Keywords: Basel committee, banking supervision, BCBS, leverage requirements, funding ratio

On January 12, 2014, with the concurrent endorsement of the Group of Central Bank Governors and Heads of Supervision (GHOS), the Basel Committee on Banking Supervision (BCBS) issued additional information regarding the leverage and liquidity requirements under Basel III, including the following:

  • The full text of Basel III's leverage ratio (Leverage Ratio) framework and related disclosure requirements that modifies the earlier consultative proposal issued in June 2013;
  • Proposed revisions (the Consultative Document) to the Basel III framework's Net Stable Funding Ratio (NSFR) modifying the earlier consultative proposal issued in December 2009 and Basel III agreement of December 2010 (as revised in June 2011);
  • Disclosure standards for the Liquidity Coverage Ratio (LCR), including a template for such disclosure, reflecting additional work undertaken at the directon of the GHOS;
  • Guidance for supervisors on market-based indicators of liquidity; and
  • Modification of the LCR to permit (with national discretion) restricted-use committed liquidity facilities (RCLFs) provided by central banks to be included in the LCR's high-quality liquid assets (HQLA).

The effect of these changes and additional guidance on the US rules to implement Basel III1 is unclear. In particular, the reaffirmation by BCBS of a minimum 3 percent Leverage Ratio is not consistent with the US proposed minimum requirement of 5 percent in the case of large, systemically important banking organizations that would be subject to the supplementary leverage ratio. Also, in light of current reports of ongoing discussions among international regulators regarding a more restrictive leverage ratio, it is perhaps significant that the BCBS states that, based on the parallel run period, final adjustments to the definition and calibration of the ratio will occur by 2017 when the requirement will migrate to a Pillar 1 treatment on January 1, 2018.

Leverage Ratio

The Basel III framework introduced a simple, transparent, non-risk-based leverage ratio to act as a credible supplementary measure to the risk-based capital requirements. The leverage ratio is intended to:

  • Restrict the build-up of leverage in the banking sector to avoid destabilizing deleveraging processes that can damage the broader financial system and the economy; and
  • Reinforce the risk-based Basel III requirements with a simple, non-risk-based "backstop" measure. BCBS is of the view that:
  • A simple leverage ratio framework is critical and complementary to the risk-based capital framework; and
  • A credible leverage ratio is one that ensures broad and adequate capture of both the on-and off-balance sheet sources of banks' leverage.

The Leverage Ratio implementation began with bank-level reporting to national supervisors from January 1, 2013, with required disclosure starting from January 1, 2017 with expected migration to mandatory Pillar 1 treatment (minimum capital requirement) from January 1, 2018.

The Basel III leverage ratio is defined as the capital measure (the numerator) divided by the exposure measure (the denominator), being the following ratio (expressed as a percentage):

Leverage ratio = Capital measure/Exposure measure

with the requirement being a minimum of 3 percent during the parallel run period (i.e, from January 1, 2013 to January 1, 2017).

  • Capital Measure means Tier 1 capital under the risk-based capital framework (as defined in paragraphs 49-96 of the Basel III framework), taking into account permissible transitional arrangements under Basel III.
  • Exposure Measure generally follows the accounting value, subject to the following:

    • on-balance sheet, non-derivative exposures are included in the exposure measure net of specific provisions or accounting valuation adjustments (e.g., accounting credit valuation adjustments);
    • netting of loans and deposits is not allowed.

Unless otherwise specifically provided, banks must not take account of physical or financial collateral, guarantees or other credit risk mitigation techniques to reduce the exposure measure.

A bank's total exposure measure is the sum of the following: (i) on-balance sheet exposures; (ii) derivative exposures; (iii) securities financing transaction (SFT) exposures; and (iv) off-balance sheet (OBS) items. The specific treatments for these four main exposure types are defined below.

  • On-Balance Sheet - Banks must include all balance sheet assets in their exposure measure, including on-balance sheet derivatives collateral and collateral for SFTs (other than on-balance sheet derivative and SFT assets covered under Derivative Exposures below); however, for consistency, balance sheet assets that are deducted from Tier 1 capital (as set forth in paragraphs 66 to 89 of the Basel III framework) may be deducted from the exposure measure, while liability items (for example, any fair value or similar accounting value adjustments for gain or loss on derivative or other liabilities due to changes in the bank's own credit risk) must not be deducted.
  • Derivative Exposures – Generally, banks must calculate their derivative exposures,2 including where a bank sells protection using a credit derivative, as the replacement cost (RC) for the current exposure plus an add-on for potential future exposure (PFE). If the derivative exposure is covered by an eligible bilateral netting contract, an alternative treatment may be applied. Written credit derivatives are treated the same as cash instruments (e.g., loans or bonds). Generally, collateral received does not reduce the derivative exposure. Similarly, a bank must gross up its derivative exposure for collateral provided if the collateral reduced the accounting value of the exposure.
  • Securities Financing Transaction Exposures – Generally, the gross exposure adjusted by (i) excluding the value of the securities received if the bank reported the securities as an asset in its balance sheet, (ii) netting all cash payables and receivables with the same SFT counterparty as long as all related SFTs have the same final settlement date, set-off is legally enforceable and the parties have agreed to net settlement, and (iii) a counterparty credit risk measure (being the current exposure without a PFE add-on).
  • Off-Balance Sheet Items – OBS items include commitments (including liquidity facilities), whether or not unconditionally cancellable, direct credit substitutes, acceptances, standby letters of credit and trade letters of credit. As under the risk-based capital framework, OBS items are converted to credit exposure equivalents by using specified credit conversion factors (CCFs) applied to the related notional amounts.

Banks are required to publicly disclose their Leverage Ratios from January 1, 2015 using a consistent and common disclosure of the main components of the Leverage Ratio and including a summary comparison table on a common disclosure template included in the full text.3

Net Stable Funding Ratio

The net stable funding ratio (NSFR) is defined as the amount of available stable funding (ASF) relative to the amount of required stable funding (RSF). While many of the components of the NSFR are the subject of international agreement, some remain subject to national discretion. In addition, the NSFR is to be supplemented by supervisory assessment that may result in more stringent requirements to reflect a bank's funding risk profile.

"Available stable funding" is defined as the portion of capital and liabilities expected to be reliable over the time horizon considered by the NSFR, which extends to one year. The amount of such stable funding required of a specific institution is a function of the liquidity characteristics and residual maturities of the various assets held by that institution as well as those of its off-balance sheet (OBS) exposures.

The NSFR requirement is expressed as follows:

Amount of ASF/Amount of RSF ≥ 100%

With underlying concepts that are similar to those used for the LCR, the amount of ASF is measured based on the broad characteristics of the relative stability of an institution's funding sources, including the contractual maturity of its liabilities and the differences in the propensity of different types of funding providers to withdraw their funding.

The amount of ASF is calculated by first assigning the carrying value of an institution's capital and liabilities to one of five categories as presented in the table in Annex A. The amount assigned to each category is then multiplied by an ASF factor, and the total ASF is the sum of the weighted amounts. Carrying value represents the amount at which a liability or equity instrument is recorded before the application of any regulatory deductions, filters or other adjustments. For maturity determinations, investors are assumed to exercise a call option on the earliest possible date and, for funding options at the bank's discretion, banks must assume that they do not exercise such options.

Similar to ASF, the amount of RSF is measured based on the broad characteristics of the liquidity risk profile of an institution's assets and OBS exposures. The amount of required stable funding is calculated by first assigning the carrying value of an institution's assets to the RSF categories listed. The amount assigned to each category is then multiplied by its associated RSF factor and the total RSF is the sum of the weighted amounts added to the amount of OBS activity (or potential liquidity exposure) multiplied by its associated RSF factor as set forth in Annex B.

The NSFR also assigns an RSF factor to certain OBS as shown in Annex C.

Comments on the Consultative Document are due by April 11, 2014.

Liquidity Coverage Ratio Disclosure

The LCR disclosure standards are to apply to all internationally active banks on a consolidated basis and are expected to apply no later than January 1, 2015. Apart from the quantitative LCR components,4 the standards require sufficient qualitative discussion to facilitate an understanding of the data provided.

The disclosure is to be public and to follow the template,5 but the standards also require disclosure of additional quantitative information relating to internal liquidity risk measurement and management. While not requiring their use, the standards refer approvingly to the several monitoring tools for assessing liquidity risk that are included in the Basel III liquidity risk framework.

Market-Based Liquidity Indicators

The guidance on the use of market-based indicators of liquidity reflects additional work directed by GHOS in January 2013 and is intended to assist supervisors in their evaluation of the liquidity profile of assets held by banks and to promote greater consistency in HQLA classifications across jurisdictions for purposes of the LCR.

Restricted Committed Liquidity Facilities Conditionally Permitted as HQLA for the LCR

The BCBS has decided to modify the LCR6 to permit national regulators to modify the definition of HQLA to include greater use of committed liquidity facilities (CLFs) provided by central banks. Previously, the LCR only permitted CLFs in jurisdictions that lacked sufficient HQLA. The BCBS has determined that, subject to certain conditions and limitations, regulators in any jurisdiction may allow banks to use a restricted version of a CLF as HQLA.

Originally published February 12, 2014

Footnotes

1 Described in our earlier related Legal Update.

2 The BCBS notes that the specified approach refers to the Current Exposure Method (CEM) under Basel II and that it is considering alternatives to the CEM.

3 See p.11 of the full text for the template.

4 A template for LCR common disclosure is also included in the standards at p.4.

5 See Annex 1 included in the standards for an explanation of the disclosure template.

6 See our earlier related Legal Update for a description of the US LCR implementation proposal.

ANNEX A

AVAILABLE STABLE FUNDING (ASF)

ASF FACTOR
  • Regulatory risk-weighted capital1 before deductions (other than Tier 2 instruments with a maturity of less than one year);
  • Any other capital instrument with an effective residual maturity of one year or more (excluding any instruments with explicit or embedded options that, if exercised, would reduce the maturity of the instrument to less than one year); and
  • The total amount of secured and unsecured borrowings and liabilities (including term deposits) with effective residual maturities of one year or more (paragraph 182)

100%
  • "Stable"3 non-maturity (demand) deposits and term deposits with residual maturities of less than one year provided by retail4 and SME5 customers (paragraph 19)

95%
  • "Less stable"6 non-maturity (demand) deposits and term deposits with residual maturities of less than one year provided by retail7 and SME8 customers (paragraph 20)

90%
  • Funding (secured or unsecured) with a residual maturity of one year or less provided by nonfinancial corporate customers;
  • Operational deposits;9
  • Funding with residual maturity of less than one year from sovereigns, public sector entities (PSEs) and multilateral and national development banks; and
  • Other funding (secured and unsecured) not included in the categories above with residual maturity of not less than six months and less than one year, including funding from central banks and financial institutions (paragraph 21)

50%
  • All other liabilities and equity not included in above categories, including liabilities without a stated maturity and, if positive, derivatives payable net of derivatives receivable

0%

ANNEX B

REQUIRED STABLE FUNDING (RSF)

RSF FACTOR
  • Coins and banknotes immediately available to meet obligations;
  • Central bank reserves (including required and excess reserves); and
  • Unencumbered loans to banks subject to prudential supervision with residual maturities of less than six months (paragraph 29)

0%
  • Unencumbered Level 1 assets,10 excluding assets receiving a 0% RSF as specified above, including marketable securities representing claims on or guaranteed by sovereigns, central banks, PSEs, the Bank for International Settlements, the International Monetary Fund, the European Central Bank and European Community, or multilateral development banks that are assigned a 0% risk-weight under the Basel II Standardized Approach for credit risk and
  • Certain non-0% risk-weighted sovereign or central bank debt securities as specified in the LCR (paragraph 30)

5%
  • Unencumbered Level 2A assets,11 including marketable securities representing claims on or guaranteed by sovereigns, central banks, PSEs or multilateral development banks that are assigned a 20% risk weight under the Basel II Standardized Approach for credit risk and corporate debt securities (including commercial paper) and covered bonds with a credit rating equal or equivalent to at least AA– (paragraph 31)

15%
  • Unencumbered Level 2B assets,12 including: residential mortgage-backed securities (RMBS) with a rating of at least AA; corporate debt securities (including commercial paper) with a credit rating of between A+ and BBB–; and exchange-traded common equity shares not issued by financial institutions or their affiliates;
  • Any HQLA13 that are encumbered for a period of six months or more and less than one year;
  • All loans to banks subject to prudential supervision with residual maturity of six months or more and less than one year;
  • Deposits held at other financial institutions for operational purposes, as outlined in LCR paragraphs 93–104, that are subject to the 50% ASF factor in paragraph 21 (b); and
  • All other non-HQLA not included in the above categories that have a residual maturity of less than one year, including loans to non-bank financial institutions, loans to non-financial corporate clients, loans to retail customers (i.e., natural persons) and small business customers, and loans to sovereigns, central banks and PSEs (paragraph 32)

50%
  • Unencumbered residential mortgages with a residual maturity of one year or more that would qualify for a 35% or lower risk weight under the Basel II Standardized Approach for credit risk and other unencumbered loans not included in the above categories, excluding loans to financial institutions, with a residual maturity of one year or more, that would qualify for a 35% or lower risk weight under the Basel II Standardized Approach for credit risk (paragraph 33)

65%
  • Other unencumbered performing loans that do not qualify for the 35% or lower risk weight under the Basel II Standardized Approach for credit risk and have residual maturities of one year or more, excluding loans to financial institutions;
  • Unencumbered securities that are not in default and do not qualify as HQLA according to the LCR including exchange-traded equities; and
  • Physical traded commodities, including gold (paragraph 34)

85%
  • All assets that are encumbered for a period of one year or more;
  • If positive, derivatives receivable net of derivatives payable; and
  • All other assets not included in the above categories, including non-performing loans, loans to financial institutions with a residual maturity of one year or more, non-exchange-traded equities, fixed assets, pension assets, intangibles, deferred tax assets, retained interest, insurance assets, subsidiary interests and defaulted securities (paragraph 35)

100%

ANNEX C

OFF-BALANCE SHEET ITEMS (OBS)

OBS FACTOR
  • Irrevocable and conditionally revocable credit and liquidity facilities to any client

5% of the currently undrawn portion
  • Other contingent funding obligations, including products and instruments such as:

    • Unconditionally revocable credit and liquidity facilities;
    • Trade finance-related obligations (including guarantees and letters of credit);
    • Guarantees and letters of credit unrelated to trade finance obligations; and
    • Non-contractual obligations such as

      • potential requests for debt repurchases of the bank's own debt or that of related conduits, securities investment vehicles and other such financing facilities;
      • structured products where customers anticipate ready marketability, such as adjustable rate notes and variable rate demand notes (VRDNs); and
      • managed funds that are marketed with the objective of maintaining a stable value (paragraph 38)

National supervisors can specify based on national circumstances

Footnotes

1 Meeting all requirements under Basel III and only including amounts after any transitional arrangements have expired under fully implemented Basel III (i.e., as in 2022).

2 Unless otherwise specified, references to paragraphs in these Annexes are to numbered paragraphs in the BCBS consultative document for the NSFR.

3 Defined in LCR paragraphs 75-78.

4 Defined in LCR paragraph 73.

5 Defined in paragraph 273 of the Basel II framework.

6 Defined in LCR paragraphs 79-81.

7 Defined in LCR paragraph 73.

8 Defined in paragraph 273 of the Basel II framework.

9 Defined in LCR paragraphs 93-104.

10 Defined in LCR paragraph 50.

11 Defined in LCR paragraph 52

12 As defined and subject to the conditions set forth in LCR paragraph 54.

13 As defined in the LCR.

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