All posts by Simon Brennan

About Simon Brennan

Email: [email protected]
Simon is a Senior Manager in the EMEA Centre for Regulatory Strategy, specialising in prudential regulation for banks. Simon joined Deloitte after 11 years at the Bank of England, where he worked in a number of areas covering macro and micro prudential policy, and financial institution risk assessment.

UK Leverage Ratio Requirement: A Cornucopia Of Capital Complexity?

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The Bank of England Financial Policy Committee’s (FPC) recently published review on the role of the leverage ratio in the UK proposes moving ahead of international standards to introduce new requirements for the biggest UK banks and building societies from next year. It recommends those banks eventually meet a ‘static’ requirement of up to around 4% on an ongoing basis (comprising a minimum of 3% and a supplementary buffer capturing systemic risk). There would also be a time-varying component that varies with the credit cycle and could add around 90 basis points more for some banks at the top of the cycle (on the FPC’s current assumptions).

Calibration, complexity and risk-sensitivity were important topics of debate in advance of the report. The fixed part of the requirement came out close to most industry expectations, although considerably lower than some. The overall package is simpler than in the previous consultation, although it remains more complex than some would have liked. The FPC highlighted that 3% leverage is consistent with the minimum Tier 1 risk-weighted capital required against mortgage lending under the Basel Standardised Approach, so as not to disincentivise banks and building societies from (new) mortgage lending.

The government will now lay legislation before Parliament to effect the recommendations (giving the FPC the power to direct the Prudential Regulation Authority (PRA)). Once approved, the minimum requirement of 3% will be applied straightaway for the largest banks and building societies (superseding the current supervisory expectation that these firms meet a 3% minimum). Buffers within the ratio will be implemented subsequently. Other PRA-regulated firms will be required to meet the 3% minimum from 2018.

UK leverage ratio: simples

The complexity of the proposed leverage ratio framework is borne out of symmetry with the risk-weighted framework, which the FPC argues is required to maintain the relationship with the risk-weighted ratio (and therefore its effectiveness). The ratio will comprise:

  • A minimum requirement of 3%, for all PRA-regulated firms.
  • A supplementary leverage ratio buffer (SLRB) for UK G-SIBs, ring-fenced banks and large building societies. The G-SIBs buffer will be set at 35% of the risk-weighted systemic risk buffer and will be phased in from 2016. The appropriate calibration of the buffer for the other firms will be reviewed next year and will apply from 2019.
  • A countercyclical leverage ratio buffer (CCLB) that varies with the (macro prudential) countercyclical capital buffer (CCB). The FPC expects to set the CCLB at 35% of the CCB. The CCLB will apply to all PRA-regulated firms, as the CCB does, and will be introduced at the same time as the minimum requirement.

The requirements will initially apply at a consolidated level. The FPC will review in 2017 whether the requirements should be extended to apply at the solo level.

Banks will need to meet the requirements using a minimum amount of Core Equity Tier 1 (CET1) capital (at least 75 per cent) for the baseline requirement. All leverage ratio buffers should be met using CET1 exclusively. The Chancellor has asked for this to be aligned with international standards, when they are reviewed – in particular the eligibility of AT1 instruments.

The FPC says that in future it expects the PRA to consider the leverage ratio when determining the regulatory response to stress testing. It does not though give an indication of a minimum requirement for the leverage ratio under stress scenarios.

What it all means

While the new framework provides an important missing piece of the capital jigsaw, the picture is by no means complete. The Financial Stability Board‘s (FSB) proposals for Total Loss Absorbing Capacity are due early this month, and the Bank of England will consult on the “PRA buffer” in January 2015. In addition, both the Basel Committee and the EU Commission are due to review aspects of the leverage ratio in coming years, and further changes may follow. So it will still be some time before the overall capital requirements for the major UK banks are fully specified and an assessment can be made of their aggregate impact.

Looking to implementation, an increasingly important challenge for banks will be managing capital planning and business model decisions within a capital framework that considers simultaneously a risk-weighted capital ratio, leverage ratio, stress testing and loss absorbing capacity requirement. The leverage ratio also interacts with other prudential measures, such as the liquidity coverage requirements

Eurozone Banks Wake Up To A New Supervisor. What’s Next?

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The Single Supervisory Mechanism (SSM) formally opens for business today.  For months, supervisors and banks have been preparing for the transfer of supervisory responsibilities to the European Central Bank (ECB).  Yet the 4 November milestone is just the start of a much longer, possibly testing journey for all involved.

Over time, the SSM will change the terms of engagement between supervisors and banks. It will introduce higher supervisory standards than some banks have been used to in the past; greater standardisation of approach, and a change in perspective (so that different issues might come to the fore of the supervisory relationship).

Related insight:

Meeting the challenge of the SSM | How banks should get ready for the new regime.

Banks need to seize the initiative, recognise the raised expectations and take the opportunity to make a fresh start in the supervisory sphere. The first 12 months of the SSM will be key for establishing the priorities and approach of the SSM. Through a careful analysis of the SSM supervisory objectives, the experience of banks during the comprehensive assessment, and of other supervisory regimes, banks can cut through uncertainty around what these priorities and approach will be.

Four characteristics stand out as drivers for change in day-to-day supervision. Each of these could affect the supervisory expectations placed on banks substantially, although the effect will be felt more and more rapidly by directly supervised ‘significant’ banks:

  • The SSM will harmonise how risk-based, forward looking supervision is conducted in the Eurozone.
  • The SSM will integrate qualitative and quantitative analysis, but may have a stronger quantitative approach to supervision than most NCAs currently have, at least initially.
  • Seeking supervisory consistency will be a key driver for how banks are supervised.
  • Peer group analysis will be a key new supervisory tool, in part to deliver consistency between countries.

Under the risk-based approach, supervisory interactions will increasingly move towards focusing on areas of concern. The intensity of supervision will be affected by the efficiency of banks’ risk and risk appetite management, and how effective is the link between risk management and strategy when calibrating the intensity of its supervision. While this is not a novel approach, the ECB will have an opportunity to apply it more rigorously and consistently. The ability of banks to coordinate internally, between Eurozone entities as well as between regulatory projects such as their capital, liquidity, and recovery and resolution projects.

The supervisory emphasis on quantitative analysis and data (evident through the comprehensive assessment) will result in heightened expectations of data availability, quality and governance. Data governance, risk data aggregation and automisation of processes such as stress testing and AQR will be a key investment. At the same time, quantitative analysis will highlight disparities between banks quickly. Banks need to ensure that disparities are not driven by poor data quality, and be prepared to explain such disparities where they are driven by bank interpretation and policy or local market idiosyncrasies.

The ECB will have discretion over a number of important decisions which previously sat with NCAs, for example the application of exemptions or waivers. As the ECB looks to improve supervisory consistency, banks will find some of these key decisions reversed or amended.

Peer-group analysis will be a key tool in the delivery of consistent supervision, and it may be the case that some of the peer groups created are less than obvious and could end up resulting in some novel and challenging comparisons. One possible outcome is to encourage a wider spread of ‘best’ practice across banks.

Making a success of the SSM

The impact of supervision on banks – both in terms of the financial cost and the call on senior management time – can be affected by how actively banks manage the regulatory relationship. Thus, it is important for banks establish trust and understanding of their business with supervisors. In the past this has been an interactive process over many years; in contrast the new relationship with the SSM needs to be established immediately. In our experience, the impact of supervision on banks – both the financial cost and the call on senior management time – depends on how actively banks manage the regulatory relationship.

To be successful under the new regime, banks should be proactive – in addressing the outcomes of the CA, and beyond, in assessing which aspects of their business could cause supervisory concern, and in managing the supervisory dialogue around such issues. Any resultant changes should not be implemented in a vacuum – instead, banks should take a strategic view of how the adaptation to the new supervisory regime links to on-going and forthcoming regulatory change projects, and what synergies can be drawn. All in all, this is a new start not just for the supervisor, but for many aspects of a bank’s work.