Basel IV and Proportionality Initiatives

Basel IV and proportionality initiatives

Upcoming changes to the Canadian capital and liquidity framework Introduction

Enhancements to risk-based capital requirements and minimum Q1-2020. Attention is now focused on the implementation of liquidity and funding standards for Deposit-Taking Institutions final Basel III reforms, informally referred to as ‘Basel IV’, which (DTIs) are two foundational aspects of post-financial crisis introduces extensive revisions to the calculation of Risk-Weighted reforms introduced by Basel III. In Canada, initial Basel III reforms Assets (RWA) for Pillar 1 risks. OSFI’s proposed policy direction dedicated to raising the quality and quantity of capital have and implementation timelines for Basel IV are included in OSFI’s already been implemented. The domestic implementation of July 2018 discussion paper, Implementation of the final Basel III Basel III liquidity and funding standards will be complete when reforms in Canada. DTIs begin reporting the Net Stable Funding Ratio (NSFR) in

Figure 1: Summary of basel capital, leverage and liquidity requirements

Fu e : ratio Raising the i F eerge ri quality and quantity of capital

Fu e : Revising how risks are calculated i ii

SA for Securitisation Operational SA for IRB for Market risk CVA risk Output measuring risk credit risk credit risk (FRTB) ﬂoor counterparty credit risk

Source: Workshop Basel IV, KPMG International, 2018.

While the Basel framework was originally designed to apply to which obligates DTIs to achieve compliance with updated large, internationally-active banks, domestic regulators including standards in short order. OSFI have applied Basel standards to a wider set of banks In this paper, we provide a consolidated overview of the for pragmatic reasons. However, the complexity introduced scope and timelines for the upcoming revisions to capital and by Basel III/ IV has led regulators to now consider how the liquidity requirements for DTIs and outline the extent to which framework can be better tailored to smaller, less complex proportionality considerations affect the scope of changes banks. OSFI’s July 2019 discussion paper titled Advancing affecting Small and Medium Sized Institutions (SMSBs). Foreign Proportionality: Tailoring Capital and Liquidity Requirements for Bank Branches (FBBs) are subject to different standards and Small and Medium-Sized Deposit Taking Institutions presents expectations with respect to capital and liquidity, and a brief outline its proposals to tailor requirements for non-D-SIB banks. of the current state and future changes is also provided. Finally, OSFI’s timelines for implementing the changes related to we conclude with a summary of KPMG’s perspective on key Pillar 1 capital and liquidity requirements conclude in Q1-2022, considerations and challenges for DTIs leading up to Q1-2022.

© 2019 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 2 Basel IV and proportionality initiatives

Overview of the current Canadian capital and liquidity framework

1. Current capital and liquidity requirements for SMSBs and D-SIBs Capital requirements, leverage requirements and the output floor The following table summarizes the minimum target levels for risk-based capital ratios for DTIs:

Table 1: SMSB and D-SIB Risk-based Capital Ratios Common Equity Tier 1 (CET1) Tier 1 Total Minimum Ratios 4.5% 6.0% 8.0% Capital Conservation Buffer (CCB) 2.5% 2.5% 2.5% Countercyclical Buffer (CCyB) Not activated Not activated Not activated Minimum Target for SMSBs (including buffers) 7.0% 8.5% 10.5% D-SIB Buffer 1.0% 1.0% 1.0% Domestic Stability Buffer (DSB) 2.0% 2.0% 2.0% Minimum Target for D-SIBs (including buffers) 10.0% 11.5% 13.5%

Sources: Capital Adequacy Requirements Guideline, OSFI, 2019 Industry Notice on Domestic Stability Buffer, OSFI, June 2019

DTIs are also expected to maintain a leverage ratio (LR) of at DTIs that have received OSFI’s approval to use advanced least 3%. Disclosure requirements for capital and the leverage approaches to determine credit or operational risk capital ratio can be found in OSFI’s Capital Disclosure Requirements requirements are required to calculate a capital floor which limits and D-12 Leverage Ratio Disclosure Requirements. the extent that RWAs can be lowered relative to standardized approaches. Prior to Q2-2018, Canadian DTIs using internal In addition to the above changes that raise the quality and models to calculate a Basel I capital floor as per OSFI’s now quantity of capital, the implementation of updated Basel IV expired A-3 Guideline. Effective Q2-2018, Canadian DTIs using standards related to the calculation of RWAs has also begun. internal models, or Internal Models Approved Institutions Revisions to the securitization framework, the capitalization of (IMAIs), switched over to revised capital floor based on Basel II central counterparty exposures (for inclusion in the calculation standardized approaches which will stay in place until Q4-2021 of both risk-based capital and leverage requirements), and the using a scaling factor of 72.5%. standardized approach for counterparty credit risk (SA-CCR) were implemented in Q1-2019. Outstanding revisions to RWA calculations will be implemented by Q1-2022. Figure 2: Interim domestic Basel II output floor

ess dedtions or alloanes inlded in apital ls alloane or sortall dedtions

otal sin Iapproved advaned approaes pls partialse portolios treated nder nonodelled approaes redit aret ter redit and V sin standardied approaes it soe advaned inpts or V and aret ris dependin on a Is approval stats

Source: Capital Adequacy Requirements Guideline, Chapter 1.9.1., OSFI 2019

Liquidity requirements As stated in the Liquidity Adequacy Requirements (LAR), OSFI’s with OSFI’s D-11 Guideline. DTIs are also required to report to assessment of an institution’s liquidity adequacy is informed by OSFI the Net Cumulative Cash Flow (NCCF) metric for multiple its minimum liquidity and funding standards, additional liquidity time horizons up to one year as well as a suite of liquidity and metrics and supervisory standards. All DTIs are currently required intraday liquidity monitoring tools. Although NCCF and other to maintain a Liquidity Coverage Ratio (LCR) of no lower than monitoring tools do not have defined minimum thresholds, OSFI 100% and D-SIBs must provide public disclosures in accordance reserves the right to set regulatory requirements as needed.

Figure 3: Factors in the supervisory assessment of liquidity adequacy

inimum liquidity and dditional liquidity metrics uperisory assessments funding standards CCF onitoring tools BCB F B riniples or sond liidity ris LC F iidity priniples ffective 1- anaeent and ntraday monitoring tools spervision

Source: Liquidity Adequacy Requirements Guideline, OSFI, 2019

2. Current capital and liquidity requirements for foreign bank branches (FBBs)

FBBs are subject to different capital and liquidity requirements Figure 4: FBBD maintenance requirements for full-service than D-SIBs and SMSBs. Instead of risk-based capital branches requirements, FBBs hold a foreign bank branch deposit (FBBD) requirement that is met by unencumbered assets deposited Supervisory concerns with an approved financial institution in Canada. For a lending (if required by OSFI) branch, the FBBD is $100,000, whereas for a full-service branch there is an initial FBBD requirement of $5 million with additional Fluctuation in liabilities maintenance requirements to account for fluctuations in liabilities and supervisory concerns.

With respect to liquidity, OSFI’s draft B-6 guideline indicates that Base requirement FBBs may require quantitative reporting pertaining to the liquidity of the branch in Canada and its degree of ongoing reliance on its head office. Source: Draft Guideline A-10, OSFI, 2019

In this section, we begin by reviewing the upcoming changes to in Canada. Next, we explore OSFI’s proposals for how the the Canadian capital and liquidity framework for D-SIBs, which tailoring of base D-SIB requirements helps to better fit the unique are directly transcribed from Basel, with modifications to take characteristics of SMSBs. This section concludes with a brief into account the unique aspects of domestic implementation synopsis of changes to FBB branch capital requirements.

1. Domestic systemically important banks (D-SIBs) Capital requirements, output floor and leverage (SA), and modifications to the Internal Ratings Based (IRB) – requirements the removal of the IRB eligibility of some asset classes and As mentioned in Section II, the implementation of updated the introduction of parameter floors. The Basel Committee on standards related to Basel IV is currently underway. This section Banking Supervision (BCBS) has also indicated that the 1.06 provides a summary of the changes for which implementation scaling factor that currently applies to credit RWAs no longer is not complete and outlines the details of OSFI’s proposals for applies in light of revisions to the risk-weighted framework and 1 domestic implementation. the revised output floor . KPMG’s Basel IV: The Way Ahead series includes two articles that explore the changes to the Credit risk SA and IRB approaches in further detail. Changes to the credit risk standards in Basel IV introduce a OSFI’s July 2018 discussion paper proposes additional changes revised, more risk sensitive and granular Standardized Approach intended to better reflect Canadian market characteristics:

Table 2: Proposed changes to the domestic credit risk capital framework – Applicability to SA and IRB approaches

Residential mortgages Credit card exposures Retail SBE / Corporate SME

Maintaining a Separate risk Risk weight for CCF for PD floor for Apply Corporate 10% LGD Floor weight function transactors and unconditionally non-transactors SME risk for ‘property cancellable weights to both Impacted Risk weight for generated cash commitments Retail SBE and approach non-transactors flow dependent’ Corporate SME residential categories mortgages

Revised Standardized × × × Approach (SA)

Modifications to the IRB × × × × Approach

Source: Domestic Implementation of the Final Basel III reforms, OSFI, July 16, 2018.

Operational risk Basel IV reforms remove the Advanced Measurement Approach capital is determined by using an income statement based proxy (AMA) from the regulatory framework and streamlines the known as the Business Indicator Component (BIC) and applying operational risk framework by replacing the existing standardized a scaling factor known as the Internal Loss Multiplier (ILM) which approaches (The Basic Indicator Approach and the Standardized accounts for a bank’s historical loss levels based on internal data. Approach) with a single, approach named the Standardized KPMG’s Basel IV: The Way Ahead series explains the mechanics Measurement Approach (SMA). The SMA for operational risk of the SMA approach in further detail.

1 Footnote 3, Page 3, Basel III: Finalising post-crisis reforms. https://www.bis.org/bcbs/publ/d424.pdf

OSFI’s July 2018 discussion paper proposes exercising the 2. Allow smaller FIs (with a business indicator, or BI < C$1.25B) national discretion permitted by the BCBS in relation to the to use historical losses if they are able to meet minimum inclusion and exclusion of internal loss data in the following ways: requirements with respect to loss data collection. This would make smaller banks’ operational risk capital requirements 1. Establish a minimum threshold of C$25,000 for including loss sensitive to their internal loss experience. events in data collection and average annual loss calculations used in calculating the ILM. OSFI is providing a transition period for DTIs currently using AMA for operational risk capital (‘AMA DTIs’) as illustrated below: Figure 5: Transition period for Basel III SMA implementation

Contine sing AMA apital eporting sing the rrent standardied Implement SMA for reporting for the remainder of approah (SA) for fisal 2020 operational risk apital fisal 2019 reporting. emoval of reirement for sing bsiness environment and internal ontrol fators (IC)

After AMA is de-commissioned, OSFI expects AMA DTIs to The revised standards for CVA Risk consist of two new options: continue conducting internal and external loss data and scenario the Basic Approach (BA-CVA) and a new Standardized Approach analysis as part of their internal risk management practices. (SA-CVA). KPMG’s Basel IV: The Way Ahead series includes an article that explains the mechanics of the BA-CVA and SA-CVA Market risk and CVA risk approaches in further detail. In its July 2018 discussion paper, OSFI The new Fundamental Review of the Trading Book (FRTB) indicated that it intends to implement the changes for the updated framework introduces essential structural changes to all CVA risk framework without any modifications in Q1-2022. processes and calculations involved in determining market risk capital requirements. KPMG’s Basel IV: The Way Ahead series Output floor includes an article that explains the mechanics of the FRTB in Basel reforms introduce an updated output floor based on Basel further detail. III standardized approaches. Basel will phase in the capital floor from January 1, 2022 to January 1, 2027 by increasing the scaling In a July 2017 industry letter, OSFI communicated its commitment factor from 50% to 72.5% over a five year period. However, OSFI to implementing the revised market risk capital standards by has proposed implementing the output floor at a level of 72.5% Q1-2022, however uncertainty remains within the marketplace in effective Q1-2022, as it believes the transition period on the relation of the scope and timing of implementation plans for the output floor is not needed. internal models approach (IMA).

Figure 6: Basel IV Capital Floor

Post ﬂoor RWAs = Max (pre-ﬂoor RWAs, 72.5% x standardised RWAs)

re-floor RA Standardized RAs ost floor RA RWA using banks Hypothetical Maximum of pre-ﬂoor approved methods standardised RWA RWA and 72.5% of the standardised RWA Operational risk SA 2 72.5% of SA

Market risk SA 1 Additional RWA due 3 = 2-1 Operational risk SA to ﬂoor Credit risk SA 4.5% of Market risk IMA (roll out) RWAs as Credit risk SA CET1 capital (roll out) CVA SA to meet CVA SA Step 1 RWA pillar 1 CCR SA CCR IMM rquirements if SA Credit risk SA Credit risk IRB

Source: Workshop Basel IV, KPMG International, 2018.

Leverage ratio the new SA for counterparty credit risk, but additional technical Basel III reforms to the leverage ratio (LR) include a new LR refinements to the treatment of on-balance sheet exposures, buffer for G-SIBs and technical refinements to the exposure securities financing transactions (SFTs) and off-balance sheet measure in the denominator of the LR. In its July 2018 discussion items will be considered as part of OSFI’s consultation process paper, OSFI proposes conservatively treating D-SIBs as first for annual changes to the LR framework prior to Q1-2022. bucket G-SIBs and applying a LR buffer of 50 bps to D-SIBs (i.e. 50% of the D-SIB capital buffer of 1%). This raises the minimum Liquidity LR requirement for D-SIBs to 3.5% starting in Q1-2022. The LR Net stable funding ratio exposure measure has already been updated in Q1-2019 to reflect Effective Q1-2020, OSFI will incorporate the NSFR into the Figure 7: D-SIB Leverage requirements Liquidity Adequacy Requirements (LAR). NSFR Disclosure requirements become effective in January 2021. The NSFR is 3.5% Leverage ratio buffer a long-term structural liquidity metric defined as the ratio of Available Stable Funding (ASF) to Required Stable Funding (RSF). 3.0% Based on KPMG’s interpretation of OSFI’s discussion papers Leverage requirement on Final Basel III reforms and Proportionality, OSFI proposes requiring D-SIBs and IRB approved SMSBs to calculate the NSFR and maintain a level of at least 100% on an ongoing basis. Source: Leverage Requirements Guideline, OSFI, 2019.

2. Small and medium sized banks (SMSBs) According to OSFI’s July 2019 Discussion Paper, proportionality segmenting SMSBs using the following qualitative and initiatives will follow a phased approach. Phase 1 will focus on quantitative criteria: the development and implementation of a final set of rules that 1. IRB approval status: IRB-approved DTIs demonstrate a high apply to Pillar 1 capital and liquidity, while Phase 2 will address level of sophistication with respect to their use of ratings, Pillar 2 and 3. corporate governance and internal controls. –– Phase 1: Rules will be finalized by December 2020 and 2. Size of on-balance sheet assets: Used as a proxy for a implemented effective Q1-2022. DTI’s size. –– Phase 2: Consultations will begin mid-2020 and finalization 3. Size of Assets Under Management (AUM) or Assets timelines are TBD. Under Administration (AUA): Used as an additional factor to segment DTIs for SMSBs with relatively small amounts of Segmentation approach – dividing SMSBs into four on-balance sheet assets. categories 4. Supervisory judgement: Retained as a final category in The SMSB category is comprised of domestic banks and assessing the nature of a DTI’s business. credit unions, foreign bank subsidiaries, and trust and loan companies that differ significantly with respect to their nature, Based on these criteria, OSFI has proposed the segmentation of size, complexity and business activities. OSFI has proposed SMSBs into four categories, as seen in Table 3:

Table 3: Proposed segmentation scheme for SMSBs

Category 1 2 3 4 Criteria Approved to use IRB SMSBs > $10B in SMSBs with Assets SMSBs with ≤ $0.5B in Assets and approach for credit risk assets of $0.5B to $10B or ≤ $20B in AUA/AUM >$20B in AUA/AUM Characteristics Large, diverse SMSBs Large SMSBs (with Smaller SMSBs (with Smallest, varying complexity less complexity and least complex institutions and diversification) diversification)

Source: Advancing Proportionality: Tailoring Capital and Liquidity Requirements for Small and Medium-Sized Deposit-Taking Institutions, OSFI, 2019.

Tailoring capital requirements, output floor and leverage requirements for SMSBs

Credit risk Operational risk Output floor

Category 1 SMSBs with IRB approval will SMSBs will continue to use their The output floor will only apply to SMSBs be subject to the revisions to the credit current approach (either the BIA or TSA) that are also Internal Models Approved risk capital framework as described in the for operational risk until Q1-2021. OSFI Institutions (IMAIs). D-SIB section above: the removal of IRB is considering the following approach SMSBs that do not use advanced eligibility of some asset classes, newly for tailoring SMSB operational risk approaches to determine Pillar 1 capital introduced parameter floors, and changes requirements: requirements do not have to take the intended to reflect Canadian market –– Category 1 and 2 SMSBs: Implement output floor into consideration. characteristics. OSFI proposes tailoring the SMA as outlined in the final Basel requirements to reduce complexity and III reforms. better capture risks for Category 2 – 4 Leverage requirements –– Category 3 SMSBs: Continue to SMSBs in the following way: use a simple approach to calculate Under OSFI’s proposal, Category 4 –– Category 2 SMSBs: Fully implement operational risk capital (e.g. a simple SMSBs will no longer be required to the final Basel III SA with the option flat rate charge based on the current calculate risk-based capital ratios. The of using a simplified standardized BIA or another measure such as leverage ratio would be used to assess approach (SSA). assets, AUA/AUM). capital adequacy against an exposure –– Category 3 SMSBs: Use a SSA with –– Category 4 SMSBs: Exempt from measure that does not require assets to the option of fully implementing the all risk-based capital requirements for be risk-weighted. final Basel III standardized approach. Pillar 1 risks. They would instead be held to a higher –– Category 4 SMSBs: Exempt from minimum leverage ratio. Instead of the all risk-based capital requirements for current 3% minimum, a possible range of Pillar 1 risks. 8%-12% was proposed.

Liquidity requirements SMSBs are currently required by OSFI to calculate the Liquidity the liquidity risks that they face. They will not be required to Coverage Ratio (LCR), Net Cumulative Cash Flow (NCCF), and calculate the NCCF and NSFR. a suite of assessment tools for assessing liquidity adequacy. –– Category 4 SMSBs will only be required to calculate a series OSFI’s July 2019 Discussion Paper proposes tailoring liquidity of simplified liquidity metrics. They will not be required to requirements for SMSBs in the following way: calculate the LCR, NCCF, and NSFR. –– Category 1 SMSBs will have similar reporting requirements OSFI has indicated that they are looking into possible revisions as D-SIBs. In addition to calculating the LCR and the NCCF, to the NCCF with the objective of increasing risk capture and Category 1 SMSBs will be required to calculate the NSFR. modifying cash flow assumptions. The simplified liquidity metrics –– Category 2 SMSBs will continue calculating both the LCR mentioned above have not been finalized, but may take the form and NCCF. However, they will not be required to calculate of a minimum liquid asset holding requirement and a simplified the NSFR. cash flow metric depending on the nature of the SMSBs activities. –– Category 3 SMSBs will be required to calculate the LCR and a series of simplified liquidity metrics that better reflect

Table 4: Summary of SMSB proportionality proposals for Pillar 1 capital and liquidity

Category 1 2 3 4

Approved to use SMSBs with Assets SMSBs with ≤ $0.5B in Criteria SMSBs > $10B IRB approach for of $0.5B to $10B or Assets and ≤ $20B in in assets credit risk >$20B in AUA/AUM AUA/AUM

Risk-based Credit Risk IRB approach SA Simplified SA N/A Capital Operational SMA SMA Flat add-on N/A Capital Ratios Risk

Leverage Ratio (LR) LR LR LR Increased LR requirement

LCR LCR LCR LCR N/A

Liquidity NCCF NCCF NCCF Simplified Metrics* Simplified Metrics*

NSFR NSFR N/A N/A N/A

Source: Advancing Proportionality: Tailoring Capital and Liquidity Requirements for Small and Medium-Sized Deposit-Taking Institutions, OSFI, 2019.

3. Foreign bank branches (FBBs) On June 18, 2019, OSFI published its proposed changes to Guideline A-10 that are scheduled to be implemented in Q1 2020. Revisions include updates and simplifications to reflect current practices and changes to the deposit ratio calculation.

There are four key issues faced by banks globally: higher Ahead series elaborates on these issues in further detail. In capital requirements, upgrades to data, systems and reporting, addition to the global concerns listed above, we provide KPMG’s managing increased RWAs (by adjusting their product mix, finding perspective on the following considerations and challenges cost efficiencies, issuing new capital or reducing RWA) and related to the domestic implementation of Basel IV: reforms consideration of the broader context of other regulatory reforms. and proportionality initiatives. Piecing the Jigsaw Together from KPMG’s Basel IV: The Way

1. Implementation of operational risk reforms DTIs’ implementation of SMA for operational risk should take into –– SMSBs currently using the Basic Indicator Approach account the following considerations: (BIA) or TSA face a degree of uncertainty regarding what to expect in relation to their future ORC requirements. OSFI has –– Before migrating to the SMA in fiscal 2022, DTIs currently proposed requiring Category 1 and 2 SMSBs to use the SMA using the AMA must first transition to the TSA approach for and having Category 3 SMSBs calculate a to-be-determined operational risk capital in fiscal 2020. The resulting changes flat rate charge for ORC. Category 4 SMSBs are exempt from in the derivation of the ORC charge requires banks to compile risk-based capital requirements. gross income data and quickly address any issues that may arise as a result of data requirements associated with the –– AMA DTIs and Category 1 and 2 SMSBs should consider TSA (e.g. three years of gross income data by Basel-defined investigating the potential scope of SMA implementation business line, proxy development to address missing data, and efforts, as calculating the ILM vastly increases the scope incorporating gross income data from recent acquisitions). of a DTI’s implementation as they must meet minimum standards for loss data identification, collection, and treatment documented in sections 5 and 6 of BCBS D424.

2. Implications of proportionality for SMSBs with plans for growth and applying for IRB approval After the implementation of Basel IV: and proportionality related the greatest, as migration to Category 3 results in the re- reforms in Q1-2022, SMSBs will be held to capital and liquidity introduction of risk-based capital requirements and elevated requirements that are tailored to their size and complexity. liquidity requirements (i.e. being subject to LCR standards). However, SMSBs with plans for growth or applying for IRB –– SMSBs interested in applying for IRB approval should approval will have to take into account the broader implications prepare for the impact of OSFI’s proportionality proposals in on its capital and liquidity requirements. their work plans. Under the proposed SMSB categorization –– Under OSFI’s proposed proportionality initiatives, Category 3 scheme, a newly approved IRB SMSB would be re-classified and Category 4 SMSBs are subject to less complex Pillar 1 as a Category 1 SMSB and this would trigger the requirement capital and liquidity requirements. However, any future plans to report and meet minimum standards for the NSFR. By for business growth that result in an increase in on-balance electing to use an advanced approach for credit risk capital, sheet assets, AUA, or AUM beyond the thresholds must a SMSB would be faced with meeting increased liquidity take into consideration the impact of elevated capital and adequacy requirements. liquidity requirements. The impact on Category 4 SMSBs is

3. SMSBs with exposures to CVA risk SMSBs with non-centrally cleared derivatives will have capital the minimum capital requirements for CVA risk (see Page 109, requirements for both counterparty credit risk and CVA risk. The Paragraph 7 of BCBS 424) permit DTIs below a materiality same rules for both D-SIBs and SMSBs apply, and therefore CVA threshold of €100B have the option to be able to determine CVA risk is not addressed in OSFI’s discussion paper on proportionality. capital with CCR capital (i.e. CVA capital = 100% of CCR capital) or through either of the prescribed CVA approaches (BA-CVA or However, given that SMSBs typically have smaller derivative SA-CVA with supervisory approval). portfolios, it is worthwhile to note that the general provisions of

4. Areas of SMSB proportionality initiatives requiring further elaboration OSFI’s proposals for tailoring SMSB’s capital and liquidity a simple flat charge based on the existing Basic Indicator requirements do not provide specific details with respect to the Approach or another measure such as AUM or AUA. simplified SA for credit risk, and simplified liquidity metrics: –– With respect to liquidity requirements, little has been said –– Under OSFI’s proposed approach for credit risk, Category 2 about the exact nature of the simplified liquidity metrics for and 3 SMSBs have the option of using either the SA or the Category 3 and 4 SMSBs, except that they could take the SSA for credit risk. The exact format of the SSA has yet to be form of a minimum liquid asset holding requirement or a determined however we are aware of simplified approaches simplified cash flow metric. for credit risk that have been implemented for smaller banks in –– Category 4 SMSBs would be held to higher minimum both the US (based on domestic standards), Hong Kong (based standards for the leverage ratio, in the range of about on Basel I), and Switzerland (for mutual fund exposures). 8% to 12%. –– According to OSFI’s proposal, Category 3 SMSBs would SMSBs can get involved in the consultation process to provide continue to use a simple approach for operational risk capital, feedback and express opinions on the format of these aspects of the proposed proportionality related changes.

5. Model governance implications for changes to IRB eligibility IRB approved DTIs need to consider the model governance procedures and in compliance with Section 5.6 of OSFI E-23 implications resulting from the removal of Banks and other FIs, Guideline. DTIs should notify relevant stakeholders that Large/mid-sized corporates and Equities from the Advanced IRB models are being decommissioned and established standards (AIRB) approach in Q1-2022. regarding the retention of model information and model inventory documentation should be followed. –– Banks with separate parameter models for regulatory capital (RC) and economic capital (EC) purposes will need –– Banks that use the same parameter models for RC and EC to decommission their RC parameter models for the above will have to update their model inventories to reflect the portfolios in accordance with documented policies and change in model usage for EC purposes only.

Conclusion

The Canadian implementation of the final Basel III reforms and optimization initiatives on the institution’s required (Basel IV) has already begun and it is scheduled to be implementation efforts. KPMG can provide support across the completed by Q1-2022. For individual DTIs, the nature and end-to-end implementation efforts from rules interpretation, data scope of Basel IV reforms will differ for D-SIBs and the and systems, model development to independent review, and different categories of SMSBs. regulatory reporting. OSFI’s proportionality initiatives for SMSB’s Pillar 1 capital KPMG in Canada’s Financial Risk Management practice and liquidity requirements will be finalized in December leverages risk and regulatory specialists to provide the latest 2020 and they will need to be ready to implement these insights regarding the issues that DTI’s face, and the customers initiatives as part of their Basel IV implementation in Q1-2022. they serve. Our dedicated teams have developed leading and Their implementation efforts will also be shaped by public innovative strategies and solutions which are tailored to individual consultations regarding Pillar 2 and Pillar 3 considerations that client needs. Utilizing these insights and solutions, KPMG are scheduled to begin in mid-2020. professionals use their deep Financial Services experience to help DTI’s achieve and maintain regulatory compliance in an KPMG can help DTIs implement, interpret and perform gap optimal manner. analyses for the Basel IV regulations and identify synergies

AIRB Advanced Internal Ratings Based (Approach for Credit Risk) AMA Advanced Measurement Approach (for Operational Risk) ASF Available Stable Funding AUA Assets under Administration AUM Assets under Management BA-CVA Basic Approach for CVA Capital BCBS Basel Committee for Banking Supervision BI Business Indicator BIC Business Indicator Component CCB Capital Conservation Buffer CCF Credit Conversion Factor CCR Counterparty Credit Risk CCyB Countercyclical Buffer CET1 Common Equity Tier 1 capital CVA Credit Valuation Adjustment D-SIB Domestic Systemically Important Bank DTI Deposit-Taking Institution G-SIB Global Systemically Important Bank ILM Internal Loss Multiplier IMAI Internal Models Approved Institution IMM Internal Model Method (for Counterparty Credit Risk) IRB Internal Ratings Based Approach – Credit Risk FBB Foreign Bank Branch FBBD Foreign Bank Branch Deposit FRTB Fundamental Review of the Trading Book LAR Liquidity Adequacy Requirements LCR Liquidity Coverage Ratio LGD Loss Given Default LR Leverage Ratio NCCF Net Cumulative Cash Flow NSFR Net Stable Funding Ratio OSFI Office of the Superintendent of Financial Institutions RSF Required Stable Funding RWA Risk-Weighted Assets SA Standardized Approach SA-CVA Standardized Approach for CVA Risk SBE Small Business Entities SFT Securities Financing Transaction SMA Standardized Measurement Approach SME Small and Medium Sized Entities SMSB Small and Medium Sized Banks

Craig Davis Diana Lowe Partner, Risk Consulting Partner, Risk Consulting 416-777-8671 416-777-3838 [email protected] [email protected]

Jason Au Corina Deaconu Director, Risk Consulting Executive Director, Risk Consulting 416-777-3037 647-777-5254 [email protected] [email protected]