Potential Bank Rating Implications Of The
Banking Union
Stefan Best, Managing Director
European Financial Services stefan_best@standardandpoors.com
Copenhagen
27 February, 2014
For Internal Use Only —Not For External Distribution
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4 All data as at: 01/02/14

5 All data as at: 01/02/14

6 All data as at: 01/02/14

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• Deleveraging and restructuring to continue
• Potential for further large credit impairments
(weak economy and upcoming asset quality review and stress tests)
• Earnings pressure will persist (weak economy, low interest rates, deleveraging, restructuring, litigation, regulatory changes)
• Initiatives to reduce funding gaps and repay
ECB LTROs
• Capital strengthening
• Adapt to evolving bank resolution legislation

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Banking Union Update
Initiative
Single rule book
Objective
Uniform application of Basel 3 in all member states
Status
Approved
Effective Jan. 2014
Single Supervisory
Mechanism
Common supervision of the about 130 largest banks in the euro area but open to all EU member states
Approved
Effective Nov. 2014
Single Resolution
Mechanism and
BRRD
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Align supervision and resolution at central level
• Create single resolution fund (SRF)
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Comon legislation on bank resolution (BRRD)
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To be agreed on before the elections in
May 2014
• BRRD/SRM effective by Jan. 2015
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Bail-in tool Jan. 2016?
Direct bank recapitalization through
ESM
Provide financial backstop besides SRF
Common Deposit
Guarantee Scheme
Strengthen customer confidence and stability of banks' funding bases
Requires finalization of BRRD/SRM
Progress uncertain
Structural Reform
Measures
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EU „Too-big-too-fail banks“:
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Reduce risk of failure
• Facilitate bank resolution
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Ease monitoring and supervision
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EC Proposal on Jan 29, 2014
• Prop trading ban Jan. 2017?
• Separation other trading July 2018?

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• Ban on prop trading for deposit taking institutions which would apply to ~30 of the biggest EU banks
 W ould prohibit activities “for the sole purpose of making a profit for own account without any connection to actual or anticipated client activity” in banks that meet certain criteria and exceed a specified threshold (applicable from 1 Jan. 2017)
 Would also prohibit the same banks from investing in hedge funds
• Grant supervisors the power or obligation (BRRD Art.13) to require the transfer of other high-risk trading activities such as market making, complex derivatives and securitization (applicable from 1 July 2018)
• Rules on operational links between trading entity and rest of the banking group to ensure that separation is effective
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BRRD
– Art. 14 already gives the authorities the “powers to address or remove impediments to resolvability” (including the power to require changes to the legal or operational structures of banks)
• Likely to apply to foreign subsidiaries of EU banks and EU branches of foreign banks (exemptions possible for third country equivalence regime)

Uplift to the SACP for potential government support
“Moderately high" likelihood of extraordinary government support
• The long-term counterparty credit ratings on highly systemically important Western European banks is up to two notches higher than the SACP, reflecting our view of a “ moderately high " likelihood of extraordinary government support (up to one notch higher for moderately systemically important banks)
Source: Banks: Rating Methodology And Assumptions Nov. 9, 2011
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• Systemic importance, according to our criteria, is the degree to which a bank's failure affects all or parts of the financial system and the real economy of the country where the bank operates.
• We currently regard almost all top 50 Western European banks as “highly systemic”. In most cases, this leads to a 1 or 2 notch support uplift in their current rating, as well as to the ratings of their subsidiaries.
• Emerging resolution powers could have implications for the notches of government support currently included in ratings on systemically important banks
– We could re-classify governments as less supportive
– We could re-classify banks as less systemically important
– There may be specific risks associated with particular classes of debt (e.g. subordinated)
– Parental support for foreign subsidiaries and branches may be less certain
• Changes to business and financial profile could affect ratings up or down
• There may be other specific implications
– For example, in the U.S., the FDIC’s proposal for a single point of entry could affect ratings on bank holding companies
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• Although political consensus is emerging, obstacles for resolution remain which means that providing extraordinary government support to senior creditors in a timely fashion remains a strong possibility
 Resolvability of banks: that is, the ability to stabilize a failing institution and effect an orderly wind-down
 The need to preserve confidence in the banking system and support economic recovery
 Common resolution tools and legislation
 Sufficient longterm liabilities eligible for “bail-in”
 For internationally-active banks, it remains unclear how authorities will be able to ensure coordination when executing a resolution
• We expect most Western governments to remain supportive of the senior creditors of systemic banks while economies recover and resolution regimes develop
• We will continue to review rating implications as resolution powers become more advanced and harmonized, and more banks become easily resolvable
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New regulation, supervision, and legislation can affect bank ratings positively and negatively in multiple ways
Regulation, Supervision, Legislation:
• Single Rule Book
• Single Supervisory Mechanism
• Single resolution mechanism/BRRD
• Structural reform
• Financial backstops
Rating factors:
• BICRA: Economic and Industry Risk
• Business position:
• Stability, Diversity, Restructuring needs
• Capital & Earnings:
• Capital buffers, Operational cost,
Earnings potential
• Risk position:
• Growth, Concentration, Complexity
• Funding & Liquidity:
• Liquidity buffers; Funding mismatches;
Funding access; Asset Encumbrance
• Government support:
• Ability and willingness
• Group support: Fungibility/Ringfencing

• European banks are navigating in uncertain times
• The five key risks that we have identified some time ago continue dominating bank ratings
1. Weakening sovereign creditworthiness
2. Threat of economic recession or only sluggish recovery
3. Funding constraints
4. Transition to more stringent regulatory requirements
5. Changing nature of government support
• Extraordinary support has been the key stabilizing factor for many
European bank ratings
• Banking Union can affect bank ratings positively and negatively in multiple ways
• Impact depends on banks ´ business and financial profile and how banks ´ managements, authorities and market participants respond to these changes

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