How will regulation reshape the banking system?
Yasmine de Bray
11/05/2012
Summary
01 New regulation is putting pressure on the size of the banking
system…
02 …but the risk of an abrupt shrinkage has more to do with the
current sovereign crisis
03 Regulation should be instrumental in avoiding future liquidity
crisis but should not overshoot
How will new regulation reshape the banking system? - 17/03/2016 - page 2
1/ New regulation is putting pressure on the size of the banking system
 Regulators require banks to hold more
capital
– The switch from Basel 2 to Basel 3 is
reducing the average common equity ratio
of the top 100 global banks by 3% points
from 10.2% at June-end 2012 to 7.1% as
per the latest QIS published by the Basel
Committee on April 12th.
– In practice, European regulators are
requesting their domestic banks to hold
common equity ratios of at least 9%.
 More than €500bn has been raised so
far in Europe: 55% of which has been
provided by governments and 45% by
private investors. European banks’
core tier 1 ratios have improved from
6.5% in 2008 to 10% in 2011.
Country
(€ bn)
Source of capital
Form of capital raising
Private
State
Total
Ords / MCN
Other
Total
Austria
Benelux
France
Germany
Greece / Cyprus
Italy
Ireland
Spain
2,3
0,0
26,7
24,1
7,1
25,5
1,8
31,7
5,9
15,4
16,5
38,2
3,8
4,1
71,1
27,5
8,2
15,4
43,2
62,4
10,9
29,6
72,8
59,2
3,9
6,0
24,2
44,4
6,8
21,7
69,8
54,5
4,3
9,4
19,0
17,9
4,2
7,9
3,0
4,7
8,2
15,4
43,2
62,4
10,9
29,6
72,8
59,2
Portugal
Nordics
Switzerland
UK
Eurozone
3,8
10,4
25,6
76,8
123
13,0
4,2
3,9
82,3
195
16,8
14,6
29,5
159,2
318
4,8
11,1
26,0
149,4
236
12,0
3,5
3,6
9,8
82
16,8
14,6
29,5
159,2
318
39%
61%
100%
74%
26%
100%
113
90
203
186
17
203
56%
44%
100%
92%
8%
100%
as %
Non-Eurozone
as %
Total
as %
236
286
522
423
99
522
45%
55%
100%
80%
20%
100%
Source: Goldman Sachs
 Ability to raise further capital is limited given governments’ over-indebtedness and the lack of investors’
appetite for bank stocks due to poor risk-adjusted returns (cf Unicredit’s difficult capital increase in early
January which required a 40% discount to TERP).
 The other way for banks to release capital is to reduce their balance sheets…
How will new regulation reshape the banking system? - 17/03/2016 - page 3
1/ New regulation is putting pressure on the size of the banking system
 Regulation is to structurally reduce the size of the
senior debt market:
 Regulation is likely to reduce the velocity of money
– Growing scrutiny on re-hypothecation.
– Higher risk weights for credit exposure to large regulated banks
(>100bn asset).
 We estimate the total deleveraging effort to be close
to €1.3 trillion of assets (5.7% of total assets) over
the next 3 years for European listed banks, which
could release €50bn of capital.
– Under the IMF base-case scenario for a sample of 58 large EU
banks, the reduction of bank assets would be €1.6bn over the next
two years, €2.5bn under their worst-case scenario.
 This should help close an estimated capital shortfall
of around €80bn in Europe and help manage down
the stock of senior debt funding (€730bn maturities
in 2012-2014).
19 000
Lending
CEE
Greece /
Ireland
Total
deleverage
% of total
assets
Lending as a %
of deleveraging
plan
61 500
7 000
87 500
9%
78%
ISP
Medio
15 700
3 600
5 000
20 700
3 600
3%
6%
100%
100%
BMPS
16 000
16 000
7%
100%
BP
18 894
18 894
14%
100%
UBI
7 000
7 000
5%
100%
PMI
500
500
1%
100%
40 000
163 194
34 300
47 000
10 000
12 000
2 053
406
60
91 300
7 545
2 520
5 400
5 710
9 800
40 000
194 194
38 603
70 206
34 044
27 700
170 554
29 045
2%
5%
3%
4%
2%
6%
3%
10%
100%
90%
94%
68%
30%
0%
55%
45%
7 545
19 962
14 678
5 256
6 810
7 069
3 177
5 678
4 180
60 000
126 809
216 624
5 400
9 800
25 981
-
216 624
25 981
-
29 045
19 962
14 678
5 256
6 810
7 069
3 177
5 678
4 180
60 000
126 809
257 769
24 333
282 102
55 168
53 508
108 676
151 220
108 171
20 122
63 846
343 358
36 000
16 800
52 800
8 524
19 517
28 041
1 335 580
100%
4%
2%
3%
2%
5%
7%
3%
9%
6%
6%
5%
37%
1%
9%
5%
6%
5%
8%
9%
1%
3%
5%
23%
13%
19%
4%
14%
8%
5,7%
Other
Italy
Soc Gen
BNP
CASA
Natixis
France
KBC
ING
Benelux
SAN
BBVA
Caixa
Pop
BTO
SAB
BKT
BCIV
Other
Spain
CBK
Deutsche
Germany
UBS
CS
Switz
RBS
Lloy
Barc
HSBC
UK
BOI
AIB
Ireland
Erste
RI
Austria
Total
% of Total
19 000
2000
22800
11524
19300
55 624
6 300
0
0
7 000
8 400
15 400
6 300
-
15 164
15 164
22 648
5 405
28 053
12 195
28 049
20 122
60 000
120 366
1 385
12 800
14 185
258 691
19%
-
24 333
24 333
32 520
48 103
80 623
85 366
85 366
3 360
3 360
209 082
16%
48 171
70 976
-
119 146
36 000
13 440
49 440
-
774 059
58%
7 140
6 717
13 857
59 757
4%
250
5 460
5 488
9 146
3 846
18 480
-
33 990
3%
1
– Term senior unsecured debt would become more “capital” than
“funding” in nature, and would become more expensive. This could
lead to a structural reduction in banks’ unsecured debt funding
reliance, only partially offset by growing covered bond issuance.
Legacy assets
UCG
CIB/
markets
1bp
1,2
1bp
1
1bp
0,8
1
1bp
0,6
0,4
0bp
0,2
0bp
0
0bp
0
45%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
94%
0%
86%
0%
0%
0%
32%
66%
0%
0%
35%
100%
80%
94%
84%
34%
49%
62%
1
– The European commission recently issued a consultation paper
suggesting that regulators should be able to impose losses on
bank creditors before the bank become insolvent potentially
based on a trigger mechanism. The key is whether it will be a low
or high trigger.
Assets/loans
0,5
1
1,5
Source: Amundi, Morgan Stanley
How will new regulation reshape the banking system? - 17/03/2016 - page 4
2/ New regulation is putting pressure on the size of CIB activities
 The deleveraging effort is focusing on corporate and investment banking
– European banks announced risk-weighted asset reduction plans of €700bn since 2009 in their CIB business, 37% of
which has been completed so far.
– 35% of the remaining deleveraging efforts will focus on CIB activities.
– CIB activities can be downsized faster.
– CIB is very competitive and will become less profitable under Basel 3 (CVA, greater capital requirement for market risks
etc..).
– Example of explicit regulatory/political pressure: RBS requested to specifically downsize its investment bank.
EUR bn
UBS
CS
Deutsche Bank
CASA
BNP
Soc Gen
Natixis
RBS
TOTAL
RWA Reduction
done so far
14
38
30
36
26
16
3
94
257
% Target
18%
48%
25%
120%
58%
40%
30%
32%
37%
RWA Reduction
Target
78
80
120
30
45
40
10
292
694
 Regulation will lead to a polarisation in the investment banking industry
– Scale will be a competitive advantage given the sector’s high operational leverage (elevated fixed cost base)
– Heavy technological investments will be required, with the FICC business likely to move to electronic platform trading
business.
How will new regulation reshape the banking system? - 17/03/2016 - page 5
3/ New regulation is putting pressure on cross-border lending
 Regulators are increasingly requesting liquidity to be ring-fenced
– The UK independent commission for banking (“ICB”) is requesting the UK ring-fenced entity to be subject to minimum
liquidity ratios on its own
– The Austrian regulator recommended that Austrian banks’ foreign subsidiaries do not issue new loans in excess of 110%
of available local funding.
– Hungary, Romania and Bulgaria particularly at risk.
 Foreign subsidiaries’ compliance with the Basel 3 NSFR will also put pressure on intra-group funding
and lending growth given the yet limited size of local debt capital markets.
CEE countries will be most impacted…
Sector loan-to-deposits (LHS)
Reduction in credit supply by European banks under the three IMF
deleveraging scenarios (in % of total bank credit)
CZ
SLK
SA
0%
TR
0%
RU
25%
PL
50%
BG
50%
RO
100%
HU
75%
SRB
150%
SLO
100%
UKR
200%
Assets controlled by European banks (RHS)
 Basel 3 creates a capital shortage: banks will seek to better optimize capital utilization by favouring
multiproduct relationships over lending-only relationships, which tend to favour domestic clients.
– Banks will however not stop funding their core clients’ off-shore projects.
How will new regulation reshape the banking system? - 17/03/2016 - page 6
4/ Basel 3 will reduce the amount of stable funding to the economy
 Banks will favour short-term lending over long-term lending to meet Basel 3 liquidity ratio.
 Banks will seek to gain large corporate (investment-grade) exposures through corporate bonds
rather than lending.
Asset
Cash
Short-term unsecured <1Y
Repos
Sovereign
Corporate bonds AA+, >1Y
Corporate bonds ACorporate lending <1Y
Retail loans <1Y
Mortgages
All other assets
Credit facilities
Asset weighting
as per first draft
0%
0%
0%
5%
20%
50%
50%
85%
100%
100%
10%
New
weighting
Liability weighting
as per first draft
All other liabilities
0%
Wholesale funding 1Y50%
Retail and SME deposits
70-85%
Wholesale funding 1Y+
100%
Tier 1 & Tier 2 capital
100%
Liability
New
weighting
80-90%
65%
5%
Sources of corporate debt
 Corporate balance sheets might be weakened
(reduced availability of long-term funding for SMEs
and greater reliance on volatile market funding for
large corporates).
100%
 This is already visible in the ECB banking surveys:
“Some further tightening is expected to affect large
firms (8%) rather than SMEs (2%), as well as
primarily long-term loans”, April 2012.
50%
90%
Borrowed from
banks
80%
70%
Obtained
directly from the
bond market
60%
40%
30%
20%
10%
0%
US Corporates
US All
Incorporations
UK
Eurozone
Europe
How will new regulation reshape the banking system? - 17/03/2016 - page 7
Domestic credit will also be impacted
 Smaller investment banking and international, activities, together with growing disintermediation for
corporate funding will help reduce the size of the European banking system…
900%
Banking system assets as a % of GDP
Loan to deposit ratios by region
800%
700%
120%
600%
110%
Europe
LDR 2011
500%
With a European
sized corporate
bond market
400%
300%
Adding
Mortgages
held in GSEs
200%
90%
80%
South Africa
Canada
Norway
US
Australia
Italy
Sweden
Belgium
Germany
Austria
Spain
Netherlands
France
60%
Denmark
0%
Switzerland
70%
UK
100%
Ireland
Other regions
100%
EUROPE
LatAm
Europe- with
a US sized
corporate
bond market
Africa
US
Asia
ex Japan
Japan
Source: Barclays
How will new regulation reshape the banking system? - 17/03/2016 - page 8
Domestic credit will also be impacted
 But closing the customer gap will still be needed through:
1. Re-intermediation of off-balance sheet assets, although this could be partially crowed out by State
borrowing
– Italian banks selling their own retail bonds and term deposits instead of third-party bonds. Introduction of a more favorable fiscal
regime for government bonds vs. other savings products.
– French banks trying to repatriate savings on balance-sheets:
€bn
60
50
40
2009
30
2010
2011
20
10
0
Net inflows (life insurance)
Net inflows (on-balance sheet savings
products)
Source: OEE
2. And real lending deleveraging efforts :
– Key risk to growth is tightening conditions for investment loans.
Dotted lines show the IMF’s three deleveraging scenarios
How will new regulation reshape the banking system? - 17/03/2016 - page 9
Domestic credit will also be impacted
2. And real lending deleveraging efforts :
– Key risk to growth is tightening conditions for investment loans.
Source: IMF
Dotted lines show the IMF’s three deleveraging scenarios
How will new regulation reshape the banking system? - 17/03/2016 - page 10
Summary
01 New regulation is putting pressure on the size of the banking
system…
02 …but the risk of an abrupt shrinkage has more to do with the
current sovereign crisis
03 Regulation should be instrumental in avoiding future liquidity
crisis but should not overshoot
How will new regulation reshape the banking system? - 17/03/2016 - page 11
But what is at stake is the risk of an abrupt credit crunch
 The current risk of credit crunch has more to do with the current crisis.
Net % of banks contributing to tightening their credit standards, ECB
Credit standards
have tightened in
H1 2012 with the
worsening of the
sovereign crisis.
Recent relief in Q1
is due the easing
of banks and
governments’
funding access in
the wake of the
two LTROs (Dec
and Feb).
How will new regulation reshape the banking system? - 17/03/2016 - page 12
But what is at stake is the risk of an abrupt credit crunch
 Credit tightening has more to do with sovereign-related liquidity and capital issues rather than
regulations.
– Credit conditions for corporates: a net 87.5% of Italian banks reported tighter standards in Q4 vs 35% of
European banks in the Q4 2011 ECB survey (25% vs. 9% respectively in the Q1 2012 survey)
– Credit conditions for households: a net 87.5% of Italian banks reported tighter standards in Q4 vs 29% of
European banks in the Q4 2011 ECB survey (37.5% vs. 17% respectively in the Q1 2012 survey)
Difficult wholesale funding access based on sovereign risk
Capital shortfall driven by net unrealized losses on bonds
5 YR CDS spreads
ITALY
SPAIN
FRANCE
GERMANY
Country split of EBA's €106bn european banks capital shortfall
NORDICS
800
SWEDEN
AUSTRIA 1%
3%
CYPRUS
BELGIUM3%
700
600
4%
500
GREECE
29%
GERMANY
5%
400
NORWAY SLOVENIA
0%
1%
DENMARK
0%
PORTUGAL
7%
300
200
FRANCE
8%
100
an No B
de rd
ls ea
ba
nk
en
ed
ITALY
14%
N
H
D
Sw
BK
M
Z
D
C
SO
G
N
C
AS
A
BN
P
C
I
IS
P
U
BP
M
PS
Sa
n
Ba
nk
in
Sa ter
ba
de
B B ll
VA
0
SPAIN
25%
Source: EBA
As at end of April 2012
How will new regulation reshape the banking system? - 17/03/2016 - page 13
…driven by market forces and a previous lack of regulation
Banks’ market funding costs were extrememly low…
$tr
Total market funding issued by European banks p.a.
3 500
700
3 000
EU BANKS SECTOR
CDS INDEX 5Y - CDS
PREM. MID
600
500
2 500
US BANKS SECTOR
CDS INDEX 5Y - CDS
PREM. MID
400
2 000
300
1 500
200
100
1 000
02/10/2011
02/07/2011
02/04/2011
02/01/2011
02/10/2010
02/07/2010
02/04/2010
02/01/2010
02/10/2009
02/07/2009
02/04/2009
02/01/2009
02/10/2008
02/07/2008
02/04/2008
02/01/2008
02/10/2007
02/07/2007
02/04/2007
02/01/2007
02/10/2006
02/07/2006
02/04/2006
02/01/2006
02/10/2005
02/07/2005
02/04/2005
02/01/2005
02/10/2004
02/07/2004
02/04/2004
02/01/2004
0
500
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
YTD
… creating a strong incentive for banks to leverage their balance sheets.
3,8
Eurozone banking assets / GDP (x)
3,6
3,7
3,7
3,7
150%
L/D Ratio European System
3,5
145%
3,4
3,2
3,2
3,0
2,9
2,7
2,8
2,6
2,6
2,4
140%
3,1
2,4
2,7
135%
2,8
2,6
130%
2,4
125%
2,2
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
2,0
120%
Jan-1999
Jan-2001
Jan-2003
Jan-2005
Jan-2007
Jan-2009
Jan-2011
Source: ECB
How will new regulation reshape the banking system? - 17/03/2016 - page 14
Monetary authorities are trying to smooth the process
 Authorities are seeking to avoid a severe credit crunch:
– In Dec 2011 and Feb 2012 the ECB provided €530bn of net additional funding to European banks (LTROs
take up less MRO transfers), equivalent to the amount of senior and covered bonds maturing over the next 12
months.
– Spanish and Italian banks have covered their 2012 maturities and invested in short-term government bonds.
ECB Lending, Since End-Nov 11
Use
210 526 2012 debt maturities
7 000 Sov Acqn
Balance
217 526
ECB new loans as a % of total assets
99 734
87 748
30 043
217 526
6%
ITALY
Source
ECB New Loans
LT debt issued in 1Q12
Use
116 813 2012 debt maturities
5 931 Sov Acqn
Balance
122 744
ECB new loans as a % of total assets
1 200
45 764
80 630
3 650
122 744
3%
ECB lending to commercial banks
1 000
600
400
200
janv 12
juil 11
janv 11
juil 10
janv 10
juil 09
janv 09
juil 08
janv 08
0
juil 07
€bn
800
janv 07
SPAIN
Source
ECB New Loans
LT debt issued in 1Q12
How will new regulation reshape the banking system? - 17/03/2016 - page 15
Summary
01 New regulation is putting pressure on the size of the banking
system…
02 …but the risk of an abrupt shrinkage has more to do with the
current sovereign crisis
03 Regulation should be instrumental in avoiding future liquidity
crisis but should not overshoot
How will new regulation reshape the banking system? - 17/03/2016 - page 16
The cost of financial crises might outweigh that of regulation
 A survey of the Basel Committee on Banking Supervision (BSBC) estimates that the net present
value costs to output from financial crises range between 19% and 163% of annual GDP (with a
median estimate of 63%). The same survey estimates that financial crises occur approximately every
twenty to twenty-five years. So financial crisis would cost 3% of GDP per year.
 According to a BIS paper published in 2010, the probability of systemic banking crisis is substantially
reduced for systems’ core tier 1 in excess of 9%.
 The relationship between bank lending growth and GDP growth, although intuitively positive, is not
straightforward
– 1980s: the introduction of credit cards did not lead to stellar GDP growth
– Past periods of deleveraging show varying outcome for underlying economic growth.
– Credit crunch induced by banking crises negatively impact investments.
8%
Crisis Probability
7%
6%
5%
4%
3%
2%
1%
0%
6%
7%
8%
9%
10%
11%
12%
13%
14%
15%
Core Tier 1 ratio
How will new regulation reshape the banking system? - 17/03/2016 - page 17
Too much regulation kills regulation? The shadow banking system
 Shadow banking is defined as “the system of credit intermediation that involves entities and activities
outside the regular banking system“ as per the FSB): insurance companies, asset managers, hedge
funds, pension funds, non-regulated credit institutions…”
– Non-rated private securitization placements (with more flexible collateral eligibility criteria)
– Loans
 Liquidity and credit risks are being transferred to “unregulated” institutions. When regulated,
regulation plays against this transfer (cf Insurance).
 Non-regulated shadow banking entities could pose systemic risk if connected to the banking system
(ex: banking affiliates):
– Risk of moral hazard,
– Remember that US subprime loans were primarily originated by non banking institutions.
 Banking is a confidence business no matter what: regulators need to be pragmatic when deciding
upon the final calibrations of the NSFR and LCR ratios (40% cap on level 2 assets, calibration of
corporate deposit outflows).
Excess return/capital requirement (%) of different asset classes under the draft solvency 2 rules
 The shadow banking
system is particularly big
in the US. Globally,
shadow banking account
for 25-30% of the financial
system.
Source: Morgan Stanley/Oliver Wyman
How will new regulation reshape the banking system? - 17/03/2016 - page 18
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How will new regulation reshape the banking system? - 17/03/2016 - page 19