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The Impact of Basel III on Korean Financial Services

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The Impact of Basel III on Korean Financial Services Financial Services The Impact of Basel III on Korean Financial Services Disclaimer This report was produced by Oliver Wyman on behalf of the Financial Supervisory Service. The figures presented in this report are based on outside- in analysis, using public data sources and internal Oliver Wyman reference data. The report aims to be neutral about the need for and merits of the new Basel III regulation, and to be purely factual about its strategic implications on the Korean banking landscape. The implications are hypotheses on behalf of Oliver Wyman and do not necessarily reflect the FSS’s own judgments; neither do they promise nor preclude any FSS action. Copyright © 2011 Oliver Wyman Contents 1. Executive summary................................................................................................ 1 2. Introduction .......................................................................................................... 10 3. Background to regulatory changes .................................................................... 11 3.1. The global financial crisis: causes and impact................................... 11 3.1.1. The subprime crisis .................................................................. 11 3.1.2. The global financial crisis ........................................................ 16 3.2. Lessons from the crisis .......................................................................... 18 3.3. Revision of Basel II.................................................................................. 20 4. Basel III details and market reaction................................................................. 22 4.1. Definition of capital................................................................................ 23 4.1.1. Criteria governing inclusion as regulatory capital ............... 23 4.1.2. Regulatory adjustments applied to regulatory capital ........ 25 4.2. Calibration and phase-in of capital requirements............................. 25 4.3. Regulatory buffers, provisions and cyclicality.................................... 26 4.3.1. Capital conservation buffer ..................................................... 26 4.3.2. Countercyclical capital buffer ................................................. 27 4.3.3. Forward-looking provisioning................................................. 28 4.4. Counterparty credit risk capital requirements.................................. 28 4.5. Leverage ratio .......................................................................................... 29 4.6. Liquidity proposals ................................................................................. 30 4.6.1. Liquidity coverage ratio............................................................ 30 4.6.2. Net Stable funding ratio ........................................................... 32 4.7. Treatment of systemically important financial institutions............ 33 4.8. Timing of implementation .................................................................... 34 4.9. Market-related monitoring tools .......................................................... 35 4.10. Market reaction....................................................................................... 36 4.10.1. International market reaction................................................. 36 4.10.2. Korean banks’ reaction............................................................. 39 5. Overview of the Korean banking market.......................................................... 41 5.1. The three tier banking system.............................................................. 41 5.2. Strong capital positions ......................................................................... 42 5.3. Financial holding group structure........................................................ 44 Copyright © 2011 Oliver Wyman 5.4. Reliance on wholesale funding............................................................. 45 5.5. Consolidating market............................................................................. 50 5.6. Conclusion ............................................................................................... 52 6. Impact on the banking sector............................................................................. 53 6.1. Impact on the Korean banking sector.................................................. 53 6.1.1. Balance sheet implications...................................................... 53 6.1.1.1. Capital requirements and bank response................ 53 6.1.1.2. Short-term liquidity requirements and bank response........................................................................ 57 6.1.1.3. Long-term stable funding requirements and bank response .............................................................. 62 6.1.2. Impact on ROE ........................................................................... 69 6.1.3. Analysis of ROE by product...................................................... 71 6.1.4. Impact on the competitive dynamics of Korean financial services....................................................................... 78 6.1.4.1. Comparison of impact on national, regional, specialized and glocal banks ..................................... 78 6.1.4.2. Impact on adjacent industries................................... 79 6.1.5. The likely shape of Korean banking post-Basel III .............. 81 6.2. Impact on overseas banking sectors.................................................... 87 6.2.1. Capital impact ........................................................................... 88 6.2.2. Liquidity impact ........................................................................ 90 6.2.3. Combined capital and liquidity impact on ROE.................... 93 6.3. Impact on Korea’s competitiveness as a financial hub..................... 94 6.3.1. Korea’s current positioning as a regional financial hub ..... 95 6.3.2. Restrictions on cross-border liquidity flows ......................... 97 6.3.3. Changes in competitive landscape......................................... 98 6.4. Macro-economic impact on Korea and globally............................... 100 6.4.1. Costs.......................................................................................... 101 6.4.2. Benefits..................................................................................... 107 6.4.3. Summary .................................................................................. 109 7. Implications for Korean Banks’ finance and risk management .................. 110 7.1. Compliance approach .......................................................................... 111 7.2. Opportunistic information user.......................................................... 112 7.3. Best in class aspirations....................................................................... 114 7.4. Benefits and implementation challenges ......................................... 118 7.5. Other capability refinements.............................................................. 119 Copyright © 2011 Oliver Wyman 7.6. Basel 3 investment priorities .............................................................. 120 8. Implications for regulators ............................................................................... 122 8.1. Specific local discretion available to the FSS.................................... 122 8.1.1. Countercyclical buffer ............................................................ 122 8.1.2. Treatment of trade finance under liquidity ratios ............ 123 8.1.3. Other areas of local discretion concerning liquidity ratios ......................................................................................... 124 8.1.4. Treatment of HQLAs ............................................................... 125 8.1.4.1. Central bank eligibility.............................................. 125 8.1.4.2. Central bank reserves ............................................... 125 8.1.4.3. Options for alternative HQLA treatment................ 126 8.2. Timing of implementation .................................................................. 127 8.3. Harmonization of existing standards with Basel III ........................ 128 8.4. Treatment of specialized banks.......................................................... 132 8.5. Other possible actions by Korean policy-makers............................. 133 8.6. Implications for ICAAP and SREP ....................................................... 134 8.6.1. More prescriptive capital levels ............................................ 135 8.6.2. Stressed liquidity adequacy................................................... 139 8.6.3. Summary .................................................................................. 141 8.7. Conclusion ............................................................................................. 141 9. Additional regulatory changes ......................................................................... 143 10. Final remarks ...................................................................................................... 147 Appendix A. Glossary ........................................................................................ 148 Appendix B. Further reading............................................................................ 150 Copyright © 2011 Oliver Wyman 1. Executive summary During the post-mortem following the global financial crisis, various gaps in existing banking regulation and risk
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