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FSB EMDE Report Jun2012

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FSB EMDE Report Jun2012 Identifying the Effects of Regulatory Reforms on Emerging Market and Developing Economies: A Review of Potential Unintended Consequences Report to the G20 Finance Ministers and Central Bank Governors Prepared by the Financial Stability Board in coordination with Staff of the International Monetary Fund and the World Bank 19 June 2012 Table of Contents Foreword .................................................................................................................................... 1 Glossary...................................................................................................................................... 2 Executive Summary ................................................................................................................... 3 I. Introduction ........................................................................................................................ 6 II. Recent Financial Sector Developments in EMDEs ........................................................... 8 III. Effects of Regulatory Reforms..................................................................................... 10 A. Basel 2.5 and III capital framework......................................................................... 11 B. Basel III liquidity framework................................................................................... 15 C. Policy measures for G-SIFIs .................................................................................... 17 D. OTC derivatives market reforms.............................................................................. 19 E. Other national and regional reforms......................................................................... 20 IV. Conclusions .................................................................................................................. 23 Annex I: Deleveraging in EMDEs ........................................................................................... 26 Annex II: Additional Information ............................................................................................ 28 Annex III: Questionnaire Used to Collect Information From EMDEs .................................... 34 Annex IV: Members of the EMDEs Review Group ................................................................ 37 i Foreword At the meeting of G20 Finance Ministers and Central Bank Governors on 26 February 2012, the Financial Stability Board (FSB) was asked “to coordinate, with the IMF and World Bank, a study to identify the extent to which the agreed regulatory reforms may have unintended consequences for EMDEs” (emerging market and developing economies). This request reflected a recognition of the need to examine the impact of these reforms for a large and diverse group of countries whose financial systems have become increasingly important at the global level over the past decade. The study focuses primarily on those regulatory reforms that have already been broadly agreed by the G20 and whose implementation may affect EMDEs. It also considers other national or regional reforms that may have cross-border effects on EMDEs. The study does not, however, cover other international regulatory reforms that may also be relevant for EMDEs but whose policy development is still at a relatively early stage. Such reforms include the design of a framework to address the risks arising from domestic systemically important financial institutions, a policy framework for global systemically important insurers, and policy measures to strengthen the oversight and regulation of the shadow banking system. The study was prepared by the FSB Secretariat in collaboration with staff of the IMF and World Bank and with the input of relevant standard-setting bodies. An FSB Review Group (see Annex IV) comprising FSB members and co-chairs of RCGs provided guidance on the selection and analysis of the issues included in the study as well as on the main messages. 1 Glossary AEs Advanced Economies BCBS Basel Committee on Banking Supervision CCF Credit Conversion Factor CCP Central Counterparty CEE Central and Eastern Europe CMG Crisis Management Group CRA Credit Rating Agency EBA European Banking Authority ECAI External Credit Assessment Institution ECB European Central Bank EMDEs Emerging Market and Developing Economies EU European Union FSB Financial Stability Board G-SIBs Global Systemically Important Banks G-SIFIs Global Systemically Important Financial Institutions HQLA High-Quality Liquid Assets (Basel III liquidity requirements) IMF International Monetary Fund IRB Internal Ratings-Based (Basel capital framework approach) LCR Liquidity Coverage Ratio NSFR Net Stable Funding Ratio OTC Over-the-Counter QIS Quantitative Impact Study RCG (FSB) Regional Consultative Group SMEs Small and Medium-sized Enterprises 2 Executive Summary At the request of the G20 Finance Ministers and Central Bank Governors, the FSB, in collaboration with the IMF and World Bank, has prepared this study to identify the extent to which the agreed regulatory reforms may have unintended consequences for EMDEs. The intent of the study is not to re-open recent internationally agreed reforms but to better understand the possible effects of those reforms in the context of broader post-crisis developments on EMDEs. In so doing, the study should enhance financial stability by facilitating the timely, full and consistent implementation of the reforms. There is widespread support among EMDEs for the objectives of the agreed reforms, although there is also a broad range of views regarding the extent to which these reforms are having, or expected to have, an impact on their financial systems. This heterogeneity in perspectives can be attributed to the early stage of implementation of these reforms and to the diversity of EMDE financial systems, which give rise to different considerations and concerns. As a result, most of the responses received by national authorities from EMDEs concerning unintended consequences reflect respondents’ expectations and concerns regarding potential future effects. While many EMDEs do not expect significant adverse effects from the implementation of the reforms, those respondents that did identify unintended consequences focused on a few key areas. The main issues raised are as follows: Basel III capital framework – that the risk weighting of assets in the trading book and for securitised products under Basel 2.5, the convertibility of certain capital instruments, differences in the measurement of risk between a parent bank and its subsidiary, capital requirements for certain business activities (such as trade finance) as well as higher overall capital requirements may exacerbate deleveraging and increase the costs of global banks operating in EMDEs, thereby reducing credit and financial market liquidity; Basel III liquidity framework – that the definition of high quality liquid assets and the calibrations used in the calculation of the liquidity ratios do not accurately reflect EMDEs’ financial market structures, which may adversely affect the functioning of the domestic financial markets and the lending capacity of banks in EMDEs; policy measures for global systemically important financial institutions (G-SIFIs) – that higher capital requirements imposed by home authorities for G-SIFIs may disproportionately impact their operations in EMDEs and lead to their retrenchment or raise the cost of intermediation, and that host authorities may not always be invited to participate in the crisis management group or resolution planning for those firms even if their operations in the host jurisdiction are systemically important; and over-the-counter (OTC) derivatives reforms – that the various implementation and policy issues being discussed have not enabled EMDEs to determine what derivatives- related infrastructures to establish domestically or how best to regulate cross-border OTC derivatives transactions, and that changes in the market landscape as a result of the reforms underway in major jurisdictions may raise hedging costs for end users in 3 EMDEs and place domestic central counterparties at a competitive disadvantage vis-à- vis global ones, which may impede the development of domestic derivatives markets. Some respondents also identified regulatory reforms by other countries as giving rise to spillovers and/or extraterritorial effects that may lead to unintended consequences. The two most cited reforms are the higher capital requirements by the European Banking Authority for large banks in the European Union and the Volcker Rule in the United States. Several concerns relate to cross-border effects and perceived home bias in the design or implementation of reforms. The effects on EMDEs may be caused by spillovers (e.g. through the activities of foreign financial institutions) or by the extraterritorial nature of some reforms (e.g. because they directly affect the operations of domestic financial institutions with cross-border business). A common concern in many cases is home bias, either in the design of the reforms or in the way that they are implemented in other jurisdictions. A number of the identified concerns arise from the use of credit ratings in regulation and reinforce the need to reduce reliance on such ratings. Some of these concerns arise from differences in the interpretation or the implementation of international rules guiding the use of credit ratings, while others arise from the perception that these ratings do not accurately reflect the creditworthiness
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