JAMES OKARIMIA - BASEL III PRESENTATION

1. Basel III
James J. Okarimia
Partner at RM associates
Amsterdam 10th May 2016

2. Overview
Meaning of Basel III
• Why Basel III
• Aims
• Objectives
• Major Changes Implementation of the Changes

3. What is "Basel III":
" A global regulatory standard on:
• Bank Capital Adequacy
• Stress Testing and
• Market Liquidity Risk

4. Also a set of reform measures to improve
• Regulation
• Supervision
• Risk Management

5. Reasons for Basel III Formulation:
Failures of Basel II being:
A. Inability to strengthen financial stability.
B. Insufficient capital reserve.
C. Inadequate comprehensive risk management
approach.
D. Lack of uniformed definition of capital

6. Aims & Objectives of Basel III
• To minimize the probability of recurrence of crises to
greater extent.
• To improve the banking sectors ability to absorb
shocks arising from financial and economic stress.
• To improve risk management and governance.
• To strengthen banks transparency and disclosures .

7. Targets:
• Bank‐level or micro prudential which will help raise the
resilience of individual banking institutions in periods of
stress.
• Macro prudential system wide risks that build up across
the banking sector as well as the pro‐cyclical
amplification of these risk over time.

8. Key Elements of Reforms
• Increasing the quality and quantity capital
• Enhancing risk coverage of capital
• Introducing Leverage ratio
• Improving liquidity rules
• Establishing additional buffers
• Managing counter party risks

9. The three Pillars of Basel II and Basel III
9

10. Basel III Overview
Credit
Risk
Market
Risk
Operational
Risk
Capital Market Risk
Capital
Definition (Tier
1, 2)
Securitisation
Exposures –
Banking &
Trading Book Leverage
Ratio*
Stress Testing,
Model
Validation,
Back testing
Capital Ratios
Counterparty
Credit Risk
Stressed Inputs
for risk models
Credit Value
Adjustment
(CVA) Capital
Charge
Higher Capital
Charge for
Specific wrong
way risk
Liquidity
Coverage Ratio
Net Stable
Funding Ratio
External Credit
Ratings Capital Buffers
(Capital
Conservation
Buffer &
Countercyclical
buffer),
Additional
Capital -Global
SIFI & Local
SIFI
Liquidity
Monitoring
Metrics
(Maturity
Mismatch,
Funding
Concentration)
Market Risk
Measures
(Stressed VaR,
IRC)
Capital
Deductions

11. Basel III Implementation Framework approach
Assessment of
existing Basel
Implementation –
Business Req,
Applications,
Reporting etc
Gap
Analysis
(B3/B2.5 vs.
Current State)
Business
Architecture (E2E)
Application
Architecture
(E2E)
Basel Current
State
Assessment
Gap Analysis
& Impact
Assessment
Our & Bank –
Joint Activity
Our Activity
Basel 2.5 & Basel
3 Requirements
(BCBS, Home,
Host Regulator )
Impact
Assessment
(Systems,
& Data)
Requirements
& Architecture
Data
Requirements
Initiative Definition
Information
Architecture (E2E)
Define high level
initiatives, their
workstreams and
identify dependencies
Discovery - Bank’s
asset classes,
Basel program
current state,
Risk management
policy, objectives Evaluate options to
close gaps
Categorize gaps,
identify/prioritize
initiatives &
workstreams
Implementation
Roadmap
Initiative 1..N &
Workstreams
Functional
Requirements
System
Requirements Phases
Activities
Timelines
Estimates – Effort,
Resources
Phase Deliverable
High Level Scope
definition doc
Requirements
document
Implementation
Roadmap
Activities
Gap Assessment,
Initiative Definition Doc
Architecture
Diagram
Business
Req. doc, Gap
Analysis &
Impact Assessment
Report
Establish the
High level scope for
Gap analysis phase
Provide inventory of
Business requirements,
gaps & their impact
Categorize & prioritize
gaps to define initiatives,
workstreams and their
dependencies
Initiative 1..N &
Workstreams
Capture detailed functional, system & data
Requirements across initiatives & workstreams.
Define To -be state business, application and
Information architecture at program level
Define detailed
Implementation roadmap
Covering initiatives &
workstreams
Phase
Objective

12. Approach – Current State Assessment

13. Basel 3 – Business Architecture
Approach – Requirements & Architecture

14. Pillar 1:Minimum Capital Requirements
• Pillar 1 aligns the minimum capital requirements
more closely to actual risks of banks economic loss
• Revised risks:
√ Credit risk
√ Operational risk
√ Market risk

15. Pillar 1:Minimum Capital Requirements(cont)
• Credit risk
√ The standardised approach
√ Foundation internal ratings based (IRB) approach
√ Advanced IRB approach
• Operational risk
√ Basic indicator approach
√ Standardized approach
√ Advanced measurement approach
• Market risk
√ standardized approach
√ internal models approach

16. Pillar 2:Supervisory Review Process
• Pillar 2 requires banks to think about the whole spectrum of
risks they might face including those not captured at all in Pillar 1
such as interest rate risk.
• Coverage in Pillar 2:
√ risks that are not fully covered by Pillar 1
√ Credit concentration risk
√ Counterparty credit risk
√ Risks that are not covered by Pillar 1
√ Interest rate risk in the banking book
√ Liquidity risk
√ Business risk
√ Stress testing

17. Pillar 3:Market Discipline
• Pillar 3 is designed to increase the transparency of
lenders risk profile by requiring them to give details of
their risk management and risk distributions.

18. Weaknesses of Basel II
• The quality of capital.
• Pro‐cyclicality.
• Liquidity risk.
• Systemic banks.

19. Basel III: Strengthening the global capital
framework
A. Capital reform.
B. Liquidity standards.
C. Systemic risk and interconnectedness.

20. A. Capital Reform
• A new definition of capital.
• Capital conservation buffer.
• Countercyclical capital buffer.
• Minimum capital standards.

21. A new definition of capital
Total regulatory capital will consist of the sum of the following
elements:
1. Tier 1 Capital (going‐concern capital)
a. Common Equity Tier 1
b. Additional Tier 1
2. Tier 2 Capital (gone‐concern capital)
• For each of the three categories above (1a, 1b and 2) there is a
single set of criteria that instruments are required to meet
before inclusion in the relevant category.

22. Capital conservation buffer
• The capital conservation buffer is designed to ensure that
banks build up capital buffers outside periods of stress
which can be drawn down as losses are incurred.
• A capital conservation buffer of 2.5%, comprised of
Common Equity Tier 1, is established above the regulatory
minimum capital requirement.
• Outside of periods of stress, banks should hold buffers of
capital above the regulatory minimum.

23. Countercyclical capital buffer
• The countercyclical buffer aims to ensure that banking sector capital
requirements take account of the macro‐ financial environment in
which banks operate.
• It will be deployed by national jurisdictions when excess aggregate
credit growth is judged to be associated with a build‐up of system‐
wide risk to ensure the banking system has a buffer of capital to
protect it against future potential losses.
• The capital conservation buffer is designed to ensure that banks build
up capital buffers outside periods of stress which can be drawn down
as losses are incurred.

24. Minimum capital standards
• GRC discipline has rightly
taken the center stage in top
management agenda and is
no more seen as a mere
compliance function.
• Wave of regulations (Dodd
Frank Act, Basel III/CRD IV etc)
will garner most of the Risk
attention in FSIs
• Base III/CRDIV will be
implemented in a phased
manner instead of a Big Bang
approach

25. B. Liquidity Standards:
1. Short‐term: Liquidity Coverage
Ratio(LCR)
2. Long‐term: Net Stable Funding
Ratio(NSFR)

26. 1.Short‐term:
• The LCR is a response from Basel committee to the
recent financial crisis.
• The LCR proposal requires banks to hold high quality
liquid assets in order to survive in emergent stress
scenario
Stock of High Quality Assets ≤ 100%
Net Cash outflows over a 30 day Time Period

27. Short‐term: LCR
• Must be no lower than 1
• The higher the better
• High quality liquid: liquid in markets during a time of stress and,
ideally, be central bank eligible.
• Banks are still expected to conduct their own stress tests to
assess the level of liquidity they should hold beyond this
minimum, and construct scenarios that could cause difficulties
for their specific business activities.

28. 2. Long‐Term: NSFR
• Objectives:
• To promote more medium and long‐term funding
activities of banking organizations.
• Ensure that the investment activities are funded by
stable liabilities.
• To limit the over‐reliance on wholesale short‐term
funding(money market)
Available amount of stable funding ≤ 100%
Required amount of stable funding

29. Short‐term: NSFR
Available stable funding (ASF) is defined as the total amount
of an institution’s:
• capital.
• preferred stock with maturity of equal to or greater than
one year.
• liabilities with effective maturities of one year or greater.
deposits and/or term deposits with maturities of less than
one year that would be expected to stay with the
institution for an extended period a stress event.

30. Required Stable Funding :
• The required amount of stable funding is calculated as
the sum of the value of the assets held and funded by
the institution, multiplied by a RSF factor, added to the
amount of OBS activity (or potential liquidity
exposure) multiplied by its associated RSF factor

31. Required Stable Funding :
These components of required stable funding are not equally
weighted.
• 100% of loans longer than one year.
• 85% of loans to retail clients with a remaining life shorter than
one year.
• 50% of loans to corporate clients with a remaining life shorter
than one year.
• and 20% of government and corporate bonds.
• off‐balance sheet categories are also weighted.

32. C. Systemic risk and interconnectedness
(Counterparty risk)
• Capital incentives for using CCPs for OTC.
• Higher capital for systemic derivatives.
• Higher capital for inter‐financial exposures.
• Contingent capital.
• Capital surcharge for systemic banks.

33. CONCLUSION
• Basel III introduces a paradigm shift in capital
and liquidity standards.
• It was constructed and agreed in relatively
record time which leaves many elements
unfinished.
• The final implementation date a long way off.

34. CONTACT
JAMES OKARIMIA
Managing Partner RM Associates
Janssoniuslaan 30
3528 AJ Utrecht
t: +31 (0) 36 532 2399
m: +31 (0) 6 2319 2655
e: james.okarimia@rmassociates.nl