The instruments may be called,redeemed or repurchased only wherethe conditions laid down in Article72 of the proposed EU Regulation aremet, and not before five years afterthe date of issuance;j) The provisions governing theinstruments do not indicate explicitlyor implicitly that the instrumentswould or might be called, redeemedor repurchased and the institutiondoes not otherwise provide such anindication;k) The institution does not indicateexplicitly or implicitly that thecompetent authority would consent toa request to call, redeem or repurchasethe instruments;l) Distributions under the instrumentsmeet the following conditions:i) They are paid out of distributableitems;ii) The level of distributions made onthe instruments will not be modifiedbased on the credit standing of theinstitution, its parent institution orparent financial holding company ormixed activity holding company;iii) The provisions governing theinstruments give the institution fulldiscretion at all times to cancel thedistributions on the instruments foran unlimited period and on a non-cumulative basis, and the institutionmay use such cancelled paymentswithout restriction to meet itsobligations as they fall due;iv) Cancellation of distributions doesnot constitute an event of default ofthe institution;v) The cancellation of distributionsimposes no restrictions on theinstitution;m) The instruments do not contributeto a determination that the liabilitiesof an institution exceed its assets,where such a determinationconstitutes a test of insolvency underapplicable national law;n) The provisions governing theinstruments require the principalamount of the instruments to bewritten down, or the instruments to beconverted to CET 1 instruments, uponthe occurrence of a trigger event;o) The provisions governing theinstruments include no feature thatcould hinder the recapitalization of theinstitution;p) Where the instruments are notissued directly by the institution orby an operating entity within theconsolidation pursuant to prudentconsolidation (Chapter 2 of Title II ofPart One), the parent institution, theparent financial holding company, orthe mixed activity holding company,the proceeds are immediately availablewithout limitation in a form thatsatisfies the conditions laid down inthis paragraph to any of the following:i) The institution;ii) An operating entity within theconsolidation pursuant to Chapter 2 ofTitle II of Part One;iii) The parent institution;iv) The parent financial holdingcompany;v) The mixed activity holding company.The EU standard12 requires that allcapital instruments recognized in theAdditional Tier 1 capital are writtendown or converted into CommonEquity Tier 1 instruments when theCET 1 capital ratio falls below 5.125%(contingent capital). Contingent capitalnot fulfilling these requirementswill not be recognized asregulatory capital.18Regarding hybrid capital instruments,the EU standard builds upon theamendments made under the CRDII concerning the quality of suchinstruments, introducing strictereligibility criteria for inclusion inAdditional Tier 1 capital. Hybrid capitalinstruments need to absorb losses bybeing written down or converted intoCET 1 instruments when CET 1 capitalratio falls below 5.125%. Hybridcapital instruments with an incentiveto redeem, which are currently limitedto 15% of the Tier 1 capital base (seeCRD II), will be phased out underBasel III.The Additional Tier 1 capital baseconsists of the correspondinginstruments after deductions.According to Article 60 of theproposed EU Regulation, instrumentsneed to fulfill the following conditionsto qualify as Tier 2 capital:a) The instruments are issued and fullypaid-up;b) The instruments are not purchasedby any of the following:i) The institution or its subsidiaries;ii) An undertaking in which theinstitution has participation in theform of ownership, direct or by way ofcontrol, of 20% or more of the votingrights or capital of that undertaking;c) The purchase of the instruments isnot funded directly or indirectly by theinstitution;d) The claim on the principal amountof the instruments under theprovisions governing the instrumentsis wholly subordinated to claims of allnon-subordinated creditors;e) The instruments are not secured, orguaranteed by any of the following:i) The institution or its subsidiaries;ii) The parent institution or itssubsidiaries;iii) The parent financial holdingcompany or its subsidiaries;iv) The mixed activity holdingcompany or its subsidiaries;v) The mixed financial holdingcompany and its subsidiaries;vi) Any undertaking that has closelinks with entities referred to in points(i) to (v);f) The instruments are not subjectto any arrangement that otherwiseenhances the seniority of the claimunder the instruments;g) The instruments have an originalmaturity of at least five years;h) The provisions governing theinstruments do not include anyincentive for them to be redeemed bythe institution;i) Where the instruments include oneor more call options, the options areexercisable at the sole discretion ofthe issuer;j) The instruments may be called,redeemed or repurchased only wherethe conditions laid down in Article72 of the proposed EU Regulation aremet, and not before five years afterthe date of issuance;k) The provisions governing theinstruments do not indicate or suggestthat the instruments would or mightbe redeemed or repurchased otherthan at maturity and the institutiondoes not otherwise provide such anindication or suggestion;l) The provisions governing theinstruments do not give the holderthe right to accelerate the futurescheduled payment of interest orprincipal, other than in the insolvencyor liquidation of the institution;m) The level of interest or dividendpayments due on the instruments willnot be modified based on the creditstanding of the institution, its parentinstitution or parent financial holdingcompany or mixed activity holdingcompany;n) Where the instruments are notissued directly by the institution orby an operating entity within theconsolidation pursuant to prudentconsolidation (Chapter 2 of Title II ofPart One), the parent institution, theparent financial holding company, orthe mixed activity holding company,the proceeds are immediately availablewithout limitation in a form thatsatisfies the conditions laid down inthis paragraph to any of the following:i) The institution;ii) An operating entity within theconsolidation pursuant to Chapter 2 ofTitle II of Part One;iii) The parent institution;iv) The parent financial holdingcompany;v) The mixed activity holding company.The Tier 2 capital base consists ofthe corresponding instruments afterdeductions.2.2.3 Tier 2 capitalThe new definition of capitalrationalizes Tier 2 capital byeliminating Upper Tier 2 from thecapital structure. It also introducesharmonized and strict eligibilitycriteria. Under Basel III, Tier 2 capitalensures loss absorption in case ofliquidation (gone-concern).Tier 2 capital includes the followingitems:a) Capital instruments, where theconditions laid down in Article 60 aremet;b) The share premium accounts relatedto the instruments referred to in point(a);c) For institutions calculating risk-weighted exposure amounts inaccordance with the StandardizedApproach, general credit riskadjustments, gross-of-tax effects, ofup to 1.25% of risk-weighted exposureamounts calculated in accordancewith the Standardized Approach;d) For institutions calculating risk-weighted exposure amounts underthe Internal Ratings Based approach(IRB), positive amounts, gross-of-taxeffects, resulting from the calculationlaid down in Article 154 and 155 upto 0.6% of risk-weighted exposureamounts calculated under the IRBapproach.192.3 Prudential filters and deductions2.3.1 Prudential filtersThe Basel III standard harmonizesregulatory adjustments (i.e., deductionsfrom capital and prudential filters)which will generally be applied at thelevel of CET 1 capital or its equivalentin the case of non-joint stockcompanies in the future.Table 2: Prudential filters Basel IIIRegulatory AdjustmentsItemPrudential filtersSecuritized assetsAn institution shall exclude from any element of own funds any increase in itsequity under the applicable accounting standard that results from securitizedassets.The fair value reserves related to gains or losses on cash flow hedges offinancial instruments that are not valued at fair value, including projectedcash flows; and gains or losses on liabilities of the institution that are valuedat fair value that result from changes in the credit standing of the institutionshould not be included in any element of own funds.Institutions shall apply the requirements for prudent valuation specifiedin the proposed Regulation to all their assets measured at fair value whencalculating the amount of their own funds and shall deduct from CET 1capital the amount of any additional value adjustments necessary.Institutions shall generally not make adjustments to remove from their ownfunds unrealized gains or losses on their assets or liabilities measured at fairvalue.DescriptionCash flow hedges and changes in thevalue of own liabilitiesAdditional value adjustmentsUnrealized gains and losses measuredat fair valueSource: New proposals on capital requirements (July 2011), European Commission found at http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm202.3.2 Deductions from CET 1 capitalTable 3: Deduction from CET 1 capital in Basel IIIRegulatory AdjustmentsItemDeductions from CET 1 capitalLosses for current fiscal yearIntangible assetsInstitutions shall determine the intangible assets to be deducted in accordancewith the following:(a) the amount to be deducted shall be reduced by the amount of associateddeferred tax liabilities that would be extinguished if the intangible assets becameimpaired or were derecognized under the relevant accounting standard;(b) the amount to be deducted shall include goodwill included in the valuation ofsignificant investments of the institution.Deferred tax assets that rely on future profitability according to Article 35 of theproposed EU Regulation.Deferred tax assets that do not rely on future profitability according to Article 36of the proposed EU Regulation.IRB banks should deduct negative amounts resulting from the calculation ofexpected loss (see Article 37 of the EU proposed Regulation).Benefit pension fund assets should be deducted according to Article 38 of theproposed EU Regulation.Direct and indirect holdings by an institution of own CET1 instruments, includingown CET 1 instruments that an institution is under an actual or contingentobligation to purchase by virtue of an existing contractual obligation (see Article39 of the proposed EU Regulation).Holdings of the CET 1 instruments of relevant entities where those entities havea reciprocal cross holding with the institution that the competent authorityconsiders to have been designed to inflate artificially the own funds of theinstitution (see Article 41 of the proposed EU Regulation).The applicable amount of direct and indirect holdings by the institution of CET 1instruments of relevant entities where the institution does not have a significantinvestment in those entities (see Article 43 of the proposed EU Regulation).The applicable amount of direct and indirect holdings by the institution of theCET 1 instruments of relevant entities where the institution has a significantinvestment (e.g., the institution owns more than 10% of the CET 1 instrumentsissued by that entity) in those entities (see Article 40 of the proposed EURegulation).The amount of items required to be deducted from Additional Tier 1 items thatexceed the Additional Tier 1 capital of the institution.The exposure amount of the specified items (e.g., qualifying holdings outside thefinancial sector) which qualify for a risk-weight of 1.250%, where the institutiondeducts that exposure amount from CET 1 capital as an alternative to applying arisk-weight of 1.250%.Any tax charge relating to CET 1 items foreseeable at the moment of itscalculation, except where the institution suitably adjusts the amount of CET 1items insofar as such tax charges reduce the amount up to which those items maybe applied to cover risks or losses.DescriptionDeferred tax assetsNegative expected lossesBenefit pension fund assetsDirect and indirect holding of CET 1itemsHoldings of CET 1 items of entitieswith reciprocal cross holdingNot-significant investments in relevantentitiesSignificant investments in relevantentitiesAmount that exceed Additional Tier 1capitalAlternative to risk-weight of 1.250%Tax chargeSource: New proposals on capital requirements (July 2011), European Commission found at http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm212.3.3 Exemptions fromand alternatives todeduction from CET 1itemsThe following items, which inaggregate are equal to or less than15% of the CET 1 capital of theinstitution (after adjustments), maynot be deducted from CET 1 capital: Deferred tax assets that aredependent on future profitability andarise from temporary differences,and in aggregate are equal to or lessthan 10% of the CET 1 items of theinstitution (after adjustments); Significant investments in a relevantentity,13 the direct and indirectholdings of that institution of theCET 1 instruments of those entitiesthat in aggregate are equal to or lessthan 10% of the CET 1 items of theinstitution (after adjustments).Instruments that are not deductedshall be assigned a risk-weight of250%.The EU standard allows alternatives tothe deduction of significant holdingsof institutions in the CET 1 instrumentsof other financial entities likeinsurance undertakings, reinsuranceundertakings and insurance holdingcompanies included in the scope ofconsolidated supervision (Article46 of the proposed EU Regulation).The European Commission justifiesthis aspect with the so-calledbancassurance business modelwhich is a key feature of the EUbanking landscape, i.e., groups thatcontain significant banking/investmentbusinesses and insurance businesses.14Further, the standard permits mutuals,cooperative societies or similarinstitutions not to deduct significantand not-significant holdings in anothersuch institution or in its centralor regional credit institution if thespecified conditions are met (seechapter 2.5).2.3.4 Deductions from Additional Tier 1 capitalTable 4: Deduction from Additional Tier 1 capital in Basel IIIRegulatory AdjustmentsItemDeductions from AdditionalTier 1 capitalDirect and indirect holdingof Additional Tier 1 itemsDirect and indirect holdings by an institution ofown Additional Tier 1 instruments, including ownAdditional Tier 1 instruments that an institutioncould be obliged to purchase as a result ofexisting contractual obligations (see Article 54 ofthe proposed EU Regulation).Holdings of the Additional Tier 1 instruments ofrelevant entities with which the institution hasreciprocal cross holdings that the competentauthority considers to have been designed toinflate artificially the own funds of the institution(see Article 55 of the proposed EU Regulation).Direct and indirect holdings of the AdditionalTier 1 instruments of relevant entities, where aninstitution does not have a significant investmentin those entities (see Article 57 of the proposedEU Regulation).Direct and indirect holdings by the institutionof the Additional Tier 1 instruments of relevantentities where the institution has a significantinvestment in those entities, excludingunderwriting positions held for five working daysor fewer.The amount of items required to be deductedfrom Tier 2 items that exceed the Tier 2 capital ofthe institution.Any tax charge relating to Additional Tier 1 itemsforeseeable at the moment of its calculation,except where the institution suitably adjusts theamount of Additional Tier 1 items insofar as suchtax charges reduce the amount up to which thoseitems may be applied to cover risks or losses.DescriptionHoldings of Additional Tier1 items of entities withreciprocal cross holdingNot-significant investmentsin relevant entitiesSignificant investments inrelevant entitiesAmount that exceeds Tier2 capitalTax chargeSource: New proposals on capital requirements (July 2011), European Commission found at http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm222.3.5 Deductions from Tier 2 itemsTable 5: Deduction from Additional Tier 2 capital in Basel IIIRegulatory AdjustmentsItemDeductions from Tier 2 capitalDirect and indirect holding of Tier 2itemsHoldings of Additional Tier 2 items ofentities with reciprocal cross holdingDirect and indirect holdings by an institution of own Tier 2 instruments, includingown Tier 2 instruments that an institution could be obliged to purchase as a resultof existing contractual obligations.Holdings of the Tier 2 instruments of relevant entities with which the institutionhas reciprocal cross holdings that the competent authority considers to have beendesigned to inflate artificially the own funds of the institution (see Article 65 ofthe proposed EU Regulation).The applicable amount determined in accordance with Article 67 of direct andindirect holdings of the Tier 2 instruments of relevant entities, where an institutiondoes not have a significant investment in those entities.Direct and indirect holdings by the institution of the Tier 2 instruments of relevantentities where the institution has a significant investment in those entities,excluding underwriting positions held for fewer than 5 working days.DescriptionNot-significant investments in relevantentitiesSignificant investments in relevantentitiesSource: New proposals on capital requirements (July 2011), European Commission found at http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm232.4 Minority interests2.4.1 Minority intereststhat qualify for inclusionin consolidated CET 1capitalMinority interest includes CET 1instruments, the related retainedearnings and share premium accountsof a subsidiary where the followingconditions are met:a) The subsidiary is one of thefollowing:i) An institution;ii) An undertaking that is subject byvirtue of applicable national law tothe requirements of the proposed EURegulation and proposed Directive;b) The subsidiary is included fully inthe consolidation;c) Those CET 1 instruments are ownedby persons other than the undertakingsincluded in the consolidation.Minority interests that are fundeddirectly or indirectly, through aspecial-purpose entity or otherwise, bythe parent institution, parent financialholding company, mixed activityholding company or their subsidiariesshall not qualify as consolidated CET 1capital.Institutions should determine theamount of minority interests of asubsidiary included in the consolidatedCET 1 capital according to Article 79of the proposed EU Regulation.2.4.2 QualifyingAdditional Tier 1, Tier1, Tier 2 capital andqualifying own fundsQualifying Additional Tier 1, Tier 1,Tier 2 capital and qualifying ownfunds include the minority interest,Additional Tier 1, Tier 1 or Tier 2instruments, as applicable, plus therelated retained earnings and sharepremium accounts, of a subsidiarywhere the following conditionsare met:a) The subsidiary is one of thefollowing:i) An institution;ii) An undertaking that is subject byvirtue of applicable national law tothe requirements of the proposed EURegulation and proposed Directive;b) The subsidiary is included fully inthe consolidation;d) Those instruments are owned bypersons other than the undertakingsincluded in the consolidation.Additional Tier 1 and Tier 2 capitalissued by special-purpose entitiesmay be included only if the conditionsspecified in Article 78 of the proposedEU Regulation are met.Institutions should determine theamount of qualifying Tier 1 capitalof a subsidiary that is included inthe consolidated Tier 1 capital andconsolidated Additional Tier 1 capitalaccording to Articles 80-81 of theproposed EU Regulation. The amountof qualifying own funds of a subsidiarythat is included in consolidated ownfunds and in consolidated Tier 2capital shall be determined accordingto Article 82 and 83 respectively ofthe proposed EU Regulation.2.5InstitutionalnetworksThe EU standard allows mutuals,cooperative societies or similarinstitutions not to deduct significantand not-significant holdings in anothersuch institution or in its centralor regional credit institution if thefollowing conditions are met:i) Where the holding is in a centralor regional credit institution, theinstitution with that holding isassociated with that central orregional credit institution in anetwork subject to legal or statutoryprovisions and the central or regionalcredit institution is responsible, underthose provisions, for cash-clearingoperations within that network;ii) The institutions fall within the sameinstitutional protection scheme;iii) The competent authorities havegranted the permission referred to inArticle 108(7);15iv) The conditions laid down in Article108(7) are satisfied;v) The institution draws up andreports to the competent authoritiesthe consolidated balance sheetreferred to in point (e) of Article108(7) no less frequently than ownfunds requirements are required to bereported under Article 95.A regional credit institution maynot deduct holdings in its central oranother regional credit institutionif the conditions mentioned aboveare met.242.6 Capital buffersBasel III introduces two capital buffersin addition to the capital requirements:a capital conservation buffer and acountercyclical capital buffer. Whilethe definition of capital is treatedin the proposed EU Regulation, thecapital buffers are discussed in thecorresponding proposed Directiverequiring national transposition.16calculate the MDA depends on howmuch an institution is dropping belowthe requirement and ranges from 0%(first/lowest quartile) to 60% (fourth/highest quartile).17Further, the affected institutionsshould prepare a capital conservationplan and submit it to the competentauthorities including the following:estimates of income and expenditureand a forecast balance sheet;measures to increase the capital ratiosof the institution; and a plan andtimeframe for the increase of ownfunds with the objective of meetingfully the combined buffer requirement.The capital conservation buffer partlysolves the regulatory paradox afterwhich higher minimum capital shouldnot be used to absorb losses fallingbelow the minimum requirements,leading to a withdrawal of thebanking license. With the introducedcapital buffers and the associateddistribution constraints falling belowthe requirements, a softer regulatorytool is introduced.18The designated authority that isresponsible for setting the buffershould calculate a buffer guide basedon a deviation of the ratio of credit-to-GDP from its long-term trend ona quarterly basis. An increase of thecountercyclical capital buffer shouldgenerally be communicated 12 monthsin advance. A decrease of the buffercould be applicable immediately. Thedesignated authority should give anindicative (not binding) period duringwhich no increase in the buffer isexpected.International institutions need tocalculate the institution-specificcountercyclical capital buffer whichconsists of the weighted averageof the countercyclical buffer ratesthat apply in the jurisdictions wherethe relevant credit exposures of theinstitution are located (based on theown funds requirements for creditrisk).2.6.1 Capitalconservation bufferThe capital conservation buffer, 2.5%of RWA and to be met with CET 1capital, applies at all times and it isintended to ensure that institutionsare able to absorb losses in stressperiods lasting for a number ofyears. Considering the 4.5% CET 1capital ratio, institutions must hold7.0% CET 1 capital on an individualand consolidated basis at all times.Institutions are expected to build upthe capital in good economic times.In case institutions fail to meet fullythe combined buffer requirement(i.e., the total CET 1 capital required tomeet the requirement for the capitalconservation buffer extended by aninstitution-specific countercyclicalcapital buffer), distribution constraintson CET 1 capital are imposed. CET1 capital should thereby include thefollowing items:a) A payment of cash dividends;b) A distribution of fully or partlypaid bonus shares or other capitalinstruments;c) A redemption or purchase by aninstitution of its own shares or otherspecified capital instruments;d) A repayment of amounts paid upin connection with specified capitalinstruments;e) A distribution of items referred to inpoints (b) to (e) of Article 24(1) of thatRegulation.Falling below the combined bufferrequirement, institutions have tocalculate the Maximum DistributableAmount (MDA). The factor to2.6.2 Countercyclicalcapital bufferThe countercyclical capital buffer isintroduced to achieve the broadermacro-prudential goal of protectingthe banking sector and the realeconomy from the system-widerisks stemming from the boom-bustevolution in aggregate credit growthand more generally from any otherstructural variables and from theexposure of the banking sector toany other risk factors related to risksto financial stability.19 The level ofthis buffer is set by each MemberState, ranges between 0% and 2.5%of RWA 20 and has to be met by CET 1capital.21 The buffer is required duringperiods of excessive credit growth andit is released in an economic downturn.In cases where institutions fail to meetfully the countercyclical capital bufferrequirements, capital distributionconstraints are imposed (see above).2.7 EnhanceddisclosurerequirementsThe proposed EU Regulation includesimproved disclosure requirementsregarding the capital endowmentand own funds of institutions. Thepurpose is to strengthen marketdiscipline and enhance financialstability. The corresponding technicalstandards to specify uniform formats,frequencies, etc., are to be developedby the European Banking Authorityand submitted to the EuropeanCommission by January 1, 2013.253Counterparty Credit Risk2627Basel III strengthens the requirements for themanagement and capitalization of counterparty creditrisk (CCR). It includes an additional capital charge forpossible losses associated with deterioration in thecreditworthiness of counterparties or increased risk-weights on exposures to large financial institutions. Thenew framework also enhances incentives for clearingover-the-counter (OTC) instruments through centralcounterparties (CCP).22All other banks must calculate astandardized CVA risk capital charge.Within this method it is based on thebond equivalent approach portfolioown funds requirements for CVA riskfor each counterparty have to becalculated using the given formula.The calculation of the aggregate CCRand CVA risk capital charges dependson the methods used by banks. For banks with IMM approval andmarket-risk internal-models approvalfor the specific interest-rate risk ofbonds, the total CCR capital charge isthe sum of the following components:i) The higher of (a) its IMM capitalcharge based on current parametercalibrations for EAD and (b) its IMMcapital charge based on stressedparameter calibrations for EAD;ii) The advanced CVA risk capitalcharge calculated with the internalmodels. For banks with IMM approval andwithout Specific-Risk VaR approval forbonds, the total CCR capital charge isthe sum of the following components:i) The higher of (a) its IMM capitalcharge based on current parametercalibrations for EAD and (b) its IMMcapital charge based on stressedparameter calibrations for EAD;ii) The standardized CVA risk capitalcharge. For all other banks, the total CCRcapital charge is the sum of thefollowing components:i) The sum over all counterparties ofthe Current Exposure Method (CEM)or Standardized Method (SM)-basedcapital charge (depending on thebanks CCR approach);ii) The standardized CVA risk capitalcharge.3.1 EffectiveExpectedPositiveExposureFor banks using an Internal ModelMethod (IMM) to calculate CCRregulatory capital, Basel III requiresdetermining the default risk capitalcharge by using the greater of theportfolio-level capital charge (notincluding CVA charge) based onEffective Expected Positive Exposure(EEPE) using current market dataand the one based on EEPE using astress calibration. The greater of theEEPEs should not be applied on acounterparty-by-counterparty basis,but on a total portfolio level.3.2 CreditvaluationadjustmentIn addition to the default risk capitalrequirements for CCR, Basel IIIintroduces an additional capital chargeto cover the risk of mark-to-marketlosses on the expected counterpartyrisk (Credit Valuation Adjustment, CVA)to OTC derivatives. The calculationof the CVA charge depends on themethod banks use to determine thecapital charge for CCR and specific-interest rate risk. Transactions witha central counterparty (CCP) andsecurities financing transactions (SFT)need not be considered.Banks with IMM approval for CCRrisk and approval to use the marketrisk internal models approach for thespecific-interest rate risk of bonds mustcalculate the additional capital chargeby modeling the impact of changes inthe counterpartys credit spread onthe CVAs of all OTC derivatives usingthe internal VaR model for bonds. ThisVaR model is restricted to changes inthe counterparties credit spreads anddoes not model the sensitivity of CVAto changes in other market factors suchas changes in the value of the referenceasset, commodity, currency or interestrate of a derivative. The CVA risk capitalcharge consists of both general andspecific credit spread risks, includingStressed VaR but excluding incrementalrisk charge (IRC).283.3 Wrongway riskIn addition to the considerationof general wrong way risk stresstesting and scenario analysis mustbe designed to identify such risks Basel III introduces an explicitPillar 1 capital charge for specificwrong way risk. Banks are exposedto specific wrong way risk if futureexposure to a specific counterpartyis highly, positively correlated withthe counterpartys probability ofdefault. Banks must have proceduresin place to identify, monitor andcontrol cases of specific wrong wayrisk, beginning at the inception of atrade and continuing through the lifeof the trade. To calculate the CCRcapital charge, the instruments forwhich there exists a legal connectionbetween the counterparty and theunderlying issuer, and for whichspecific wrong way risk has beenidentified, are not considered tobe in the same netting set as othertransactions with the counterparty.Furthermore, for single-namecredit default swaps where a legalconnection exists between thecounterparty and the underlying issuer,and where specific wrong way riskhas been identified, EAD counterpartyexposure equals the full expectedloss in the remaining fair value of theunderlying instruments assuming theunderlying issuer is in liquidation.23Regulation consider institutions aslarge if the total assets, on thelevel of that individual firm or on theconsolidated level of the group, aregreater than or equal to EUR 70 billionthreshold. The Basel III document bythe BCBS includes a threshold of US$100 billion.Depending on the probability ofdefault of the institution, theintroduction of this multiplierincreases the risk-weight byapproximately 20% to 35%. A detailedcalculation is provided in the appendixof this handbook.3.6 EnhancedCCRmanagementrequirementsBasel III strengthens not only theCCR measurement but also the CCRmanagement by requiring institutionsto establish and maintain a CCRmanagement framework consisting of:a) Policies, processes and systemsto ensure the identification,measurement, management, approvaland internal reportingof CCR;b) Procedures for ensuring that thosepolicies, processes and systems arecomplied with.The framework should ensure thatinstitutions comply with the followingprinciples:a) It does not undertake business witha counterparty without assessing itscreditworthiness;b) It takes due account of settlementand pre-settlement credit risk;c) It manages such risks ascomprehensively and practicable at thecounterparty level by aggregating CCRexposures with other credit exposuresand at the firm-wide level.Basel III also includes newrequirements for CCR back testingand stress testing. Banks must havea comprehensive stress testingprogram including regular execution,single- and multi-factor tests, tradecoverage and internal control. Inaddition, new requirements forcollateral management and policiesare stipulated. The regulatory floor forthe margin period of risk will increase,depending on the counterpartyportfolio and historic margincall failures.3.5 Centralcounter-partiesThe new capital framework alsoenhances incentives for clearinginstruments through centralcounterparties (CCP) by applying lowerown funds requirements relative toOTC transactions. Also, the additionalCVA capital charge does not applyto exposures towards eligible CCPs.It should be noted that severalconditions need to be fulfilled toclassify as CCP.While so far there is no capitalcharge for derivatives with a CCP theproposed EU Regulation introducesown funds requirements for tradeexposures. According to this aninstitution has to apply a risk-weightof 2% to the exposure values of allits trade exposures with CCPs. Anexposure value of zero can be used incases where the posted collaterals to aCCP or a clearing member bankruptcyare remote events, or if the CCP, theclearing member or one or more of theother clients of the clearing memberbecomes insolvent.In addition to institutions acting asclearing members, they have to holdown funds to cover the exposuresarising from their contributionsto the default fund of a CCP, thecorresponding methodology isspecified in Article 298 of theproposed EU Regulation.3.4 AssetvaluecorrelationBasel III increases the risk-weights(RW) on exposures to financialinstitutions relative to the non-financial corporate sector in the IRBapproach. The correlation coefficientin the IRB formula is increasedby 25% for all exposures to largeregulated financial entities and toall unregulated financial entities.24In effect, a multiplier of 1.25 isintroduced. The proposals of the EU294Leverage ratio30314.1 Definition and calibrationTo prevent an excessive build-upof leverage on institutions balancesheets, Basel III introduces a non-risk-based leverage ratio to supplementthe risk-based capital framework ofBasel II. This new regulatory tool is notintended to be a binding instrument atthis stage but as an additional featurethat can be applied on individualbanks at the discretion of supervisoryauthorities with a view to migratingto a binding ('Pillar one') measure in2018, based on appropriate review andcalibration.25 Reporting requirementsfrom January 1, 2013 would allow acorresponding review and decisionon its introduction as a bindingrequirement in 2018. Starting in 2015,publication of the leverage ratio by theinstitutions is proposed.26The leverage ratio should be calculatedby dividing an institutions capitalmeasure by the total exposure(expressed as a percentage). The ratioshould be calculated as the simplearithmetic mean of the monthlyleverage ratios over a quarter.27For the numerator of the ratio (capitalmeasure), the Tier 1 capital shouldbe considered. The denominator(exposure measure) should be thesum of the exposure values of allassets and off-balance sheet itemsnot deducted from the calculation ofTier 1 capital. For off-balance-sheetitems, a specific credit risk adjustmentof 10% generally applies for undrawncredit facilities, (this may be cancelledunconditionally at any time withoutnotice), and 100% for all other off-balance-sheet items.28At this time a leverage ratio of 3%is proposed. By October 31, 2016,the EBA will report to the EuropeanCommission among others on whether3% would be an appropriate level for aTier 1 capital-based leverage ratio andwhether the leverage ratio should bethe same for all institutions or differfor various types of institutions. Basedon the EBA report, final adjustmentsof the ratio would be made in the firsthalf of 2017. The EBA would developdrafts of technical standards todetermine the contents and format ofthe uniform reporting template.Within the disclosure requirements,the following information should bereported:a) The leverage ratio;b) A breakdown of the total exposuremeasure;c) A description of the processesused to manage the risk of excessiveleverage;d) A description of the factors thathad an impact on the leverage ratioduring the period to which thedisclosed leverage ratio refers.Figure 4: Leverage Ratio within Basel IIILeverage Ratio =Tier 1 capitalTotal exposure 3%CalculationSimple arithmetic mean of the monthly leverage ratio over the quarterScope of applicationSolo, consolidated and sub-consolidated levelDisclosureDisclosure of the key elements of the leverage ratio under Pillar 3IntroductionPlanned for Jan. 1, 2018 Exposure measure generally followsaccounting measure Credit risk adjustement foroff-balance-sheet items:- Generally 100%- 10% for unconditionallycancellable commitmentsTransition period Jan. 1, 2011: Start supervisory monitoring period (development of templates) Jan. 1, 2013 Jan. 1, 2017: Parallel run (leverage ratio and its components will be tracked, including its behavior relative tothe risk based requirement) Jan. 1, 2015: Disclosure of the leverage ratio by banks First half of 2017: Final adjustments Jan. 1, 2018: Migration to Pillar 1 treatmentSource: Accenture32335Global liquidity standard3435Basel III includes a new liquidity standard introducingtwo liquidity ratios. The Liquidity Coverage Ratio (LCR)is introduced to improve the short-term resilience ofthe liquidity risk profile of institutions, requiring themto hold a buffer of high quality liquid assets to matchnet liquidity outflows during a 30-day period of stress.The Net Stable Funding Ratio (NSFR) is designed topromote resilience over the longer term by requiringinstitutions to fund their activities with more stablesources of funding on an ongoing structural basis.Further, EBA will develop draftimplementation technical standardsregarding liquidity monitoring metricswhich should allow competentauthorities to obtain a comprehensiveview of the liquidity risk profiles ofinstitutions. The Basel III documentfrom the BCBS contains a number ofmonitoring tools which are presentedin section 5.3.It should be noted that institutionsare not only expected to meet thenew standards but also to adhereto the Principles for Sound LiquidityRisk Management and Supervision.29These principles provide guidance onthe risk management and supervisionof liquidity and funding risk and havebeen considered in the context of theCRD II. The following figure gives anoverview of the relevant topics.Figure 5: Liquidity risk management (LRM) frameworkGovernance Liquidity risk tolerance Responsibility senior management Pricing of liquidity costsMeasurement and management Liquidity risk management (LRM) process Group-wide perspective Funding strategy Intraday liquidity positions Collateral positions Stress testing Contingency funding plan High quality liquid assetsPublic disclosure DisclosureRole of supervisors Assessment LRM framework Monitoring Effective/timely intervention Communication with other supervisorsFundamental principle A bank should establish a robust liquidity risk managementframework that ensures it maintains sufficient liquidity Liquidity riskmanagement frameworkGovernanceMeasurementand managementPublic disclosureRole ofsupervisorsFundamental principle for the managementand supervision of liquidity riskSource: Accenture365.1 Liquidity Coverage RatioThe Liquidity Coverage Ratio (LCR)requires institutions to hold asufficient buffer of high qualityliquid assets to cover net liquidityoutflows during a 30-day period ofstress. The stock of high quality liquidassets (numerator) should includeassets of high credit and liquidityquality. The stress scenario that isused to determine the net cashoutflows (denominator) reflectsboth institution-specific andsystemic shocks.30The LCR will be introduced by 2015after an observation period to avoidpossible unintended consequences.From 2013 on, there is a generalrequirement for banks to keepappropriate liquidity coverage.According to the proposed EURegulation, the LCR will in principleapply at the level of every individualinstitution (with legal personality).Competent authorities may subjectto stringent conditions waivethe application to a consolidatedrequirement.31To meet the requirement, institutionsshall at all times hold liquid assets,the sum of the values of whichequals, or is greater than, the liquidityoutflows less the liquidity inflowsunder stressed conditions so as toensure that institutions maintain levelsof liquidity buffers which are adequateto face any possible imbalancebetween liquidity inflows and outflowsunder stressed conditions over a shortperiod of time. Institutions shall notcount double liquidity inflows andliquid assets.32If an institution does not meet therequirements, it is asked to notify thecompetent authorities and submita plan for the timely restoration ofcompliance with the LCR requirement.Until the institution has restoredcompliance, it must report the items tothe competent authorities on a dailybasis.The LCR should be reported on amonthly basis. Competent authoritiesmay authorize a lower reportingfrequency on the basis of theindividual situation of an institution.Competent authorities might alsorequire institutions with significantliquidity risk in a foreign currency toreport these items separately.Figure 6: Liquidity Coverage Ratio (LCR)LCR=High quality liquid assetsTotal net liquidity outflowsover 30-day time period 100%Institutions have to ensure that they haveat all times sufficient high quality liquidassets to survive an acute stress scenariolasting for 30 daysIntroductionJan. 1, 2015; observation period starting Jan. 1, 2013Scope of applicationLevel of individual institution (with legal personality)ReportingMonthly with the operational capacity to increase the frequency to weekly or even daily in stressed situationsDisclosureDisclosure of LCR under Pillar 3Source: Accenture375.1.1. Definition of high-quality liquid assetsThe following items should qualify asliquid assets:a) Cash and deposits held withcentral banks to the extent that thesedeposits can be withdrawn in timesof stress;b) Transferable assets that are ofextremely high liquidity andcredit quality;c) Transferable assets representingclaims on or guaranteed by the centralgovernment of a Member State or athird country if the institution incurs aliquidity risk in that Member State orthird country that it covers by holdingthose liquid assets;d) Transferable assets that are of highliquidity and credit quality.As an operational requirement, itemslisted in points a, b and c (also calledlevel 1 assets) should not be lessthan 60% of the liquid assets of aninstitution. Such items owed and dueor callable within 30 calendar daysshall not count towards 60% unlessthe assets have been obtained againstcollateral that qualifies under pointsa, b or c.Regarding the definition of highand extremely high liquidity andcredit quality of transferable assets,EBA will work on a uniform definitionuntil December 31, 2013, consideringthe following criteria: minimum tradevolume of the assets; credit qualitysteps; average volume traded andaverage trade size; remaining timeto maturity. Until then, institutionsthemselves should identify thecorresponding transferable assets thatare of high or extremely high liquidityand credit quality.Institutions should not consider thefollowing items as high qualityliquid assets:a) assets that are issued by a creditinstitution unless they fulfill one of thefollowing conditions:i) They are bonds eligible for treatmentas covered bonds;ii) They are bonds as defined in Article52(4) of Directive 2009/65/EC33 otherthan those referred to in (i);iii) The credit institution has beenset up and is sponsored by a MemberState central or regional governmentand the asset is guaranteed bythat government and used to fundpromotional loans granted on anon-competitive, not-for-profit basisin order to promote its public policyobjectives;b) Assets issued by any ofthe following:i) An investment firm;ii) An insurance undertaking;iii) A financial holding company;iv) A mixed-activity holding company;v) Any other entity that performsone or more of the activities listedin Annex I of the Directive as itsmain business (e.g., financial leasing;acceptance of deposits and othermutual recognition).The items shall fulfill the followingconditions to qualify as high qualityliquid assets:a) They are not issued by theinstitution itself or its parent orsubsidiary institutions or anothersubsidiary of its parent institutions orparent financial holding company;b) They are eligible collateral in normaltimes for intraday liquidity needsand overnight liquidity facilities of acentral bank in a Member State or,if the liquid assets are held to meetliquidity outflows in the currency ofa third country, of the central bank ofthat third country;c) Their price can be determined by aformula that is easy to calculate basedon publicly available inputs and doesnot depend on strong assumptions asis typically the case for structured orexotic products;d) They are listed on a recognizedexchange;e) They are tradable on active outrightsale or repurchase agreement marketswith a large and diverse number ofmarket participants, a high tradingvolume and market breadth and depth.Items have to fulfill several operationalrequirements to be considered as high-quality liquid assets:a) They are appropriately diversified;b) Level 1 assets should not be lessthan 60% of the liquid assets (seeabove);c) They are legally and practicallyreadily available at any time duringthe next 30 days to be liquidated viaoutright sale or repurchase agreementsin order to meet obligationscoming due;d) The liquid assets are controlled by aliquidity management function;e) A portion of the liquid assets isperiodically and at least annuallyliquidated via outright sale orrepurchase agreements for thefollowing purposes:i) To test the access to the market forthese assets,ii) To test the effectiveness of itsprocesses for the liquidation of assets,iii) To test the usability of the assets,iv) To minimize the risk of negativesignaling during a period of stress;38f) Price risks associated with theassets may be hedged but the liquidassets are subject to appropriateinternal arrangements that ensure thatthey will not be used in other ongoingoperations, including:i) Hedging or other trading strategies;ii) Providing credit enhancements instructured transactions;iii) To cover operational costs;g) The denomination of the liquidassets is consistent with thedistribution by currency of liquidityoutflows after the deduction ofcapped inflows.The value of the liquid assets shallbe the market value, subject toappropriate haircuts. For level 2 assetsthe haircut shall not be less than 15%.If institutions hedge the price risk,they should take into account thecash flow resulting from the potentialclose-out of the hedge. Shares or unitsin CIUs should be subject to haircuts,looking through to the underlyingassets. The haircuts range from 0%to 20%.Figure 7: LCR: High quality liquid assetsLCR=High quality liquid assetsTotal net liquidity outflowsover 30-day time period 100%High quality liquid assetsConditions high quality liquid assets (e.g.,) Not issued by the institution or parent/subsidiary Eligibility as collateral in normal times for intraday liquidity needs and overnight liquidity facilities of a Central Bank Listed on a recognized exchangeOperational requirements (e.g.,) Appropriate diversification Assets are legally and practically readily available at any time during the next 30 days Liquid assets are controlled by a liquidity management functionHigh quality liquid assets items Level 1 assets (cash; transferable assets of extremely high liquidity and credit quality): min. 60% of liquid assets; marketvalue; no haircut Level 2 assets (transferable assets that are of high liquidity and credit quality): max. 40% of liquid assets; market value;haircut of min. 15%Source: Accenture395.1.2. Definition of netliquidity outflowsThe denominator of the LCR consistsof the net liquidity outflows overa 30-day period of stress. They arecalculated as the liquidity inflowsminus the outflows, whereas theinflows are limited to 75% of liquidityoutflows.The liquidity outflows are calculatedby multiplying the assets with thespecified run off factors; the inflows,by multiplying the assets with thespecified inflow factor.ii) held in a transactional account,including accounts to which salariesare regularly credited;10% of other retail deposits;34b) For other liabilities that come due,can be called for payout, or entail animplicit expectation of the provider ofthe funding that the institution wouldrepay the liability during the next 30days, the following percentages shouldbe used to calculate liquidity outflows:i) 0% of the liabilities resultingfrom the institutions own operatingexpenses;ii) 0% of liabilities resulting fromsecured lending and capital-market-driven transactions whichare collateralized with high qualityliquid assets (up to the value of theliquid assets); 100% of the remainingliabilities;iii) 25% of liabilities resulting fromsecured lending and capital-market-driven transactions if the assets wouldnot qualify as liquid assets, the lenderis the central bank or another publicsector entity of the Member Statein which the credit institution wasauthorized.iv) For liabilities resulting fromdeposits that have to be maintained:(a) By the depositor in order to obtainclearing, custody or cash managementservices from the institution;(b) In the context of common tasksharing within an institutionalprotection scheme or as a legal orstatutory minimum deposit by anotherentity being a member of the sameinstitutional protection scheme;5% in case of point a) to the extent towhich they are covered by a DepositGuarantee Scheme or an equivalentdeposit guarantee scheme in a thirdcountry, and by 25% otherwise;v) 75% of liabilities resulting fromdeposits by clients that are notfinancial customersvi) 100% of payables and receivablesexpected over the 30-day horizonfrom the contracts listed in AnnexII into account on a net basis acrosscounterparties;vii) 100% of other liabilities.5.1.2.1 Liquidity outflowsLiquidity outflows are calculated asthe sum of the following items:a) 5% of retail deposits that arecovered by a Deposit GuaranteeScheme and the depositor is either:i) Part of an established relationshipmaking withdrawal highly unlikely;Figure 8: LCR: Net liquidity outflowsLCR=High quality liquid assetsTotal net liquidity outflowsover 30-day time period 100%Net liquidity outflows =Liquidity outflows Min (Liquidity inflows; 75% of liquidity outflows)c) Collateral other than level 1 assetswhich is posted by the institution forcontracts listed in Annex II shall besubject to an additional outflow of15% of the market value of assets forlevel 2 assets and 20% of the marketvalue of other assets;d) Outflows from credit and liquidityfacilities that qualify as medium ormedium-to-low risk, which shall bedetermined as a percentage of themaximum amount that can be drawnduring the next 30 days. The maximumamount should be multiplied by:i) 5% if the facilities qualify forthe retail exposure class under thestandardized or IRB approaches forcredit risk;Net liquidity outflowsLiquidity outflows minus liquidity inflows in the stress scenarioThe scenario includes firm-specific and systemic factorsCalculation liquidity outflowsMultiplication of the items with the respective run off factorCalculation liquidity inflowsMultiplication of the items with the specified inflow factor;inflows are capped at 75% of the outflowsSource: Accenture40ii) 10% if they do not qualify forretail exposure; have been providedto clients that are not financialcustomers; have not been provided forthe purpose of replacing funding of theclient in situations when the client isunable to obtain funding requirementsin the financial markets;iii) 100% applies in particular to (a)liquidity facilities that the institutionhas granted to securitization specialpurpose entity (SSPEs); and (b)arrangements under which theinstitution is required to buy or swapassets from an SSPE.e) Additional outflows in period ofstress.35inflows should be taken into accountin full with the following exceptions:a) Monies due from customers thatare not financial customers shall bereduced by 50% (this does not applyto monies due from secured lendingand capital-market-driven transactionsthat are collateralized by level 1 andlevel 2 assets);b) Monies due from securedlending and capital-market-driventransactions, if they are collateralizedby liquid assets, shall not be taken intoaccount up to the value net of haircutsof the liquid assets but shall be takeninto account in full for the remainingmonies due;c) Monies due that the institutionowing those monies treats, anyundrawn credit or liquidity facilitiesand any other commitments receivedshall not be taken into account.Payables and receivables expectedover the 30-day horizon from thecontracts listed in Annex II shallbe reflected on a net basis acrosscounterparties and shall be multipliedby 100% of a net amount receivable.Institutions should not considerinflows from any of the liquidassets (as specified in the proposedRegulation) other than payments dueon the assets that are not reflected inthe market value of the asset.Further inflows from new issuance ofany obligations should not be takeninto account.Institutions shall take into accountliquidity inflows which are to bereceived in third countries wherethere are transfer restrictions or whichare denominated in non-convertiblecurrencies only to the extent that theycorrespond to outflows in the thirdcountry or currency in question.5.1.2.2 Liquidity inflowsInstitutions should measure liquidityinflows over the next 30 days. Theyare limited to 75% of the liquidityoutflows and should include onlycontractual inflows from exposuresthat are not past due and for whichthe bank has no reason to expect non-performance within 30 days. LiquidityFigure 9: LCR: High quality liquid assets and net liquidity outflowsLiquidity Coverage RatioLCR=High quality liquid assetsTotal net liquidity outflowsover 30-day time period 100%High quality liquid assets Level 1 assets Cash; transferable assets of extremely high liquidity and credit quality (min. 60% of liquid assets) Level 2 assets Transferable assets that are of high liquidity and credit quality: max. 40% of liquid assets; market value; haircut of min. 15%Liquidity outflows Retail deposits (5-10%) Other liabilities coming due during next30 days (0-100%) Collateral other than level 1 assets(15-20%) Credit and liquidity facilities (5-100%)Liquidity inflows Monies due from non financial customer (50%) Secured lending and capital market driventransactions (0%-100%) Undrawn credit and liquidity facilities (0%) Specified payables and receivables expected overthe 30 day horizon (100%) Liquid assets (0%) New issuance of obligations (0%) 100%Source: Accenture415.2 Net Stable Funding RatioThe Net Stable Funding Ratio (NSFR)requires institutions to maintain asound funding structure over one yearin an extended firm-specific stressscenario. Assets currently funded andany contingent obligations to fundmust be matched to a certain extentby sources of stable funding. Theminimum requirement described inmore detail below is to be introducedby January 1, 2018. There is anobservation period until then.The reporting frequency for the LCRshould not be less than monthly. TheNSFR should be reported not lessthan quarterly. Competent authoritiesare allowed to authorize a lowerreporting frequency on the basis of theindividual situation of an institution.The numerator of the NSFR includesthe stable sources of funding. Thefollowing items shall be reported tocompetent authorities separately inorder to allow an assessment of theavailability of stable funding:a) Own funds;b) The following items not included inthe own funds:i) Retail deposits as defined in theRegulation;ii) Deposits that fulfill certainconditions;iii) All funding obtained from financialcustomers;iv) Funding from secured lending asspecified in the Regulation;v) Liabilities resulting from coveredbonds;vi) Other liabilities resulting fromsecurities issued;vii) Any other liabilities.The items shall be presented in thefollowing five time blocks according tomaturity date or the earliest date theycan be contractually called:a) Within 3 months;b) Between 3 and 6 months;c) Between 6 and 9 months;d) Between 9 and 12 months;e) After 12 months.The denominator of the NSFR includesthe items requiring stable funding.Institutions shall report the followingitems to competent authorities inorder to allow an assessment of theneed for stable funding:a) Liquid assets, broken down byasset type;b) Securities and money marketinstruments not included in (a);c) Equity securities of non-financialentities listed on a major index in arecognized exchange;d) Other equity securities;e) Gold;f) Other precious metals;g) Non-renewable loans andreceivables, and separately, those theborrowers of which are:i) Natural persons other thancommercial sole proprietor andpartnerships and deposits placed bysmall and medium-size enterpriseswhere the aggregate deposit placedby that client or group of connectedclients is less than 1 million EUR;ii) Sovereigns, central banks and PSEs;iii) Clients not referred to in (i) and (ii)other than financial customers;iv) Any other borrowers;h) Derivatives receivables;i) Any other assets;j) Undrawn credit facilities that qualifyas 'medium risk' or 'medium/low risk'.Where applicable, all items shallbe reported in the five time blocksdescribed above.The proposed EU Regulation does notinclude any available stable fundingfactors (ASF factors) or requiredstable funding factors (RSF factors),i.e., factors by which the availableor required stable funding itemsmust be multiplied to calculate thecorresponding value. Neither at thistime is it stated whether the NSFRshould be > or 100%.36To give an overview of the currentdiscussion regarding ASF and RSFfactors, the following figures representthe proposals from the Basel IIIdocument of the BCBS.3742Figure 10: Net Stable Funding RatioNSFR=Available stable fundingRequired stable funding 100%Institutions are required to maintain asound funding structure over one yearin an extended firm-specific stressscenarioIntroductionJan. 1, 2018; under observation until thenScope of applicationLevel of individual institution (with legal personality)ReportingQuarterlyDisclosureDisclosure of NSFR under Pillar 3Source: AccentureFigure 11: NSFR: Available stable fundingSource: AccentureNote: Based on Basel III document from Basel Committee on Banking Supervision43Figure 12: NSFR: Required stable fundingNSFR=Available stable fundingRequired stable funding 100%Required stable fundingItems - RSF factor 0% Cash Unencumbered short-term unsecured instruments and transactions with outstanding maturities < 1 year Unencumbered securities with stated remaining maturities < 1 year with no embedded options Unencumbered securities held where the institution has an offsetting reverse repurchase transaction Unencumbered loans to financial entities with effective remaining maturities < 1 year that are not renewable and for whichthe lender has an irrevocable right to callItems - RSF factor 5% Unencumbered marketable securities with residual maturities of one year or greater representing claims on or claimsguaranteed by sovereigns, central banks, BIS, IMF, EC, non-central government PSEs or multilateral development banks thatare assigned a 0% risk-weight under the Basel II standardized approach, provided that active repo or sale-markets exist forthese securitiesItems - RSF factor 20% Unencumbered corporate bonds or covered bonds rated AA- or higher with residual maturities 1 year satisfying all of theconditions for Level 2 assets in the LCR Unencumbered marketable securities with residual maturities 1 year representing claims on or claims guaranteed bysovereigns, central banks, non-central government PSEs that are assigned a 20% risk-weight under the Basel II standardizedapproach, provided that they meet all of the conditions for Level 2 assets in the LCRItems - RSF factor 50% Gold Unencumbered equity securities, not issued by financial institutions or their affiliates, listed on a recognized exchange andincluded in a large cap market index Unencumbered corporate bonds and covered bonds that are central bank eligible and are not issued by financial institutionsItems - RSF factor 65% Unencumbered residential mortgages of any maturity that would qualify for the 35% or lower risk-weight under Basel IIStandardized Approach Other unencumbered loans, excluding loans to financial institutions, with a remaining maturity of one year or greater, thatwould qualify for the 35% or lower risk-weight under Basel II Standardized Approach for credit riskItems - RSF factor 85% Unencumbered loans to retail customers and SME (as defined in the LCR) having a remaining maturity < 1 yearItems - RSF factor 100% All other assets not included in the above categoriesSource: AccentureNote: Based on Basel III document from Basel Committee on Banking Supervision445.3 Monitoring toolsA further objective of Basel IIIis to strengthen and promoteglobal consistency in liquidityrisk supervision. According to theproposed EU Regulation, EBA shalldevelop draft implementing technicalstandards regarding additionalliquidity monitoring metrics that allowcompetent authorities to obtain acomprehensive view of the liquidityprofile of institutions.In the Basel III document of the BCBS,the following monitoring tools ormetrics are proposed.38Concentration of fundingDifferent ratios/figures 39 to helpidentify sources of wholesale fundingthat are of such significance that theirwithdrawal could trigger liquidity