Global Cash Management A Report on the Impact of Basel II on the use of Money Market Funds by & other Credit Institutions

Authored by Walbrook Consulting Limited. Commissioned by Invesco Aim, a division of Invesco Asset Management Limited.

For UK Professional Clients only. Not for circulation in the US. Introduction

The forthcoming implementation of the Basel II capital adequacy framework will result in a significant change in the regulatory treatment of various asset types that will change the way in which credit institutions manage their balance sheets.

Under the new rules the capital charge will be based more closely on credit quality and less on the general sector classification of the asset. Amongst other things, the new rules will significantly reduce the capital that credit institutions will be required to maintain for investments in highly rated Money Market Funds (MMFs) which means that they will become an attractive destination for short- term cash placements by banks.

In addition, the opening-up of the banking sector to direct investment in MMFs is likely to encourage banks to become more involved in the distribution of MMFs to their clients, either by establishing their own funds or by working with existing MMF providers. This will provide banks with an opportunity to use MMFs as a deposit management tool, with clients being offered an attractive off balance sheet alternative for their short-term cash.

This report provides a detailed analysis of the implications of the new Basel II framework for investments in MMFs and concludes with a view on how the banking sector is likely to be affected by these changes.

Note

This report was prepared by Walbrook Consulting Limited in 2005 at a time when Basel II had not yet been finalised or put into effect.

Implementation of the Basel II Accord advanced approachs began in January 2008 as planned and though the economic environment has changed, the description of the different approaches and implications attributed to Basel II in this report still hold true.

The Basel II Accord has many different aspects that effect banks. It is being phased in as each aspect takes time to assimilate into banking processes. The sections on the treatment of money market funds under Basel II still accurately represent the approaches that may be taken. Putting them into action is still being investigated so the discussion of the implications of Basel II for these funds is by no means final.

02 Report on the Impact of Basel II on the use of Money Market Funds by Banks & other Credit Institutions Executive Summary

• Triple-A rated institutional MMFs are well • Whilst MMFs are not perfect substitutes for all established in the USA and have grown rapidly forms of interbank loans, they are likely to be in the last ten years in Europe. regarded as a viable alternative to placing short-dated money with other banking • Under current banking sector capital adequacy institutions. The potential flow of funds from rules these funds are weighted at 100% banks into MMFs could be huge as the UK and compared with 20% for interbank placements, Eurozone overnight market in EUR, USD and which means that banks have not been GBP is an estimated $3,200 billion equivalent. significant investors in MMFs. • There are certain practical issues that will need • However, under the new capital adequacy to be addressed for banks to become active framework (Basel II) which is planned to be investors in MMFs. For banks on the IRB implemented from 2007 onwards, the risk Approach the arrangements for calculating the weights applied to bank investments in MMFs risk weights need to be clarified. Also banks will will more closely reflect the of the need to enhance their systems and procedures underlying assets. to enable them to utilise MMFs.

• The risk weights applied to Banking Book assets • The new investor flows from the banking sector will depend on the specific Basel II credit risk may put downward pressure on MMF yields. approach adopted by the bank. For banks that MMFs are significant investors in commercial are on the Standardised Approach this will paper (CP) and asset-backed securities (ABS), mean that funds rated double-A or higher will and the new Basel II rules have implications for be risk weighted at 20% putting them on an the issuance of these instruments. equal footing with interbank loans. • The Basel II changes are expected to result in • For banks on the more sophisticated Internal some of the larger interbank deposit market Ratings Based (IRB) Approach the risk weight players developing their own funds (if they do will be based on a calculation that reflects the not already have them) in order to complement credit performance of the underlying asset their existing interbank activities and to have class. The risk weight for triple-A rated MMFs is the capability to offer clients an alternative to likely to be around 15% for banks on the cash deposits thereby avoiding use of the Foundation IRB Approach and may be as low as bank’s balance sheet. 2% for banks on the Advanced IRB Approach. • Banks with an active client deposit base but • For banks that utilise MMFs within their Trading with insufficient scale to justify establishing Books, the effective risk weight for triple-A their own MMFs are likely to seek partnerships MMFs is expected to be around 8% or less. with existing MMFs using “white label” type arrangements which allow them to apply their • This across-the-board reduction in risk weights own brand to someone else’s funds. will remove the current disincentive for banks to place money with MMFs. • Other credit institutions may be interested in establishing distribution arrangements with existing funds in order to offer a MMF facility to their clients.

03 Report on the Impact of Basel II on the use of Money Market Funds by Banks & other Credit Institutions Background to Money Market Funds Development of Banking Sector Capital Adequacy Regulation The triple-A rated institutional Money Market Funds (MMFs) sector in the USA has been in existence for over twenty-five years and at the end of June 2005 had US$1,092 billion in The Basel Committee (the Committee) was established by the Governors of the so-called G-10 countries at the assets under management (AUM) (Source: ICI, 30/06/05). In Europe the first triple-A rated institutional MMFs were end of 1974. Its members represent Belgium, Canada, France, established in the mid 1990s and have since grown rapidly. Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, In July 2005 European institutional MMFs had around Sweden, Switzerland, United Kingdom and United States. US$266 billion equivalent in AUM across three currencies: The role of the Committee is to formulate broad supervisory USD, EUR and GBP (Source: iMoneyNet, 01/07/05). standards and to produce guidelines and recommended The standard same-day access triple-A rated institutional statements of best practice. These standards are then MMFs are sometimes referred to as stable NAV or “2a – 7” implemented by each country in accordance with their own funds after the rule in the Investment Company Act 1940 (as individual legal and regulatory frameworks. amended) which governs MMFs in the USA. A number of fund sponsors have established “enhanced yield” MMFs over The Basel Capital Accord (known as ) was produced the last few years which are rated triple-A or double-A, but by the Committee in 1988. Basel I provided a framework for target a slightly higher yield, usually in return for a measuring the credit risk in banks and ensuring that banks reduction in liquidity and an increase in . held a minimum of 8% of capital to support their credit exposures. Since 1988, the Basel I capital adequacy regime In Europe credit institutions are currently required to risk has been adopted by member countries and most other weight MMFs at 100%, which means that investments in countries that have an international banking presence. MMFs by banks will incur a regulatory of at least 8% of the amount invested. This contrasts with In the EC the Solvency Ratio Directive of 1989 implemented claims on other banks which are only risk weighted at 20%, Basel I and this was augmented by the 1993 Capital giving rise to a capital requirement of 1.6%. As a result it Adequacy Directive (the CAD) that extended the regime to has been more attractive for banks to invest surplus funds incorporate market risk as well as credit risk which was in the interbank deposit market rather than with MMFs. implemented in 1996. The CAD also distinguished between the Banking Book and the Trading Book when analysing However, in June 2004 the Basel Committee announced a capital adequacy. The Banking Book consists primarily of a new capital adequacy framework which will apply to credit bank’s loan portfolios and the funding of these assets, whilst institutions and this will have a widespread impact on the the Trading Book is made up of tradeable assets, foreign banking sector when it is implemented. There are a number of exchange and derivative instruments. changes that will directly impact on the treatment of investments in MMFs. In June 1999 the Committee published its proposals to update and replace Basel I. The new capital adequacy regime proposed by the Committee contains Three Pillars:

First Pillar Minimum Capital Requirements – to support credit risk, market risk and, for the first time, . This report focuses primarily on the impact of changes in minimum capital rules.

Second Pillar Supervisory Review – requires supervisors to evaluate how well banks are assessing their capital needs relative to their and to intervene, where appropriate.

Third Pillar Market Discipline – is intended to develop a set of disclosure requirements that will allow market participants to assess the capital adequacy of an institution.

Following extensive consultation, the revised framework, known as Basel II, was issued on 26 June 2004. The EC will implement Basel II by amendment to the CAD and the Banking Consolidation Directive, with the new instrument currently referred to as the draft Capital Requirements Directive.

In the EC, Basel II implementation is expected to be phased in over a number of years. The initial implementation is scheduled for January 2007, with the more advanced approaches to credit and operational risk being introduced in January 2008.

In the USA, the authorities have announced that the main international banks domiciled in the USA will be expected to adhere to the most rigorous of the Basel II standards, with implementation being scheduled for January 2008. However, other US domestic banks will continue to be supervised in accordance with the standards developed under Basel I.

04 Report on the Impact of Basel II on the use of Money Market Funds by Banks & other Credit Institutions Treatment of MMFs under Basel II Foundation Approach – for retail exposures the institution is required to derive all the inputs for the risk functions, Under Basel II there are a variety of ways in which an whereas exposures to sovereigns, banks and corporates only investment in a MMF could be treated from a risk weighting require the institution to derive the PD as the other inputs perspective. are given in the rules. Advanced Approach – the institution is required to derive all If the investment is held on the Banking Book the treatment inputs. follows the credit risk approach applicable to the credit institution. Under the Standardised Approach the credit risk Under the IRB Approach set out in Basel II, Collective assessment is similar to the existing Basel I methodology, Investment Undertakings (CIUs), which includes MMFs, fall within although the risk weights are based on the external rating of the corporate exposure class and given the excellent credit the underlying credit exposure. Alternatively, for institutions history of triple-A rated institutional MMFs, the PD is likely to be that have been approved by the regulator to apply the at the regulatory minimum of 0.03%. This would imply a risk Internal Ratings Based (IRB) Approach to credit risk, the weight of around 15% for banks on the Foundation Approach treatment will depend on whether they are on the and a risk weight of between 2 –15% for banks on the Advanced Foundation IRB or Advanced IRB Approach. Approach (dependent on the values used for LDG and M).

Finally, there is a different treatment if the MMF asset is However, under the EC draft Directive, banks are required to “look held in the Trading Book. Trading Book assets attract capital through” to the underlying assets in the fund in order to derive charges that reflect the market or position risk arising. the risk weight. In order to qualify for the “look through” treatment Capital charges are calculated using either a Standard the credit institution must be aware of all the underlying Approach or an Internal Risk Model (IRM) Approach. exposures of the CIU (Volume I Article 87 Para 11). In addition, a Chart 1 summarises the rules which are then explained in number of conditions (see Technical Annex VI Part 1 Para 74 –75) more detail below. must be fulfilled in order to apply this approach. In essence: (i) the CIU manager must be subject to supervision in a member state, or subject to equivalent supervision (ii) the prospectus Banking Book Treatment must detail the eligible assets and investment limits of the CIU (iii) the CIU must provide a financial report at least annually. Standardised Approach For credit institutions on the Standardised Approach the risk Assuming the above conditions are met, and given the quality of weight for a MMF rated triple-A or double-A will be 20%*. the underlying collateral, it is expected that triple-A rated MMFs This will give rise to a 1.6% regulatory capital requirement would be assessed under EC rules at the regulatory minimum PD. for a credit institution that is operating with the minimum Therefore, as with the basic Basel II rules set out above, the risk capital ratio of 8% (i.e. 20% x 8% = 1.6%). weight under the Foundation Approach would be around 15% Under the draft EC Directive an institution may opt to and under the Advanced Approach it would be between 2 – 15%. calculate an average risk weight based on a “look through “ to the underlying assets in the MMF (see Technical Annex V However, under EC draft rules, if the institution is aware of all Para 76). This is subject to a number of conditions and is the underlying exposures, but the other conditions are not unlikely to provide a material improvement in the risk met, then the bank must risk weight the exposures in weighting for the standard MMFs. Accordingly, few banks on accordance with the Standardised Approach using the risk the Standardised Approach are likely to use this option. weight applicable to the Credit Quality Steps (CQS) immediately above the CQS that would normally be assigned IRB Approach to the exposure. This is likely to result in a 50% risk weight for The IRB Approach specifies a series of risk functions which a standard triple-A rated MMF. are used to calculate the risk weights. These functions require the following inputs: (i) PD – (ii) Finally, the EC draft Directive states that if the institution is LGD – (iii) EAD – , and not aware of all the underlying exposures, then it must use the (iv) M – effective maturity. Under the IRB Approach to credit “Simple Risk Weight Approach” which would result in a penal risk there are two methods available to credit institutions: risk weight of 370%.

Chart 1 Summary of Risk Weights for Investment in a Triple-A rated MMF RISK APPROACH RISK WEIGHTING

Risk Weight 20% Standardised BANKING Credit Risk ‘Look Through’ Risk BOOK Foundation Internal Ratings Weight c. 15% Based (IRB) Advanced ‘Look Through’ Risk Weight c. 2% - 15% Standard ‘Look Through’ Risk TRADING Position Risk Weight c. 7.5% BOOK Internal Risk Model (IRM) ‘Look Through’ Risk Weight <7.5%

Source Walbrook Consulting Limtied *The national regulator is required to evaluate External Credit Assessment Institutions (ECAIs), which are the main credit rating agencies, and map each agency’s ratings to various Credit Quality Steps (CQSs). However, it is generally accepted that the top two ratings categories for the main rating agencies will qualify for CQS1 which carries a 20% risk weight for claims on Collective Investment Undertakings, the exposure class to which MMFs belong.

05 Report on the Impact of Basel II on the use of Money Market Funds by Banks & other Credit Institutions Trading Book Treatment the units/shares must be redeemable in cash on a daily basis (iv) the CIU’s assets must be segregated from those of the Basel II Para 685 states that: “A trading book consists of manager (v) there must be adequate risk assessment of the positions in financial instruments and commodities held CIU by the investing institution, and (vi) the CIU must be either with trading intent or in order to hedge other supervised in the EC or by a competent authority. If the CIU elements of the trading book.” is unable to meet the above conditions then the investing institution will be subjected to an onerous 32% capital Further, Para 687 goes on to say; “Positions held with requirement for position risk (which is equivalent to a 400% trading intent are those held intentionally for short-term risk weight for an institution with an 8% capital ratio). resale and/or with the intent of benefiting from actual or expected short-term price movements or to lock in arbitrage profits, and may include for example proprietary positions, positions arising from client servicing (e.g. Summary of Treatment of MMFs under Basel II matched principal broking) and market making.” The implementation of Basel II will significantly reduce the regulatory capital requirement on credit institutions investing in It could be argued that banks might validly use MMFs to triple-A / double-A rated MMFs. Under the basic Standardised hedge other elements in the trading book, or positions Approach the risk weight will fall from 100% to 20%. arising as a result of client servicing. For banks on the IRB Approach the risk weight will be Trading Book assets attract position risk capital charges for around 15% for those on the Foundation IRB Approach and specific and general risk. The specific charge reflects the between 2% and 15% for institutions on the Advanced IRB asset quality, whereas the general risk charge reflects the Approach. Standard triple-A rated MMFs held on the trading exposure to changes in market prices / rates. A Standard book are expected to have an effective risk weight of 8% or Approach or an Internal Risk Model (IRM) Approach may be less, although the weighting of higher risk enhanced yield used to calculate the capital charges. MMFs are likely to be higher than this. Table 1 below, based on the Standard Approach, illustrates the Although most institutional MMFs will be able to comply with capital requirement for holding a fairly typical triple-A rated the conditions to undertake a “look through” calculation of MMF that has a 47-day WAM (weighted average maturity), the risk weight under the IRB approaches and for trading and a WAL (weighted average life) of just under 5 months. book position risk, there are some practical issues surrounding the requirement for investing institutions to be A capital charge of 0.60% translates to an equivalent risk aware of all the underlying exposures of a MMF. weight of 7.5% based on an 8% minimum capital ratio. For institutions using IRMs the risk weight and capital charge This question is being addressed by the Institutional Money are likely to be lower than those derived using the Standard Market Funds Association and the EC. It is proposed that MMFs Approach. Enhanced yield MMFs are likely to carry a higher will provide sufficient information so that investing institutions capital charge as a result of longer WAMs or WALs. will be aware of the exposures and will be able to calculate the average risk weight for each fund. However, the form and The EC draft Directive explicitly deals with CIUs in the frequency of the information flows has still to be determined. trading book in Volume II Annex I Para 47 – 56. Where an institution is aware of the underlying investments on a daily basis it may look through to the underlying investments in order to calculate the capital requirements for position risk using the Standard Approach or the IRM Approach.

However, there are a number of conditions set out in Volume II Annex I Para 51 that must be fulfilled for the institution to use the look through: (i) the CIU prospectus must detail eligible assets, investment & counterparty limits & leverage (ii) the CIU must produce a financial report semi-annually (iii)

Table 1 Illustration of Trading Book Treatment for MMFs General risk – Coupon > 3% Coupon < 3% % portfolio Capital charge (Maturity based) 0 - 1 month 0 - 1 month 0.00% charge 65% 0.00% 1 - 3 months 1 - 3 months 0.20% charge 25% 0.05% 3 - 6 months 3 - 6 months 0.40% charge 5% 0.02% 6 - 12 months 6 - 12 months 0.70% charge 3% 0.02% 1 - 2 years 1 - 1.9 years 1.25% charge 2% 0.03% 2 - 3 years 1.9 - 2.8 years 1.75% charge 0% 0.00% WAM= 47 days 0.12%

Specfic risk Investment grade Under 6 months residual maturity 0.25% charge 70% 0.18% qualifying debt 6 - 24 month residual maturity 1.00% charge 30% 0.30% securities Over 2 years 1.60% charge 0% 0.00% Other debt securities 8.00% charge 0% 0.00% WAL= 4.8 months 0.48%

Total Trading Book Capital Charge 0.60% Source Walbrook Consulting Limtied

06 Report on the Impact of Basel II on the use of Money Market Funds by Banks & other Credit Institutions Implications of Basel II for Banks and the Impact on MMFs

available until it is notified by the fund administrators after Interbank Deposit Market & Funding the dealing cut-off time.

Under Basel I all exposures to banks are risk weighted at 20%. Table 3 provides estimates of the size of the interbank However, under Basel II this will change; under the market in the three main currencies across the Eurozone Standardised Approach the risk weight will depend on the and in the UK. external credit rating and under the IRB Approach it will be determined by reference to the risk functions discussed earlier. Table 3 Estimated Eurozone & UK Interbank Market

National regulators have some discretions available to them Total Overnight when setting the Standardised Approach risk weights for EUR (in €billions) 5,500 1,700 credit institutions, but the most common approach to be adopted is likely to result in all exposures to investment GBP (in £ billions) 700 200 grade banks in CQS 1 – 3 (likely to be triple-A to triple-B) USD (in $ billions) 2,200 600 with up to 3 month original maturities to be risk weighted at 20%, with non-investment grade banks carrying a risk Source Walbrook Consulting Limtied weight of 50% or higher. For exposures to credit institutions with original maturities over 3 months the risk The total overnight deposit market is estimated to be weight for CQS 2 – 3 institutions (expected to be single-A to US$3,200 billion equivalent, which compares with a total of triple-B) will increase from 20% to 50%. around US$266 billion currently invested in European MMFs. This suggests that there is considerable scope for additional This means that the risk weighting of MMFs will be on a par growth in the European MMF market when the funds qualify with the 20% risk weighting of short-term investment grade for the improved risk weight treatment under Basel II. bank exposures and, as a result, MMFs will be able to compete for wholesale cash placements in the interbank market. The In addition, it is likely that this increased capital efficiency improved treatment of the MMFs and the adverse weighting will encourage the structured finance areas of banks to use changes for credit institutions rated below double-A is likely MMFs as alternatives to other triple-A safe haven to put pressure on the funding position of these institutions. investments such as US Treasuries or Gilts. It is expected that this will be reflected primarily in credit pricing, with a more pronounced tiering based on credit Banks are expected to respond to the improved outlook for ratings in both the interbank market and the bond markets. the use of MMFs by the banking sector by also becoming However, as Table 2 below illustrates, MMFs will not be a involved in the distribution of MMFs. There are likely to be a complete substitute for all types of interbank deposits. number of different options open to banks:

MMFs will be able to compete for funds in the overnight and • Some of the larger banks which currently do not sponsor short dated money market. The triple-A rating of the MMFs their own MMFs, but which have an active interbank will provide an advantage, although, under certain market deposit business, may choose to develop their own funds conditions, such as a rising interest rate environment, the in order to be able to continue to provide a full service MMFs may struggle to compete on yield (after fees). MMFs offering to their banking sector counterparties. The provide excellent same day market liquidity, although the business case for developing a MMF offering will be liquid deal amount will be a function of the size of the fund enhanced for those banks that also have a strong (10% of the fund AUM is generally regarded as the corporate and institutional client deposit base. maximum liquid ticket size). • Banks without a major interbank market position and a The MMFs tend to operate earlier cut-off times compared with significant non-bank client base may not be able to build the interbank deposit market, although in sterling and euro funds of sufficient scale to merit going down this route. most market activity tends to take place in the morning when Nevertheless, the larger of these may still wish to provide the MMFs are still open for business. However, during their a MMF capability to their clients and they are likely to hours of business MMFs will generally accept money from seek partnerships with existing MMFs using “white label” investors at a price that reflects the running yield of the type arrangements where the bank uses its own brand to underlying fund’s assets, whereas at times it may be difficult market funds operated by another institution. to place money in the interbank market at a competitive yield. • Other credit institutions may be interested in establishing Another practical issue that MMFs face is that banks will distribution arrangements with existing funds in order to need to adapt their systems and procedures to deal in offer a MMF facility to their clients and to generate off MMFs, including dealing without knowing precisely the yield balance sheet fee income.

Table 2 Comparison of Interbank Deposits and MMFs Credit Risk Weight Market Liquidity Term Net Yield Execution Operation Double-A Rated Bank Stong 20% Excellent Overnight term & call Libid Late cut-off Systems in place Triple-B Rated Bank Weaker 20% Good to fair Overnight term & call Libid Plus Late cut-off Systems in place but short (<3 months) term risk Triple-A Rated MMF Best 20% Excellent - but Rolling overnight +/– Libid Earlier cut-off New systems depends on fund size & procedures

Source Walbrook Consulting Limtied

07 Report on the Impact of Basel II on the use of Money Market Funds by Banks & other Credit Institutions Impact on Bank Asset Portfolios For highly rated CP programmes the additional cost that will arise is not expected to have a significant effect on bank Basel II will incentivise banks to retain higher rated assets sponsored conduits which are used to securitise commercial and to securitise lower rated corporate assets and assets. However, certain securities arbitrage vehicles that unsecured consumer credit assets (such as credit card tend to operate on tighter margins are likely to suffer and receivables and personal loans) as the default and loss issuance by some of these entities is likely to decline (see record of these asset classes will generate relatively high S&P report of October 2004). risk weights under the IRB Approach. As mentioned previously, Basel II will encourage credit The larger banks are expected to move to the IRB institutions to retain retail mortgages on balance sheet. This Approach, and whilst there is an expectation that the will likely result in a reduction in the issuance of Residential smaller credit institutions will implement the Standardised Mortgage Backed Securities (RMBS) which have been the Approach, there are likely to be a significant proportion that mainstay of the European ABS market. Over the last couple will aspire to the IRB Approach, particularly if they are retail of years a number of the major originators of retail mortgage lenders. mortgages have begun to retain these assets on balance sheet and finance them via the covered bond market, as Under the Standardised Approach residential mortgages will this technique has provided a cheaper source of funding be risk weighted at 35% compared with 50% at present. than the RMBS market. So although RMBS issuance may However, given the low levels of defaults and strong decline, this may be offset by continued growth in the issue recoveries when defaults do occur in this asset class, the of covered bonds. weightings generated by the IRB risk formula are likely to be even lower at around 20 – 25%. As a result, credit Issuance of credit card, auto loan and consumer loan ABS institutions which focus on the residential mortgage market is likely to continue to grow under Basel II, along with (mortgage banks and building societies) will have a strong structures involving lower rated corporate collateral. incentive to apply for the IRB Approach. The expected increase in MMF investment by the banking However, if national discretions are adopted, some of these sector, allied to a mixed supply picture on the funds’ assets, institutions may opt to have their wholesale assets made indicates that there may be downward pressure on the subject to Standardised Approach risk weights, meaning yields of eligible assets, which will feed through to the that their investments in MMFs would be risk weighted at performance of the MMFs. 20%. For example, in the UK under current FSA proposals, permanent exemptions from the IRB Approach for sovereign and institutional exposures will be available if higher risk credits (those rated below single-A) are under Concluding Remarks £1bn or less than 5% of assets. In addition, the FSA intend to apply a materiality exemption for corporate exposures if The improved capital treatment of MMFs under Basel II, they represent less than 15% of the credit risk capital allied to the enormous size of the potential pool of banking requirement (after excluding the exempt items). sector monies that may be attracted into MMFs, is expected to provide a step-change opportunity for the MMF market.

Impact on Off Balance Sheet Activities In addition to becoming involved as investors in MMFs, credit institutions are also likely to become more active MMFs are major purchasers of unsecured and asset-backed players in the distribution of these funds, although an commercial paper issued by off balance securitisation vehicles analysis of the fund economics indicates that only the set-up by banks. They have also been buyers of selected asset- larger institutions may be able to justify developing their backed securities issued by bank-sponsored entities. own funds. Other banks that wish to have a MMF capability are more likely to seek partnerships with existing MMF Basel II will impact both CP and ABS issuance. Currently the operators on one basis or another. standby liquidity facilities provided by banks to support CP programmes do not generate a regulatory capital Finally, whilst banks have long been familiar with the requirement and as a result are relatively inexpensive to concept of managing the balance sheet by securitising provide. After Basel II is implemented the provision of these assets, it is likely that as they become more active in the facilities will attract a capital requirement that will increase MMF sector they will come to see MMFs as a vehicle that the operating costs of CP programmes. allows them to more actively manage their balance sheet liabilities by offering clients an attractive off balance sheet alternative for their short-term cash surpluses.

08 Report on the Impact of Basel II on the use of Money Market Funds by Banks & other Credit Institutions References About Walbrook Consulting

Bank of England, Monetary & Financial Statistics, Walbrook Consulting Limited specialises in providing January 2005. consultancy services on financial markets to corporate and institutional clients. This report has been authored by Paul Basel Committee on Banking Supervision, Roby, a Director of Walbrook Consulting, who has 25 years “International Convergence of Capital Measurement experience working as both a practitioner and a consultant and Capital Standards - A Revised Framework”, in wholesale financial markets. He is an Associate of the June 2004. Chartered Institute of Bankers and a Member of the Association of Corporate Treasurers. Commission of European Communities, “Capital Requirements Directive (draft)”, Volumes I & II Walbrook Consulting gratefully acknowledge the assistance and Technical Annex, 14 July 2004. provided by Alan McRae of Prebon Marshall Yamane in the production of this report. European Central Bank, Monthly Bulletin, January 2005. Contact: [email protected]

Financial Services Authority, “Strengthening All data quoted is accurate to 1st July 2005 Capital Standards – Consultation Paper 05/3”, January 2005. It is acknowledged that the content of Basel II has not yet been finalised and put into effect and consequently all such Investment Company Institute (ICI), www.ici.org interpretations, views and opinions may change. iMoneyNet, www.imoneynet.com

Standard & Poor’s “What Effects will Basel II have on the Global ABCP Market”, 11 October 2004.

09 Report on the Impact of Basel II on the use of Money Market Funds by Banks & other Credit Institutions Contact Us

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