MALTA-COMMONWEALTH THIRD COUNTRY TRAINING
PROGRAMME
BANKING AND FINANCE IN SMALL STATES:
ISSUES AND POLICIES
Workshop organised by the
Islands and Small States Institute, University of Malta
In collaboration with the Commonwealth Secretariat and the
Ministry of Foreign Affairs, Malta
16-20 April 2012
Karol J. Gabarretta
Director – Banking Supervision Unit MFSA
Regulatory Developments: Basel III - 16 April 2012
2
“A bank regulator’s lot is not a happy one”
“Chained but untamed”; The Economist’s Special Report on International Banking, 14 May 2011
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Disclaimer
3
The author wishes to specify that the views
expressed within this presentation, as well as any
errors, are the author’s sole responsibility and do
not in any way represent the official views of the
MFSA
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Overview
4



Introduction to the EU’s proposal known as CRD IV
Highlights from the capital adequacy and liquidity
framework (i) the Directive and (ii) the Regulation plus a
‘quick and dirty’ look at some particular areas and
concomitant local implications
Conclusion – points to ponder
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Introduction
5
(Main) Timelines
26 July 2010
Group of Governors of Heads of
Supervision of BCBS – deep commitment
to reform capital and liquidity framework
12 September 2010
Same forum – “substantial strengthening
of existing requirements”
11-12 November 2010
G20 agreement and declaration
16 December 2010
Basel III formally launched!
1 June 2011
Revised Version of Basel III framework
(liquidity rules unaffected)
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Introduction
6
(Main) Timelines cont. - EU Commission Process
7 October
‘Karas Report’
February-March 2011
Public Consultation
Commission
20 July 2011
CRD IV Proposal Launched!
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
–
EU
16 April 2012
Introduction
7
On 20 July 2011, the Commission adopted a legislative proposal (so-called CRD IV) in
order to strengthen the regulation of the banking sector. The Proposal, which is to
replace the current Capital Requirements Directive (2006/48/EC and 2006/49/EC),
contains two legal instruments which should be considered together:

The Directive – governing the access to the activity of credit institutions and the
prudential supervision of credit institutions and (NB) investment firms

The Regulation – detailing the prudential requirements for credit institutions and
investment firms

The Proposal is accompanied by an impact assessment which demonstrates that
this reform will significantly reduce the probability of a systemic banking crisis in
the future
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - The Proposal
8
Main Attributes of the Proposal




Raise the quality [and quantity] of capital to ensure banks are better able to
absorb losses on both a going concern and a gone concern basis
Increase the risk coverage of the capital framework, in particular for trading
activities, securitisations, exposures to off-balance sheet vehicles and
counterparty credit exposures arising from derivatives
Raise the level of the minimum capital requirements, including an increase in
the minimum common equity requirement from 2% to 4.5% and a capital
conservation buffer of (up to) 2.5%, bringing the total common equity
requirement to 7%
Introduce an internationally harmonised leverage ratio to serve as a backstop
to the risk-based capital measure and to contain the build-up of excessive
leverage in the system
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - The Proposal
9

Enhance supervisory oversight to reinforce the supervisory regime to
require the annual preparation of a supervisory programme for
each supervised institution based on a risk assessment, greater and
more systematic use of on-site supervisory examinations, more
robust standards and more intrusive and forward-looking
supervisory assessments

Raise standards for the Supervisory Review Process (Pillar 2) and
public disclosures (Pillar 3), together with additional guidance in the
areas of sound valuation practices, stress testing, liquidity risk
management, corporate governance and compensation
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - The Proposal
10



Introducing minimum global liquidity standards consisting of both a
short term liquidity coverage ratio and a longer term, structural net
stable funding ratio
Promoting the build up of capital buffers in good times that can be
drawn down in periods of stress, including both a capital
conservation buffer and a countercyclical buffer to protect the
banking sector from periods of excess credit growth
The new framework will be translated into … national laws and
regulations, and will be implemented starting on January 1, 2013
and fully phased in by January 1, 2019
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - The Proposal
11
The “maximum harmonisation” debate:

The Directive’s ‘component’ of the Proposal deals with those requirements that
need to be transposed into national law but where more flexibility in an number
of areas may be required. On the other hand, the Regulation’s ‘component’ of
the Proposal notes that although nothing prevents institutions themselves from
holding more capital, national Member States may not impose stricter rules as
the Proposal is a maximum harmonisation measure

This has irked some Member States (including UK, Spain and Sweden) who have
criticised the inability to increase or vary Pillar 1 requirements such as capital
levels or risk weights when Member States deem it expedient to do so. Phasingin arrangements and the application of buffer requirements were also targeted
by the 8 signatories to their 19 May 2011 letter to Commissioners Barnier and
Rehn
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - The Proposal
12

On this issue the Commission retorted that member states, if they are so willing, may:
•
impose a higher counter-cyclical capital requirement
•
utilise Pillar II measures
Talking
point 1
Talking
point 2
Point 1 – why use the counter-cyclical capital buffer (0 - 2.5% range) when in the
Proposal this is “intended to achieve the broader macro-prudential goal of protecting
the banking sector and the real economy from the system-wide risks stemming from the
boom-bust evolution in aggregate credit growth and more generally from any other
risk factors related to risks to financial stability”? Besides, this implies that by design,
the counter-cyclical buffer is aimed to be a measure which is not to be constantly
applied
Point 2 – why Pillar II? This is also a tool which is utilised on a bank-by-bank basis.
Moreover, it “is not designed to set requirements for categories of banks”
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - The Proposal
13


On a related matter the Commission has repeatedly insisted that its “proposals to
implement Basel III will respect the balance and level of ambition included in Basel 3” Commissioner Barnier, 27 May 2011. At the same time it has been stated that in certain
areas at least, the Proposal seems to set lower standards than Basel III. In fact such
commentators have highlighted that since the calculation of the two capital buffers has
been put into the Directive, this seems to allow for more flexibility by Member States in
transposing these requirements into their national law - in previous drafts this was still a
component of the Regulation
The Commission justified this stance by emphasising that while the Basel III would only
apply to internationally active banks, CRD IV is applicable to all banks and investment
firms active in the EU’s single market. Presumably given the wide and varying nature and
size of the more than 8000 banking institutions within the EU (ignoring stand-alone
investment firms) the Commission felt that some elements of the Proposal would better
be implemented through other than a ‘one-size-fits-all’ approach
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - The Proposal
14


More specifically in respect of the criteria for eligible types and definitions
of high quality liquid assets under the short-term 30-day Liquidity
Coverage Ratio (LCR) in CRD IV these appear to be somewhat looser than
the criteria under Basel III. In fact covered bonds feature as highly quality
liquid assets (for the LCR calculation, more below) to the opposition of some
Member States principally the UK which has stated that for the purposes of
liquidity buffers, only one tier of liquid assets, which should be very narrow,
comprising only government bonds (problems here too!) and central bank
reserves
The exact composition and features of the LCR and eligible assets will be
determined by the European Banking Authority (EBA) by December 2015
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - The Proposal
15


Also, Basel III’s long-term Net Stable Funding Ratio (NSFR), which should
enable a bank to withstand a one-year period of stress, does not seem to
be a prudential requirement in the Commission’s Proposal. In fact, the
Regulation only notes that the EBA will evaluate the precise form of a
stable funding requirement, leaving it to banks to (for now) just report the
assets they hold to meet this requirement
The Commission will use the observation period until end December 2016
and the EBA‘s determination on whether and how it would be appropriate
to ensure that institutions use stable sources of funding“ (NSFR) to prepare,
“if appropriate” a legislative proposal
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - The Proposal
16
Thus by 31 December 2012, Member States would be expected to repeal their existing national
regulations/laws transposing Basel II/ current CRD, and adopt or keep, where necessary:

national laws, administrative rules or practices in areas where Member States find it
necessary to lay down how credit institutions must apply the Regulation (This could also
cover areas that will in the future be further specified or clarified by means of technical
standards issued by the EBA, pending the adoption of those standards)

national implementing measures in the few areas of the Regulation where options have
been kept
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - the (Proposed) Directive
17
CRD IV’s new elements, compared to CRD I – III, comprise inter alia provisions
on:



Sanctions
Effective corporate governance
Prevention of the overreliance on external credit ratings
which have been inserted in the Directive, while other elements of the Directive
repeat existing legislation or are adaptations to the current CRD text
The Proposal also unifies provisions on CIs and IFs (currently deal with
2006/49/EC) while the main changes arising from Basel III actually form part
of the proposed Regulation EXCEPT the provisions on capital buffers (which are
found in Directive)
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - the (Proposed) Directive
18
Therefore, those areas of the Proposal that deal with the “powers and responsibilities of
national authorities” such as:

supervision

capital buffers

sanctions

supervisory review process (ICAAP/SREP interaction) which builds on the current
provisions in the CRD (I, II and III)

the coordination of national provisions governing the authorisation of the business of a CI

the acquisition of qualifying holding in a CI

the exercise of the freedom of establishment and the freedom to provide services

the powers of supervisory authorities of home and host member states

initial capital requirements

supervision on a consolidated basis
are found in the Directive
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - the (Proposed) Directive
19
The Directive – 144 pages in the Proposal, also includes the following new
elements:

capital buffers – introducing two capital buffers on top of the minimum capital
requirements, i.e. a capital conservation buffer (identical for all banks in the EU)
and a countercyclical capital buffer (to be determined at national level) - the
capital conservation buffer should provide a strong incentive for banks to build up
capital in good times while the countercyclical buffer (the macroeconomic buffer
intended to counter credit bubbles) should help protect banks against the dangers of
rapid credit growth, particularly relevant for emerging economies

enhanced supervision – to reinforce the supervisory regime to require the
annual preparation of a supervisory programme for each supervised institution
based on a risk assessment, more systematic use of on-site supervisory
examinations, more intrusive and forward-looking supervisory assessments, etc
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - the (Proposed) Regulation
20
The Regulation – subdivided into three parts in the Proposal - covers the following
areas:


capital – to increase the minimum amount of own funds required to be held by banks as
well as the quality of those funds, and to harmonise deductions from own funds;

liquidity – to improve short-term resilience of the liquidity risk profile of financial
institutions (the exact composition and calibration of the proposed LCR will be determined
after an observation and review period in 2015);

leverage ratio – to limit an excessive build-up of leverage on credit institutions' and
investment firms' balance sheets (the ratio is to be subject to supervisory review;
implications of a leverage ratio will be closely monitored prior to its possible move to a
binding requirement in 2018); (iv) counterparty credit risk – to encourage banks to clear
OTC (over-the-counter) derivatives on central counterparties.
The Regulation – all 521 pages of it, in the Proposal - is directly applicable without
the need for national transposition and thus it sets a single rule book, i.e. a single
set of prudential rules to be applied within the EU Single Market
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - the (Proposed) Regulation
21
In practical terms, this implies a two-step process in Member
States to provide firms with the level of legal certainty they
benefited under national law transposing a Directive:

repeal existing national laws, administrative rules or practices which are in
contradiction with the Regulation; extract elements from it and re-legislate or
issue administrative guidance in areas where the Regulation envisages options
or needs to be clarified/specified

review existing national laws, administrative rules or practices to make sure they
are consistent with the Regulation and, at a later point in time, with the technical
standards which would be developed by the EBA
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - the (Proposed) Regulation
22
Achieving a Single Rule Book has been stated as being at the very heart of the EU
financial architecture reform. Hence:

through the Regulation, the Commission intends to remove national options and
discretions in the CRD and to strictly limit areas where "goldplating" may well be
justified given the attributes of some domestic markets and their legal
specificities

delays by member states in the transposition of applicable legislation are also
avoided through a Regulation

the European Council had made it clear that the European System of Financial
Supervision should be aimed at "establishing a European Single Rule Book
applicable to all financial institutions in the Single Market". Inconsistencies
across Member States come not only from differences in transposing current
‘versions’ of the CRD, but also from those administrative rules issued by member
states that transpose those areas of the Directive left to their implementation
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - the (Proposed) Regulation
23
Thus, in a nutshell, the Commission intends to implement the Single Rule Book
over time by means of three different work streams:

CRD IV proposal has through the Regulation resulted in the removal of
most national options and discretions

binding Implementing/Regulatory Technical Standards, which will be
developed by the EBA – thus the drafting of technical standards in
many areas laid down in the various sectoral Directives will harmonise
many technical areas where rules currently diverge between Member
States and contribute to the development of a Single European
Rulebook for the financial sector

ban on ‘goldplating’ by Member States in respect of specific areas as a
result of the maximum harmonisation measure
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Highlights - the (Proposed) Regulation
24
Regulation/Single
Rule Book
Current CRD
EBA implementing
regulatory/technical
standards
CEBS/EBA Guidelines
Maximum
Harmonisation
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
Minimum Harmonisation
16 April 2012
Capital – Quality & Quantity
25
Quality
(includes capital instruments
issued which satisfies rigorous
conditions)
Capital instruments
Share premium account
Accumulated other
comprehensive income
Other resources
CET 1
4.5%
Tier 1
6%
8%
Additional Tier 1
excludes
countercyclical buffer
Tier 2
Funds for general banking risk
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
10.5%
(2019)
2015
16 April 2012
Capital – Quality & Quantity
26
Highest quality own funds – only ordinary shares that meet strict criteria under
CRD IV
Implements these “strict criteria” but does not restrict the legal form of the highest
quality element just to ordinary shares
In a nutshell, only instruments that are as high quality as ordinary shares would be
able to qualify – However, the EBA is required to compile, maintain and
publish a list of the types of “instrument”
Why “instruments”? Ordinary shares are defined according to national company
law of member states and this would seem to be the main rationale for this
‘change’ from Basel III
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Capital – Quality & Quantity
27
The proposed Regulation requires all instruments recognised in the Additional
Tier 1 capital of a credit institution or investment firm to be written down, or
converted into CET 1 instruments, when the CET 1 capital ratio of the
institution falls below 5.125%. The proposal does not recognise other forms
of contingent capital for the purposes of meeting regulatory capital
requirements
The proposed Regulation builds upon the improvements made under CRD II to
the quality of hybrid Tier 1 capital instruments (a form of capital instrument
that has features of both debt and equity instruments) introducing stricter
criteria for inclusion in Additional Tier 1 capital
This includes a requirement for all such instruments to absorb losses by being
written down, or converted into CET 1 instruments, when the key measure of
a credit institution or investment firm's solvency - the CET 1 capital ratio - falls
below 5.125%
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Capital – Quality & Quantity
28
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Sanctions
29
Significant and sweeping changes are being proposed to reinforce member
states’ legal frameworks concerning administrative sanctions and measures by
providing for sufficiently deterrent administrative sanctions applicable to
the key violations of the Directive and the Regulation – effective, proportionate
and dissuasive sanctions
“Appropriate administrative sanctions and measures” would be applicable
to at least one of a number of instances detailed in the Directive (Arts. 66, 67)
and in the case of a:
Talking
point 3
Talking
point 4

Legal person – administrative pecuniary sanction of up to 10% of the total
annual turnover of the undertaking and in the case of a subsidiary of a
parent undertaking the total annual turnover on a consolidated basis

Natural person – administrative pecuniary sanctions of up to €5,000,000
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Sanctions
...(cont.)
30


Point 3 – it is not yet understood why breaches at a subsidiary,
a separate legal person, should be considered on the same
basis as that of the parent’s. Does this also mean that capping
of sanctions for legal persons in current national legislation
will effectively be removed? How do these principles tie in with
our own legal infrastructure?
Point 4 – the threshold of €5m is a huge increase in the level
of sanctions hitherto applicable locally. While the issues raised
in the previous point are also applicable here, it can be
speculated that the use of PII by institutions (cost considerations
again) could probably become very common
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Governance
31
This is another area which locally will have a major and significant impact. The
Directive introduces a number of principles:

the management body (Board of Directors) of a credit institution should
at all times commit sufficient time and possess adequate knowledge,
skills and experience to be able to understand the business (of the CI)
and its main risk exposures

“to avoid group think and facilitate critical challenge” – introduction
of diversity through the requirement of a policy by CIs promoting age,
gender, geographical, provenance, educational background which
aims to present a variety of views and experiences. NB: It is considered
that gender balance is of particular importance to ensure adequate
representation of demographical reality
Talking
point 5
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Governance
...(cont.)
32
Point 5 – what constitutes “sufficient time” in the Directive?
Basically, Directors shall not combine at the same time either:

One executive directorship with two non-executive directorships... OR

Four non-executive directorships (within a same group, executive or nonexecutive directorships held count as a single directorship)
It is relevant to point out here that the Directive does not specify that
directorships be limited to other CIs and/or other licensed entities, so
the implication of the prohibition is that it relates to all directorships
held, whether in licensed or unlicensed entities. This said, there is a
discretion provided to competent authorities to authorise more
directorships than permitted (as above) if this does not prevent the
member from committing sufficient time …
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Governance
...(cont.)
33
… to perform his/her functions in the institution, taking into
account individual circumstances and the nature, scale and
complexity of the institution’s activities
Moreover, the EBA shall draft regulatory technical standards (by
31/12/15) which would specify inter alia:

the notion of sufficient time

the notion of diversity
EBA shall use information provided by competent authorities to
benchmark diversity practices at EU level
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Liquidity
34
LCR – Art. 405 of the Regulation
Operational requirements for holdings of Liquid Assets
Institutions to report only those liquid assets that meet various stringent
conditions specified therein of which the following is significant:
(e) A portion of the liquid assets is periodically and at least annually liquidated via
outright sale or repurchase agreements for the following purposes:
(i)
To test the access to the market for these assets
(ii) To test the effectiveness of its process for the liquidation of assets
(iii) To test the suitability of the assets
(iv) To minimise the risk of negative signalling during a period of stress

BUT …
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Liquidity
...(cont.)
35
Talking
point 6
What about small, thin markets within the smaller
member states? How is this provision going to be applied when
trading volumes in such markets are so low, both in aggregate
and relative terms?
Point 6 - The Commission has been informed about this
requirement and it is hoped that it may be amended to take
into account the characteristics of instruments issued within such
thin markets. Seems that this area may still be ‘work-inprogress’
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Liquidity
...(cont.)
36
LCR – Liquidity Sub-Group Art. 7 of the Regulation
Talking
point 7
There is the possibility for the derogation from the full or partial application of Art. 401
(requirement to maintain minimum level of LCR). In fact, a waiver by competent authorities within
the context of a cross-border group, is a “shall” provision BUT subject to a number of strict
conditions, inter alia:

JD among ‘home’ and ‘host’ authorities

ICAAP/SREP interaction on the adequacy of the organisation and treatment of liquidity
risk

Distribution of amounts, location and ownership of the required liquid assets at sub-group
level

Minimum amounts of liquid assets which are still required to be held by the institutions
within the sub-group

The need for stricter NSFR parameters (whatever that means)
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Liquidity
...(cont.)
37
Point 7 – How would the MFSA view this provision?

While it is somewhat premature to ‘commit’
oneself on this - especially as peers’ views on this
have to be received, reviewed and further
consultation undertaken – it should be emphasised
that how institutions are funded would probably
be a determining factor in the MFSA’s thinking
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Large Exposures
38

Regulation now refers to “eligible capital” rather than
to “own funds”. In fact Eligible Capital is defined:
(a) Common Equity Tier 1 capital;
(b) Additional Tier 1 capital;
(c) Tier 2 capital that is equal to or less than 25 % of
own funds
Talking
point 8
Given that in most local banks, own funds comprises mainly
Original Own Funds (equivalent to CET1 of CRD IV) it would
seem that this change should not have a material impact on
local banks but it cannot be excluded that some ‘tweaking’ may
be required by some banks to maintain their current level of LEs
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Large Exposures
...(cont.)
39
Talking
point 9
“...exposures by an institution to its present, to other subsidiaries...” may
be fully or partially exempt (national discretion) in so far as those
undertakings are covered by the supervision on a consolidated basis to
which the institution itself is subject in terms of the Regulation or with
equivalent standards in a third country
Point 9 - The reference to supervision on a consolidated basis would
appear to be somewhat ‘clearer’ given the provisions of Art. 129 of
Current CRD and the set up of on-going operations of Colleges of
Supervisors (JRAD process – Joint Risk Assessment Decision). Moreover, the
proposed Regulation provides for the review by the Commission by
31/12/2013 on the application of inter alia the above exemption
including whether such exemptions should be discretionary
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Standardised Approach – Some Snippets
40
Art.119 – Exposures secured by mortgages on immovable property
Under the proposed Regulation, competent authorities will be required to
(“shall”) periodically, and at least annually, assess whether:
Talking
point 10

the risk-weight of 35% for exposures secured by mortgages on residential
property (referred to in Art. 120), and

the risk-weight of 50% for exposures secured on commercial immovable
property (referred to in Art. 121)
are appropriate, based on the default experience of exposures
secured by immovable property and taking into account forwardlooking immovable property markets developments AND may set a
higher risk weight than 35% or 50% (or stricter criteria) where
appropriate, on the basis of financial stability considerations
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Standardised Approach – Some Snippets
...(cont.)
41
Point 10 – the 35% and 50% RWs are not ‘automatic’ any more especially since
the EBA shall develop regulatory TS to “specify the conditions that competent
authorities shall take into account when determining stricter RWs or stricter
criteria”


Thus, the responsibility for the “monitoring of property values” currently found
in the CRD will shift to competent authorities (Are you really surprised?) with the
EBA playing a prominent role in this process
Moreover, the current CRD/BR/04 provision which states that “the value of the
property exceeds the exposures by a substantial margin” deemed by the
MFSA to be not else than 30% has in the proposed Regulation decreased to
20% (35% RW applies to 80% of the market value of the property) BUT this
would apply “unless otherwise determined under Art. 119(2)” – see above.
Re commercial property NO change from current CRD (50% RW applies to
50% of the market value of the commercial property)
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Conclusion – (some) Points to Ponder
42



The EBA is charged with the issue of around 110 implementing
technical standards, regulatory technical standards and guidelines
on most aspects of the proposed Regulation between end 2012-2017
Cost implications for small banks within the EU – remember that there
are around 8,300 banks within the Union. Can we expect a wave of
consolidations, M&As in the coming years? (currently, it does not seem to
be the time for such developments)
Besides capital, more capital and even more capital, banks will be
expected to build up liquidity buffers substantially, rely more on
covered bonds and shift (somewhat) to exposures with Central
Counterparts (CCPs) besides reducing their overreliance on credit
ratings. What are the implications here for small banks within the EU?
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Conclusion – (some) Points to Ponder
...(cont.)
43


Menu of choice for investors in banks will be rather restricted. They
have to choose between CET1, Additional Tier 1, Contingent
Convertibles (CoCos) and bail-in debt. Will investors be ‘tempted’?
Besides the emergence of the EBA as a key player within the CRD IV,
the Commission has been granted significant powers to adopt
“delegated acts” on various aspects of the proposed Regulation
including the imposition of stricter prudential requirements (Art. 443) for
all exposures or for exposures to one or more sectors, regions or
member states to address changes in micro-prudential and macroprudential risks arising from market developments following the
recommendation or opinion of the ESRB – another key player in the
process – welcome to the new paradigm!
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Conclusion – (some) Points to Ponder
...(cont.)
44


Will local retail banks, even ‘small’ banks shift towards IRB approaches?
Perhaps its cost-effectiveness would need to be given a fresh look in the
light of the extremely onerous changes to be brought about through the
forthcoming CRD IV process
How much capital is needed? Estimates vary widely and wildly and have (it
seems) not taken into consideration the costs arising from the on-going
financial crisis. Some mind-boggling figures:


McKinsey estimates: European banks need to raise around:

€1.1 trillion (additional Tier 1 capital)

€1.3 trillion (short-term liquidity)

€2.3 trillion (long-term liquidity)
Source: EIU Report
Compliance and
Competitiveness 2011
Deleveraging (shrinking B/Ss) and ‘crowding-out’ effects (shifting to lower
RWAs) on the cards – impact on real economies?
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Sources
45
EU Regulations 1093/2010 (EBA) and 1092/2010 (ESRB) of 24/11/2010 ;
Basel III: towards a safer financial system, Speech by Mr Jaime Caruana 15/9/2010;
Regulating financial services for sustainable growth: A progress Report – February 2011, EU Commission
document;
Emerging form the chrysalis: Reaction to the interim Basel announcement of July 2010, PwC document;
Basel III: A global regulatory framework for more resilient banks and banking systems, BCBS, BIS December
2010;
The Basel III Capital Framework: a decisive breakthrough, speech by Herve’ Hannoun BIS, 22/11/2010;
Current CRD IV Proposal, EU Commission website;
European Banking Committee Info-letter, December 2010, Issue No. 4, EU Commission;
Capital Requirements Directive IV (CRD IV) - a Cicero Consulting Special Report – hb.betteregulation.com;
Basel iii Compliace Professionals Associaiton – basel-iii-asssociation.com;
FT.com – various articles
Basel III and European banking: Its impact, how banks might respond, and the challenges of
implementation, Nov. 2010 report by McKinsey & Company
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
MALTA-COMMONWEALTH THIRD COUNTRY TRAINING
PROGRAMME
BANKING AND FINANCE IN SMALL STATES:
ISSUES AND POLICIES
Regulatory Developments: Basel III - 16 April 2012
THANK YOU FOR YOUR ATTENTION
The (Proposed) Directive
47
Table of Contents
BA/BR/01 BA/MFSA Act BA/BR/01 -
Title I Subject matter, scope and definitions
Title II Competent authorities
Title III Requirements for access to the activity of the business of credit institutions
BA/BR/01 -
Chapter 1 General requirements for access to activity of the business of credit institutions
BA Act. 13 -
Chapter 2 Qualifying holding in a credit institution
BA/BR/01 BA/LN -
Title IV Initial capital of investment firms
Title V Provisions concerning the freedom of establishment and the freedom to provide services
Chapter 1 General Principles
LN -
Chapter 2 The right of establishment of credit institutions
LN -
Chapter 3 Exercise of the freedom to provide services.
BA -
Chapter 4 Powers of the competent authorities of the host Member State
BA -
Title VI Relations with third countries
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
The (Proposed) Directive
48
BA -
Title VII Prudential supervision
Chapter 1 Principles of prudential supervision
BA -
Section I Competence of home and host Member State
BA -
Section II Exchange of information and professional secrecy
BA -
Section III Duty of persons responsible for the legal control of annual and
consolidated accounts
BA/LN/MFSA Act Rule ‘BA/12’ -
Section IV Supervisory powers, power of sanction and right of appeal
Chapter 2 Review Processes
Rule ‘BA/12’ -
Section I Internal capital adequacy assessment process
Rule ‘BA/12’ -
Section II Arrangements, processes and mechanisms of institutions
Rule ‘BA/12’ -
Sub-Section 1 General principles
Rule ‘BA/12’ -
Sub-Section 2 Technical criteria concerning the organisation and treatment of risks
Rule ‘BA/12’ -
Sub-Section 3 Governance
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
The (Proposed) Directive
49
Rule ‘BA/12’ -
Section III Supervisory review and evaluation process
Rule ‘BA/12’ -
Section IV Supervisory measures
Rule ‘BA/12’ -
Section V Level if application
Rule ‘BR/10’ -
Chapter 3 Supervision on a consolidated basis
Rule ‘BA/12’ -
Section I Principles for conducting supervision on a consolidated basis
Rule ‘BA/12’ -
Section II Financial holding companies and mixed financial holding companies
New Rules (?) -
Chapter 4 Capital Buffers
New Rules (?) -
Section I Capital Conservation and Countercyclical Capital Buffers
New Rules (?) -
Section II Setting and calculating Countercyclical Capital Buffers
New Rules (?) -
Section III Capital conservation measures
SD MESA (web-site) -
Title VIII Disclosure by competent authorities
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Basel III - Phase-in periods and targets
50
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Basel III - Capital Conservation Buffer
51
In this example the
credit cycle required
the applicability of
the full buffer (CET1)
but it could also go
down to 0%
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Basel III - Capital requirements
52
* The Committee is still reviewing the question of permitting other fully loss absorbing capital beyond Common
Equity Tier 1 and what form it would take. Until the Committee has issued further guidance, the countercyclical buffer
is to be met with Common Equity Tier 1 only.
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
Basel III - Capital requirements
53
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
The (Proposed) Regulation
54
Contents of the proposed Regulation
PART I
PART ONE GENERAL PROVISIONS
TITLE I SUBJECT MATTER, SCOPE AND DEFINITIONS
TITLE II LEVEL OF APPLICATION OF REQUIREMENTS
CHAPTER 1 APPLICATION OF REQUIREMENTS ON AN INDIVIDUAL BASIS
CHAPTER 2 PRUDENTIAL CONSOLIDATION
SECTION 1 APPLICATION OF REQUIREMENTS ON A CONSOLIDATED BASIS
SECTION 2 METHODS OF PRUDENTIAL CONSOLIDATION
SECTION 3 SCOPE OF PRUDENTIAL CONSOLIDATION
PART TWO OWNS FUNDS
TITLE I DEFINITIONS SPECIFIC TO OWN FUNDS
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
The (Proposed) Regulation
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TITLE II ELEMENTS OF OWN FUNDS
CHAPTER 1 TIER 1 CAPITAL
CHAPTER 2 COMMON EQUITY TIER 1 CAPITAL
SECTION 1 COMMON EQUITY TIER 1 ITEMS AND INSTRUMENTS
SECTION 2 PRUDENTIAL FILTERS
SECTION 3 DEDUCTIONS FROM COMMON EQUITY TIER 1 ITEMS, EXEMPTIONS AND ALTERNATIVES
SUB-SECTION 1 DEDUCTIONS FROM COMMON EQUITY TIER 1 ITEMS
SUB-SECTION 2 EXEMPTIONS FROM AND ALTERNATIVES TO DEDUCTIONS FROM COMMON
EQUITY TIER 1 ITEMS
SUB(?)-SECTION 3 COMMON EQUITY TIER 1 CAPITAL
CHAPTER 3 ADDITIONAL TIER 1 CAPITAL
SECTION 1 ADDITIONAL TIER 1 ITEMS AND INSTRUMENTS
SECTION 2 DEDUCTIONS FROM ADDITIONAL TIER 1 ITEMS
SECTION 3 ADDITIONAL TIER 1 CAPITAL
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
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CHAPTER 4 TIER 2 CAPITAL
SECTION 1 TIER 2 ITEMS AND INSTRUMENTS
SECTION 2 DEDUCTIONS FROM TIER 2 ITEMS
SECTION 3 TIER 2 CAPITAL
CHAPTER 5 OWN FUNDS
CHAPTER 6 GENERAL REQUIREMENTS
TITLE III MINORITY INTEREST AND ADDITIONAL TIER 1 AND TIER 2 INSTRUMENTS ISSUED BY SUBSIDIARIES
TITLE IV QUALIFYING HOLDINGS OUTSIDE THE FINANCIAL SECTOR
PART THREE CAPITAL REQUIREMENTS
TITLE I GENERAL REQUIREMENTS, VALUATION AND REPORTING
CHAPTER 1 REQUIRED LEVEL OF OWN FUNDS
SECTION 1 OWN FUNDS REQUIREMENTS FOR INSTITUTIONS
SECTION 2 OWN FUNDS REQUIREMENTS FOR INVESTMENT FIRMS WITH LIMITED AUTHORISATION
TO PROVIDE INVESTMENT SERVICES
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
The (Proposed) Regulation
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CHAPTER 2 CALCULATION AND REPORTING REQUIREMENTS
CHAPTER 3 TRADING BOOK
TITLE II CAPITAL REQUIREMENTS FOR CREDIT RISK
CHAPTER 1 GENERAL PRINCIPLES
CHAPTER 2 STANDARDISED APPROACH
SECTION 1 GENERAL PRINCIPLES
SECTION 2 RISK WEIGHTS
SECTION 3 RECOGNITION AND MAPPING OF CREDIT RISK ASSESSMENT
SUB-SECTION 1 RECOGNITION OF ECAIS
SUB-SECTION 2 MAPPING OF ECAIS CREDIT ASSESSMENTS
SUB-SECTION 3 USE OF CREDIT ASSESSMENTS BY EXPORT CREDIT AGENCIES
SECTION 4 USE OF THE ECAI CREDIT ASSESSMENTS FOR THE DETERMINATION OF RISK WEIGHTS
CHAPTER 3 INTERNAL RATINGS BASED APPROACH
SECTION 1 PERMISSION BY COMPETENT AUTHORITIES TO USE THE IRB APPROACH
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
The (Proposed) Regulation
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SECTION 2 CALCULATION OF RISK WEIGHTED EXPOSURE AMOUNTS
SUB-SECTION 1 TREATMENT BY TYPE OF EXPOSURE
SUB-SECTION 2 CALCULATION OF RISK WEIGHTED EXPOSURE AMOUNTS FOR CREDIT RISK
SUB-SECTION 3 CALCULATION OF RISK WEIGHTED EXPOSURE AMOUNTS FOR DILUTION RISK
OF PURCHASED RECEIVABLES
PART II
SECTION 3 EXPECTED LOSS AMOUNTS
SECTION 4 PD, LGD AND MATURITY
SUB-SECTION 1 EXPOSURES TO CORPORATES, INSTITUTIONS AND CENTRAL GOVERNMENTS
AND CENTRAL BANKS
SUB-SECTION 2 RETAIL EXPOSURES
SUB-SECTION 3 EQUITY EXPOSURES SUBJECT TO PD/LGD METHOD
SECTION 5 EXPOSURE VALUE
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
The (Proposed) Regulation
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SECTION 6 REQUIREMENTS FOR THE IRB APPROACH
SUB-SECTION 1 RATING SYSTEMS
SUB-SECTION 2 RISK QUANTIFICATION
SUB-SECTION 3 VALIDATION OF INTERNAL ESTIMATES
SUB-SECTION 4 REQUIREMENTS FOR EQUITY EXPOSURES UNDER THE INTERNAL MODELS
APPROACH
SUB-SECTION 5 INTERNAL GOVERNANCE AND OVERSIGHT
CHAPTER 4 Credit Risk Mitigation
SECTION 1 Definitions and General Requirements
SECTION 2 ELIGIBLE FORMS OF CREDIT RISK MITIGATION
SUB-SECTION 1 FUNDED CREDIT PROTECTION
SUB-SECTION 2 UNFUNDED CREDIT PROTECTION
SUB-SECTION 3 TYPES OF CREDIT DERIVATIVES
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
The (Proposed) Regulation
60
SECTION 3 REQUIREMENTS
SUB-SECTION 1 FUNDED CREDIT PROTECTION
SUB-SECTION 2 UNFUNDED CREDIT PROTECTION AND CREDIT-LINKED NOTES
SECTION 4 CALCULATING THE EFFECTS OF CREDIT RISK MITIGATION
SUB-SECTION 1 FUNDED CREDIT PROTECTION
SUB-SECTION 2 UNFUNDED CREDIT PROTECTION
SECTION 5 MATURITY MISMATCHES
SECTION 6 BASKET CRM TECHNIQUES
CHAPTER 5 SECURITISATION
SECTION 1 DEFINITIONS
SECTION 2 RECOGNITION OF SIGNIFICANT RISK TRANSFER
SECTION 3 CALCULATION OF THE RISK WEIGHTED EXPOSURE AMOUNTS
SUB-SECTION 1 PRINCIPLES
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
The (Proposed) Regulation
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SUB-SECTION 2 ORIGINATOR INSTITUTIONS’ CALCULATION OF RISK-WEIGHTED EXPOSURE ANOUNTS
SECURITISED INA SYNTHETIC SECURITISATION
SUB-SECTION 3 CALCULATION OF RISK-WEIGHTED EXPOSURE AMOUNTS UNDER THE STANDARDISED
APPROACH
SUB-SECTION 4 CALCULATION OF RISK-WEIGHTED EXPOSURE AMOUNTS UNDER THE IRB APPROACH
SECTION 4 EXTERNAL CREDIT ASSESSMENTS
CHAPTER 6 Counterparty credit risk
SECTION 1 DEFINITIONS
SECTION 2 METHODS FOR CALCULATING THE EXPOSURE VALUE
SECTION 3 MARK-TO-MARKET METHOD
SECTION 4 ORIGINAL EXPOSURE METHOD
SECTION 5 STANDARDISED METHOD
SECTION 6 INTERNAL MODEL METHOD
SECTION 7 CONTRACTUAL NETTING
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
The (Proposed) Regulation
62
SECTION 8 ITEMS IN THE TRADING BOOK
SECTION 9 OWN FUNDS REQUIREMENTS FOR EXPOSURES TO A CENTRAL COUNTERPARTY
PART III
TITLE III Own funds requirements for operational risk
Chapter 1 General principles governing the use of the different approaches
Chapter 2 Basic indicator approach
Chapter 3 Standardised approach
Chapter 4 Advanced measurement approach
SECTION 1 QUALIFYING CRITERIA
TITLE IV Own funds requirements for market risk
Chapter 1 General provisions
Chapter 2 Own funds requirements and position risk
SECTION 1 GENERAL PROVISIONS AND SPECIFIC INSTRUMENTS
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
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SECTION 2 DEBT INSTRUMENTS
SUB-SECTION 1 SPECIFIC RISK
SUB-SECTION 2 GENERAL RISK
SECTION 2 DEBT INSTRUMENTS
SECTION 3 EQUITIES
SECTION 4 UNDERWRITING
SECTION 5 SPECIFIC RISK OWN FUNDS REQUIREMENTS FOR POSITIONS HEDGED BY CREDIT DERIVATIVES
SECTION 6 OWN FUNDS REQUIREMENTS FOR CIUs
Chapter 3 Own funds requirements for foreign-exchange risk
Chapter 4 Own funds requirements for commodities risk
Chapter 5 Use of internal models to calculate own funds requirements
SECTION 1 Permission and own funds requirements
SECTION 2 GENERAL REQUIREMENTS
SECTION 3 REQUIREMENTS PARTICULAR TO SPECIFIC RISK MODELLING
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
The (Proposed) Regulation
64
SECTION 4 INTERNAL MODEL FOR INCREMENTAL DEFAULT AND MIGRATION RISK
SECTION 5 INTERNAL MODEL FOR CORRELATION TRADING
TITLE V Own Funds Requirements for Settlement Risk
TITLE V Own Funds Requirements for credit valuation adjustment risk
PART FOUR LARGE EXPOSURES
SECTION 1 LARGE EXPOSURE REGIME
PART FIVE EXPOSURES TO TRANSFERRED CREDIT RISK
Title I General provisions for this Part
Title II Requirements for investor institutions
Title III Requirements for sponsor and originator institutions
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
The (Proposed) Regulation
65
PART SIX LIQUIDITY
Title I Definitions and liquidity coverage requirement
Title II Liquidity reporting
Title III Reporting on stable funding
PART SEVEN LEVERAGE
PART EIGHT DISCLOSURE BY INSTITUTIONS
Title I General principles
Title II Technical criteria on transparency and disclosure
Title III Qualifying requirements for the use of particular instruments or methodologies
PART NINE DELEGATED AND IMPLEMENTING ACTS
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
The (Proposed) Regulation
66
PART TEN TRANSITIONAL PROVISIONS, REPORTS AND REVIEWS
Title I Transitional provisions
Chapter 1 Own funds requirements, unrealised gains and losses measured at fair value and deductions
SECTION 1 OWN FUNDS REQUIREMENTS
SECTION 2 UNREALISED GAINS AND LOSSES MEASURED AT FAIR VALUE
SUB-SECTION 1 DEDUCTIONS FROM COMMON EQUITY TIER 1 ITEMS
SUB-SECTION 2 DEDUCTIONS FROM ADDITIONAL TIER 1 ITEMS
SUB-SECTION 3 DEDUCTIONS FROM TIER 2 ITEMS
SUB-SECTION 4 APPLICABLE PERCENTAGES FOR DEDUCTION
SECTION 4 MINORITY INTEREST AND ADDITIONAL TIER 1 AND TIER 2 INSTRUMENTS ISSUED BY
SUBSIDIARIES
SECTION 5 ADDITIONAL FILTERS AND DEDUCTIONS
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
The (Proposed) Regulation
67
Chapter 2 Grandfathering of capital instruments
SECTION 1 INSTRUMENTS CONSTITUTING STATE AID
SECTION 2 INSTRUMENTS NOT CONSTITUTING STATE AID
SUB-SECTION 1 GRANDFATHERING ELIGIBILITY AND LIMITS
SUB-SECTION 2 INCLUSION OF INSTRUMENTS WITH A CALL AND INCENTIVE TO REDEEM IN
ADDITIONAL TIER 1 AND TIER 2 ITEMS
Chapter 3 Transitional provisions for disclosure of own funds
Chapter 4 Large exposures, own funds requirements, leverage and the Basel I floor
Title II Reports and reviews
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012
The (Proposed) Regulation
68
PART ELEVEN FINAL PROVISIONS
Annex I Classification of Off-balance sheet items
Annex II Types of derivatives
Annex III Items subject to supplementary reporting of liquid assets
Annex IV Risk-adjusted assets and off-balance sheet items for the temporary capital ratio
Annex 5 Correlation table
Karol J. Gabarretta (Director – Banking Supervision Unit MFSA)
16 April 2012