Basel III implementation in Asia faces several key issues and concerns: 1) Potential for synchronized global recession if Basel III constrains Asian growth by limiting banks' ability to support the real economy. 2) Risk weightings are biased against Asian banks as they favor advanced risk models Asian banks have not fully developed. 3) Asia has its own banking development agenda that does not perfectly align with Basel III timeline and level of regulation. National discretion is needed.

1. 0
Balance between Regulation and Growth
- Implementation of Basel III in Asia
Andrew Sheng
President, Fung Global Institute
Advanced Programme for Central Bankers and Regulators on Basel III
17-19, January 2013
The Chinese University of Hong Kong
Institute of Global Economics and Finance
© Fung Global Institute

2. 1
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3. 2
Financial Reform Landscape remains Complex
2
Source: E&Y. Financial Regulatory Reform - What it means for bank business models, November 2012.

4. 3
Financial Regulatory Reform
• Ensure that tighter standards, such as higher capital and
liquidity requirements, do not choke off the global recovery.
• Support the development of a global mechanism for managing
volatile short-term capital flows, and development of
macroprudential surveillance and regulation at the national and
regional levels.
• Establish an effective regulatory framework for
macroprudential supervision and regulation at the national and
regional levels.
Source: Asian Development Bank Institute, Policy Recommendations to Secure Balanced and Sustainable 3
Growth in Asia, October 2010.

5. 4
Asian Voice and Interests
• There needs to be an Asian voice on financial reform and regulation
rather than allowing the debate on issues to be dominated by a
perceived choice between American and European approaches.
• A “one-size-fits-all” approach is inappropriate due to differences in
financial systems, stages of development and banking industry
practices, and may lead to excessive burdens in areas such as
capital and liquidity adequacy requirements and leverage ratios.
• In addition, there is a risk of spillover effects from developed country
regulatory changes and low-interest-rate policies that lead to
migration of risky financial activities to Asia that could affect regional
financial stability.
• Asian leaders should consider sponsoring their own research on the
impacts of the new regulations on Asian financial institutions and
markets.
Source: Asian Development Bank Institute, Policy Recommendations to Secure Balanced and Sustainable 4
Growth in Asia, October 2010.

6. 5
Key Points
• We need to put the Implementation of Basel III in Asia within the proper context.
• Post-2007 Global Financial Crisis, Basel III is an important standardization of
minimum capital and liquidity standards for global banking.
• This is a NECESSARY, but NOT SUFFICIENT CONDITION for global financial
stability, because Financial Stability Board and national regulators have only just
begun to address SHADOW BANKING, or non-bank financial intermediaries, risk
issues. Although important, banks account for 43.1 percent of global financial
assets as at the end of 2011, whereas stock market capitalization and bond markets
(excluding derivative financial assets) account for more than half of financial sector
risks.
• Hence, to obtain overall financial system stability, we need to look also at real sector
imbalances, monetary and fiscal policies, and interconnectivity and feedback
mechanisms between financial sectors (banks and shadow banks) as a systemic
whole.
• We must never forget that Finance must serve the Real Sector, not the other way
around.
5

7. 6
Key Questions
• What are Basel III’s main impact on (1) banking system and (2)
growth and overall credit?
• While Basel III are Minimum conditions for capital and liquidity,
do the complex calculations on risk weights impair or
disadvantage EME banks?
• Which parts of Basel III should be priority for implementation?
Should we move out of standard risk-based model towards
Internal Risk-Based (IRB) models?
• What areas of structure (shadow banking), financial
infrastructure and other issues should we consider ( Basel III
included as part of package) for financial system stability?
6

8. 7
Contents
• Introduction
• What are the key issues and concerns?
• Role of Asia finance in rebalancing Asia’s Growth
Model
• Conclusion
Appendix: Amendments to the Liquidity Coverage Ratio (LCR)
and the new BCBS Charter; and CRR4
7

9. 8
8

10. 9
Section 1 Introduction

11. 10
Asia finance must be there to serve the real
sector
10

12. 11
Asian banks are the primary providers of
funding for private sector growth
Asia’s shift towards a domestic and regionally-driven engine of
growth would require continuous funding from Asia’s bank-
dominated financial system
However, Asia faces funding issue under Basel III rules that would
reduce the incentive for banks to lend to trade finance and SMEs,
and discourage long-term lending for infrastructure at a time when
this is critical for Asia’s sustained growth
While Basel III requirements on higher capital adequacy, enhanced
liquidity and an overall leverage cap are commendable, the detailed
rules on liquidity and risk-weighting may restrain the funding
capacity of Asian banks
11

13. 12
Banking sector has to adjust to unprecedented
regulatory change
12
Source: McKinsey. The Triple Transformation, October 2012.

14. 13
Global capital markets business also has to
adjust to regulation
13
Source: McKinsey. The Triple Transformation, October 2012.

15. 14
Need for adaptive business models to seize
new growth trends
14
Source: McKinsey, BCG.

16. 15
Going to where the new trade corridors are
15
Source: BCG. The Transaction Banking Advantage, October 2012.

17. 16
Revamping payments value chain
16
Source: BCG. The Transaction Banking Advantage, October 2012.

18. 17
Need true banking transformation to improve
financial metrics
17
Source: McKinsey. The Triple Transformation, October 2012.

19. 18
Need to reverse declining ROE due to lack of
performance improvement and rising capital ratios
18
Source: McKinsey. The Triple Transformation, October 2012.

20. 19
Business model transformation – the basis for
future growth
• Capital markets business is most challenging due to regulatory
pressure, high funding costs, and shrinking revenues.
19
Source: McKinsey. The Triple Transformation, October 2012.

21. 20
The need for a balanced view, with appropriate
“fit” for EMEs
1. Basel III was designed to address the causes of the 2007-2009
Financial Crisis in the advanced markets, aimed to resolve the
issue of under-capitalisation and over-leverage in the advanced
wholesale banking model.
2. Current Basel III on risk-taking governance requirements represent
substantial improvement in quality, quantity and comparability of
banks’ risk/reward profile. Asia needs that and supports Basel III.
3. However, there is substantial variation in quality of banks,
supervisors and regulators between more retail-based systems
(e.g., China, Canada, India, Australia) and wholesale systems (US,
UK and some EU countries).
4. Need for clarity on WHAT is National discretion? WHAT fits local
conditions and what is necessary to supplement Basel III
implementation to ensure overall systemic stability.
20

22. 21
Agree that under-capitalisation and illiquidity of
internationally-active banks need to be solved
Figure 1. Ratio of Debt to GDP Among Selected Advanced Economics
(In percent, GDP-weighted, 1987=100)
21

23. 22
Do Basel III rules address the priority policy and
real sector needs in Asia?
• While Asian banks can meet the current Basel III capital
requirements, it is not clear as Asia grows faster with higher
credit needs, whether there will capital constraints going
forward.
• Asian banks are at different stages of development and Asian
countries have different national imperatives.
• Capacity of Asian banks to implement Basel II/III vary hugely
between banks, especially the smaller and non-internationally
active banks.
• Europe is expected to have the largest shortfall of over €272
billion in meeting Basel III capital requirements, and the US
may have a shortfall of $60 billion.
22

24. 23
Tighter financial conditions resulting in capital
shortfalls, in turn worsening the real economy
Source: IIF. “The Cumulative Impact on the Global Economy of Changes in the Financial 23
Regulatory Framework”. September 2011.

25. 24
Basel 2.5/III uses Risk Weighting and Models to
assess Risks
• Advanced country banks have high sovereign ratings and have
experience in Internal Risk Based (IRB) Models which assign
lower risks, if banks can prove with data.
• Asian banks are less sophisticated and rely on standard
model, and because sovereign credit ratings are lower, and
Asian banks do not have good risk data, they automatically
have higher capital costs relative to European banks (see next
Slide).
• Example:
For top ASEAN banks For top European banks For top American banks
• Basel III’s CET1 = • Basel II’s CT1 average = • Basel III’s Tier 1 Common
average of 10.7% 10.2% (one bank has an Ratio average = 8.4%
• Basel II’s CT1 = average average of below 7%)
of 11.5%
24

26. 25
Asian banks disadvantaged with the use of
sovereign credit rating
• Much more capital needed to support the same amount of
loans or bonds (based on S&P risk weights, ASEAN+3 banks
will need 300% more capital).
25

27. 26
Asian banks have high RWA relative to total
assets
26

28. 27
Top banks in Asia
Total ROA CAR CAR Cost to Income LTD Ratio
Country Largest Bank Assets % (Tier 1 %) (Total %) % %
Germany Deutsche Bank 2805.29 0.20 12.90 14.50 82.83 68.55
France BNP Paribas 2547.68 0.31 11.60 14.00 NA 121.88
US J.P. Morgan 2265.79 0.84 12.30 15.40 64.70 64.17
US Citibank 1873.88 0.59 13.60 16.99 65.00 71.25
Japan Mitsubishi UFJ 2603.95 0.19 12.31 14.91 NA NA
China ICBC 2476.30 1.35 10.07 13.17 29.91 63.50
Hong Kong HSBC 1333.03 0.28 9.10 14.40 66.20 83.20
Singapore DBS 279.49 0.89 12.90 15.80 43.30 86.40
South Korea Kookmin Bank 238.62 0.80 10.14 13.09 NA 105.00
Malaysia Maybank 135.96 1.08 11.84 15.36 49.60 90.10
Taiwan Bank of Taiwan 135.74 0.09 10.50 11.38 NA 67.61
India ICICI Bank 94.73 1.61 12.70 18.50 42.91 76.10
Thailand Bangkok Bank 68.69 1.30 12.21 15.35 NA 92.60
Indonesia Bank Mandiri 56.66 2.23 14.90 17.20 41.60 74.10
Philippines Banco de Oro 26.84 0.95 10.00 15.80 67.90 66.73
27
Source: The Asset, Volume 14 Number 11, December 2012.

29. 28
Whither Basel III for Asia?
• The US has postponed implementation of capital rules for the year 2013
and delayed implementation of liquidity rules. Pressure to delay the start
date was due to concerns over the complexity of the rules and the cost to
banks at a time of weak global economic growth.
• Europe is also re-considering and the Bank of England has expressed
concerns on the complexity of the rules, especially since bank supervision
is returning to the Bank of England.
“Rather than pushing through a flawed Basel III, we need to take the time to
do it right so we do not have to do it over. … Basel III’s implementation has
been postponed, and that offers a real chance to get it right. If we do, we
won’t need Basel IV” – Thomas M. Hoenig, 2012*
As a result, Basel Committee announced agreement on Liquidity Rules with
a delayed phase in period.
* Get Basel III right and avoid Basel IV. http://www.ft.com/intl/cms/s/0/99ece1b0-3fa0-11e2-b2ce-
00144feabdc0.html#axzz2HRMF1qU1
28

30. 29
Section 2 What are the key issues and
concerns?

31. 30
Emerging Market banks find it currently easier
to meet Basel III requirements
Figure 2. International Comparison of the Financial Liabilities/Assets Ratio
30

32. 31
Asia has its own national banking development
agenda and time frame
• The extensiveness of the rules will have tremendous
implications on re-shaping and micro-managing the business
models of banks locally, regionally and worldwide.
• This raises the question of whether national regulators should
be given more discretion to adjust their regulatory and
supervisory guidelines in line with the Basel principles in a
manner that suit their national banking development agenda
and time frame.
• BCBS has now created a small team to look at “simplifying
Basel III”. This is the time to engage BCBS through Asian
regulators which can influence the final outcome, especially
those which are represented either at G20 or FSB/BCBS
levels.
31

33. 32
Implementation of Basel III will have costs on all
banks, global or local
Constrained credit
provision by Emerging
Market banks
Risk of synchronised
slowdown globally if
Asian growth also
constrained by limits
on credit
Retrenchment and
deleveraging by global
banks
32

34. 33
Issue 1: Potential trap of synchronized
recession
• If the unintended consequences of implementing Basel III are
to slow Asian growth because of the limited capacity of the
banking system to support the growth of the real economy,
especially for SMEs, trade and infrastructure finance, then the
whole world may be trapped in a policy-induced unintended
synchronized recession.
• Solution: Each Asian country should study what are the credit
needs projected to 2020 and see if addition capital would be
required to meet the new credit needs.
33

35. 34
Issue 2: Risk-weightings biased against Asian
banks
• Basel capital rules favour banks that have developed
“advanced risk models” for determining risk-weighted assets
(RWA). Asian banks are some 10 years behind in this respect.
Hence, they will not be able to use efficient conversion factors
even if they are given a transition period up to 2019.
• Solution: Each Asian country will have to develop better data-
bases on credit history in order to re-calculate the risk weights;
this will enable the larger banks to move toward Internal Risk-
Based models with their own risk weights.
34

36. 35
Issue 3: Credit ratings biased against Asian
banks
• The Basel III risk-weightings are based on current sovereign
credit ratings.
• Asian economies (and by definition, Asian banks) have lower
credit ratings, even though their sovereign debt has high
foreign exchange backing (up to 50%) and Asian economies
have higher savings and lower fiscal debt.
• Many Asian banks are state-owned, thus the urgency to raise
large capital cushions is not as imperative as the European
case.
• Solution: Asia should consider creating Mutual (owned by
users and industry) not-for-profit Credit Rating Agencies that
can give ratings that are more objectively based. This will
provide competition to current top 3 that have become TBTF.
35

37. 36
Issue 4: Liquidity risk framework not directly
relevant to Asian banks
• The Basel liquidity risk framework aims to restrain the balance
sheets of banks which: (1) are highly leveraged; (2) have
significant maturity mismatches; and (3) are funded mainly by
the wholesale markets.
• However, Asian banks generally do not fall within any of these
three categories because they have large deposit bases, the
population has high savings rate, and the fiscal and balance of
payments positions at the national level are much more robust.
Solution: Asian banks should work with central banks to
examine how domestic liquidity can be provided in manner
which would not create a ‘rush for funding’.
36

38. 37
Basel liquidity rules vs. Asian situation
• Flexible
exchange
rates
• High loan-to-
deposit ratios • Substantial
liquid assets
• High leverage
• Low nominal
leverage
With low fiscal debt and high foreign
exchange, limits on loan-to-deposit
ratio, Central Banks can easily
provide liquidity to domestic banks.
37

39. 38
Issue 5: Asia has huge need for infrastructure
funding
• The detailed rules on liquidity, risk-weightings and leverage
may constrain the capacity of Asian banks to fund
infrastructure since there is growing maturity mismatch risk.
• Furthermore, Basel III rules also make asset securitization
more expensive.
• The ADB estimates that US$8 trillion will be required to finance
infrastructure, creating massive potential for the development
of Asian municipal and infrastructure bond markets.
• Solution: Develop Asia’s fixed income markets through asset
securitization. This would help to lessen the maturity mismatch
in bank balance sheets [e.g., Cagamas and HKMC].
38

40. 39
Large interest in infrastructure financing
• Asia is at the early stages of securitized debt markets.
• China also needs mortgage securitization to reduce maturity
mismatch, particularly through bond market.
39

41. 40
Issue 6: Trade finance is Asia’s lifeblood
• Trade finance business is forecast to grow at 9% annually to 60% of
all global trade by 2020, with one leg in Asia.
Trade finance underpins
30–40% of the lending
SMEs received. It forms
the most relevant part of
working capital financing
• Solution: Central banks should incentivise banks to promote trade
finance and consider establishing a “Trade window” for real market
transactions.
40

42. 41
How to ringfence trade finance in times of crisis
• Central bank could offer low-cost liquidity to commercial banks,
against “ringfenced” portfolios of trade assets.
• Public entity could purchase trade and hold trade assets
directly.
• Public entity could “guarantee” specific trade obligations, to
support a liquid market in trade assets.
41

43. 42
Basel III’s impact on trade
BAFT-IFSA: Basel III Demand for trade
may raise trade finance finance rising rapidly
costs by 18-40%
42
* BAFT-IFSA, Basel III-Impact on Trade, Tod Burwell, November 2011, Washington, D.C.

44. 43
Issue 7: Asia’s SME development drive and job
creation
• Asia is at the cusp of an SME development drive to promote job
creation, innovation and market competition. SMEs rely heavily on
trade finance and short-term bank credit, they account for 80-90% of
job creation to address employment and equity challenges.
• Both European Commission and UK recognize that lending to
SMEs, though carrying higher credit risks, have large social benefits
in terms of growth and employment generation.
• The net effect of higher risk-weights on SMEs and higher costs and
lesser credit to SMEs may generate exactly the economic slowdown
that creates higher risk for the banking system.
• Hence, policymakers have to weigh the positive spillover effects of
SME health vs protecting banks against credit risk.
• Solution: Policy-makers should work alongside private sources of
equity to meet SME financing needs.
43

45. 44
Lending to small enterprises still lower than
medium and large enterprises
Figure 3. Growth Rate of Outstanding Loans Extended to Large Enterprises, Medium
Enterprises, and Small Enterprises
44

46. 45
Access to finance is a major problem for SMEs
• A ECB survey shows that access to finance is perceived as the
second most pressing problem for SMEs, after their order
book.*
• Accordingly, the European Banking Authority (EBA) is
examining a proposal by the European Parliament to adjust the
risk-weights for lending to SMEs, and an increase in the
threshold of EUR2 million for the Standardised Approach and
EUR5 million for the Internal Ratings-Based (IRB) Approach.
* European Central Bank, Survey on the Access to Finance of SMEs in Euro Area, April 2012.
45

47. 46
We are in a self-fulfilling vicious cycle
Risk-
SME
weighting
have high
increases
risks
risk
Economy We do
will slow not lend
down to SMEs
SMEs will
not be
able to
grow
We have to distinguish the positive externalities of SMEs, trade finance,
infrastructure, which creates jobs and future growth, from the negative externalities
of fast trading, high leverage, things that will destroy the economy systemically
46

48. 47
Issue 8: Implementation cost on banking
operations
• Lastly, the implementation of complex Basel III rules will result in
Asian banks incurring disproportionately large costs.
• Asian banks are still in the process of implementing Basel I and II
(and 2.5); and yet they are now burdened by Basel III.
• Asian banks’ expertise and experience are scarce.
–Whether scarcity management and regulatory resources should be
focused on developing a banking system that supports and fits
Asian realities, rather than “one-size-fits-all” rules designed for
implementation by advanced countries.
• Global banks have the capacity to absorb these costs but not the
smaller national banks in Asia, which are at different stages of
development.
• Solution: Asian banks should review their business models that can
help generate new revenues to help fund these costs.
47

49. 48
Non-Bank Assets (NBFI or shadow banking) more
than Bank Assets
• Regulatory arbitrage from banks to shadow banks more than bank
assets.
• Contagion can occur between banks and shadow banking. Risk are
not just in banks.
48

50. 49
Basel Rules are not law and do not have legal
force
• Whilst national regulators need to use Basel III as standards,
the total national requirements and law are still paramount.
“3. Legal Status. The BCBS does not possess any formal
supranational authority. Its decisions do not have legal
force. Rather, the BCBS relies on its members'
commitments, as described in Section 5, to achieve its
mandate.” - New Basel Committee on Banking
Supervision (BCBS) Charter, January 2013
Source: BIS. Group of Governors and Heads of Supervision endorses revised liquidity standard for 49
banks http://www.bis.org/speeches/sp130106.htm

51. 50
Section 3 Role of Asia finance in
rebalancing Asia’s Growth Model

52. 51
What do we mean by “Rebalancing”?
51

53. 52
National rebalancing must address mismatches
and gaps
52

54. 53
Impact of rebalancing on non-reserve currency
countries
• For every 10% revaluation relative to G4 countries, the surplus
holders of global FX reserves stand to lose roughly 5% of their GDP.
Table 2: Impact of Global Imbalances on Surplus Countries
- Global Net Foreign Asset (NFA) and Liability Position, 2008
Region/Country Net Foreign GDP NFA/GDP Exchange rate Impact as
Asset (+), Deficit 2008 % impact due to % of GDP
(-) US$ bn 10% change in
US$ bn USD
Asian Surplus + 4,994 12,309 + 40.6 - 499 - 4.1
Other Surplus + 2,863 3,706 + 77.3 - 286 - 7.7
Total Surplus + 7,857 16,015 + 49.1 - 786 - 4.9
Euro Area - 2,584 13,631 - 16.9 +258 + 1.9
USA - 3,690 14,441 - 25.6 +369 + 2.6
Australia - 501 1,062 - 47.2 + 50 + 4.7
Subtotal Deficit - 6,775 29,134 - 23.3 + 678 + 2.3
Other Countries - 1,082 16,070 - 6.7 -108 +0.1
Global Total 0 61,219
Source: Author’s calculations.
53

55. 54
Section 4 Conclusion

56. 55
What should be Asia’s stance on Basel III?
• Basel III is now a complex rule books of over 600 pages and has become a
“one-size-fits-all” rule-book.
• Risk that Basel rules have become too prescriptive, leaving little room for
banks and regulators in developing countries to exercise judgment in
conducting lending activities that support the national development agenda.
• The issue is trust between industry and regulators. Board of Directors
have fiduciary duty and must be trusted to make their judgment on risks and
rewards. Supervisory authorities should step in when there is supervisory
judgment that the bank has not recognized the risks and may contribute to
systemic risks.
• BCBS must trust national regulators to monitor their system risks and only
step in (via FSAP/FSB/IMF) if the activities of D-SIFIs, G-SIFIs or national
system contribute to global systemic risks.
55

57. 56
Basel III is necessary, but not sufficient. Look at
system as a whole (including shadow banking)
• We support Basel III’s capital adequacy and we are also fine with the
compromise on liquidity requirements. The use of model – risk-weighting is
still under dispute.
• The question is can we solve the banking problem by only looking at the
banking system while ignoring the shadow banking, NBFI, and long-term?
• The banking problem is that it is too short-term. Basel III only concentrates
on banking but not on shadow banking, capital markets, pension, insurance
(the whole system). There is no proper pension or insurance system in
place to take the long-term risks.
• It doesn’t mean that “if institutions are fixed, then everything will be fixed”.
It’s the whole class of systemic assets and the linkages of systemic
liabilities which cut across different institutions that will cause things to blow
up if they become fragile. We need to focus on cross-cutting issues along
with institutions. The current policy approach is an “either or” situation.
56

58. 57
An implementation time table, customized to
domestic conditions and imperatives
US: postponed adoption of Basel III
Europe: adopting their own approach and argue that they are
“broadly consistent” with Basel rules
Bank of England: argued against the complexity of bank
regulatory rules, and the opacity these rules create
• Asian policymakers should reconsider the practicality of the time
frame in implementing Basel III, and the urgency of adopting broader
financial infrastructure and national risk management framework that
would help to enhance overall system resilience against
endogenous and exogenous shocks.
• So long as local banks do not have systemic implications on global
markets with negative spillovers, national regulators should reserve
the discretion to draw up a timetable for implementation that is
customized to domestic conditions and imperatives.
57

59. 58
Need to work together
• Emerging Asia needs practical implementable rules that best-
fit Asian conditions.
• We seek to achieve the most effective OUTCOMES of Basel
objectives AND systemic stability, including NBFIs.
Unless we coordinate, we are less likely to have impact in the
global debate.
We need to rebalance between implementing rules and
financial markets to serve the real economy.
We have to avoid rules that will fragilize the Asian economy.
58

60. 59
Appendix Amendments to the Liquidity
Coverage Ratio (LCR) and the
new BCBS Charter; and
CRR4

61. 60
Amendments to LCR in four main areas – BCBS, 6
January 2013
High quality assets Definition of high quality assets for LCR (numerator of the ratio) and the factors that
(HQLA) & net cash determine the net liquidity outflows that banks would face in stress (denominator of the
outflows ratio)
Revised timetable • Same as that of capital requirements: coming fully into effect only in 2019
for introduction of • The LCR will be introduced as planned on 1 January 2015. But the minimum
the LCR – phase-in requirement will begin at 60%, rising in equal annual steps of 10 percentage points to
arrangements reach 100% on 1 January 2019
• This will ensure that the new liquidity standard will in no way hinder the ability of the
global banking system to finance a recovery
Usability of stock of • During periods of stress, banks can use their stock of HQLA, thereby falling below the
liquid assets in minimum. It is the responsibility of bank supervisors to give guidance on usability
distress/transition according to circumstances
• Countries with distressed banking systems have complete flexibility in their application
of the LCR until the distress has passed
• Liquidity buffers defined by the LCR are to be used in times of stress
• This is applicable both during the transition and in steady state
Further work on the • Deposits with central banks are the most liquid asset, the interaction between the LCR
interaction between and the provision of central bank facilities is important
LCR & the provision • Ensure that banks hold sufficient liquid assets to prevent central banks becoming the
of central bank "lender of first resort"
facilities
Source: BIS. Group of Governors and Heads of Supervision endorses revised liquidity standard for 60
banks http://www.bis.org/speeches/sp130106.htm

62. 61
LCR - Description
• To promote short-term resilience of a bank’s liquidity risk profile.
• To ensure that a bank has an adequate stock of unencumbered high quality
liquid assets (HQLA).
– Consists of cash or assets that can be converted into cash at little or no
loss of value in private markets, to meet liquidity needs for a 30 calendar
day liquidity stress scenario.
• Two components: Stock of HQLA
Total net cash outflows over the next 30 calendar days
• Absent a situation of financial stress, the value of the ratio be no lower than
100%1 (i.e. the stock of HQLA should at least equal total net cash
outflows). Banks are expected to meet this requirement continuously and
hold a stock of unencumbered HQLA as a defence against the potential
onset of liquidity stress. During a period of financial stress, banks may use
their stock of HQLA, thereby falling below 100%.
61
Source: BIS. Annex 1 - Summary description of the LCR.

63. 62
LCR – Detailed changes: HQLA (1/3)
Expand the definition of • Corporate debt securities rated A+ to BBB– with a 50% haircut
HQLA subject to a higher • Certain unencumbered equities subject to a 50% haircut
haircut and limit • Certain residential mortgage-backed securities rated AA or higher with a 25%
haircut
Aggregate of additional assets, after haircuts, subject to a 15% limit of the
HQLA
Rating requirement on Use of local rating scales and inclusion of qualifying commercial paper
qualifying Level 2 assets
Usability of the liquidity Incorporate language related to the expectation that banks will use their pool of
pool HQLA during periods of stress
Operational requirements Refine and clarify the operational requirements for HQLA
Operation of the cap on Revise and improve the operation of the cap
Level 2 HQLA
Alternative liquid asset Develop the alternative treatments and include a fourth option for sharia-
(ALA) framework compliant banks
Central bank reserves Clarify language to confirm that supervisors have national discretion to include
or exclude required central bank reserves (as well as overnight and certain
term deposits) as HQLA as they consider appropriate
62
Source: BIS. Annex 2 - Complete set of agreed changes to the Liquidity Coverage Ratio.

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LCR – Detailed changes: Inflows and Outflows (2/3)
Insured deposits • Reduce outflow on certain fully insured retail deposits from 5% to 3%
• Reduce outflow on fully insured non-operational deposits from non-financial corporates,
sovereigns, central banks and public sector entities (PSEs) from 40% to 20%
Non-financial corporate Reduce the outflow rate for “non-operational” deposits provided by non-financial corporates,
deposits sovereigns, central banks and PSEs from 75% to 40%
Committed liquidity Clarify the definition of liquidity facilities and reduce the drawdown rate on the unused portion of
facilities to non-financial committed liquidity facilities to non-financial corporates, sovereigns, central banks and PSEs
corporates from 100% to 30%
Committed but unfunded Distinguish between interbank and inter-financial credit and liquidity facilities and reduce the
inter-financial liquidity and outflow rate on the former from 100% to 40%
credit facilities
Derivatives • Additional derivatives risks included in the LCR with a 100% outflow (relates to collateral
substitution, and excess collateral that the bank is contractually obligated to
return/provide if required by a counterparty)
• Introduce a standardised approach for liquidity risk related to market value changes in
derivatives positions
• Assume net outflow of 0% for derivatives (and commitments) that are contractually
secured/collateralised by HQLA
Trade finance Guidance to indicate that a low outflow rate (0–5%) is expected to apply
Equivalence of central Reduce the outflow rate on maturing secured funding transactions with central banks from 25%
bank operations to 0%
Client servicing brokerage Clarify the treatment of activities related to client servicing brokerage (which generally lead to an
increase in net outflows)
63
Source: BIS. Annex 2. http://www.bis.org/press/p130106.htm

65. 64
LCR – Detailed changes: Clarification to rule text and
LCR phase-in (3/3)
Rules text • Clearer guidance on the usability of HQLA, and the
clarifications appropriate supervisory response, has been
developed to ensure that the stock of liquid assets is
available to be used when needed
• A number of clarifications to the rules text to promote
consistent application and reduce arbitrage
opportunities (e.g., operational deposits from
wholesale clients, derivatives cash flows, open
maturity loans). Also incorporating previously agreed
FAQ
Internationally The minimum LCR in 2015 would be 60% and
agreed phase-in increase by 10 percentage points per year to reach
of the LCR 100% in 2019
64
Source: BIS. Annex 2. http://www.bis.org/press/p130106.htm

66. 65
Capital Requirements Regulation (CRR 4) – Overall
impact on trade finance (TF)
• CRR 4 is the equivalent of Basel 3 and will be implemented in Europe
across all 27 countries.
• Proposed changes under CRR4 in the treatment of TF products supportive
of TF, which is a critical part to keep the economy ticking on an even keel.
• Recognition that TF is a low risk activity.
– ICC study for 2011* shows on an industry-wide basis, there were fewer
than 3,000 defaults observed in a dataset comprising 11.4 million
transactions collected for 2005-2010. Typical loss rates for 2008-2010: for
TF products like L/Cs were 0.007%, export confirmed L/Cs 0.03%, Import
loans 0.07%, export loans 0.017%.
– Strong case for arguing that Trade deserves a better treatment under the
internal ratings based approach (IRB). A lower asset value correlation
charge (AVC) for TF products would go some way to ensure that trade
products get the appropriate capital treatment they deserve.
65
Source: International Chamber of Commerce (ICC). Global Risks ‒ Trade Finance, 2011.

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Capital Requirements Regulation (CRR 4) – Proposed
changes
Uniform • Under Basel 2, local regulators had to translate the European rules into local rules and
rule book regulations – this created scope for differences in the rules and regulations
Maturity Floor • Basel left open the option to national discretion to extend the MFW to all TF products –
Waiver (MFW) CRR-4 proposes to extend the MFW to all TF products
Credit Conversion • To reduce CCF applied to non-financial guarantees (i.e. bid bond, advance payment,
Factor (CCF) performance and retention guarantees) from 50% to 20%
• Under Basel III and CRR 4, exposures to large financial institutions (assets > $100bn) will
attract a 1.25 scaling factor to account for systemic risk
• While systemic risk is an important issue for banks, trade finance was not a contributor to
Asset Value the increased systemic risk within banks during the crisis and should not be penalised
Correlation • Important to note that increased linkages between banks, at least for trade finance, is a
(AVC) function of a bank’s primary role in facilitating payments within the financial system and not
necessarily one of taking on increased counter party risk
• Hence, strong case for arguing that the scaling factor applied should be a range varying
from anything greater than 1 to a max. of 1.25 instead of applying a flat scaling factor of
1.25 across all banks
Leverage • To apply more favourable CCF of 20% and 50% to TF products like L/Cs and guarantees.
Ratio Basel III proposes to apply a 100% CCF to all contingent liabilities including TF products
Liquidity • To recognise 100% of trade inflows in the calculation of the liquidity coverage ratio (LCR)
Ratios in lieu of the Basel III proposed 50% of trade inflows
66

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