Liquidity and Leverage requirements of the Capital Requirements Directive (CRD) IV and the Capital Requirements Regulation (CRR).

Related topics discussed in this post include counterparty risk and the adoption of the single Europe wide rule, and implications for banks in this region.

CRD IV introduces standardized EU regulatory reporting in the form of COREP and FINREP.
– COREP applied from 1 January 2014,
– FINREP will be phased in over the second half of 2014.

Recently, chief central bankers in Europe announced an ease in restriction with regards to Basel III regulations, effectively pushing back the liquidity deadline for banks by four years. Key new rules were also introduced as the level of corporate debt for banks widened.

The MENA market will benefit the most from these recent announcements. If MENA banks were to carry out full implementation by 2015, then tight lending would continue and the global recovery would be at a slow pace and thus affect MENA market growth plans as an emerging market. Lending has generally been eased as are trade finance restrictions which will help fuel the current growth seen within the MENA region.

The European Union’s Basel III legislative package known as “CRD IV”, covers prudential rules for: banks, building societies and investment firms. It was formally published in the Official Journal of the European Union on Thursday 27 June 2013. CRD IV will require these institutions to:
– Hold more and better quality capital
– Satisfy new macro-prudential standards including a countercyclical capital buffer and capital buffers for systemically important institutions
– Meet new rules for counterparty credit risk
– Meet new minimum standards for short and long term liquidity in the form of the:
– Liquidity Coverage Ratio (LCR)
-Net Stable Funding Ratio (NSFR)
– Meet minimum standards for leverage to act as a backstop to balance sheet growth in the form of the leverage ratio
– Improve risk management governance and make senior management / board members accountable
-Introduce restrictions on variable remuneration

COREP and FINREP

These reporting requirements specify the information firms must report to supervisors in areas such as own funds, large exposures and financial information, as well as defining the XBRL taxonomy through which institutions will be required to submit their COREP and FINREP reports to their national supervisor.

COREP, , increased regulatory reporting requirements for European banks significantly. Under COREP and FINREP banks are required to offer much more granular data in a fully standardized format. The quality and quantity of data disclosures required for COREP will make it necessary for banks to significantly upgrade their reporting framework.

FINREP The framework instructs firms to align the accounting calendar with the calendar year – for firms that use any other timeline for their accounting, this is a major upheaval of internal procedures.

Similar to COREP, FINREP is transmitted using strong>XBRL, which makes it even more crucial that firms investigate the new delivery method.

Liquidity
– Due to Basel III and CRD IV, close monitoring and control are increased over credit and financial institutions’ liquidity.
– The role of senior management to set risk boundaries is more onerous. – New liquidity metrics include liquidity coverage ratio (LCR) and the Net Stable Funding Ratio (NSFR). The rules on the calculation of the LCR and NSFR are not yet finalised. Regulators are still gathering information to adjust the metrics adequately.

Liquidity Coverage Ratio (LCR)
This is to ensure both that financial and credit institutions have the assets to handle short-term liquidity disruptions and that companies are able to improve their short-term resilience.

The ratio aims to ensure that in a 30 day period of stress with an LCR maintained at 100%, the company will be capable to withstand the pressure by virtue of having sufficient unencumbered high quality liquidity assets.

When the percentage is lower than 100%, the institution will be subject to regulatory scrutiny and a plan would have to be made to indicate how the institution plans to raise its liquidity buffer to reach the necessary limit.

Net Stable Funding Ratio (NSFR)
This deals with ratios of both long term assets and long term funding. The NSFR supports both of those measures and will come into practice as of January 2018. Until then, there will be other general rules regarding long term funding for financial institutions from January 2016. The objective behind these rules is for institutions to actively deliberate on their funding profile for the next 2 years.

The remaining issues that concern liquidity, and the LCR and NSFR are expected to be resolved in the following months. The EU is currently completing these to be in line with the international Basel III agreement and is currently on track with their 2015 and 2018 implementations.

Leverage
A new leverage ratio will be introduced by the CRD IV to protect against the risks often attributed to risk models. The new ratio is calculated by dividing the Tier 1 capital by a measure of the institution’s non-risk weighted assets, including the institution’s on and off balance sheet amounts. The new leverage ratio has not yet been finalised.

During the calibration period a 3% ratio is being considered, which means that Tier 1 capital will not be allowed to be lower than 3% of non-RWAs. Furthermore, institutions will have to adhere to a third prudential metric because distinct from Basel II calculations, on-balance sheet loans and deposits will not be allowed to be netted.

Initially as a Pillar 2 measure, the national regulator may alter the leverage ratio. To set the final ratio, the data gathered from January 2014 will be used. Leverage ratios will be disclosed publically in January 2015 within the European Union and according to Basel III from 2018 onwards in all EU countries, leverage ratios will be a pillar 1 measure.

The amount of capital will no longer be the sole determinant of whether certain banking business can be done. Capital, liquidity and leverage will all have to be taken into serious consideration and decisions may involve sacrificing one in order to strengthen the other.

Finance and credit institutions will have to take into consideration other aspects apart from capital, liquidity and leverage. These include :
1. Single Europe-wide rule book.
The rule book governs all of the EU’s financial institutions and it consists of the CRR together with the EBA’s Binding Technical Standards (BTS). By compiling a single rule book, the EBA’s objective is to reduce the amount of available national discretions which would in turn reduce the number of national divergences.

2. Counterparty Risk
CRD IV includes new regulatory exposure to central counterparties (CCPs) treatments, adjustments in credit values, increased capital charges for OTS derivatives for transactions which are not centrally cleared and wrong-way risk charges.

3. Reduction of the reliance on credit rating agencies
Credit and financial institutions should no longer rely on credit rating agencies to be given an overview of their credit exposure. In order to do this, institutions need to develop their own criteria on which they can rate their own credit exposure.

4. Single Supervisory Mechanism
The aim of the mechanism is to harmonise and strengthen sanctions across the EU resulting in the increase of fines in some EU jurisdictions.

5. Remuneration
The variable bonus payment is now limited to the 100% of the fixed salary amount for risk control, risk-takers and senior management. On the other hand, it may go up to 200% pending shareholders’ consent. 50% of the variable remuneration should be paid in equity-linked products with at least 40% of the variable payment deferred to a maximum of 5 years.

CRD IV will undoubtedly pose challenges in the manner which financial and credit institutions are regulated but it concurrently helps institutions in the EU to comply with Basel III. A change in the way institutions behave and in the economic realities of banking seem inevitable.

The same considerations will apply in the GCC as central banks adopt Basel lll and CRD4 compliance.

The Central Bank of Kuwait (CBK) has taken necessary measures to put Basel III standards in place out of its interest in the significance of international reform packages. Governor Mr. Al Hashel is recorded as stating that the CBK board of directors has approved a minimum capital adequacy ratio of 13 percent with phased out applications; 12 percent in 2014, 12.5 percent in 2015 and 13 percent in 2016.

Qatar Central Bank (QCB) has decided to combine Basel III with proposals put forward specifically for Islamic banking operations by the Islamic Financial Services Board (IFSB).

Other countries in the Middle East – the U.A.E. and Saudi Arabia, for instance – have elected to implement Basel III and the IFSB standards separately, to give their banks time to deal with one before the other.

Qatar’s banks are thus dealing with a unique combination of regulatory challenges: to implement a strict interpretation of Basel III across both conventional and Islamic operations whilst at the same time ensuring their Islamic arms comply with the new IFSB guidelines.

Qatari banks that deal with both conventional and Islamic finance will have to establish processes to ensure that the two sets of rules are implemented across two divisions simultaneously. For those banks already specialising in either conventional or Islamic finance, the impact is no less significant. They will have to comply with new regulatory measures around their liquidity ratios. They will also have to implement strategies for stress testing that allow for complex data to be analysed in order to demonstrate compliance with the QCB’s guidance on the Basel III directives.

These requirements will require considerable technology change at many banks to ensure that the required financial and risk data can be accurately gathered, cleansed, analysed and reported to board members and the regulator in the formats required.

The Central Bank of Bahrain website provided guidance on its Basel lll implementation plan in June last year:

On 13 February 2014, the Organization for Economic Co-operation and Development (OECD), at the request of the G8 and the G20, released a model Competent Authority Agreement (CAA) and Common Reporting Standard (CRS) designed to create a global standard for the automatic exchange of financial account information.

The publication of the CAA and the CRS is a significant step in governments’ efforts to improve cross border tax compliance. This follows a raft of tax compliance legislation such as the US Foreign Account Tax Compliance Act (FATCA) and active campaigns of voluntary disclosures and legal procedures.

The CRS is another global compliance burden for financial institutions and increases the risks and costs of servicing globally mobile wealthy customers – an otherwise attractive customer segment.

The OECD has modelled the CRS on FATCA, which means it may be possible to leverage existing and planned
FATCA processes and systems. However, the data required is different, and the volume of reporting required is likely to be significantly greater under the CRS.

The OECD’s model CRS,is designed to be a standardized approach to identifying and reporting information about taxpayers by financial institutions that will be exchanged with residence jurisdictions.

The common reporting standard will require financial institutions and brokers to report information to their own jurisdiction and this information will in turn be passed on to other relevant countries automatically each year. It is not designed to replace any existing basis or any other means of information exchange, but instead intends to supplement current measures. It applies to financial accounts and sets out the due diligence which financial institutions will need to follow in order to comply
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This could mean new customer due diligence procedures being required as early as 2015 with the first reporting being due in 2016. It seems unlikely that all jurisdictions intending to participate will be able to
enter into agreements under the same timeframe. Due to the increased scope and volume of information required by the CRS, financial institutions may need to reconsider their approach to FATCA compliance to accommodate the new standard.

Significant uncertainties remain and commentary is not expected to be released until the summer of 2014.
about the detailed requirements. Financial institutions will want to see competent authorities providing clear guidance to help clients determine their tax residency.

The standard has no direct legal force but it is expected that jurisdictions will follow the model CAA and CRS closely when implementing bilateral agreements.

There is significant political will to implement this standard, with more than 40 jurisdictions signing up for early adoption. The expected timeframe could see jurisdictions seeking to sign agreements in 2014, with new customer due diligence procedures required in 2015 and reporting in 2016.

Many OECD countries may be reluctant to sign up to information exchange with less developed countries which may not have the legal and basic processing capacities to keep the information confidential and to use it only for the purposes for which it’s been collected. The OECD may need to go further, e.g. by providing withholding tax mechanisms to enable less developed countries to collect tax