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Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Copyright (c) 2006 Standard.

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Presentation on theme: "Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Copyright (c) 2006 Standard."— Presentation transcript:

1 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Copyright (c) 2006 Standard & Poors, a division of The McGraw-Hill Companies, Inc. All rights reserved. Basel II and Standard & Poors Approach to Financial Institutions Capital Adequacy Craig Bennett May 20, 2008

2 2 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Capital ratios have been the focus of much attention, both internal and external, over recent months, Chairman Royal Bank of Scotland Group, Tom McKillop. Britains second biggest lender announcing the sale of £12 billion shares to boost capital depleted by subprime write-downs and joint acquisition of ABN Amro for 72 billion.

3 3 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Agenda 1)Why do we need a different capital measure? 2)S&P Risk-Adjusted Capital Framework concepts 3)Interactions with Basel II capital requirements 4)How are we going to use Pillar III 5)Concluding remarks

4 4 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. 1. Why do we need a different capital measure?

5 5 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Two primary goals Enhance our quantitative and qualitative analysis –Address inconsistencies in: Local regulations, including definition of regulatory capital; Risk measures; Regulatory options (incl. stress tests); and Economic capital models Incorporate our different risk assessment –Trading book, equity portfolios, securitisation, etc. –Opinion on credit markets –Correlations / diversification Development a globally consistent risk adjusted measure to facilitate the assessment and comparison of capital adequacy as well as profitability.

6 6 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Standard & Poors Applauds Basel II More comprehensive and risk sensitive than –Basel I –Leverage ratio Incentive to develop better risk management systems Increased disclosure to the market should allow better market discipline Global framework But some issues remain …

7 7 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Comparing different approaches will be difficult Differing methodologies employed impact results

8 8 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Direct comparisons between IRB results could be misleading Database infrastructure and models are still unseasoned.

9 9 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Transition period could last up to a decade Floors, grandfathering options (up to 2017) Technical challenges to move to advanced methodologies Trend comparisons difficult due to continued changes in methodologies Most banks will apply several methodologies at the same time

10 10 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Trends in Basel II ratios will be complex to compare Transitional regulatory requirements and floors affect peer comparison

11 11 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. 2. S&P Risk-Adjusted Capital Framework Concepts

12 12 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. A two stage process to calculate risk weighted assets Starting Point Benchmark Charges Approach (BCA) –Based on publicly or already available information –Globally consistent industry capital charges per risk class and regions through the implementation of floors Specific Charges Adjustments (SCA) –Leveraging bank-specific data where available and satisfactory –Review of the information provided by the institutions and potentially adjust benchmark capital charges to reflect specificities of individual banks specificities risk profile compared to the industry average

13 13 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Specific Case Adjustment Example Illustrative purpose –Corporate portfolio average risk weight (after diversification) was reduced to 63.2% from 82.9% to reflect systematic hedging policy –Market risk risk-weighted assets (after diversification) was increased from $2.8 bn to $6.9 bn due to large specific risk not captured by the Value-at-Risk –Corporate portfolio average risk weight was reduced to 79% from 88% reflecting non public geographic diversification details –Large portfolio of investment risk weight was reduced to 322% from 706% to reflect large proportion of low risk funds in the portfolio, such as Money Market type and rated Fixed Income funds

14 14 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. 3. Interactions With Basel II Capital Requirements

15 15 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Introduction of benchmark charges per Basel II Asset Class Floors to the regulatory capital charges to factor in: –Standard & Poors different risk assessment; or –Uncertainty/lack of robustness of the institutions internal data: or –Non risk-sensitive standardized charges. Risk sensitivity maintained across several risk categories under BCA –We differentiate with 10 floor levels for each risk class Operational risk, a revenue based floor used –Similar to Basel II standardized approach –Add-ons for above average model risk, legal risk or fraud risk; and –In some cases, such as custody, we use other metrics Trading risk –Leverage VaR as least worst –Scaling the regulatory measure by a factor of three to align 1 year time horizon

16 16 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. S&P capital benchmark charges a function of BICRA score Bank industry country risk (BICRA) affects risk weight

17 17 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. The benchmark concept allows better comparability Future ratios driven by changes in methodologies

18 18 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Capturing other risks In addition to our adjustments to Basel II Pillar I, we will reflect the following factors into the adjusted RWA –Concentration & Diversification (name; industry sector; geographic; asset class; risk types); and –Interest rate risk in the banking book A number of risks will not impact capital measures at this stage –Liquidity and Funding risk; and –Reputation risk.

19 19 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Accounting for diversification / concentration Diversification / concentration is one of the most sensitive factors of loss distributions Results from the International Association of Credit Portfolio Managers (IACPM) ISDA study 2006 It is not differentiated in Basel II Pillar I, which assumes that portfolios are diversified and exposures granular

20 20 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. 4. How are we going to use Pillar III

21 21 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. How are we going to use Pillar III Pillar III disclosure will also allow us to enhance our analysis of a banks risk profile –Expect a far richer disclosure of risk attributes –Our intention is to store systematically this information in a S&P internal risk database, and use it for our analysis of banks risk profile. Pillar III risk disclosure will allow us to roll out our global Risk Adjusted Capital Framework (RACF) –The more granular the information, the more we will be able to factor in diversification benefits.

22 22 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. 5. Concluding remarks

23 23 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Bank responses could potentially impact rating levels Some banks might seek to spend the regulatory benefits of Basel II –Capital buybacks –Higher growth We will assess such changes in capital policy closely –Basel II merely changes the measurement of risk but not the economic risk itself –We will use our new adjusted RWA to assess banks risk adjusted capital adequacy and profitability It is not a change in criteria (no rating changes expected as a consequence of the implementation of this framework) Is the quantitative transcription of our current qualitative opinion on banks risk adjusted capitalization Capital is just one rating factor among others –Business profile analysis, strategy, risk management, earnings, liquidity, market risk, credit risk, etc…are equally important factors.

24 24 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Capital is just one rating factor among others Other factors are equally important

25 25 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Conclusion: smoothing the transition to Basel II Benchmarking tool –Internal (against banks own data) –External (against other banks and other banking systems) Transparent framework –Provide much more insight on the drivers of S&P opinion on capital –Opportunity to have more structure dialogue Consistent over time, across banks and geographies –Neutralise impact of Basel II methodologies –National discretions, grandfathering options, etc. –Banks internal estimates –Less volatile than Basel II

26 26 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Appendix 1. Pillar III Best Practice Disclosure

27 27 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Pillar III disclosure – Credit risk What could be best practice? Breakdown by relevant risk classes –Mortgage, consumer, revolving, etc. –Public sector loans should be separately identified –Within corporate loans (break down by other sub-asset class if relevant) For each risk class –Exposure at default: before and after credit risk mitigation (we consider that disclosure on CRM is too limited) –Breakdown per significant geographic area, with disclosure of weighted average Probability of Default, Loss Given Default and Capital allocated. –Industry sector breakdown –Disclosure of amount of impaired loans as well as realized losses/expected loss for each significant risk class would also be a useful risk indicator –Single name concentration indicator

28 28 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Pillar III disclosure – Operational Risk What could be best practice? Breakdown of capital charge for each risk factor with explanations of the major drivers behind these charges Breakdown for each business line Magnitude of the largest operational risk losses and event type –These disclosures would also contribute to the development of a better operational risk culture and awareness of analysts and investors

29 29 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Pillar III disclosure – Trading Risk What could be best practice? Definition of trading book / banking book perimeter Disclosure of Specific risk component –Capital required, concentration indicator (size of top three contributors to specific risk), breakdown of EAD in the trading book per risk bucket, and incremental default risk measure Disclosure of key characteristics and drivers of regulatory approved Value-at-Risk measures –Contribution of risk factors, diversification benefits, maximum/minimum/average VaR during the year, results of VaR back testing Information on Stress tests and or expected shortfall as complementary measures Amount of assets which are fair valued based on mark to model in the absence of reliable observable market prices. –Comprehensive analysis of valuation methodologies and assumptions should be disclosed

30 30 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Pillar III disclosure – Equity Portfolios What could be best practice? Separate disclosure of: –Listed and unlisted exposures; –Identification of book and current value; –Methodology used to determine current value; –Geographic breakdown; and –Concentration issues, when relevant (sector, geographic, single name).

31 31 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Pillar III disclosure – Securitisation and Pillar II risks Securitization framework –Extensive disclosure would be necessary –Volume of securitization performed broken down per type of asset securitized with the details and amounts of retained portions and other supporting factors For Pillar II risks - extensive disclosure should be provided –Internal capital assessment process, including identification and quantification of key risk factors not factored in Pillar I –Interest rate risk in the banking book 200bp parallel shock impact on NAV and interest income When calculated, sensitivity analysis to multiple interest rate scenarios, including slope curve changes Qualitative and quantitative disclosure on the metric used, including the underlying assumptions and model parameters

32 32 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Appendix 2. Related Publications

33 33 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Related Publications on RatingsDirect 2007 Transition To Basel II Creates a Need For A Consistent, Comparable Measure of Bank Capital, February 21, 2008 Implication For Japanese Banks of Basel II Pillar III Disclosure, December 11th, 2007 Latin American Banks In Dissimilar Stages Of Implementation Of Basel II, October 4th, 2007 Greater Basel II Pillar III Disclosure would Enhance Transparency and Comparability In the Global Banking Sector, July 10, 2007 FAQ: Building Standard & Poor's Risk-Adjusted Capital Framework, June 5, 2007 Financial Institutions Group Provides More Transparency Into Adjustments Made To Bank Data, April 26, 2007 Japans Banks Rethink Fund Investments As Basel II Dawns, February 20, 2007 Where do the Key Formulas Come From?, February 15, 2007 Basel II In EU Gives Banks Greater Incentive To Invest In High-Quality Fixed- Income Funds, January 3, 2007

34 34 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Main contacts Asia-Pacific –Craig Bennett, Melbourne, –Ritesh Maheshwari, Singapore, –Naoko Nemoto, Tokyo, –Yuri Yoshida, Tokyo, Europe –Bernard de Longevialle, Paris, –Elie Heriard Dubreuil, Paris, –Thierry Grunspan, Paris, –Nick Hill, London, –Harm Semder, Frankfurt, –Renato Panichi, Milan, Unites States –Chuck Rauch, New York, –Tanya Azarchs, New York, –Vicky Wagner, New York, –Simon Kam, New York, Latin America –Carina Lopez, Buenos Aires, –Angelica Bala, Mexico,

35 35 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors. Analytic services and products provided by Standard & Poors are the result of separate activities designed to preserve the independence and objectivity of each analytic process. Standard & Poors has established policies and procedures to maintain the confidentiality of non-public information received during each analytic process.


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