Basel Committee publishes framework for D-SIBs

Introduction

On 11 October 2012, the Bank for International Settlements (BIS) published a framework for identifying and dealing with domestic systemically important banks (D-SIBs).

The purpose of the framework is to reduce the probability of D-SIB failure compared to non-systemic institutions.  In furtherance of this goal, 12 principles have been identified.  These establish a minimum set of requirements in relation to treatment of D-SIBs, whilst recognising the need for a degree of national discretion.  They can be applied both to consolidated groups and to branches within a host jurisdiction.  Broadly, the principles fall into two categories which define:

• the assessment methodology for D-SIBs; and
• higher loss absorbency (HLA) requirements for D-SIBs.

Assessment Methodology

Assessment methodologies should be public and clearly articulated with a focus is on the impact D-SIB failure would have on both the domestic financial system and the domestic economy.  In determining systemic importance, home authorities should consider banks from a (globally) consolidated perspective and host authorities should assess foreign subsidiaries in their jurisdictions on a consolidated basis which includes any downstream subsidiaries, some of which may be in other jurisdictions.  Annual assessments of the systemic importance of domestic banks should be conducted by reference to the following bank-specific factors:

• size;
• interconnectedness;
• substitutability/financial institution infrastructure; and
• complexity.

National authorities can also consider other factors that would inform the above list, such as the size of a bank relative to domestic GDP.

Higher Loss Absorbency

From January 2016, any institution identified as a D-SIB will be subject to an HLA requirement, which must be met fully by Common Equity Tier 1 through an extension of the Basel III capital conservation buffer.   Banks that are both D-SIBs and Global SIBs should be subject to the higher HLA requirement, but double counting should be avoided.  Specific HLA requirements should be commensurate with the D-SIB’s degree of systemic importance and could be affected by:

• the resolution regimes (including recovery and resolution plans) in and between jurisdictions; and
• available resolution strategies and any specific resolution plan in place for the firm.

 

Ending “Too-Big-To-Fail”: FSB Progress Report to the G20

Last week, the leaders of the G20 met in Los Cabos, to discuss, among other things, the progress of financial regulatory reform, a key aim of which is to address the issue of financial institutions which are ‘too-big-to-fail.  The Financial Stability Board (“FSB”), tasked with overseeing this reform programme, published a report detailing progress in the implementation of the G20 recommendations.

The FSB report addressed three main areas:

• Improving the capacity to resolve firms in crisis;
• Improving the intensity and effectiveness of systemically important financial institution (“SIFI”) supervision; and
• Extending the SIFI framework.

Improving the capacity to resolve firms in crisis

General

The FSB Key Attributes of Effective Resolution Regimes for Financial Institutions outlines the essential elements of any resolution regime, highlighting the following requirements:

• the establishment of Crisis Management Groups (CMGs);
• the elaboration of recovery and resolution plans (RRPs);
• the conduct of resolvability assessments;
• the adoption of institution-specific cross-border cooperation agreements (COAGs); and
• the establishment of cooperation arrangements with jurisdictions that are hosts to systemic operations of a G-SIFI but are not represented on its CMG.

Crisis Management Groups and RRPs

The FSB reported that 24 out of 29 G-SIFIs have established CMGs, of which a few have discussed resolution strategies and ‘started to develop operational plans to implement them.’  However, the FSB concedes that, in many cases, the work of CMGs and the development of RRPs is restricted by the absence of ‘clearly articulated resolution strategies’, and has given priority to resolving this matter by the end of 2012.

Resolvability Assessments

The aim of a resolvability assessment is to highlight obstacles to resolution.  Again, there is an acknowledgement that the development of resolution strategies is a precondition of effective resolvability assessments.  The FSB concludes that such assessments should be conducted from Q1 2013, after the development of the necessary resolution strategies.

Institution-specific cooperation agreements

The FSB report states that no institution-specific cooperation agreements have been agreed to date.  This is due, in part, to the lack of developed resolution strategies and also due to the difficulties of sharing information across jurisdictions.  Therefore, the FSB will examine obstacles to the exchange of information with a view to developing minimum common terms and content for information sharing to be included within cooperation agreements by early 2013.

Cooperation with Non-CMG host jurisdictions

The FSB acknowledges that channels of communication need to exist between a CMG and host authorities that are not represented in the CMG, and proposes to develop further guidance on the matter.

Improving the intensity and effectiveness of SIFI supervision

More intense and effective supervision of SIFIs is posited as a key pillar of the FSB’s financial reform framework, and focuses on four key areas:

• Holding supervisors to higher standards;
• Improving supervisory tools and methods;
• Enhancing the effectiveness of supervisory colleges; and
• Improving firms’ risk data aggregation capabilities.

The consensus is that progress is being made in these areas, but that more work is needed. The development of uniform principles of banking supervision, (based on the BCBS’s Core Principles for Effective Banking Supervision) is underway, with a projected publication date of autumn 2012. Significantly, on the subject of improving supervisory tools and methods, the FSB concludes that ‘while resources at supervisory authorities have increased since the financial crisis, the pace of increase has not been commensurate with higher regulatory and supervisory demands.’ The report also highlights the relative lack of expertise across supervisory bodies, and the need to improve the risk measurement capabilities of supervisory colleges.  Finally, the FSB is compiling guidelines concerning firms’ risk aggregation capabilities, to be published by the end of the year, with firms being expected to begin implementation in 2016.

Extending the SIFI Framework

Domestic Systemically Important Banks (“D-SIBs”)

At the 2011 G20 summit, it was proposed that the G-SIFI framework, addressing the issue of ‘too-big-to-fail’, should be extended to cover D-SIBs. Whereas the G-SIB framework considers the global impact of banking failures, by realigning the framework, it is hoped that the externalities of bank failure at the local level can be identified and addressed. The Basel Committee on Banking Supervision (“BCBS”), in collaboration with the FSB, is in the process of developing a D-SIB framework which is compatible with that of the G-SIB, facilitates home-host coordination and improves D-SIB loss absorbency. The findings of the FSB and BCBS will be presented to the G20 Finance Ministers and Central Governors meeting in November 2012.

Global Systemically Important Insurers (“G-SIIs”)

The report further notes that the International Association of Insurance Supervisors (“IAIS”) was tasked with the ‘development of an assessment methodology for the identification of G-SIIs’ and has made significant progress to this end, publishing a paper on policy measures that should apply to G-SIIs.  A consolidated paper on the assessment methodology and the policy measures will be delivered to the G20 in April 2013, with an initial list of G-SIIs being produced soon thereafter. For more information on this aspect, please see the post on this blog entitled “Recovery and Resolution Plans for Globally Systemically Important Insurers by Mid-2014” dated 7 June 2012.

Non-bank G-SIFIs

In recognition of the fact that non-bank G-SIFIs can also cause widespread disruption to the global financial system, G20 leaders asked the FSB, with the International Organisation of Securities Commission (“IOSCO”) to design a methodology for identifying such institutions.  However, no date was given by which IOSCO is due to report.