BANKING
AUGUST 4, 2014
Basel III Implementation in Full Swing: Global
Overview and Credit Implications
SPECIAL COMMENT
Summary
Table of Contents:
SUMMARY
OVERVIEW OF BASEL III
IMPLEMENTATION TRENDS AND CREDIT
IMPLICATIONS
BASEL III IMPLICATIONS FOR BANKING
INDUSTRY STRENGTH
BASEL III BACKGROUND
BASEL III IMPLEMENTATION: REGIONAL
DISCUSSION
APPENDIX 1 – BASEL III AND THE
FINANCIAL CRISIS
APPENDIX 2 – HOW DO WE RATE BASEL
III SECURITIES?
MOODY’S RELATED RESEARCH
1
2
4
4
8
23
27
28
Analyst Contacts:
NEW YORK
+1.212.553.1653
Meredith Roscoe
+1.212.553.7258
Vice President - Senior Research Analyst
[email protected]
Gregory Bauer
+1.212.553.1498
Managing Director - Global Banking
[email protected]
LONDON
+44.20.7772.5454
Laurie Mayers
+44 20.7772 5582
Associate Managing Director- EMEA
[email protected]
Frederic Drevon
+44.20.7772-5356
Managing Director - Global Banking
[email protected]
The Basel capital framework, developed by the Basel Committee for Banking Supervision
(BCBS), has evolved from a regulatory reporting function under Basel I to an integrated
capital, funding and liquidity framework known as Basel III, impacting all levels of bank
operations,. Basel III guides to better quality and quantity of capital, a leverage ratio
constraint, and short-term liquidity and longer term funding rules – all positives for bank
stability. Most countries have started implementing the Basel III risk-based capital reforms,
with many implementing rules requiring full compliance well ahead of the BCBS phase-in
end-date. Most of the implementation trends are positive for bank creditworthiness.
» In systems where the banks already hold high levels of capital and liquidity – such as in
Asia, the Middle East, and Latin America – authorities are imposing higher “superequivalent” requirements, and maintaining the liquidity and capital in the systems, a credit
positive. A key challenge for banks will be replacing non-qualifying instruments through
organic capital generation, or issuance of new Tier 1 and Tier 2 capital instruments.
» In some countries, including the UK and Canada, implementation is stricter than BCBS
rules to avoid regulatory back-stepping, because capital or liquidity rules in those
jurisdictions were already tougher than the requirements of previous regimes like Basel II.
» Many jurisdictions are implementing stricter requirements for larger banks, including
accelerated phase-in or higher capital levels. In the US, systemically important banks have
a 5% leverage ratio requirement, including a capital buffer above the 3% minimum level.
» However, the Basel III framework does not address some Basel II weaknesses, including
comparability of risk-weighted assets, and inconsistent use of Pillar 2 assessments.
Given the differences in implementation schedules highlighted in this report, users of bank
financial disclosures should be aware that transitional capital and leverage ratios are not
directly comparable without taking into account accelerated or “super-equivalent” local rules.
Once fully implemented, the Basel III framework will improve banks’ resilience to asset and
liquidity stresses and shocks, but it is also too soon to conclude that the industry has
fundamentally stronger creditworthiness. While banks have made progress in implementing
stress testing, improving liquidity frameworks and reducing leverage, many remain
challenged in meeting full Basel III requirements and sustaining profitable business models
under these more stringent regulatory constraints.
BANKING
Overview of Basel III Implementation Trends and Credit Implications
Globally, most countries started implementing Basel III risk-based capital reforms in 2014, while leverage and liquidity rules are in
much earlier stages, including the rulemaking stage. Below are key implementation highlights and related credit implications.
Quality of Capital
Implementation Trends
Credit Implications
Many countries in Asia and some in the Middle East have accelerated
capital deduction phase-in periods or changed limited deductions to
full deductions.
Stricter capital quality rules in Asia and the Middle East are credit
positive, as capital will be more loss absorbing.
In Europe, some countries are implementing a slower phase-in period
for deferred tax asset (DTA) deductions and are phasing in unrealized
gains and losses into CET1.
Slower DTA deduction phase-in is credit negative, as DTAs are a weak
component of core capital.
Minimum Capital Levels
Implementation Trends
Credit Implications
Minimum required levels are generally in line with BCBS
recommendations in Europe and the Americas, but are significantly
higher in Asia, the Middle East and Africa.
More and better quality capital under Basel III is positive for senior
debtholders.
In Asia, the Middle East and Africa, higher minimum requirements
largely reflect higher existing capital ratios.
Firms with high capital ratios will still need to replace non- qualifying
instruments with Basel III-eligible instruments.
Globally, most jurisdictions are implementing the minimum capital
requirements according to the BCBS schedule (by 2015) or more
rapidly, with some countries requiring faster phase-in only for their
largest banks.
Pillar 2
Implementation Trends
Credit Implications
Most jurisdictions are allowing the use of total capital to meet Pillar 2
add-on requirements, although a few are requiring Pillar 2 capital
quality to be in line with the quality of capital for Pillar 1 (e.g. 56%
CET1).
Disclosure of CET1 Pillar 2 add-on requirements are important for
investors who hold contingent capital instruments that have CET1 based
triggers.
Many jurisdictions either do not formally assess additional Pillar 2
capital, or when they do, the levels are often not disclosed by
regulators (exceptions include Sweden and Denmark).
Without disclosure of Pillar 2 requirements, how much of a firm’s
available regulatory capital is required versus surplus can be unclear,
making it hard to judge a bank’s capital adequacy against its risk profile,
as well as its relative position to peers.
Buffers
Implementation Trends
Credit Implications
Most regions are following the BCBS phase-in schedule (which begins in
2016), but some Asian and Middle Eastern countries are requiring faster
compliance.
With new buffers, regulators will intervene earlier than was the case
under Basel II, posing risk to bondholders, though preserving greater firm
value.
In some countries, systemically important banks (SIBs) must meet
capital conservation buffer or systemically important bank buffer
requirements more rapidly than the BCBS schedule (UK, Canada)
Additional Tier 1 (AT1) discretionary non-cumulative coupons/dividends
are subject to potential non-payment when buffers are eroded, posing
risk to AT1 holders, but help to restore bank capital levels if AT1 losses
are incurred.
Largest Swiss banks have higher SIB buffer levels (up to 6%), but can
meet requirements with lower tier capital.
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on
www.moodys.com for the most updated credit rating action information and rating history.
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Non-Qualifying Capital Instruments
Implementation Trends
Credit Implications
Most jurisdictions are adopting the Basel 10-year timeline for phaseout, with a few countries shortening the timeline to five years.
For smaller banks, the key challenge will be to replace non-qualifying
instruments through either organic capital generation or AT1 issuance.
The US has stricter phase-out criteria than the BCBS guidelines for its
largest banks, but less stringent criteria for smaller firms.
Leverage Ratio
Implementation Trends
Credit Implications
Switzerland, the UK and China are implementing the leverage ratio as a
Pillar 1 requirement earlier than 2018.
The leverage requirement creates complementary incentives to riskadjusted capital measures, and can help mitigate model risks and what is
known as tail risks, which are losses under a stress scenario.
In some jurisdictions, including the US and Switzerland, SIBs will be
subject to higher leverage ratio minimums.
Some emerging market jurisdictions (South Africa, China, and India)
have leverage ratio requirements higher than the BCBS-proposed 3%
level.
Addressing the challenge of meeting leverage rules could be credit
negative, if banks with low-risk assets increase their risk profile to
enhance their returns on assets.
In jurisdictions imposing higher minimum leverage ratios, leverage levels
are often already low – higher requirements ensure capital remains
within the system.
Liquidity Coverage Ratio
Implementation Trends
Credit Implications
Liquidity Coverage Ratio (LCR) implementation is in the early stages,
but we see examples of stricter LCR rules than BCBS guidelines in both
developed and emerging countries.
Accelerated liquidity requirements are credit positive, as banks in these
jurisdictions – namely the US, Canada, and the UK - had already
established high levels of liquid assets and more robust funding profiles.
Many countries in Asia-Pacific and the Middle East have not yet drafted
liquidity rules.
Building up of sufficient liquidity buffers of high-quality low-yielding
assets might challenge some banks, resulting in pressures on their
profitability levels.
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Basel III Implications for Banking Industry Strength
Basel III attempts to address the shortcomings that were identified during the global financial crisis
(see Appendix 1) and should improve the ability of banks to absorb losses to their capital and shocks to
their funding, while remaining a going concern in the event of an idiosyncratic or systemic loss event.
Basel III seeks to accomplish these aims through increased capital requirements, the use of capital and
liquidity buffers, leverage constraints and the presence of contingent capital instruments, which may
help to recapitalize banks, potentially avoiding the need to put a bank into resolution or liquidation.
However, the banking industry is not yet in a steady state for a variety of reasons. Since June 2012,
when Moody’s repositioned ratings downward for many banking groups, including the global
investment banks, substantial improvements have occurred in bank fundamentals, such as reductions
in leverage, higher capital levels, and the implementation of firm-wide stress testing and more robust
liquidity and funding profiles. Nevertheless, capital requirements under Basel III will continue to
pressure many firms to increase capital further, as buffers begin to phase in starting in 2016. In
addition, firm-wide stress testing still requires substantial investment at many firms. Moreover,
constraints on leverage pose a particular challenge for firms which have been focused on optimizing
returns on risk-adjusted capital under Basel II. Finally, tail risks, especially relating to the increasing
cost of litigation in regard to legacy businesses, still expose many firms to sizeable losses.
Consequently, other than recognizing idiosyncratic mitigation of risk or material improvements in
controls, we do not intend at this point in time to review the positioning of the industry, despite
improvements in the quality and quantity of financial resources they now hold. Capital, leverage, and
liquid asset levels are all likely to improve as a result of full Basel III implementation, and some
jurisdictions, positively, have accelerated Basel III phase-in requirements. However, the rules in many
jurisdictions are aligned with the BCBS guidelines and will not have full phase-in completed before
2019.
At this stage of the capital reform process, many banks are challenged to meet requirements and have
not yet found sustainable, profitable business models in the new environment, finding it difficult to
generate earnings in excess of their cost of capital. While some banks are already better positioned to
meet the Basel III requirements and will be less challenged, resulting in greater strategic flexibility, they
are already relatively higher rated. 1
Basel III Background
The Basel III framework, which was introduced in 2010, is the latest bank capital framework produced
by the Basel Committee on Banking Supervision, and provides the basis for significant bank capital
reforms which are now being implemented globally. 2 The reforms aim to improve the banking
sector’s ability to absorb shocks arising from financial and economic stress, reducing the risk of
spillover from the financial sector to the real economy.
Basel III complements the Basel II and 2.5 capital frameworks – which focused on asset weightings in
risk-based capital ratios – and attempts to address key areas of weakness identified after the financial
sector crisis through the following new features:
1
Ratings are subject to constraints of sovereign country ceilings.
2
BCBS, which includes members of G20 countries, produces best practices documents on the measurement and management of risk, corporate governance, and risk
modeling. Its guidance is translated into legislation within relevant jurisdictions.
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SPECIAL COMMENT: BASEL III IMPLEMENTATION IN FULL SWING: GLOBAL OVERVIEW AND CREDIT IMPLICATIONS
BANKING
»
Higher quantity and quality of capital;
»
Short-term liquidity and stable funding requirements; and
»
A leverage ratio to complement risk-based measures.
The Basel II framework updated the 1988 Basel I capital framework that had standardized risk weights
for credit and market risk exposures (See Exhibit 1). Basel II continued the focus on the asset side of
the balance sheet and attempted to capture more nuanced risk-based capital requirements for credit,
market, operational and counterparty credit risk, with the latter two being included for the first time.
For the most advanced banks, internal models could be used, subject to regulatory approval, to assign
asset risk weights. The Basel II framework introduced the concepts of Pillar I (minimum capital
requirements), Pillar II (additional capital for risks not captured or not fully covered in Pillar I and
capital requirements under a forward looking stress test), and Pillar III (enhanced risk disclosure to
enhance market discipline). Basel 2.5 was introduced in response to the recent financial crisis to
improve the capture of tail risks in the trading book.
EXHIBIT 1
Evolution of Basel Capital Frameworks
Basel II:
Introduced risk
based capital
calculations for
credit, market,
operational and
counterparty
credit risk
Standardized
and model
based
approaches
Basel I:
(with regulatory
Standardized approval)
risk weights
for credit and Introduced
concept of 3
market risk
Pillars: I, II and
exposures
III
Basel 2.5:
Addressed
weaknesses in
value at risk
calculation for
market risk
(VaR) which
did not capture
tail risk through
introduction of
concept of
stressed VaR
Basel III: Focused on
the liability side of the
balance sheet
Only major revisions to
risk weighted asset
calculations are for
counterparty credit risk
Key changes:
- Capital buffers
- Increased quantity
and quality of capital,
including stricter
deductions from CET1
- Liquidity coverage
and stable funding
requirements
- Leverage ratio
requirement
Sources: Basel Committee on Banking Supervision, Moody’s Investors Service
Basel III largely focuses on the liability side of the balance sheet, modifying requirements for both
quantity and quality of loss-absorbing capital, and introduces requirements for a leverage ratio, as well
as liquidity and stable funding requirements (a short-term 30-day liquidity coverage ratio and a 1-year
net stable funding ratio). Basel III requires more high-quality common equity Tier 1 (CET1) capital
relative to total Tier 1 and Tier 2 capital, and adds a number of capital buffers which can only be met
with CET1 capital (Exhibit 2). Finally, the Basel III framework also includes revisions to riskweighted assets (RWAs) relating to counterparty credit risk, including the treatment of “wrong-way”
risk. 3
3
5
Wrong-way risk is the risk of positive correlation between potential future exposure to a trading counterparty and the creditworthiness of the counterparty.
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BANKING
EXHIBIT 2
Basel III Requires More High-Quality CET1 Capital; New Buffers Must Also Be Met With CET1
18%
16%
16.5%
D-SIB / G-SIB Capital
Surcharges (CET1)
14%
Countercyclical Capital
Buffer (CET1)
12%
10%
8%
6%
4%
2%
Capital Conservation Buffer
(CET1)
8.0%
6.0%
4.0%
3.1%
2.0%
Lower Tier 2
Upper Tier 2
Tier 2 (T2/AT1/CET1)
Additional Tier 1 (AT1/CET1)
Common Equity
10.5%
8.0%
6.0%
4.5%
Innovative Tier 1
Non-Innovative Tier 1
13.0%
Common Equity Tier 1
(CET1)
0%
Basel II
Basel III
Source: Basel Committee on Banking Supervision
The Basel III framework introduces the concept of buffers above regulatory minimums that range
from an additional 2.5% of risk-weighted assets up to 8.5%, and even higher in some regions. The
buffers must be met with loss-absorbing CET1 capital.
»
The capital conservation buffer (CCB), which is set at 2.5%, is meant to ensure that banks build
up capital buffers above regulatory minimums outside periods of stress. Such buffers can be
drawn down as losses are incurred and rebuilt through restrictions on capital distributions.
»
The countercyclical capital buffer, which can range up to 2.5%, would be introduced in a period
of high credit growth, as a precaution against losses in a subsequent downturn. 4
»
Basel III recommends an additional loss-absorbing buffer for global and domestic systemically
important banks (G-SIB and D-SIB, respectively). The size of the buffer – which can range up to
3.5% – would depend on a bank’s cross-jurisdictional activity (only for G-SIBs), size,
interconnectedness, substitutability, and complexity. 5
»
In the European Union (EU), the Capital Requirements Directive (CRD IV) implementing Basel
III creates an additional buffer known as a systemic risk buffer, which is applied to the whole
financial sector, or subsets of it, to prevent or mitigate long-term non-cyclical systemic or
macroprudential risks. EU member states can apply systemic risk buffers of 1% – 3% for all
exposures, and up to 5% for domestic exposures, without having to seek prior approval from the
European Commission. 6 For banks subject to both a systemically important bank buffer and the
systemic risk buffer, the higher of the two will apply, but if the systemic risk buffer applies to
domestic exposures only, they will be combined.
4
Each regulator determines when a buffer is required, depending on the country’s position in the credit cycle. Banks are subject to the countercyclical buffer
requirements for all the jurisdictions in which they operate.
5
Currently, BCBS has created five buckets of additional loss-absorbency buffer requirements under Basel III, ranging from 1.0% to 3.5%, and has allocated a group of
global banks (G-SIBs) among the categories. No banks currently fall in the highest bucket, requiring 3.5% additional CET1 capital. The group of G-SIBs will be
updated annually and published by the Financial Stability Board.
6
EU member states can impose buffers higher than 5% with prior approval from the European Commission.
6
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BANKING
When buffers are breached, they progressively restrict the amount of capital distributions (dividends
and discretionary Tier 1 payments) and discretionary bonus payments that can be made out of
earnings. Basel recommends that minimum capital conservation standards are based on a combined
buffer, which is divided into quartiles to determine payout restrictions. See Exhibit 3 as an illustration
for how much in earnings banks would be allowed to distribute, based on buffer levels.
EXHIBIT 3
Capital Buffer Illustration: Systemically Important and Non-Systemically Important Banks
12%
10%
8%
6%
CET1 Minimum
2nd Buffer Quartile - 20% Distributions
4th Buffer Quartile - 60% Distributions
10.0%
9.5%
8.25%
7.0%
5.75%
4%
2%
1st Buffer Quartile - No Distributions
3rd Buffer Quartile - 40% Distributions
No Restrictions on Distributions
4.5%
5%
Combined
Buffer 2.5% Capital
Conservation
Buffer and
2.5% GSIB
Buffer
7.5%
7.0%
6.375%
5.75%
5.125%
4.5%
2.5%
Capital
Conservation
Buffer
0%
Systemically Important Bank with 10.0% CET1 Ratio Non-Systemically Important Bank with 7.5% CET1 Ratio
Source: Basel Committee on Banking Supervision
The purpose and design of Pillar 2 requirements are important to understand in the context of Basel
III buffer standards. Pillar 2, which requires an internal capital adequacy assessment process (ICAAP)
and a supervisory review and evaluation process (SREP), entails an incremental assessment of capital
for risks not sufficiently or not covered in Pillar I. Pillar 2 is divided into capital held against risks not
captured or not fully captured by the regulations (sometimes referred to as Pillar 2A and illustrated in
Exhibit 4) and risks to which a firm may become exposed, as assessed under forward-looking stress
tests, over a 3-5 year horizon (referred to as Pillar 2B). In some jurisdictions, regulatory authorities
may retain the discretion under Basel III to assess additional Pillar 2 buffer requirements for specific
banks in cases where they deem the standardized Basel III buffers are insufficient, given a firm’s risk
profile and potential exposure to losses under stressed conditions. 7
7
7
Some European regulators have developed special SREP practices to foster increased capitalization of banks – for example, the UK Prudential Regulation Authority
(PRA) conducts thorough reviews of a bank’s risk assessments and risk and capital management processes, including ICAAP. Such assessments can result in Individual
Capital Guidance (where ICG = Pillar 1 + Pillar 2A) and Pillar 2B stressed capital buffer requirements that materially increase overall capital requirements. In the US,
the Federal Reserve has mandated stress tests for the largest domestic and foreign-owned banks, and in Europe, the European Banking Authority and now the European
Central Bank have undertaken forward-looking stress tests to assess capital adequacy under a range of adverse scenarios and shocks.
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EXHIBIT 4
Pillar 2 - Examples of Risks Not Captured or Not Fully Captured under Pillar I
Quantitative
assessments
Credit Risk
Market Risk
ICAAP
Pillar 1 risks
Operational Risk
Risk not fully covered under
Pillar 1
Residual Risk
Risks not covered by Pillar
1
Securitisation Risk
Settlement Risk
Business / Strategy Risk
Pension Risk
IRRBB
Credit Concentration Risk
Liquidity Risk
Basel III Implementation: Regional Discussion
To take effect, the Basel Committee guidance, including the Basel III framework, must be transposed
into local regulatory rules, which allow for deviations from the original guidance both in terms of
requirements and timeline. The Basel Committee proposed a phased approach to the implementation
of the new framework to give banks time to comply. BCBS intended for implementations to begin in
2013, but most jurisdictions began implementation in January 2014. In some countries, regulators
have chosen to accelerate or eliminate phase-in schedules for certain aspects of the framework for some
or all institutions. Exhibit 5 shows the standardized BCBS schedule.
EXHIBIT 5
Basel III Transitional Phase-In Arrangements of New Requirements Proposed by BCBS
(All dates as of 1 January)
Basel II
2013
2014
2015
2016
2017
2018
2019
Capital
Leverage Ratio
None
Minimum CET1 Ratio
2.0%
3.5%
4.0%
4.5%
4.5%
4.5%
4.5%
4.5%
Capital Conservation Buffer
None
0%
0%
0%
0.625%
1.250%
1.875%
2.5%
Min CET1 plus CCB
2.0%
3.5%
4.0%
4.5%
5.125%
5.75%
6.375%
7.0%
Phase-in of Deductions from CET1
None
0%
20%
40%
60%
80%
100%
100%
Minimum Tier 1 Ratio
4.0%
4.5%
5.5%
6.0%
6.0%
6.0%
6.0%
6.0%
Minimum Capital Adequacy Ratio
8.0%
8.0%
8.0%
8.0%
8.0%
8.0%
8.0%
8.0%
Capital Instruments That No Longer
Qualify as Non-core T1 or T2
Capital
Countercyclical Capital Buffer
N/A
None
Parallel Run (2013-2017), Disclosures Start 1 Jan 2015
Pillar 1 (3.0%)
Phased-Out over 10-Year Horizon, Starting 2013
0%
0%
0%
0.625%
1.250%
1.875%
2.5%
60%
70%
80%
90%
100%
Liquidity
Liquidity Coverage Ratio
None
Net Stable Funding Ratio
None
Introduce
Minimum
Standard
Source: Basel Committee on Banking Supervision
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Most countries are now in the process of implementing Basel III with transition arrangements in place
until 2019, in accordance with BCBS recommendations. In the EU, the Capital Requirements
Regulation (CRR) and Capital Requirements Directive IV (CRD IV) legislation were published on 27
June 2013 and fully entered into force on 17 July 2013, with new rules applying from January 2014.
Switzerland, which is not subject to the CRR and CRD IV, began implementation of its version of
Basel III in 2013. Australia, Canada and some countries in Asia Pacific also began implementation of
Basel III in 2013. The US began implementation in 2014 for its Basel II advanced approaches banks,
and non-advanced approaches banks are required to comply one year later in 2015.
Quality of Capital and Capital Deductions
Basel III improves the quality of capital by adding new types of deductions from capital (such as deferred tax
assets that rely on future profitability) and moving existing deductions into higher quality tiers of capital,
which will be phased in by 20% a year between 2014 and 2018. 8 Basel III also recommends that
unrealized gains and losses be included in CET1 capital (they were excluded under Basel II), with
unrealized losses eligible for phase-in.
In terms of implementation, many countries in Asia and some in the Middle East have tightened the
deduction rules by eliminating a phase-in period or by modifying Basel’s threshold (limited) deductions to
full deductions, which are credit positive. In Europe, there are more cases of rules that are less stringent than
Basel’s recommendations that have been driven by financial crisis effects, including a slower phase-in period
for deferred tax asset deductions.
EXHIBIT 6
Quality of Capital - Common Equity Tier 1 and Deductions
CET1 should include
Fully deducted from CET1
Threshold Deductions (limited recognition)
» Directly issued common share capital and
related stock surplus
» Goodwill
» Minority interests of investments in common
shares of unconsolidated financial institutions
» Retained earnings
» Intangible assets
» DTAs arising from temporary differences
» Accumulated other comprehensive income
(AOCI) and other reserves, including unrealized
gains and losses
» DTAs that rely on future profits
» Minority interest
» Pension fund assets
» For internal ratings based approach banks,
excess expected loss relative to provisions
Source: Basel Committee on Banking Supervision
»
Some jurisdictions have accelerated the phase-in of deductions either for CET1 or T1 for some or
all of their banks. The UK has accelerated the CET1 deductions for its largest eight banks, such
that CET1 is “fully-loaded” (i.e. deductions are completely phased-in) as of 1 January 2014.
»
Many Asian and some Middle Eastern countries have tightened rules regarding quality of CET1
capital and required deductions, including elimination of the phase-in period for deductions, 9 or
full deduction of all deferred tax assets. 10 In addition, Malaysia and Singapore have excluded
unrealized gains related to revaluations of land and building assets or investment property. 11
8
See Appendix 1 for further details.
9
Includes Philippines, Australia, China (only minority interest phase-in allowed), New Zealand, Saudi Arabia and Kuwait.
10
Includes Australia, Singapore, Indonesia, Malaysia, Thailand, Philippines, India, and New Zealand.
11
Under certain conditions, 45% of “revaluation surpluses on land and building assets or investment property” can be included.
9
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»
In contrast, European countries have in some cases extended the phase-in period for DTA
deductions – this is credit negative as DTAs are a weak capital component – and are transitioning
the impact of including unrealized gains and losses in capital. France, Spain and Portugal all
extended the deduction phase-in period for DTAs generated before 2014 until 2024, phasing in at
10% per year. France and the Netherlands are transitioning recognition of unrecognized gains
and losses into CET1, which is permitted under CRD IV rules (Basel guidelines indicate that only
unrealized losses are subject to transitional arrangements). 12
Minimum Capital Levels
Minimum required capital levels in Europe and the Americas are generally being adopted and phased in
according to BCBS recommendations under Basel III (end-point CET1 ratio of 4.5%, Tier 1 ratio of 6%,
and total capital ratio of 8%), but minimum capital requirements in Asia, the Middle East and Africa are
significantly higher. This is likely due to the fact that firms’ capital ratios are already very high in these
regions. However, even in these regions, despite banks being well-capitalized, they may still need to replace
non-qualifying capital instruments with those that meet the eligibility requirements for CET1, T1 and T2
under Basel III.
Globally, most jurisdictions are implementing the minimum capital requirements, including CET1, Tier 1
and Total Capital, either according to the BCBS schedule or more rapidly. See Exhibit 7 for a summary
across jurisdictions.
EXHIBIT 7
Basel III Implementation Schedules by Region – Minimum Capital Requirements – CET1, Tier 1, and Total Capital Ratio (CAR)
= More strict than BCBS
= Less strict than BCBS
Americas
US US NonBCBS Advanced Advanced Bermuda
Min CET1
Min T1
4.5%
6.0%
Min CAR
Compliant by
4.5%
6.0%
4.5%
6.0%
4.5%
6.0%
Canada
Mexico
Brazil
4.5%
(1)
4.5%
4.5%
6.0%
(1)
6.0%
6.0%
(1)
8.0%
8.0% (2)
Jan-13
Oct-13
8.0%
8.0%
8.0%
8.0%
8.0%
Jan-15
Jan-15
Jan-15
Jan-15
Jan-14 (1)
Asia-Pacific
BCBS
ChinaHong Kong
Taiwan Australia Singapore Indonesia Malaysia
Thailand Philippines
India
Korea
Japan
New
Zealand
Min CET1
4.5%
5.0%
4.5%
7.0%
4.5%
6.5%
4.5%
4.5%
4.5%
6.0%
5.5%
4.5%
4.5%
4.5%
Min T1
6.0%
6.0%
6.0%
8.5%
6.0%
8.0%
6.0%
6.0%
6.0%
7.5%
7.0%
6.0%
6.0%
6.0%
Min CAR
Compliant by
8.0%
8.0%
8.0%
10.5%
8.0%
10.0%
8.0%
8.0%
8.5%
10.0%
9.0%
10.5%
8.0%
8.0%
Jan-15
Jan-13
Jan-15
Jan-19
Jan-13
Jan-15
Jan-14
Jan-15
Jan-13
Jan-14
Mar-15
Jan-19
Jan-15
Jan-13
UK (3)
France Germany
Austria
Spain
Portugal
Russia Denmark
4.5%
4.5%
4.5%
Europe
BCBS
Min CET1
4.5%
4.5%
4.5%
4.5%
NetherSwiss
lands Swiss SIB Category 2
4.5%
11.4%
6.0%
6.0%
6.0%
6.0%
14.4%
10.0%
8.0%
8.0%
8.0%
Jan-15
Jan-15
Jul-13
Jan -14
13.0%
19.0%
(4)
Jan-19
Jan-17
6.0%
6.0%
6.0%
6.0%
6.0%
6.0%
7.0%
6.0%
8.0%
8.0%
8.0%
8.0%
8.0%
8.0%
8.0%
8.0%
Jan-15
Jan-15
Jan-15
Jan-15
Jan-15
Jan-14
Jan-14
Jan-14
10
4.5%
(4)
Min CAR
12
Sweden
4.5%
10.0% (4)
Min T1
Compliant by
Norway
5.0%
4.5%
9.2%
The Netherlands and France are phasing out available-for-sale (AFS) securities unrealized gains in capital, and the Netherlands is also phasing in AFS unrealized losses at
20% per year. France is fully recognizing all unrealized losses, but has elected to exclude unrealized losses on AFS sovereign bonds until the European fair value
accounting rule IAS 39 is replaced (anticipated for 2018).
AUGUST 4, 2014
SPECIAL COMMENT: BASEL III IMPLEMENTATION IN FULL SWING: GLOBAL OVERVIEW AND CREDIT IMPLICATIONS
BANKING
Middle East and Africa
BCBS
South
Africa
Israel Pakistan
Saudi
Arabia
Kuwait Morocco
Oman
Qatar
Min CET1
4.5%
5.0%
9.0%
6.0%
4.5%
7.0%
5.5%
7.0%
6.0%
Min T1
6.0%
8.25%
9.0%
7.5%
6.0%
8.5%
6.5%
9.0%
8.0%
8.0%
9.0%
(5)
10.0%
12.0%
10.5%
9.5%
12.0%
10.0%
Jan-15
Jan-19
Jan-15
Jan-15
Jan-15
Jan-16
Jan-14
Jan-14
Jan-14
Min CAR
Compliant by
12.5%
Sources: Moody's, national regulators. Compliance date indicates when the country is compliant with its own local minimum ratio requirements.
Notes: (1) Canadian financial system is dominated by six banks classified as D-SIBs which hold around 93% of Canada’s total banking assets. The D-SIBs are required to meet “all-in” capital
targets (including the 2.5% CCB) of 7% for the CET1 ratio by the first quarter of 2013, and 8.5% for the T1 ratio and 10.5% for the Total CAR by the first quarter of 2014. Beginning on 1 January
2016, the “all-in” capital target for CET1 ratio for D-SIBs will be 8%, including a D-SIB buffer of 1%; (2) Brazil currently has an 11% total capital ratio requirement under local BCB rules – the
requirement will decrease from 11% in 2013 to 8% by 2019, at the same time as other Basel III rules (such as buffers and capital deductions) are phased-in, thus overall capital levels (including
buffers) and quality will remain strong; (3) A UK requirement of 7% CET1 by January 2014 (includes CCB) only applies to the largest 8 banks. Others are subject to the 4.5/6/8 phase-in
arrangements; (4) For SIBs, minimum CET1 includes 4.5% minimum plus a 5% CET1 buffer component (part of an 8.5% permanent buffer requirement, of which 5.5% must be met through CET1
and up to 3% can be met through high-trigger contingent capital instruments or CoCos). Tier 1 minimum includes 4.5% CET1 plus the 8.5% buffer. The minimum total capital includes a
progressive component of up to 6% composed of low trigger CoCos. The progressive component is revised each year by Swiss regulator FINMA according to the size and resolvability of the
institution; and (5) CET1 and CAR will increase to 10% and 13.5% respectively for banks with more than 20% market share.
»
Many countries in Asia and the Middle East have imposed higher minimum requirements for
CET1 (ranging from 5.0-7.0%), Tier 1 (6.5-9.0%) and Total Capital (8.5%-12%). 13 Israel and
Taiwan have incorporated the capital conservation buffer into their minimum requirements.
»
Europe and the Americas have generally adopted the BCBS levels with the exceptions of
Switzerland, Portugal, and Russia, which have implemented higher minimum requirements.
»
In Asia and the Middle East & Africa, many countries are implementing their minimum capital
requirements faster than the 2015 recommended timeline. 14 There are also examples of
accelerated implementation of minimums in Latin America and Europe.
»
Some countries require faster phase-in of minimum capital levels and buffers just for their largest
banks. Canada and the UK require that their largest, systemically important banks meet the
CET1 and CCB requirement of 7.0% CET1 capital at an accelerated pace (rather than 2019,
Canada required compliance by 2013 for D-SIBs and the UK requires it by 2014 for its largest 8
banks).
»
As illustrated in Exhibit 8, based on current capital ratios, most regions appear prepared to meet a
7% CET1 ratio, which includes a 4.5% minimum plus a 2.5% capital conservation buffer.
13
Includes South Africa, Pakistan, Morocco, Oman, Qatar, Singapore, Taiwan, Thailand, Philippines, and India.
14
Includes Thailand (2013), Philippines (2014), Saudi Arabia (2014), Morocco (2014), Oman (2014), and Qatar (2014).
11
AUGUST 4, 2014
SPECIAL COMMENT: BASEL III IMPLEMENTATION IN FULL SWING: GLOBAL OVERVIEW AND CREDIT IMPLICATIONS
BANKING
EXHIBIT 8
Tangible Common Equity / Risk-Weighted Assets For Moody’s-Rated Banks
2009 YE
16.0%
14.0%
2010 YE
2011 YE
2012 YE
2013 YE
= 7%, or BCBS Minimum CET1 plus capital conservation buffer
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
Africa
Asia Pacific
Europe
Latin America
Middle East
North America
Source: Moody’s Banking Financial Metrics.
Note: Basel II basis unless system reports under Basel I.
Pillar 2 – How Firms Will Be Required to Meet Additional Capital Requirements
While most jurisdictions are allowing the use of total capital to meet Pillar 2 add-on requirements, though
some regulators are modifying the required quality of capital to be more restrictive, requiring at least 56%
CET1, in line with the proportions of CET1, Tier 1 and T2 in the 8% total capital requirement.
However, jurisdictions have inconsistent application of Pillar 2 additional capital assessments as well as
inconsistent disclosures, which are problems that remain from Basel II. Many jurisdictions do not formally
assess additional capital for risks not captured or not fully captured under Pillar 1, or when they do, these are
often not disclosed by regulators or the banks themselves.
12
AUGUST 4, 2014
»
The UK has ruled that from 2015 onwards, instead of total capital, capital to meet Pillar 2A
requirements must be at least 56% CET1, no more than 44% AT1 and at most 25% T2. Hong
Kong and Sweden have also proposed this requirement. Australia has indicated that it expects
Pillar 2 capital to be primarily CET1.
»
While few authorities actively disclose Pillar 2 requirements (with Sweden and Denmark as
exceptions), which are generally firm specific, the imposition of requirements to meet a portion of
Pillar 2 in CET1 has resulted in some banks disclosing this portion of their overall Pillar 2 add-on
requirement in their target capital stack disclosures. This information regarding total CET1
requirements is important for investors who hold contingent capital instruments of issuers whose
securities have CET1-based triggers.
»
In Europe, the move to the ECB as the single supervisor for the region’s largest banks (with the
exception of the UK, Switzerland and others outside of the framework) may lead to greater
harmonization in the use of Pillar 2 and potentially in greater disclosure of Pillar 2 requirements
or Pillar 1 adjustments, such as risk-weight floors, all of which would be credit positive.
SPECIAL COMMENT: BASEL III IMPLEMENTATION IN FULL SWING: GLOBAL OVERVIEW AND CREDIT IMPLICATIONS
BANKING
Capital Buffers
Most regions are following the BCBS buffer phase-in schedule, which begins in 2016, although some Asian
and Middle Eastern countries are requiring faster compliance or have added the buffers into minimum
requirements.
BCBS has recommended the combined buffer (capital conservation buffer, countercyclical buffer plus other
applicable buffers) represent the capital buffer used for determining restrictions on capital distributions when
buffers are breached, but buffer definitions across jurisdictions vary. Refer to Exhibit 9 for more details on
buffer implementation.
With the introduction of explicit buffers and restrictions on distributions when buffers are breached,
regulators will intervene earlier than was the case under Basel II, posing additional risks for bond holders,
while preserving greater value, potentially resulting in lower losses given default. Issuers of AT1 instruments
will have incentives to maintain capital cushions above regulatory requirements to minimize the risk of
coupon impairment or trigger breach, a credit positive.
EXHIBIT 9
Basel III Implementation Schedules by Region – Capital Buffers
= Less Strict Than BCBS
= Stricter Than BCBS
Americas
US US NonAdvanced Advanced Bermuda
BCBS
CCB
Compliance
Canada
Mexico
Brazil
2.5%
2.5%
2.5%
2.5%
2.5%
2.5%
2.5%
Jan-19
Jan-19
Jan-19
Jan-19
Jan-13
Jan-19
Jan-19
D-SIBs
--
TBD
TBD
TBD
1%
TBD
TBD
G-SIBs
1.0-3.5%
TBD
NA
NA
NA
NA
NA
Min CET1 + CCB
7.0%
7.0%
7.0%
7.0%
7.0%
7.0%
7.0%
Min CAR + CCB
10.5%
10.5%
10.5%
10.5%
10.5%
10.5%
10.5%
BCBS
China
Hong
Kong
2.5%
2.5%
Asia-Pacific
CCB
Compliance
Taiwan Australia Singapore Indonesia Malaysia Thailand Philippines
India
Korea
Japan
New
Zealand
2.5%
In CET1
min
2.5%
2.5%
2.5%
2.5%
2.5%
2.5%
2.5%
2.5%
2.5%
2.5%
Jan-14
Mar-19
Jan-19
Jan-19
Jan-14
TBD 0.2-1.0%
TBD
TBD
TBD
NA
TBD
NA
Jan-19
Jan-19
Jan-19
Jan-19
Jan-16
Jan-19
Jan-19
Jan-19
Jan-19
D-SIB
--
1.0%
TBD
TBD
1.0%
(1)
1.0-2.5%
TBD
TBD
G-SIB
1.0-3.5%
TBD
NA
NA
NA
NA
NA
NA
NA
2.0%
NA
NA
Min CET1 + CCB
7.0%
7.5%
7.0%
7.0%
7.0%
9.0%
7.0%
7.0%
7.0%
8.5 %
8.0%
7.0%
7.0%
7.0%
Min CAR + CCB
10.5%
10.5%
10.5%
10.5%
10.5%
12.5%
10.5%
10.5%
11.0%
12.5%
11.5%
13.0%
10.5%
10.5%
BCBS
UK
France Germany
Austria
Russia Denmark
2.5%
2.5%
Europe
CCB
Compliance
2.5%
2.5%
2.5%
Spain Portugal
2.5%
NetherSwiss
lands Swiss SIB Category 2
Norway
Sweden
2.5%
2.5%
8.5% (2)
6.4% (4)
2.5%
2.5%
2.5%
2.5%
Jan-19
Jan-19
Jan-19
Jan-19
Jan-19
Jan-19
Jul-13
Jan-13
0-2.0% 1.0-3.0%
NA
NA
1.0% Up to 3%
2% (5)
3% (6)
Jan-19
Jan-19
Jan-19
Jan-19
Jan-19
Jan-19
D-SIB
--
TBD
0-2.0%
0-2.0%
0-2.0%
0-2.0%
G-SIB
1.0-3.5%
1.0-3.5%
1.0-3.5%
1.0-3.5%
1.0-3.5%
1.0-3.5%
1.0-3.5%
NA
NA
NA
NA
3%
Min CET1 + CCB
7.0%
7.0%
7.0%
7.0%
7.0%
7.0%
7.0%
7.0%
13.0%
9.2%
7.5%
7.0%
7.0%
7.0%
Min CAR + CCB
10.5%
10.5%
10.5%
10.5%
10.5%
10.5%
10.5%
10.5%
19.0% (3)
14.4%
12.5%
10.5%
10.5%
10.5%
13
AUGUST 4, 2014
3% Up to 6%(2)
SPECIAL COMMENT: BASEL III IMPLEMENTATION IN FULL SWING: GLOBAL OVERVIEW AND CREDIT IMPLICATIONS
BANKING
EXHIBIT 9
Basel III Implementation Schedules by Region – Capital Buffers
= Less Strict Than BCBS
= Stricter Than BCBS
Middle East and Africa
BCBS
South
Africa
2.5%
CCB
Compliance
Israel
Pakistan
Saudi
Arabia
Oman
Qatar
2.5%
In CET1
min
2.5%
2.5%
2.5%
2.5%
2.5%
2.5%
Jan-19
Jan-14
Jan-14
Jan-17
Jan-14
TBD 0.5-2.0%
TBD
TBD
TBD
Jan-19
Jan-19
Jan-15
Jan-19
D-SIB
--
TBD
1.0%
TBD
G-SIB
Kuwait Morocco
1.0-3.5%
NA
NA
NA
NA
NA
NA
NA
NA
Min CET1 + CCB
7.0%
8.5%
9.0% (7)
8.5%
7.0%
9.5%
8.0%
9.5%
8.5%
Min CAR + CCB
10.5%
11.5%
12.5% (8)
12.5%
12.0%
13.0%
12.0%
14.5%
12.5%
Sources: Moody's Investors Service, national regulators.
Notes: (1) D-SIB charge applied to minimum CET1 ratio of three Singapore banks; (2) Swiss SIBs are required to hold a permanent buffer (above the 4.5% CET1 minimum) of 8.5% of RWAs, of
which 5.5% must be CET1 and 3.0% can be met with high trigger CoCos. The SIB add-on is a progressive component (revised each year by FINMA) of up to 6% of RWAs composed of low trigger
CoCos; (3) Includes G-SIB buffer; (4) Swiss categories 2 through category 5 banks, the share of capital exceeding the overall capital ratio of 8% is regarded as part of the capital buffer. Swiss
regulator FINMA divides individual institutions and financial groups into five categories based on total assets, assets under management, privileged deposits and required own funds; (5) D-SIB
surcharge applies to three institutions. Norway has also implemented a systemic risk buffer of 3% which fully applied as January 2014, and a countercyclical buffer of 1% effective July 2015; (6)
Instead of D-SIB buffers, Sweden has chosen to implement a 5.0% systemic risk buffer from 1 Jan 2015, of which 3.0% of the requirement is under Pillar 1 and an extra 2.0% requirement is under
Pillar 2. These buffers apply only to the four major banks (Nordea, SEB, Swedbank, Handelsbanken); (7) 10% for banks with a market share higher than 20%; and (8) 13.5% for the largest two
banks.
15
14
»
Jurisdictions are implementing various buffer definitions to restrict capital distributions when
buffers are breached. European countries are using a combined buffer, countries in the Americas
(except the US) are using capital conservation buffers, and Asia-Pacific countries are mixed
between a combined buffer and the capital conservation buffer. The US is using a combined
buffer and, for the largest firms, capital distributions are also subject to annual stress test results.
Little data is available on this rule for countries in the Middle East and Africa.
»
Switzerland’s capital requirements for its two largest banks are super-equivalent to BCBS
standards, particularly in its capital buffers – these in effect include loss absorbing resolution
capital given the systemic importance of these firms particularly in relation to the size of the Swiss
economy. On top of a minimum CET1 requirement of 4.5% of risk-weighted assets, the two
largest Swiss banks are required to hold an 8.5% of risk-weighted assets (RWAs) buffer, of which
5.5% of RWAs must be met with CET1, and up to 3% can be met with low trigger CoCos. 15
»
Requirements for coupons on AT1 instruments to be discretionary and non-cumulative and
subject to potential non-payment when buffers are eroded poses risk to AT1 investors.
Nevertheless, issuers of these instruments will have incentives to maintain adequate capital
cushions above regulatory requirements to minimize the risk of coupon impairment or, in the case
of contingent capital instruments, trigger breaches. The required capital management discipline is
credit positive.
Switzerland’s adoption of buffer requirements is closely aligned with Basel standards, but although FINMA has far-reaching powers and discretion in this area, the
restrictions foreseen by Basel III rules on dividend payments, share buybacks and discretionary bonus payments do not apply “automatically” as the detailed quartile
system was not taken over into Swiss rules.
AUGUST 4, 2014
SPECIAL COMMENT: BASEL III IMPLEMENTATION IN FULL SWING: GLOBAL OVERVIEW AND CREDIT IMPLICATIONS
BANKING
Non-Qualifying Capital Instruments – Phase-Out Trends
According to BCBS guidelines, securities that no longer qualify as non-common equity Tier 1 capital or Tier
2 capital under Basel III have been in the phase-out process since 1 January 2013, with their aggregate
recognition capped at 90% from 1 January 2013, and the cap reducing by10% each year. 16
Most jurisdictions are adopting the Basel-recommended timeline, with a few instances of phase-out being
implemented in five years. Determining how constraining these phase-out arrangements are for a particular
institution requires a comparison of the normal amortization of existing non-qualifying securities versus the
phase-out arrangements for those with longer maturities.
For banks in regions such as Asia and Latin America, managing the non-qualifying capital phase-out process
may be their most active Basel III management actions, as they will not likely be constrained by the increased
capital and new leverage and liquidity requirements.
»
In Asia and the Middle East, some countries are shortening the phase-out period, including Qatar
(five years until 2018), the Philippines (until 2015), and New Zealand (five years until 2018). 17
Brazil – which started its phase-out period in October 2013 – has also shortened the period to five
years.
»
The US is one of the unique jurisdictions with stricter phase-out criteria than BCBS for its largest
banks, but somewhat less stringent phase-out criteria for smaller firms. For its Basel II advanced
approaches banks, non-qualifying Tier 1 securities receive 50% credit in 2014 and phase out two
years later, while non-qualifying Tier 2 securities phase out over a 10-year horizon. For nonadvanced approaches banks, non-qualifying Tier 1 securities phase out with 25% credit in 2015
and 0% in 2016, and non-qualifying Tier 2 capital instruments are permanently grandfathered. 18
»
In regions such as Asia and Latin America, managing the non-qualifying capital phase-out process
may be the most challenging Basel III actions banks need to take, as there are already high levels of
capital and liquidity in these systems. Actions will likely include managing to the phase-out
schedules of certain non-compliant capital instruments and taking advantage of AT1 and T2
issuance, while leaving common equity Tier 1 to meet minimum CET1 requirements and the
Basel III buffer requirements.
Total End-Point Risk-Based Capital Requirements – Summary 19
Exhibits 10 through 13 provide a visual summary of end-point capital requirements across regions, which
can range from 2014 to 2019 in terms of final implementation dates. Minimum required capital levels in
Europe and the Americas are generally being adopted in line with BCBS recommendations, but minimum
capital requirements in Asia, the Middle East and Africa are significantly higher. In 2014, many regulators
will be determining D-SIB buffer levels for banks in their systems. Countercyclical buffers have not yet been
imposed, but could add up to 3% to these requirements.
While Basel III should improve the ability of banks to absorb losses, and reduce their need to revert to
deleveraging in a downturn, banks in regions most affected by the global financial crisis are experiencing low
profitability and continued reliance on monetary authority funding; making their transition to the Basel III
end-point requirements more challenging.
16
Qualifying new capital securities under Basel III, other than common equity, must have explicit terms that impose losses on investors at the point of non-viability and
must have no incentive to be redeemed prior to maturity (e.g. step-up). Coupons/dividends on AT1 securities must be discretionary and non-cumulative.
17
In the Philippines, all capital instruments issued before 2011 are derecognized as capital. Instruments issued after 1 January 2011 will be fully recognized until end-2015,
after which they will also be derecognized.
18
For non-advanced approaches US banks with assets less than $15 billion, non-qualifying Tier 1 securities are permanently grandfathered.
19
These charts do not include the countercyclical buffer nor Pillar 2 assessments that are incremental to Pillar 1 minimum total capital requirements.
15
AUGUST 4, 2014
SPECIAL COMMENT: BASEL III IMPLEMENTATION IN FULL SWING: GLOBAL OVERVIEW AND CREDIT IMPLICATIONS
BANKING
EXHIBIT 10
Basel III End-Point Capital Requirements – Americas
Minimum CET1
AT1
T2
Capital Conservation Buffer D-SIB / G-SIB Buffer
14%
12%
3.5%
10%
1.0%
2.5%
2.5%
2.5%
2.5%
2.5%
2.5%
2.5%
2.0%
2.0%
2.0%
2.0%
2.0%
2.0%
2.0%
1.5%
1.5%
1.5%
1.5%
1.5%
1.5%
1.5%
4.5%
4.5%
4.5%
4.5%
4.5%
4.5%
4.5%
BCBS
US (Advanced)
US (Non-Advanced)
Bermuda
Canada
Mexico
Brazil
8%
6%
4%
2%
0%
Sources: Moody's Investors Service, national regulators
Note that the D-SIB/G-SIB buffers represent the top end of the range.
EXHIBIT 11
Basel III End-Point Capital Requirements – Asia-Pacific
Minimum CET1
AT1
T2
Capital Conservation Buffer
D-SIB / G-SIB Buffer
16%
14%
12%
10%
8%
6%
2.0%
3.5%
2.5%
1.0%
2.5%
1.0%
2.0%
2.5%
2.0%
2.0%
2.0%
1.5%
1.0%
1.5%
4.5%
5.0%
4.5%
BCBS
China
Hong Kong
1.5%
2.0%
2.5%
2.0%
1.5%
1.5%
4%
2%
2.5%
2.5%
2.5%
7.0%
4.5%
6.5%
2.5%
2.5%
2.5%
2.0%
2.0%
2.5%
1.5%
1.5%
1.5%
4.5%
4.5%
4.5%
2.5%
1.5%
1.0%
2.0%
1.5%
6.0%
2.5%
2.5%
5.5%
4.5%
2.5%
2.5%
2.0%
2.0%
1.5%
1.5%
1.5%
4.5%
4.5%
4.5%
Korea
Japan
New
Zealand
0%
Taiwan
Australia Singapore Indonesia
Malaysia
Thailand Philippines
India
Sources: Moody's Investors Service, national regulators
Note that the D-SIB/G-SIB buffers represent the top end of the range.
EXHIBIT 12
Basel III End-Point Capital Requirements – Europe
20%
Minimum CET1
AT1
T2
Capital Conservation Buffer
D-SIB / G-SIB Buffer
18%
16%
6.0%
14%
12%
10%
8%
6%
4%
2%
3.5%
3.5%
3.5%
3.5%
3.5%
3.0%
2.5%
2.5%
2.5%
2.5%
2.5%
2.5%
2.0%
1.5%
2.0%
1.5%
2.0%
1.5%
2.0%
1.5%
2.0%
1.5%
2.0%
1.5%
4.5%
4.5%
4.5%
4.5%
4.5%
4.5%
BCBS
UK
France
Germany
Spain
3.0%
3.0%
2.2%
3.0%
2.0%
3.0%
2.5%
2.5%
2.5%
1.0%
2.0%
1.5%
2.0%
1.5%
2.0%
1.5%
5.0%
4.5%
4.5%
4.5%
Russia
Denmark
Norway
Sweden
2.5%
4.0%
10.0%
9.2%
0%
Netherlands Swiss SIB
Swiss
Category 2
Sources: Moody's Investors Service, national regulators
Notes: The D-SIB/G-SIB buffers represent the top end of the range; Sweden’s systemic risk buffer (which applies to the four major banks) of 5.0%
includes a Pillar 1 requirement of 3% and a Pillar 2 requirement of 2%.
16
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BANKING
EXHIBIT 13
Basel III End-Point Capital Requirements – Middle East and Africa
Minimum CET1
AT1
T2
Capital Conservation Buffer
D-SIB / G-SIB Buffer
16%
14%
12%
10%
1.0%
3.5%
4.5%
2.5%
2.0%
0.8%
2.5%
3.3%
1.5%
1.5%
2.5%
6.0%
4.5%
5.0%
BCBS
South Africa
2.5%
3.0%
3.0%
2.0%
2.0%
1.5%
2.5%
2.0%
2.0%
1.0%
1.5%
9.0%
2.5%
2.5%
3.5%
4%
2%
2.5%
2.5%
8%
6%
2.0%
7.0%
4.5%
5.5%
7.0%
6.0%
0%
Israel
Pakistan
Saudi Arabia
Kuwait
Morocco
Oman
Qatar
Sources: Moody's Investors Service, national regulators
Note that the D-SIB/G-SIB buffers represent the top end of the range.
17
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BANKING
Leverage Ratio
The leverage ratio requirement is in early stages of rulemaking in most countries, as many countries are
waiting for BCBS to finalize definitions and calibrations before implementing rules. The BCBS leverage
ratio definition includes both on- and off-balance-sheet exposures in the denominator and Tier 1
transitional capital in the numerator. 20 Most jurisdictions that have rules or proposals are in line with or
stricter than Basel standards. Exhibit 14 shows the implementation of the leverage ratio across jurisdictions.
Despite its early stages, the rule is already a binding constraint, impacting the strategies of many banks due
to market pressure. To help meet the leverage ratio requirement, banks could increase their risk profiles to
boost weak profitability or reduce holdings of high quality liquid assets, which could be credit negative. On
the other hand, how banks seek to address the Basel III leverage constraints could be credit positive if they
reduce complexity and risk or dispose of underperforming assets.
Banks that are leverage constrained are highly likely to issue AT1 securities to meet this requirement.
However, it is possible that some regulators may decide to restrict the portion of Tier 1 that can be comprised
of AT1 for purposes of calculating the leverage ratio.
EXHIBIT 14
Leverage Ratio Implementation
= Less Strict Than BCBS
= Stricter Than BCBS
Americas
BCBS US (Adv)
Pillar 1 Requirement
Minimum Ratio
2018
US (NonAdv) Bermuda
Canada
Mexico
Brazil
2018
2015
2018
2018
2018
2018
3%
3% (5%
G-SIB)
4%
(GAAP
ratio)
7%
3%
3%
TBD
BCBS
UK (1)
France Germany
Austria
Spain
Portugal
2018
2014
2018
2018
2018
Europe
Pillar 1 Requirement
Minimum Ratio
3%
3%
2018
3%
2018
3%
3%
3%
Netherlands Swiss SIB
Russia Denmark Norway
Sweden
2018
2013
2018
2018
2018
2018
3%
(2)
TBD
3%
3%
3%
India
Korea
Japan
3%
>4%
Asia -Pacific
BCBS
Pillar 1 Requirement
Minimum Ratio
China
Hong
Kong
Taiwan Australia Singapore Indonesia Malaysia
Thailand
Philippines
New
Zealand
2018
2013
TBD
2018
2018
TBD
2018
TBD
2018
TBD
2018
2018
TBD
NA (4)
3%
4%
3%
3%
3% (3)
TBD
3%
TBD
3%
TBD
4.5%
3%
TBD
NA
Israel Pakistan
Saudi
Arabia
Kuwait
Middle East and Africa
BCBS
Pillar 1 Requirement
Minimum Ratio
South
Africa
Oman Morocco
Qatar
2018
2018
TBD
TBD
2018
TBD
TBD
TBD
TBD
3%
4%
TBD
3%
3%
TBD
TBD
TBD
TBD
Sources: Moody's, national regulators.
Notes: (1) Capital numerator is fully-loaded CET1 and transitional Tier 1 . Presently only applies to the largest eight banks. A consultation paper published in July 2014 was inconclusive as to whether all
banks will be subject to the leverage framework – the outcomes will be announced in November 2014; (2) Uses total capital in the numerator, including contingent capital instruments; (3) Fullyloaded Tier 1 – no transitional measures; and (4) New Zealand does not intend to implement the leverage ratio requirement.
20
18
See “Basel Leverage Ratio a Positive for Bank Bondholders; Redefines Capital and Liquidity Management,” published in April 2014, for details on the leverage ratio rule.
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BANKING
»
There are few examples of early implementation of the leverage requirement except for the UK,
Switzerland and China. The UK introduced a 3% leverage requirement based on fully-loaded
CET1 and transitional Tier 1 for its largest banks as of 1 January 2014. It is presently consulting
on a broader leverage framework potentially applicable to all UK banks and building societies.
The Swiss regulations, which were in force as of January 2013, impose a required ratio of at least
4% for the systemically important banks, namely Credit Suisse and UBS, and use transitional total
capital as the numerator. 21
»
Some jurisdictions – including the US and Switzerland – have proposed higher leverage ratio
minimums for systemically important banks. In many jurisdictions, there are increasing political
pressures to consider a leverage constraint in excess of 3%, particularly for the largest banks. 22
»
A few emerging market jurisdictions have also imposed a higher requirement than the 3% BCBSproposed minimum. Examples include India (4.5%), China (4%), and South Africa (4%). In
some cases, banks in these countries already have low levels of leverage.
»
Countries that have limited the application of the leverage ratio rule include the US for its smaller
and less complex banks, and New Zealand. In the US, non-advanced approaches banks will not
be subject to the Basel III leverage ratio requirement, but rather just a balance-sheet leverage ratio.
New Zealand also has said that it will not be implementing a leverage ratio requirement.
»
Judging from current balance-sheet leverage ratios (Exhibit 15), Basel III leverage ratio compliance
is likely to be more difficult for certain regions such as Europe, where Basel II implementation
resulted in the banks’ focusing on the optimization of returns on risk-adjusted capital and a
balance-sheet leverage requirement was lacking. Regional banks in Africa, Latin America, and the
Middle East exhibit low balance-sheet leverage. US banks generally have lower leverage than
European peers, in part due to greater use of securitization to move assets off their balance sheets.
EXHIBIT 15
Tier 1 Leverage Ratios (Tier 1 / Average Assets)
2009 YE
2010 YE
2011 YE
2012 YE
2013 YE
12.0%
10.0%
Indicates 3% BCBS Tier 1 Leverage
R i
8.0%
6.0%
4.0%
2.0%
0.0%
Africa
Asia Pacific
Europe
Latin America
Middle East
North America
Source: Moody’s Banking Financial Metrics.
Note: Basel II basis unless system reports under Basel I.
21
For Swiss systemically relevant banks CS and UBS, the leverage ratio requirement is set at a level of 24% of the minimum Swiss risk-based total capital ratio
requirement, which consists of a capital base (4.5% CET1 capital of RWA), buffer capital (8.5% of RWA composed of 5.5% CET1 and up to 3% in high-trigger lossabsorbing capital) and a progressive component (which is assessed annually by FINMA and should be fulfilled with low-trigger loss-absorbing capital).
22
The US regulators’ rule for the Supplementary Leverage Ratio requires 3% Tier 1 capital for its Basel II advanced approaches banks, but imposes additional buffer
requirements for the eight US G-SIBs, with a 5% requirement for the holding company and 6% for the lead bank subsidiary. In Switzerland, the leverage ratio
requirements for Credit Suisse and UBS, the country’s two systemically relevant banks, include a progressive component assessed on the size of their leverage ratio
exposures and the market shares of the firms’ domestic systemically relevant businesses. Their current leverage ratio requirements are 4.0% and 4.4% respectively.
19
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BANKING
Liquidity Coverage Ratio
Basel III introduces the Liquidity Coverage Ratio (LCR), a short-term liquidity standard to ensure that
banks have sufficiently high levels of liquid assets to overcome an urgent stress scenario lasting for 30 days. 23
The LCR minimum standard will be put in place in January 2015, with 100% compliance required by
January 2019.
Liquidity coverage ratio rules remain in early stages, with many parts of the rules still undetermined,
including categorization of assets, calibration of required levels, and phase-in timelines. Nevertheless, we
already see examples of stricter LCR rules than BCBS, or a faster phase-in, in both developed and emerging
countries (Exhibit 16).
Excess liquidity is allowing some jurisdictions to phase-in requirements early, such as in Asia and North
America, trapping excess liquidity in the systems, a credit positive. Earlier or stricter implementation avoids
regulatory back-stepping, particularly where liquidity requirements were already strict, such as in the UK
and the US.
EXHIBIT 16
Liquidity Coverage Ratio Implementation
= Stricter Than BCBS
= Less Strict Than BCBS
Americas
US
BCBS Advanced
Introduction
Initial Phase-In %
100% Compliance
US NonAdvanced Bermuda
Canada
Mexico
Brazil
Jan-15
Jan-15
Jan-15
Jan-15
Jan-15
Jan-15
Jan-15
60%
80%
80%
60%
100%
60%
60%
Jan-19
Jan-17
Jan-17
Jan-19
Jan-15
Jan-19
Jan-19
BCBS
UK
France Germany
Austria
Spain
Portugal
Netherlands
Swiss SIB
Russia
Jan-15
Jan-14
Jan-15
Jan-15
Jan-15
Jan-15
Jan-15
Jan-15
Jan-15
Jan-15
Jan-15
Jan-13
TBD
60%
(1)
60%
(1)
100%
Jan-19
(1)
Jan-19
(1)
Jan-13
Europe
Introduction
Initial Phase-In %
100% Compliance
60%
80%
60%
Jan-18
Jan-15
60%
Jan-19
Jan-19
Jan-18
BCBS
China
Hong
Kong
Jan-15
Jan-14
Jan-15
TBD
60%
Jan-18
60%
Jan-18
60%
Jan-18
60%
100%
Jan-18
Jan-15
TBD
Denmark Norway
Sweden
Asia-Pacific
Introduction
Initial Phase-In %
100% Compliance
Taiwan Australia
Singapore Indonesia Malaysia Thailand
Philippines
India
Korea
Japan
New
Zealand
Jan-15
TBD
TBD
Jan-15 Jan-15
TBD
TBD
TBD
TBD Jan-15
60%
60%
60%
TBD
100%
60%
TBD
TBD
TBD
TBD
60%
60%
TBD
TBD
Jan-19
Jan-19
Jan-19
TBD
Jan-15 Jan-19
TBD
TBD
TBD
TBD Jan-19
Jan-19
TBD
TBD
BCBS
South
Africa
Israel Pakistan
Saudi
Arabia Kuwait
Oman Morocco
Qatar
Jan-15
Jan-15
Jan-15
TBD
Jan-15
TBD
TBD
Jun-15
TBD
60%
60%
60%
TBD
100%
TBD
TBD
60%
TBD
Jan-19
Jan-19
Jan-19
TBD
Jan-15
TBD
TBD
Jan-19
TBD
Asia-Pacific
Introduction
Initial Phase-In %
100% Compliance
Sources: Moody's, national regulators
Notes: (1) For systemically important institutions, 100% compliance is required from January 2015.
23
20
The ratio of high quality liquid assets to total net liquidity outflows over a 30-day period needs to be equal or greater than 1.
AUGUST 4, 2014
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BANKING
»
BCBS has recommended that national regulators introduce the liquidity coverage ratio in January
2015, beginning at a 60% phase-in, increasing by 10% a year to reach the full 100% requirement
in 2019. Most countries are proposing the same introduction date and phase-in arrangements.
Exceptions include Sweden (which introduced the LCR requirement at 100% in 2014), China
(2014), and the UK, which aligned its own liquidity regime to the LCR requirement in 2014, with
an accelerated 80% initial required ratio. 24
»
Other jurisdictions have accelerated the phase-in schedule either: (1) with an earlier end-date for
compliance (European countries subject to CRD IV rules); or (2) with an earlier compliance enddate and a higher initial phase-in percentage (the US, Canada, Australia, Saudi Arabia, Switzerland
for SIBs, Denmark, and Norway).
»
In some countries with accelerated liquidity requirements, including the US and Canada, banks
had made significant progress in establishing high levels of high-quality liquid assets, often due to
regulatory pressure.
»
Many countries in Asia-Pacific and the Middle East have not yet drafted any liquidity rules.
»
Exhibit 17 indicates that developed market regions, especially North America, demonstrate strong
levels of liquid assets when compared to less developed markets, such as Africa and the Middle East,
indicating a potentially easier transition to meeting the LCR requirements. However, as can be
seen in Exhibit 18, banks in most jurisdictions – with the exception of Europe – are mainly funded
by deposits, which tend to be more stable, particularly retail deposits. Such liabilities are subject to
lower stressed outflow assumptions in the LCR denominator.
EXHIBIT 17
EXHIBIT 18
Liquid Assets / Total Assets
2009 YE
2010 YE
(Market Funds – Liquid Assets) / Total Assets
2011 YE
2012 YE
2013 YE
50.0%
2009 YE
15.0%
45.0%
10.0%
40.0%
2012 YE
2013 YE
0.0%
30.0%
25.0%
-5.0%
20.0%
-10.0%
15.0%
-15.0%
10.0%
-20.0%
5.0%
0.0%
-25.0%
Africa
Asia
Pacific
Europe
Latin
Middle North
America East
America
Source: Moody’s -rated banks; Banking Financial Metrics.
21
2011 YE
5.0%
35.0%
24
2010 YE
Africa
Asia
Pacific
Europe
Latin
Middle North
America East America
Source: Moody’s-rated banks; Banking Financial Metrics.
Note: Market funds consist of all long- and short-term debt, including
amounts due to other banks. This ratio captures the degree to
which a bank relies on non-core funding (i.e., funding other than
customer deposits) to support its asset base.
The UK had introduced an interim liquidity regime prior to Basel III in response to the fact that a contributing factor to the financial crisis was that banks had
inadequate liquidity coverage for short-term wholesale sensitive liabilities.
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BANKING
Basel III Disclosures
The differing implementation plans and inconsistent disclosures by banks of Basel III compliance can make
comparability across systems difficult.
25
22
»
Given the different implementation schedules highlighted in this report, it is important for users
of bank financial disclosures to read the fine print. Transitional capital and leverage ratios are not
directly comparable without taking account of acceleration of “super equivalent” local
requirements. Banks that issue AT1 with CET1 triggers may be subject to transitional CET1
deductions, whereas others are already subject to a more stringent end-state definition of CET1.
»
Bank disclosures of Basel III compliance are inconsistent, reflecting either different local
requirements, or what they choose to disclose. 25 In addition, some banks are voluntarily
disclosing ratios and information ahead of time, such as LCR or, in the case of the UK, the CET1
component of Pillar 2A requirements, without being formally required to do so. Meanwhile, local
bank peers may choose not to disclose the same information.
For instance, banks subject to a transitional definition of CET1 will disclose the current level of CET1 based on phased-in deductions and may or may not disclose their
end-state fully-loaded CET1 ratio, whereas banks already subject to an end-state definition will only disclose the latter.
AUGUST 4, 2014
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BANKING
Appendix 1 – Basel III and the Financial Crisis
The Basel Committee continues to produce new guidance to address deficiencies of previous
frameworks. Such deficiencies became more apparent as a result of the global financial crisis in 200809. Below, we summarize the key issues that Basel III has been designed to address in light of lessons
learned from the financial crisis.
The crisis demonstrated that firms did not hold, nor were they required to hold, sufficient quantity or quality of
loss-absorbing capital. For example, the CET1 requirement was only 2% of RWAs and the Tier 1 requirement
was 4% of 8% total minimum capital. Coupled with the lack of leverage constraints in most jurisdictions, banks
were able to build up significant amounts and concentrations of risk when the pre-crisis market was at its peak.
Consequently, they found themselves with insufficient loss-absorption capacity when markets collapsed.
»
Basel III requires banks to gradually move towards requirements for more and better-quality
regulatory capital (more loss-absorbent) with stricter deductions from capital and the introduction
of standardized and firm-specific loss-absorbing capital buffers. Basel III makes a distinction
between going concern high-quality common equity Tier 1 capital and other capital instruments
that qualify for Additional Tier 1 versus gone concern Tier 2 capital. Eligibility criteria for
qualifying capital instruments have been enhanced, including the requirement for coupons to be
discretionary and subject to non-payment on a non-cumulative basis. Instruments that no longer
qualify as non-core Tier 1 capital or Tier 2 capital – for example, trust preferred instruments – will
be phased out over a 10-year horizon, beginning in 2013, at 20% a year.
»
Hybrid instruments proved weak in absorbing losses during the financial crisis and no longer
count as regulatory capital except for certain contingent capital instruments, which include a
mandatory full or partial write-down or conversion into equity feature. Qualifying new capital
securities under Basel III, other than common equity, must have explicit terms that impose losses
on investors when a bank is deemed by the regulator to have reached the point of non-viability or
when a CET1 trigger is breached, whichever comes first, and must have no incentive to be
redeemed prior to maturity (e.g. step-up). 26
»
Basel III changes the overall proportion of the most loss-absorbing capital within the 8% total
capital requirement versus the minimal requirements under Basel II. Going forward, 4.5% or
56% of the 8% requirement must be met with CET1 capital, excluding CET1 buffers and CET1
portions of Pillar 2A requirements (previously, only 25% of the total capital requirement had to
be met with common equity). 27
»
Basel III simplifies capital levels and requirements compared to Basel II, as illustrated in Exhibit
19.
26
Tier 1 instruments must be perpetual with non-cumulative discretionary coupons, and include features enabling them to be fully or partially written down or converted
into equity at the earlier of either: (1) when a pre-determined capital trigger is breached (the BCBS proposes a numerical trigger of a CET1 ratio below 5.125%); or (2)
when the bank is deemed to be no longer viable without the PONV securities absorbing losses or without public money being injected. Tier 2 instruments must also be
loss absorbing through features enabling them to be fully or partially written down or converted into equity at PONV. In the last five years prior to maturity, Tier 2
instruments will amortize at 20% per year.
27
In addition to the Basel III going and gone concern capital requirements, steps to enable the orderly resolution of banks and maintenance of key operations, if they fail,
will add an additional layer of loss-absorbing “bail-in” capital at the level of holding and potentially operating companies, most likely reducing loss in the event of failure.
23
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BANKING
EXHIBIT 19
Simplification of Capital Requirements from Basel II to Basel III
Tier 1 Capital
Tier 2 capital
Gone concern capital
Tier 1 Capital
Tier 2 capital
8%
Lower Tier 3
(not limited)
Tier 2
2%
Upper Tier 3
8%
Lower Tier 2
(max 50% of T1)
4%
Tier 3
AT1 Non- core
6%
Innovative
(max 15% of T1)
Core
4.5%
4%
Upper Tier 2
Non-innovative
2%
Core
(at least 50% of T1)
Going concern capital
Basel III
Basel II
Source: Basel Committee on Banking Supervision
Deductions from capital were allowed to be taken from higher tiers of capital rather than core capital.
»
Basel III requires that more deductions be taken fully from CET1, making this highest quality
capital even more scarce. BCBS Basel II guidelines required 50% of deductions from Tier 1 and
50% from total capital, but under Basel III, most deductions will be taken fully from CET1. The
shift from deducting these items from CET1 will be phased in gradually by 20% a year, between
2014 and 2018. Key items fully deducted from CET1 include goodwill and intangible assets,
deferred tax assets that rely on future profitability, pension deficits, and the excess of expected loss
relative to provisions for banks on the internal ratings based approaches for credit risk. Some
items are considered “threshold deductions,” and can only be included up to a certain proportion
of common equity. These items include DTAs arising from temporary differences, mortgageservicing rights, and investments in unconsolidated financial institutions. 28
Some capital components such as deferred tax assets (DTAs) were not realizable in resolution.
»
Basel III requires all DTAs that rely on future profitability to be deducted from capital. Deferred
tax assets that arise from temporary differences such as loan loss provisions can be included in
capital, but are limited to 10% of CET1 capital.
Certain risks were not captured in RWA calculations – particularly certain market risks and wrong-way risk in
counterparty credit risk.
»
28
24
Basel 2.5, introduced in 2011, addressed market risks that were not captured by the previous
market risk amendments, such as stressed VAR and credit migration risk on bond holdings. Basel
III modified the counterparty credit risk capital requirement of Basel II, enhancing the default risk
capital requirements for counterparty credit exposures arising from over-the-counter (OTC)
derivatives, repo and securities financing transactions, and introduced a new credit valuation
adjustment (CVA) capital charge, requiring banks to measure and capitalize the potential mark-to-
These items can each receive limited recognition in CET1 of up to 10% of the bank’s common equity and collectively cannot exceed 15% of CET1.
AUGUST 4, 2014
SPECIAL COMMENT: BASEL III IMPLEMENTATION IN FULL SWING: GLOBAL OVERVIEW AND CREDIT IMPLICATIONS
BANKING
market losses associated with OTC derivatives counterparty quality deterioration. The reforms
also enhanced counterparty credit risk management standards in a number of areas, including the
treatment of wrong-way risk (the risk of positive correlation between potential future exposure to
a derivative counterparty and the creditworthiness of the counterparty).
»
Both the Basel 2.5 and Basel III amendments in these areas have made a material difference to the
overall cost of many capital markets activities, resulting in full reviews of business models, the
exiting of many business lines, and efforts to reduce capital charges for the remaining activities
through measures such as trade compression, netting agreements and shortening of the maturities
of transactions.
Firms were over levered, particularly where there were no leverage constraints, as they had been focusing on
optimizing return on RWAs. This build-up of leverage had negative systemic consequences and resulted in greater
deleveraging, as capital was eroded by losses, exacerbating the effects of the downturn on the real economy.
»
Basel III formally introduces a leverage requirement, including both on- and off-balance-sheet
exposures, as a backstop to the risk-weighted capital requirements, a requirement that only a few
jurisdictions had before the crisis. As measurement of risk-weighted assets is based on a prediction
of the likely future course of events, involving a high degree of judgment and potential model
error, the leverage ratio is meant to provide a backstop, in cases where the risk and liquidity
inherent in assets and contingent off-balance-sheet liabilities are underestimated in risk-adjusted
capital calculations.
»
Underestimation of asset risk may also be addressed in the future by the imposition of risk-weight
floors on low-risk assets, which attract minimal RWAs when internal models are used. Although
not part of the Basel III framework, further enhancements of the capital framework along these
lines are being discussed and have already been imposed by some jurisdictions.
Liquidity buffers were inadequate both in terms of quantity and quality and there was an over-reliance on shortterm wholesale liabilities funding long-term assets.
»
Basel III introduces a short-term liquidity coverage ratio, requiring buffers against short-term
liquidity disruptions, and a longer-term net stable funding requirement, to encourage greater use
of more stable funding sources and to increase the duration of funding profiles to limit risks from
loss of market access. As a result, banks have significantly increased their liquidity buffers, reduced
their reliance on short-term wholesale funding, and reduced funding gaps by increasingly funding
loan books with deposits. They have also increased the duration of their medium- and long-term
funding profiles.
Basel I and II were pro-cyclical in that capital requirements for firms were the highest at the same time as when
losses were peaking and the ability to accrete capital was at its weakest.
25
AUGUST 4, 2014
»
Basel III addresses pro-cyclicality by adding a countercyclical buffer capacity for regulators to
enact when they believe that a banking system or particular asset sector is overheating. Such a
move was designed to dampen the buildup of credit and preserve capital in cyclical upturns,
helping to reduce the need to deleverage when downturns occur.
»
Additional proposals being considered by some authorities, including the UK, for a
complementary time varying leverage buffer will have a similar effect.
SPECIAL COMMENT: BASEL III IMPLEMENTATION IN FULL SWING: GLOBAL OVERVIEW AND CREDIT IMPLICATIONS
BANKING
Firms continued to pay capital distributions to shareholders and employees at the same time as capital levels were
receding, potentially reaching undercapitalized levels.
»
Basel III introduces capital conservation and additional systemically important institution buffer
requirements, composed of common equity Tier 1 capital, which entail predefined progressive
restrictions on distributable items (dividends, coupons and discretionary bonuses) when capital
buffers are breached, as well as requirements for firms to agree with their regulator on the actions
they will take to restore the buffers. Pre-crisis, many firms held minimal or no capital buffers
above minimum own funds requirements.
Basel III attempts to address the issues of bank interconnectedness, systemic risk, and banks that are “too big to
fail.”
26
AUGUST 4, 2014
»
Basel III adds progressive capital surcharges (D-SIB and G-SIB buffers) for the largest, most
interconnected domestic and global financial firms whose failure pose the greatest risk to financial
stability. Basel III also recognizes contingent capital, which can serve to absorb losses on a going
concern basis, as regulatory capital. The D-SIB capital surcharge will depend on a D-SIB’s
importance to a domestic banking system, while the G-SIB amount will be a function of a bank’s
cross-jurisdictional activity, size, interconnectedness, substitutability, and complexity, as
determined annually by the Financial Stability Board.
»
Further efforts to reduce interconnectedness between financial institutions have been introduced
through Basel III and other legislation, which together require mandatory clearing through central
clearing counterparties of certain types of OTC derivative transactions, and impose higher risk
weights for OTC derivatives not cleared through a central counterparty.
SPECIAL COMMENT: BASEL III IMPLEMENTATION IN FULL SWING: GLOBAL OVERVIEW AND CREDIT IMPLICATIONS
BANKING
Appendix 2 – How Do We Rate Basel III Securities?
EXHIBIT 20
Moody’s Rating Guidelines for Junior Bank Obligations
Security Type
Regulatory Treatment Notching Ranges
Standard
Notching
Comments
“Plain Vanilla” Subordinated Lower Tier 2 or Tier 2 Adj BCA -1 or -2 notches
Debt
(May or may not be subject to
a statutory bail-in regime)
Adj BCA -1
notch
If severity is greater than anticipated, we would position the
rating at Adj BCA - 2 notches.
If a country is believed to have the ability to support this
security class and we believe it continues to have a strong
willingness to do so, then the rating may be positioned
above the Adj BCA, up to the Bank Deposit Rating - 1 notch.
Junior Subordinated Debt
Upper Tier 2
Adj BCA -1 or -2 notches
Adj BCA -1
notch
If coupon suspension is non-cumulative, then Adj BCA - 2
notches.
If no systemic support is given to the “plain vanilla”
subordinated debt rating, then Adj BCA - 2 notches.
Junior subordinated debt with restricted deferral options
may be rated at Adj BCA - 1 notch.
Contractual Non-Viability
Subordinated Debt
Tier 2
Adj BCA - 1 to - 2 notches
Adj BCA - 2
notches
Relative to “plain vanilla” subordinated debt with normal
loss severity, one notch is added to reflect the potential
uncertainty associated with timing to loss absorption.
If we believe that regulators in a given jurisdiction are highly
unlikely to differentiate between contractual non-viability
securities and legacy securities, we would position NV
rating at Adj BCA – 1 notch.
Preferred Securities
Tier 1
Adj BCA - 2 to - 4 notches
Adj BCA - 3
notches
If coupon skip is cumulative, then Adj BCA - 2 notches.
If coupon skip is non-cumulative with a net loss trigger,
then Adj BCA - 4 notches, not to exceed Baa1.
Contractual Non-Viability
Preferred Securities
Additional Tier 1
N/A
Adj BCA - 3
notches
The notching for these securities is the same as for
traditional non-cumulative preferred securities.
"High Trigger" Subordinated
Debt or Preferred Securities
Tier 2 or Additional
Tier 1
N/A
N/A
Use model to determine probability of a trigger breach,
bank-wide failure and loss severity, if either or both of these
events happen. Coupon suspension risk, if applicable, is
captured in the notching for the related non-viability
security rating and, for "high trigger" securities, we rate to
the lower of the model-implied rating and the non-viability
security rating.
Source: Moody’s Investors Service rating methodology, Global Banks (July 2014), https://www.moodys.com/research/Global-Banks--PBC_172997
Note: In most cases, the ratings for securities are linked to the bank’s standalone intrinsic strength, as expressed through its adjusted baseline credit assessment (Adj BCA, which starts with the
BCA and adds parental support, if applicable).
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BANKING
Moody’s Related Research
Special Comment:
»
Basel III Securities in Asia – A Country Comparison, July 2014 (172394)
»
FAQ on key credit issues regarding Basel III subordinated debt issued by Russian banks, May
2014 (165936)
»
Review of Basel III Implementation in ASEAN and India (Presentation), April 2014 (166799)
»
Basel III Capital Securities in Australia: Answers to Frequently Asked Questions, April 2014
(166829)
»
Non-Viability Subordinated Debt in Japan: Answers to Frequently Asked Questions, April 2014
(166365)
»
Basel III Capital Securities in Singapore: FAQ (Presentation), March 2014 (166691)
»
Australian regulator maintains conservative approach with final Basel III liquidity rules, January
2014 (162206)
»
Limited GDP benefits of Basel III expected for developing economies, September 2013 (158351)
»
Russian Banks: Basel III Rules Will Improve Quality of Capital, July 2013 (156090)
»
Indian Banks’ Stricter Basel III Standards Are Credit Positive, May 2012 (141900)
Sector Comment:
»
Brazil’s Banks Get High Grades on Basel III Adoption, a Credit Positive, December 2013
(161798)
»
Australian Banks Benefit from Regulator’s Conservative Liquidity Standards, May 2013 (153862)
»
China’s New Basel III Capital Guidance Is Credit Positive for Chinese Banks, June 2012
(143240)
To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of
this report and that more recent reports may be available. All research may not be available to all clients.
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SPECIAL COMMENT: BASEL III IMPLEMENTATION IN FULL SWING: GLOBAL OVERVIEW AND CREDIT IMPLICATIONS
BANKING
Report Number: 170763
Authors
Meredith Roscoe
Laurie Mayers
Production Associate
Vinod Babu Muniappan
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