The impact of Basel 2.5 on emerging markets and smaller economies (EMSEs)Pascual O’Dogherty August 2013
Global banks are comprised
of a constellation of diverse
legal entities established in
different jurisdictions.
2
Global banks assess their risks and estimate their capital requirements at the consolidated level.
Subsidiaries must take into account the impact on parent banks’ capital.
Home‐country regulation and home‐supervisors’ guidance prevails.
The impact of Basel 2.5 on emerging markets and smaller economies (EMSEs)
Consolidation
3
For a local bank: its own country´s sovereign debt is a “risk‐free asset.”
For a global bank: a host‐country´s sovereign debt is a foreign sovereign exposure.
Balance‐sheet consolidation: host countries´ highest credit‐quality risks get transformed into foreign sovereign exposures.
The impact of Basel 2.5 on emerging markets and smaller economies (EMSEs)
AA
AA
BB
AAA
AA
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BB
ABBA
The incremental risk capital charge (IRC) for credit‐sensitive positionsCaptures default, concentration, and migration risks.
Considers gains and losses from changes in credit ratings and potential losses from counterparty debt default.
Basel 2.5
4The impact of Basel 2.5 on emerging markets and smaller economies (EMSEs)
Credit migration risk loss distribution
Loss
Basel 2.5
5The impact of Basel 2.5 on emerging markets and smaller economies (EMSEs)
Capital R
equiremen
ts
Capital requirements
Local bank
Local subsidiary of a foreign bank
Basel 2.5Basel 2.5Basel 2.0Basel 2.0
Basel 2.5
6The impact of Basel 2.5 on emerging markets and smaller economies (EMSEs)
RoE%
Return on Equity
Local bank
Local subsidiary of foreign bank
Basel 2.5Basel 2.5Basel 2.0Basel 2.0
7
Basel 2.5
The impact of Basel 2.5 on emerging markets and smaller economies (EMSEs)
Would make the playing field less level
Host country: 5‐year bond
Local bank Basel 2.0
RWA = 15
Local subsidiary of a foreign bank Basel 2.5
RWA = 26
Local subsidiary of a foreign bank Basel 2.5
RWA = 263
Guidance
8
• Home supervisors and parent banks should recognize local credit ratings for sovereign exposures funded and denominated in local currency and booked in local subsidiaries.
• The issuance of some BCBS guidance on how global banks may assign RWA at the consolidated level to their foreign subsidiaries’ risk exposures to local sovereigns denominated and funded in local currency would be very helpful.
• Revise and revaluate consolidation standards for systemically important affiliates. It may be cases where would be more appropriate to deduct an entity´s capital rather than consolidate its exposures (subsidiaries that are systemically important for a host‐country, somewhat ring‐fenced, and to which the parent bank has limited intragroup exposures).
The impact of Basel 2.5 on emerging markets and smaller economies (EMSEs)