19 Jul 2012
D-SIBs to hold additional capital under Basel III - Implications for Australian banks uncertain
by Louise McCoach, Alex Chernishev
The framework establishes a minimum set of principles against which local regulators can evaluate whether a bank is a D-SIB and what additional capital it must hold.
On 29 June 2012, the Basel Committee of Banking Supervision issued a consultative document on its proposed framework for domestic systemically important banks (D-SIBs). The proposals supplement the framework for global systemically important banks (G-SIBs) announced by the Committee in December last year under which G-SIBs are required to hold an additional capital buffer in recognition of the potentially global impact of any failure on their part.
The proposed D-SIB framework recognises that, while certain banks may not be significant from an international perspective, they nevertheless have an important impact on their domestic economies. The framework establishes a minimum set of principles against which local regulatory authorities such as the Australian Prudential Regulatory Authority (APRA) can evaluate whether a bank is a D-SIB and determine the amount of additional capital that a D-SIB is required to hold and/or whether D-SIBs should be subject to other policy tools.
Given the Committee's intention that the D-SIB framework should complement the G-SIB framework, the Committee has proposed that it will be implemented in line with the phase-in arrangements for the G-SIB framework (ie. from January 2016).
The assessment methodology set out by the Committee requires national authorities to establish a methodology for assessing the degree to which banks are systemically important in a domestic context. In so doing, the national authority is required to focus on the potential impact of a bank's failure on the domestic economy.
The impact of a D-SIB's failure on the domestic economy is required to be assessed having regard to a D-SIB's:
substitutability/financial institution infrastructure (including considerations related to the concentrated nature of the banking sector); and
complexity (including the additional complexities from cross-border activities).
The above criteria are identical to the criteria used to evaluate G-SIBs, except the G-SIB methodology includes an additional cross-jurisdictional activity assessment criterion which measures the degree of global activity of a G-SIB that the Committee did not consider relevant when assessing the impact of a bank's failure on the domestic economy.
In addition, unlike the G-SIB methodology which determines a bank's systemic importance by scoring it against each criterion based on strict guidelines prescribed by the Committee, the proposed D-SIB framework is a principles-based approach. This means that when determining a bank's systemic importance on the domestic economy, the relevant national authority may assess this without the need for a strict scorecard against a number of factors in addition to the four criteria set out above, including some country-specific factors such as the size of a bank relative to domestic GDP of the relevant country.
Capital requirements and other policy tools
National authorities such as APRA are given the power to determined the level of additional Common Equity Tier 1 which a D-SIB is required to hold (or its higher loss absorbency or "HLA") commensurate with the degree of its systemic importance.
The Committee has stated that the level of HLA should be determined by the national authorities on the basis of quantitative methodologies (where available) and country specific factors (eg. the degree of concentration of the banking sector). In determining HLA requirements, the national authorities may group D-SIBs into multiple buckets each with a different HLA requirement.
As with the G-SIB framework, D-SIBs will be required to meet their HLA requirements by holding additional Common Equity Tier 1. The HLA requirements are additional to the Basel III capital conservation and countercyclical buffers.
Interestingly, the Committee emphasised that other policy tools, particular more intensive supervision, can also play an important role in dealing with D-SIBs. In a speech to the Australian Conference of Economists on 11 July 2012, APRA Chairman John Laker highlighted that APRA already has a risk-rating framework in place that is geared towards early supervisory intervention of larger Australian banks. What wasn't clear from Mr Laker's statement is whether APRA considers more rigorous supervision of D-SIBs as an alternative to the HLA requirements.
Subsidiaries of foreign banking groups
The Committee has also provided guidance on how a host regulator should assess subsidiaries of a foreign banking group. When assessing subsidiaries of foreign banking groups, the host regulator is required to only consider subsidiaries of the group in the host jurisdiction plus any downsteam subsidiaries in the host or other jurisdictions. Therefore, subsidiaries of foreign banking groups are considered on a local or sub-consolidated basis from the level starting at the local jurisdiction.
Moreover, the Committee has recognised that imposing HLA requirements on subsidiaries may have implications for the wider banking group especially in its home jurisdiction.
The Committee has addressed this issue by stating that home and host authorities should co-ordinate and co-operate with each other before any plan is implemented to impose an HLA requirement on a subsidiary of a foreign bank.
Interaction of D-SIB and G-SIB frameworks
With the proposed introduction of the D-SIB framework, there is the possibility of a bank facing conflicting requirements from the G-SIB and D-SIB frameworks. The Committee has stated that double-counting of the G-SIB and D-SIB requirements should be avoided and the additional capital requirements imposed under the G-SIB and D-SIB frameworks should not be additive.
Where a banking group has been identified as a D-SIB in its home jurisdiction as well as a G-SIB, the home regulator will be required to impose the higher of the D-SIB and G-SIB HLA requirements.
Given the market dominance of Australia's big four banks, it is likely they will qualify as D-SIBs under the assessment criteria provided by the Committee. However, until APRA provides guidance on how it intends to implement the D-SIB framework it is not clear whether other institutions will qualify as D-SIBs. In addition, it is not clear at this stage whether APRA will require Australian D-SIBs to hold additional Common Equity Tier 1 or whether it sees increased supervision of Australian D-SIBs as an alternative to the HLA requirements.
The Committee has invited comment on its proposed D-SIB framework by 1 August 2012.
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