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RCG for the Americas and Do Not Necessarily Reflect Those of the FSB

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RCG for the Americas and Do Not Necessarily Reflect Those of the FSB Financial Stability Board Regional Consultative Group for the Americas Report on the Effect on Host Countries of Balance Sheet Consolidation and Risk Management Practices by Global Banks Notice This document has been prepared by the FSB Regional Consultative Group (RCG) for the Americas and is being published to disseminate information to the public. The views expressed in the document are those of the RCG for the Americas and do not necessarily reflect those of the FSB. The RCG for the Americas comprises FSB-Member authorities as well as non-FSB member authorities.1 The RCGs have been established as a mechanism for the FSB to consult with non-member jurisdictions and for the RCG members to share amongst themselves and the FSB views on vulnerabilities affecting the financial system, FSB policy initiatives and on other measures to promote financial stability. 1 A list of members of the RCG for the Americas can be found at http://www.financialstabilityboard.org/about/rcgamericas.pdf 22 August 2014 Contents Foreword ............................................................................................................................................. 3 Glossary ............................................................................................................................................... 4 Executive summary ............................................................................................................................. 5 1. Introduction ................................................................................................................................ 9 2. Consolidated supervision of banks and financial conglomerates ............................................. 10 3. Risk-management practices ...................................................................................................... 16 3.1 Credit risk ................................................................................................................................ 17 3.2 Market risk .............................................................................................................................. 17 3.3 Consolidated risk management in global banks...................................................................... 18 3.4 Rating agencies ........................................................................................................................ 19 4. Summary of responses from the survey ................................................................................... 20 4.1 Banking book ........................................................................................................................... 20 4.1.1 Sovereign exposures ........................................................................................................ 21 4.1.2 Exposures to other banks and to corporates ................................................................... 22 4.2 Trading book............................................................................................................................ 22 4.2.1 Internal model approach .................................................................................................. 22 4.2.2 Basel 2.5 ........................................................................................................................... 23 4.3 Capital allocation and consolidation ....................................................................................... 24 5. Conclusions and recommendations .......................................................................................... 25 References ......................................................................................................................................... 29 Annex I: Questionnaire on risk-management practices and capital allocation by global banks. ..... 32 Annex II: Market share of global and regional banks as a percentage of assets in banking sector .. 40 Annex III: Example of the quantitative impact of Basel 2.5 .............................................................. 41 Annex IV: Members of working group on effects on host countries of balance-sheet-consolidation and risk-management practices by global banks .............................................................................. 44 2 Foreword In November 2010, the Financial Stability Board (FSB) announced arrangements to expand outreach beyond its current membership. To this end, regional consultative groups were established to bring together financial authorities from FSB member and nonmember countries to exchange views on developments in financial systems and on initiatives to promote financial stability. Membership in such groups includes representatives of ministries of finance, central banks, and supervisory authorities. As part of that initiative, in 2011 the FSB created the FSB Regional Consultative Group for the Americas (RCGA), with the participation of representatives from Argentina, the Bahamas, Barbados, Bermuda, Bolivia, Brazil, the British Virgin Islands, Canada, the Cayman Islands, Chile, Colombia, Costa Rica, Guatemala, Jamaica, Mexico, Panama, Paraguay, Peru, Uruguay, and the United States. At the Los Cabos G20 Summit, the FSB presented a report drawn up in coordination with staff from the International Monetary Fund and the World Bank on the Effects of Regulatory Reforms on Emerging Market and Developing Economies: A Review of the Potential Unintended Consequences. The report focused on the potential impacts of the Basel III capital and liquidity frameworks, policy measures for global systemically important financial institutions, and over-the-counter derivatives market reforms. Among the concerns covered in the report were those related to the impacts on host countries of the methodologies used by global banks to measure risks at the consolidated level and assign capital to their foreign operations. This report presents the findings of a working group studying the balance-sheet-consolidation and risk-management practices of global banks operating in the Americas. 3 Glossary BCBS Basel Committee on Banking Supervision CRA Credit Rating Agencies EMDE Emerging and Developing Market Economies FSB Financial Stability Board IRC Incremental Risk Charge IMA Internal Model Approach IFRS International Financial Reporting Standards IRB Internal-Ratings-Based approach OECD Organization for Economic Cooperation and Development RCGA Regional Consultative Group for the Americas RWA Risk Weighted Assets SVaR Stressed VaR VaR Value- at Risk 4 Executive summary The FSB Regional Consultative Group for the Americas established a Working Group (WG) to study the effects on host countries of balance-sheet-consolidation and risk- management practices by global banks. This report presents the findings of the group, which are mainly based on a questionnaire prepared to gather information from nine international banks with an important presence in the region. The development of consolidated supervision, particularly in the way it is applied to internationally active banks, owes much to the work of the Basel Committee on Banking Supervision (BCBS). A few years after the publication of the original Basel Concordat, in 1983, the BCBS recommended that supervisory authorities of international banks should monitor risk exposures on the basis of consolidated reports. Such reports should reflect a bank´s total business, irrespective of legal entities or the countries in which business was conducted. In 1992, the BCBS also recommended that supervisory authorities should only allow banks from other countries within their jurisdiction if they could be satisfied that the home-country supervisor of an applicant bank had the capacity and information to supervise both the new institution and the parent bank on a consolidated basis. Moreover, according to the BCBS Core Principles for Effective Banking Supervision, the consolidated supervision of banking groups is an essential element of banking supervision which should be pursued on an on-going basis. Consolidated supervision and risk-management practices entail many benefits, such as an additional layer of supervision and a general view of risk undertaken by the group as a whole. However, these practices may also generate some challenges. After the consolidation process takes place, the particular characteristics of the entities within the group (such as funding sources and currencies) may only be partially taken into account in the bank’s risk management practices , and home-country regulation usually prevails for the consolidated institution. In other words, host-authority regulatory practices to which subsidiaries are subject are typically not taken into account when their balance sheets are consolidated with that of the group. However, international banks are not incorporated as single legal entities, but as conglomerates of separate legal entities operating in various jurisdictions. International banks may hedge their risks on a global basis, and they may book risk exposures in different entities within the group that will offset each other in aggregate, but these exposures may leave specific entities carrying inappropriate amounts of risk. The majority of banks answering the survey indicated that they are increasingly seeking to take a consolidated, enterprise-wide view of risk management. The motivation derives from competitive forces to increase risk-adjusted returns on equity, in part by making more efficient use of capital allocation, as well as from other
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