A Fine Balance: The Role of Regulation in Furthering MSME Development Ewald M ű ller

1. A Fine Balance: The Role of Regulation in Furthering MSME Development Ewald Műller Director, Financial Analysis 20 June 2013

2. PRESENTATION OVERVIEW The Basel Framework Credit risk and capital adequacy • Standardisedapproach versus Internal Risk Models • Credit risk mitigation Other policy issues • MSME definitions • Taxation and other red tape • Encouraging / facilitating cash flow to MSMEs • UK, EU and other initiatives • Capacity building / support Conclusion

3. EVOLUTION OF THE WORK OF THE BASEL COMMITTEE ON BANKING SUPERVISION

4. THREE PILLARS OF BASEL II / III Minimum capital requirements: Requirements based on market, credit and operational risk to: reduce risk of failure by cushioning against losses, and provide continuing access to financial markets to meet liquidity needs, and provide incentives for prudent risk management Supervisory Review: Qualitative supervision by regulators of internal bank risk control and capital assessment process, including ability to require banks to hold more capital than required under Pillar I Market Discipline: Public disclosure and transparency requirements Pillar 1 Pillar 2 Pillar 3

5. KEY BUILDING BLOCKS OF BASEL III

6. IMPLEMENTATION OF BASEL III CET1 = Common Equity Tier 1; DTAs = Deferred Tax Assets; MSRs = Mortgage Servicing Rights

7. BASEL COMMITTEE ON BANKING SUPERVISION – CURRENT AGENDA* Medium term agenda • Completing the crisis-related overhaul of the policy framework by end-2014, including: • Leverage ratio • Net stable funding ratio (NSFR) • Securitisation framework, and • Fundamental review of the trading book • Boundary between banking and trading book • Risk metrics to cover tail risks • Market liquidity risk • Quantitative Impact Study (QIS) * William Coen, Deputy Secretary General of the Basel Committee – 7th GCC Regulators’ Summit, Doha, 25 February 2013

8. BASEL COMMITTEE ON BANKING SUPERVISION – CURRENT AGENDA Other work: • Simplicity and comparability: • Internal paper on a refined set of assessment criteria; and • External paper providing neutral analyses of the balance between simplicity, comparability and risk sensitivity in the Basel framework • Large exposures: • Definition • Limits • Split between domestic and foreign sovereigns

9. BASEL COMMITTEE ON BANKING SUPERVISION – CURRENT AGENDA New mandates: • Revising the standardised approaches for: • Credit risk • Operational risk • Interest rate risk in the banking book (IRRBB) Standards Implementation Group (SIG) workplan: • Enhancing the effectiveness of micro and macro-prudential supervision Review of Basel III implementation: • The rationale, approach and next steps with regard to the three levels of the Regulatory Consistency Assessment Programme (RCAP)

10. Purpose The purpose of these returns is to: • assess the quality and credit and counterparty risk associated with assets and off-balance sheet activities; • establish the level of provisioning against classified assets, including restructured credit; • analyse the nature and impact of credit risk mitigation techniques used; and • identify the concentration and distribution of credit risk assumed CREDIT RISK

11. Key issues Use of credit ratings Prescribed classification of loans and advances and resultant suspension of interest and raising of provisions • Special mention ˗̶ Sub-standard • Doubtful ˗̶ Loss Provisions for reclassification of restructured credit (never better than Special Mention) No prescribed general provision Detailed provisions in respect of credit risk mitigation, including haircuts for security Credit concentration reported in respect of large exposures, geographies and sectors Capital “proxy” for branches – 15% of total assets CREDIT RISK

12. Purpose CAPITAL ADEQUACY To provide a summary and overview of the reporting bank’s exposure to and capital requirements in respect of credit risk, market risk and operational risk To provide a detailed analysis of the reporting bank’s exposure to credit risk, market and operational risk

13. Capital requirements arising from credit, market and operational risk Definitions of what constitutes common equity tier 1, additional tier 1 and Tier 2 capital Base minimum required capital and reserve funds Capital Conservation Buffer – proposed at 2.5% comprising of CET 1 Capital and Reserve Funds Systemically important bank (SIB) capital charge, idiosyncratic bank-specific requirement and countercyclical buffer all at 0% currently CAPITAL ADEQUACY – SUMMARY INFORMATION – BR 600

14. CAPITAL ADEQUACY - PRUDENTIAL NORMS Deductions and impairments: Significant minority investments in banking, securities and other financial entities Significant investments in commercial entities – Investments higher than 15% of the bank’s capital and reserves for individual significant investments in commercial entities and 60% of the bank’s capital for the aggregate of such investments. The amount to be deducted is the portion of the investment that exceeds the materiality level. Risk weightings: Equity exposures that are not deducted from capital and are listed on a recognised exchange – risk weighted at 300% Equity exposures that are not deducted from capital and are not listed on a recognised exchange – risk weighted at 400%

15. Standardised Approach/Simplified Standardised Approaches adopted Risk Weight Framework – broadly aligned to Basel Capital Framework. Items of national discretion aligned to QCB framework Recognised credit rating agencies – Moody’s; S&P; Fitch For corporates, where credit ratings are unavailable, banks are allowed to use 100% Risk Weighting Preferential treatment for claims on banks – Option 2 of Basel adopted subject to a floor of 20% Commercial Public Sector Entities (PSEs) treated as corporates, i.e. 100% CAPITAL ADEQUACY - CREDIT RISK (BR 610)

16. OTHER POLICY ISSUES MSME definitions • South Africa has at least four • Enterprise Qatar developing definition for Qatar Taxation and other red tape Encouraging / facilitating cash flow to MSMEs • UK, EU and other initiatives • Capacity building / support

17. CONCLUSION Constraints • Risk weighting and CRM constraints • Liquidity: LCR & NSFR Policy coordination required Clear and consistent definitions needed Liquidity and operational support mechanisms essential

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