This latest instalment in our Banking on Change event coverage charts two talks on regulatory changes delivered from the perspective of the banks. Peter Sinkis reports.
Paolo Tonucci (Group Treasurer, Commonwealth Bank of Australia) and Gordon Allison (Head of Treasury Development and Transformation, Group Treasury, National Australia Bank) took us on this tour and some engaging discussion at the Banking on Change Seminar.
Preparing for the Net Stable Funding Ratio
Gordon launched in with a focus on the next major change in liquidity regulation approaching banks, the Net Stable Funding Ratio (NSFR). With the Liquidity Coverage Ratio (LCR) taking much of the initial focus of Basel III regulation with its 1 January 2015 implementation date in Australia, the focus was now shifting to the issues and challenges of meeting the NSFR requirement.
Gordon’s starting point was that liquidity risk, in the form of inadequate stable funding, combined with the high degree of interconnectedness between banks and other financial institutions are the main drivers behind the severity of financial crises. The development and implementation of new rules for liquidity and stable funding are a major way to address this risk.
In term of NSFR from a global perspective, Australia is somewhat of an outlier; particularly compared to other banks in the Asian region. Australia is more constrained by the structural funding influences that drive NSFR outcomes. In particular, the form of investments taken by superannuation funds, which tends to disfavour investment in bank deposits, has a particularly strong influence.
Given that the NSFR is due to arrive in January 2018 how will banks begin to prepare? As a first step, the focus will be on identifying the strongest and most binding constraint. This will allow banks to identify their overall position across the range of metrics that impact the balance sheet (including CET1 capital, Leverage Ratio, LCR, NSFR and Total Loss Absorbency Capacity (TLAC) requirements). As a strong understanding of these constraints are developed, a bank can begin to develop the actions it will take to address them
From a management perspective, this change needs to be achieved through several mechanisms. These include product design, understanding key levers that influence metrics – perhaps most importantly pricing – and also in leveraging the strong data and reporting capabilities established through the introduction of the LCR. These changes will not be quickly brought into play, particularly as the structural change required to influence the NSFR and other metrics take time to establish.
Balance Sheet Management in a Constrained World
Finishing on that note, the floor was handed to Paolo Tonucci, who examined the increasing constraints on banking activities as regulatory change has come into force. In particular, he focused on the changing shape of bank balance sheets, the competition that exists between various constraints that are present and potential future developments.
Using the GFC as the boundary, Paolo highlighted that the world of banking in Australia had moved from an unconstrained place to one with many constraints. In particular, there has been a steady movement from a principles-based approach to increasingly prescriptive requirements by regulators in ensuring the safety of the financial system. There are a number of views adopted by regulators to consider capital.
In the initial stages of the Basel regulatory regime, economic capital was the active constraint, alongside rating agencies views of bank strength. This began to change over the 2008 to 2015 period where regulatory capital became increasingly important. Further, regulatory capital became a more complex measure in some ways as the various perspectives that regulators adopted moved from capital and RWAs, to the incorporate of stress testing, liquidity through LCR and NSFR. The future was clearly resolving into further change including the introduction of standard formula floors for certain classes of assets, as well as the consideration of Total Loss Absorbing Capacity requirement.
All these taken together result in various implications for balance sheet management including the need to:
- Identify your binding constraint for your business;
- Drive the right business decisions in the face of your constraint – by simplifying the discussion to a single constraint and managing the complexity in the centre of the organisation; and,
- Having clear framework owners – which likely will involve Risk, Finance or Treasury given the need to have a holistic view of the organisation and understand the underlying complexity.
Questions, Answers and Discussion
Finishing on that note, the two plenary speakers engaged the audience in a longer Q&A session.
How does it feel to operate in a constrained world now, compared to the past?
The world has always been constrained for banks. What has changed is the increase in complexity that the new regulation has brought. In the old world it was relatively straightforward to align to a single constraint, now the binding constraint is not necessarily readily apparent and continues to be subject to regulatory uncertainty for some time to come.
In Australia, the environment is not as uncomfortable as in the UK. APRA have rolled out their requirements in a structured and clear way that has been well thought through. As such the impact on customers and markets has been more readily absorbed.
The NSFR doesn’t necessarily consider local funding structures?
This goes to the heart of the design of the metrics. In the US and Canada, there is a high degree of securitisation. This is not the case in Australia.
So, taking a system-wide view – can the system as a whole meet this metric? Clearly, there is more work to be done in relation to this. Overall “Australia Inc” must find a balance between the needs of Australian savers and borrowers. The goal of the liquidity regulation is to make the Australian banking system safer, and this needs to be kept in mind as responses are developed.
Overall, it is incumbent on regulators to consider the specific characteristics of the domestic banking system they are regulating, and how they will influence and impact it as they formulate their local implementation of the Basel rules.
How do you make these complex concepts understandable across the bank?
The first step is to capture constraints and distil them into the tools that are used by the bank on a day to day basis. This is a key role of central functions. Some aspects will be applied as central costs that are pushed out through existing pricing tools used by the front line.
Customer pricing plays a key part: e.g. for mortgages it is well understood in the market that the product is highly negotiated. Educating front line staff and customers about the underlying price drivers become the key. The linkage between the RBA cash rate and mortgage rate has reduced over time, and the reasons why can be better explained to customers.
Has economic capital’s role been reduced, or simply dwarfed by the other constraints brought into play?
The focus here is that a key part of economic capital processes are the techniques that have been developed. For example, stress testing processes that are now coming to the fore are important and valuable in terms of the thinking they encourage in the organisation. As no models are perfect, it remains relevant though not central.
As always, thank you to our speakers in delivering an engaging and wide-ranging discussion on the banks perspectives and practical challenges in dealing with a complex environment of regulatory change.
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