Banks’ G-Sibs criticism summarised

Author: | Published: 18 Sep 2011
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International banks have attacked the Basel Committee on Banking Supervision’s (BCBS’s) proposed methodology for calculating the globally systemically important banks (G-Sibs) for its lack of transparency and focus on sheer size.

In their responses to the BCBS consultation paper on the methodology for calculating the G-Sibs surcharge, many banks were concerned about the lack of transparency of the actual criteria to determine the systemic importance of banks.

BNP Paribas said the reason for the selection of the 73 systemic banks in the sample is not spelt out and doesn’t even cover all the banking systems of the G20 countries.

"The range and number of buckets used to adjust the surcharge to the so-called systemic profile do not appear to have scientific grounds and cannot easily be reconstructed," said BNP Paribas in a written response.

"Designing and adopting a regulation distinguishing 28 banks in four buckets out of an undefined sample of 73 banks, without a clear updating pattern, will be, in this context, a formidable if not insurmountable legal challenge," it added.

Goldman Sachs called for more clarity for the methodology for calculating the so-called scorecard and for translating it into the additional loss absorbency bands.

In the bank’s response, chief financial officer David Viniar said that a transparent methodology would give banks the incentive to consider the potential consequences of a given action on their G-Sib banding.

Barclays in turn called for more clarity regarding the entry and exit criteria for G-Sib status to address potential mergers and financial sector growth in emerging economies.

Size v RWA

Banks had a particular concern with the BCBS’s focus on sheer size to calculate the systemic importance of a bank.

Size has a 20% weighting on the calculation of whether a bank is classed as a G-Sib, and is described as "total exposures as defined for use in the Basel III leverage ratio".

"The criterion of size is probably the most problematic on the list of criteria used by the BCBS," said BNP Paribas.

In HSBC’s response, group chairman Douglas Flint argued that there are a number of other measures heavily correlated to the total size of an institution.

BNP Paribas said the calculations used for the substitutability and complexity criteria are similar, and may lead to double counting. This, said the bank, can overweight the impact of size in the final result "well beyond the 20% stated".

UBS group chief risk officer Maureen Miskovic and the head of group government affairs Steve Hottiger, were concerned about the omission of risk-weighted assets (RWA) when calculating size.

"The absence of RWA as an indicator and focus on total exposure only as a proxy for size is, in our perspective, questionable," they said.

RWA is the main concept of the Basel Committee and is calculated by every institution to reflect the risk profile of the bank. It is also the proxy for transferring risky assets during bankruptcy and resolution, they note.

"Hence, taking RWA into account within the size indicator would better quantify the risks of a bank’s distress or failure to the global economy."

In its response, Barclays suggested the size criteria should include risk-adjusted capital ratios alongside the non-risk adjusted Basel III leverage ratios.

Cross-border exposure
The cross-jurisdictional criteria also concerned the banks. The criteria, which has a 20% weighting, measures cross-jurisdictional claims and liabilities to measure the importance of the bank’s activities outside its home jurisdiction relative to overall activity of other banks.

"The greater the global reach of a bank, the more difficult it is to coordinate its resolution and the more widespread the spill over effects from its failure," the BCBS consultation paper explains.

David Viniar of Goldman Sachs said the bank was concerned that these measurements are much more complex and open to interpretation than it would first appear. This, he said, is likely to result in differences in reporting methodologies.

In Citigroup’s response, chief risk officer Brian Leach said that such a blunt measure of international activity does not measure the probability of failure or potential for systemic disruption, and instead discourages global diversification.

Leach explained that if a bank that funds its local currency assets in each host country through cross-border financing, it will have half the risk score than if they had funded them with local currency liabilities and capital.

"This is at odds with the industry’s, including Citi’s, experiences over recent decades to closely manage, and in some cases reduce, cross-border exposure to guard against the risk of disruptions to liquidity flows during times of stress and the potential for government actions," said Leach.

Diversified and cross-border activities are the only new factors that may be viewed as supporting the capital surcharge, said BNP Paribas. But until now these characteristics were considered as the basis of sound banking.

"This dramatic change in the risk management paradigm is amazing and not seriously explained," added BNP Paribas.

Goldman Sachs’s Viniar suggested the use of alternative indicators such as non-domestic revenue as a proportion of total revenue, or non-domestic balance sheet as a proportion of the total balance sheet.

"This information is already disclosed in quarterly or annual filings and, since it is audited, out concerns regarding data integrity and consistency are greatly mitigated," he said.

Resolution discounts

UBS and HSBC both called for the calculation to take into account the existence of a credible recovery and resolution regime in its home country.

Miskovic and Hottiger of UBS said that given that the surcharge is based in part on a desire to reduce negative externalities caused by the failure of a G-Sib, the existence of an effective and credible recovery and resolution plans can reduce these externalities to a certain extent.

"It is in our perspective logical that G-Sibs based in that country should have their total scores reduced," said Miskovic and Hottiger.

Douglas Flint of HSBC explained that the bank already operates as a series of locally regulated banks that are separately capitalised with their own pools of liquidity and funding.

This structure, said Flint, would give authorities significant advantages in resolution as they could effectively ringfence large areas of the group that could continue in business in the event that other parts of the group were to fail.

This structure however has significant costs and puts pressure on returns, which Flint believes should be compensated through the G-Sib proposals or elsewhere in the regulatory system in order to incentivise other banks to adopt similar structures.

The consultation paper was released on July 19 and the comments closed on August 26.