UAB.Lebanon.Feb.10,2011.LEVERAGE AND PROVISIONING.Shahzad Tark -st

Views:
 
     
 

Presentation Description

Excessive on and off balance sheet leverage Erosion of level of capital Quality of capital – low loss absorbing capacity Insufficient liquidity buffer and excessive reliance on wholesale funding Excessive cyclicality in capital combined with unavailability of capital in times of downturn Interconnectedness of systemic institutions through complex transaction

Comments

Presentation Transcript

RE-INTRODUCINGLEVERAGE AND NEW PROVISIONING PRACTICES A REGULATORY PERSPECTIVE:

RE-INTRODUCINGLEVERAGE AND NEW PROVISIONING PRACTICES A REGULATORY PERSPECTIVE

GLOBAL FINANCIAL CRISIS KEY REASONS:

GLOBAL FINANCIAL CRISIS KEY REASONS Excessive on and off balance sheet leverage Erosion of level of capital Quality of capital – low loss absorbing capacity Insufficient liquidity buffer and excessive reliance on wholesale funding Excessive cyclicality in capital combined with unavailability of capital in times of downturn Interconnectedness of systemic institutions through complex transaction

LEVERAGE:

LEVERAGE Major Investment banks – Leverage ratio ‘Leverage ratio is a measure of the risk taken by a firm; a higher ratio indicates more risk. It is calculated as total debt divided by equity . Each of the following firms saw an increase in leverage between 2003 – 2007’ ‘Lehman Brothers, Bear Stearns, Merrill Lynch, Goldman Sachs, Morgan Stanley’

LEVERAGE:

LEVERAGE Why now? Subsequent to the global financial crisis and the need to enhance safety and soundness in the banking system; Basel III - Commercial banks considered the leverage ratio to constrain excessive on and off balance sheet leverage in the banking system Requires a minimum threshold of 3%. Banks rated strong. The ratio is to be introduced by banks for supervisory monitoring in 2011. Disclosure to start Jan 1, 2015 and will migrate to Pillar 1 in 2018.

LEVERAGE:

LEVERAGE Why was it not included as a regulatory requirement in the past? Banks did not want to limit their growth and operating performance results ‘The increased level of capital, liquidity and new leverage ratio impacts (reduces) level of growth in balance sheet assets. ... growth levels should decline impacting profitability and liquidity positions in the short term’. Banks in MENA region - Perform Quantitative Impact Study (QIS).

LEVERAGE:

LEVERAGE Why Leverage? A non risk based capital ratio It complements minimum capital adequacy requirements The ratio should reduce or assist in monitoring the risk of excessive building up of leverage in an entity or the financial system

LEVERAGE:

LEVERAGE Types of leverage Balance sheet Economic Embedded

LEVERAGE:

LEVERAGE Balance Sheet Leverage It is the most visible and widely recognized. Whenever an entity’s assets > equity base, balance sheet is said to be leveraged Note : Banks typically engage in leverage by borrowing to acquire more assets, with the aim of increasing return on equity.

LEVERAGE:

LEVERAGE Economic Leverage Banks faced economic leverage when they are exposed to a change in the value of a position by more than the amount they paid for it. Example – A loan guarantee that does not show up on the banks balance sheet even though it involves a contingent commitment that may materialize in the future.

LEVERAGE:

LEVERAGE Embedded Leverage Refers to a position with an exposure larger than the underlying market factor, such as when an institution holds a security or exposure that is leveraged. Example – minority investment held by a bank in an equity fund that itself is funded by loans. Example – Structured products.

LEVERAGE:

LEVERAGE Measures of Leverage Leverage : Tier 1 Capital/ Adjusted Assets; ‘Minimum required at 4% to 5% to be considered adequately capitalized in the USA.’ It excludes off- Balance sheet exposures. Tier 1 = Equity + Reserves – Intangible assets Adjusted Assets = Total Assets – Intangible Assets

LEVERAGE:

LEVERAGE Use of leverage ratio by regulators ; Like regulatory capital measures leverage ratio generally applies at the level of the individual bank as well as on consolidated basis. How the ratio is actually calculated and monitored will be aligned with the scope of prudential consolidation practiced in a jurisdiction.

LEVERAGE:

LEVERAGE Where is leverage ratio used ? USA and Canada with large international banking systems have continued to use leverage ratio alongside the risk based capital adequacy requirements. Switzerland has announced introduction of the leverage ratio by 2013.

LEVERAGE:

LEVERAGE CANADA – more conservative. Assets to capital multiple. (incl. off balance sheet items) Applied at level of consolidated banking Total adjusted consolidated assets/ Consolidated capital (Tier 1 + Tier 2) Total Adjusted assets should not exceed 20 times capital

LEVERAGE:

LEVERAGE Micro and Macro prudential analysis ; A leverage limit for supervised entities An indicator for monitoring vulnerability , or a trigger for increased surveillance or capital requirement under pillar 2 of the Basel II accord.

LEVERAGE:

LEVERAGE Countercyclical Measure In a Fair Value Environment – a rise in asset prices would boost bank equity or net worth as a percent of total assets. Stronger balance sheets would result in lower leverage multiple Mainly a countercyclical measure – Higher capital and loan loss provisions in good times and lower in bad times.

LEVERAGE - CONCLUSION:

LEVERAGE - CONCLUSION No single tool or measure could have prevented the global financial crisis It can be a useful prudential tool, but does not adequately consider risk sensitivity in assets. Combining the leverage ratio with Basel type capital rules and enhanced surveillance by supervisors can reduce risk of excessive leverage build up in an institution and or the whole banking system.

PROVISIONING :

PROVISIONING

PROVISIONING:

PROVISIONING Bank Management We ; have a quality risk asset portfolio are proactive and adequately provisioned consider provisions on a monthly basis consider provisions on an annual basis have sufficient collateral know our clients/ customers. If they want a restructure we support them. As regulators you should strengthen the risk asset provisioning regulations and guidelines

PROVISIONING:

PROVISIONING Credit Default and the Provisioning Process Basel Accords International Accounting Standards (IAS/IFRS)

PROVISIONING:

PROVISIONING BASEL II – DEFAULT Standardized Approach – When unsecured portion of any loan is past due over 90 days.

PROVISIONING:

PROVISIONING BASEL II – DEFAULT Internal Ratings Based – A default is considered to have occurred when either of the two following events have taken place. Obligor is unlikely to pay credit obligations in full, without recourse to collateral. Obligor is past due more than 90 days on any material credit obligation. Overdraft is considered past due once the customer has breached an advised limit or has been advised of a smaller limit than current outstanding.

PROVISIONING:

PROVISIONING THE BANK ON INDICATION OF UNLIKELINESS TO REPAY ; CORPORATE Puts the credit obligation (Obligor) on non accrual status Makes a specific provision or a charge-off due to the perceived decline in credit quality Sells the credit obligation at a material credit related economic loss Consents to a distressed restructuring Files for obligors bankruptcy.

Provisioning:

Provisioning RETAIL The definition of default can be applied at the facility level, rather than at the obligor level.

PROVISIONING:

PROVISIONING International Supervisory Standards Specific Provision General Provision

PROVISIONING:

PROVISIONING Rules Specific Provisions Reading and classifying of Credits by Regulators (Expected loss model equivalent per Basel II) at onsite examinations Net present value of future cash flows (IAS 39) discounted at the original rate of financing. – incurred loss model

PROVISIONING:

PROVISIONING Types of Exposures and Specific Provision Credit facility or Credit relationship downgrading: Depends on the size of the exposure and whether it is the parent or the related smaller companies. Restructured Exposures: Is it name lending or regular relationships; Classifying name lending corporate or retail relationships? Country environment drives the credit classification.

PROVISIONING:

PROVISIONING Types of Exposures and Specific Provisions (Contd) Overdrafts: Accounting entries without cash repayments. Any break of credit limit for over 90-180 days without corrective action would result in default. Islamic Assets: Evergreen financing portfolio.

PROVISIONS:

PROVISIONS Basel II - Standardized Approach Failure to make provisions once an exposure/ obligor has defaulted will result in higher a higher risk weighted assets e.g. 150%.

PROVISIONS:

PROVISIONS Basel II – Under IRB approach Its is expected the bank will calculate the expected loss in the exposures. Expected loss is equal to the exposure (net of recoverable amounts e.g. collateral) multiplied with the probability of default. The bank is expected to make provisions that together (specific and general) equal the expected loss Any shortfall in provisions compared with expected loss will result in a deduction of the same amount from the capital base.

PROVISIONS:

PROVISIONS General Provisions A percent of the unclassified portfolio of risk assets as required by the home supervisor. (1%..5%) in regulations (Unexpected loss model equivalent per Basel II). Portfolio Impairment method based on a model (IAS 39) (incurred loss model)

Provisioning:

Provisioning General or Specific Provisions Basel II does not specifically require specific or general provisions, it impacts the capital ratio and the capital base instead.

PROVISIONS:

PROVISIONS Types of Provisions and method of Loss assessment: Specific provision – Expected loss General provision – Unexpected loss

PROVISIONING:

PROVISIONING EXPECTED AND UNEXPECTED LOSS MODEL In the absence of data regarding LGD and standard deviations of PD and LGD a loss distribution has to be simulated. The loss distribution will estimate the various levels of losses at varying levels of probability. Large losses have smaller probabilities Mean of the above distribution ($25mn) is the Expected Loss. At a very high confidence level (99.9%) Unexpected Loss is $250mn meaning there is a 0.01% probability that losses might exceed $250mn over the 1 year period

PROVISIONING:

PROVISIONING EXPECTED LOSS Probability of Default (PD) x Loss given Default (LGD)x Exposure at Default (EAD) Most developing countries do not have adequate data and information or the required quality of information to be able to develop a PD or LGD.

PROVISIONS:

PROVISIONS

PROVISIONS:

PROVISIONS Internal Ratings Based Models Approach. Provisions > calculated expected loss – Add back to Tier 2 capital ranging from 0.6 – 1.25% of credit risk weighted assets. Provisions < calculated expected loss – shortfall in provision is deducted from capital base. Deduction must be on the basis of 50% Tier 1 and 50% Tier 2 capital

PROVISIONS:

PROVISIONS Accounting methods (IAS 39) and Provision Under IAS 39 provisions are calculated as the difference between the book value and the present value of discounted estimated future cash flows; this includes funds realized from collateral (Incurred Loss Model) based on a historical experience loss distribution.

PROVISIONS:

PROVISIONS Conclusion Leverage a regulatory standard under Basel III. Proactive and dynamic credit provisioning process required. Both Basel II and Basel III would continue to consider a more technical /models based approach to risk asset sensitivity and related provisioning process.

authorStream Live Help