INTERACTION, COHERENCE,AND OVERALL CALIBRATION OF
POST CRISIS BASEL REFORMS
AUGUST 9, 2016

Qualifications, assumptions and limiting conditions
This report is for the exclusive use of the Oliver Wyman client named herein. This report is not intended for generalcirculation or publication, nor is it to be reproduced, quoted or distributed for any purpose without the priorwritten permission of Oliver Wyman. There are no third party beneficiaries with respect to this report, andOliver Wyman does not accept any liability to any third party.
Information furnished by others, upon which all or portions of this report are based, is believed to be reliable but
has not been independently verified, unless otherwise expressly indicated. Public information and industry andstatistical data are from sources we deem to be reliable; however, we make no representation as to the accuracy orcompleteness of such information. The findings contained in this report may contain predictions based on current
data and historical trends. Any such predictions are subject to inherent risks and uncertainties. Oliver Wyman
accepts no responsibility for actual results or future events.
The opinions expressed in this report are valid only for the purpose stated herein and as of the date of this report.
No obligation is assumed to revise this report to reflect changes, events or conditions, which occur subsequent to
the date hereof.
All decisions in connection with the implementation or use of advice or recommendations contained in this report
are the sole responsibility of the client. This report does not represent investment advice nor does it provide an
opinion regarding the fairness of any transaction to any and all parties.
© Oliver Wyman 2016

© Oliver Wyman

AUTHORS
Douglas J. Elliott
Partner, Finance & Risk/Public Policy Practice, North America
Phone: +1 646 364 8444
Email: douglas.elliott@oliverwyman.com
Emre Balta
Principal, Finance & Risk, North America
Phone: +1 202 331 3692
Email: emre.balta@oliverwyman.com
Vishal Abbhinand
Email: vishal.abbhinand@oliverwyman.com
Olivia Korostelina
Email: olivia.korostelina@oliverwyman.com
Mehreen Siddique
Email: mehreen.siddique@oliverwyman.com
The authors also thank Faith Lee for her assistance in the development of this report.

PRINCIPAL ADVISORS
Andrea Federico
Partner, Regional Head – Public Policy Practice, Europe, the Middle East and Africa
Phone: +39 02 3057 7501
Email: andrea.federico@oliverwyman.com
Christian Pedersen
Partner, Regional Head – Finance & Risk Practice, Asia-Pacific Region
Phone: + 65 9487 8373
Email: christian.pedersen@oliverwyman.com
Jai Sooklal
Partner, Finance & Risk/Public Policy Practice, North America
Phone: +1 212 345 1059
Email: jai.sooklal@oliverwyman.com© Oliver Wyman

CONTENTS
EXECUTIVE SUMMARY

I

1.

BASEL COMMITTEE’S POST-CRISIS RESPONSES

1

2.

HOW CAN REGULATORY IMPACTS BE MEASURED?

11

2.1.
2.2.
2.3.
2.4.
2.5.
2.6.
2.7.

Role of the financial system in society
Broad areas of potential impacts
Importance of cost/benefit analysis
Potential benefits from enhanced regulation
Potential costs from new regulations
Attribution issues
Qualitative considerations

11
12
14
15
16
19
20

3.

IMPORTANCE OF INTERNAL ALLOCATION AND PRICING MECHANISMS AT
FINANCIAL INSTITUTIONS

23

3.1.
3.2.
3.3.
3.4.

Capital and liquidity allocation and pricing within financial institutions
Internal allocation approaches
Potential regulatory impacts
High-level discussion of post-crisis changes in allocation and pricing
mechanisms

23
24
26

4.

IMPACT ON THE LENDING CHANNEL

29

4.1.
4.2.
4.3.

Loan rates
Loan volumes
Distributional consequences

32
43
45

5.

IMPACTS ON CAPITAL MARKETS

49

5.1.
5.2.
5.3.
5.4.
5.5.

Constraints on banks and large securities dealers
Impact on the activities of banks and large securities dealers
Offsetting factors
Impact on capital markets
Potential future impacts on market liquidity and market structure

51
54
64
65
75

6.

OVERALL COHERENCE AND POTENTIAL ISSUES WITH BASEL REFORMS

77

6.1.
6.2.
6.3.
6.4.

Potentially inconsistent sets of rules
Potentially mis-calibrated rules
Potential duplication or interaction of coverage
Potential unintended consequences

81
82
95
96

7.

CONCLUSIONS

101

26

© Oliver Wyman

APPENDIX A.
A.1.
A.2.

Basel III reforms
Ongoing Basel reforms

APPENDIX B.
B.1.
B.2.

SCOPE OF REGULATIONS COVERED BY THE REPORTSUMMARY OF KEY STUDIES

Summary of key studies measuring impact of regulatory reform on lending
and capital markets
Detailed description of studies on the impact of reforms on the lending
channel

APPENDIX C.
APPENDIX D.
BIBLIOGRAPHY© Oliver Wyman

103
103
108
115
115
117

DETAILED SUMMARY OF MEASUREMENT APPROACHES USED IN
QUANTITATIVE STUDIES125

GLOSSARY OF ACRONYMS

129
131

List of Tables
Table 1.1: Basel III reforms and ongoing workstreams
Table 1.2: Summary of studies examining RWA increases
Table 4.1: Target capital ratio and calculation of the gap from baseline
Table 4.2: Impact of Basel reforms on funding costs
Table 5.1: Balance sheet reductions, 2010–15 (% change)
Table 5.2: Examples of global banks exiting or shrinking wholesale businesses
Table 5.3: Share of global volume traded on electronic platforms, by asset class
Table 6.1: Potential issues with regulatory requirements
Table 6.2: Interaction of regulatory requirements
Table 6.3: Summary of potential issues with Basel reforms
Table 6.4: Influence of central bank placements on custody banks’ leverage ratio

1
3
33
38
55
59
65
77
78
79
98

© Oliver Wyman

List of Figures
Figure 1.1: Composition of a typical large bank’s RWA
Figure 1.2 Complex web of regulations
Figure 4.1: Bank CET1 ratio and total equity to total assets ratio, 2006–2015
Figure 4.2: Gross impact of Basel reforms on funding costs in US
Figure 4.3: Gross impact of Basel reforms on funding costs in Europe
Figure 4.4: Gross impact of Basel reforms on funding costs in Japan
Figure 4.5: Impact of additional Basel reforms on median estimated increase of gross funding cost
Figure 4.6: Impact of offsetting factors in the US
Figure 4.7: Impact of offsetting factors in Europe
Figure 4.8: Impact of offsetting factors in Japan
Figure 4.9: Impact of reforms on lending volumes
Figure 4.10: Impact on lending rate market segments due to increase in capital requirements
Figure 4.11: Impact on lending volume market segments due to increase in capital requirements
Figure 5.1: Overview of the diffusion of regulatory impacts on capital markets
Figure 5.2: Basel III Capital requirements
Figure 5.3: Cash as a % of assets – All banks
Figure 5.4: Estimated dealer financial resource consumption/revenues, 2006–2017E
Figure 5.5: Net positions of primary dealers – US corporate bonds
Figure 5.6: CMBS price volatility and liquidity
Figure 5.7: Demand sensitivity of US$ High Yield corp. bond spreads and dealer inventory
Figure 5.8: Global securities revenue pools by player (2006–2014)
Figure 5.9: Changes in structure and activities of major banks (2009–2014)
Figure 5.10: Repo balances held by banks (by region)
Figure 5.11: Increase in HQLA holdings by US GSIBs
Figure 5.12: Daily turnover ratio for US Treasuries from 2005–2015
Figure 5.13: Price impact coefficient – 5 yr European sovereign bonds (in percentage points)
Figure 5.14: Price impact – US Treasuries
Figure 5.15: Average trade size in US Treasuries
Figure 5.16: Average trade size – European corporate bonds
Figure 5.17: Large Transactions in the US Corporate Bond Market (Percent)Figure 5.18: Average transaction sizes for equities – NYSE and Euronext (2004–2015)
Figure 5.19: Turnover ratios
Figure 5.20: Number of days for full liquidation of US Credit Mutual Funds and ETFs
Figure 5.21: Spreads on investment grade corporate bonds
Figure 5.22: US High Yield corporate bond issuance
Figure 5.23: Deviation of US High Yield corporate bond spreads from fundamentals
Figure 6.1: “Barbell” effect by types of assets
Figure 6.2: Estimates of optimal calibration of capital requirements
Figure 6.3: G-SIB capital requirements, including Basel requirements and TLAC
Figure 6.4: Capital requirements for US GSIBs
Figure 6.5: How the leverage ratio is linked to the Tier 1 risk-weighted capital requirement
Figure 6.6: Non-performing housing loans1
Figure 6.7: Residential real estate LTV buckets
Figure 6.8: Capital across assets: Basel III impact so far
Figure 6.9: Capital across assets: Potential new changes
Figure 6.10: Total liquid assets of mutual funds© Oliver Wyman

5
6
29
34
35
36
39
41
42
42
44
45
47
51
52
53
54
55
56
57
58
59
62
63
64
66
67
67
68
68
69
70
71
72
72
73
82
84
86
87
88
91
92
93
94
98

Post Crisis Basel Reforms

Executive Summary

EXECUTIVE SUMMARYOVERVIEW•

Since 2009, the Basel Committee on Banking Supervision (“Basel Committee” or “BCBS”) has been leading
the global effort to overhaul banking regulation to sharply increase banks’ required capital and liquidity levels.
In the wake of the crisis, most observers agreed that capital and liquidity requirements needed to rise
substantially from their pre-crisis levels, but they also agreed that there are costs and, in some cases,
unintended consequences associated with the Basel reforms.

•

In addition, the sheer volume of regulatory changes in a relatively short space of time to a complex andvaried global financial system necessitates a careful review. Further, there is less consensus on the need for
additional reforms beyond those already completed by the end of 2015. Some observers believe it would bebetter to wait until these provisions have been fully implemented and their comprehensive impact on thewider economy has been assessed. There has been no comprehensive quantitative analysis to date of the
impact of the full range of the Basel reforms, taken as a package, making judgments more difficult.

•

To its credit, the Basel Committee is actively examining the “interaction, coherence, and overall
calibration” of the new rules. Our report is intended to examine key issues and assist the Basel Committee,
and other policymakers and analysts, in their consideration of how to optimize the global regulations.

•

Oliver Wyman undertook this work under a commission from the Global Financial Markets Association, but theanalysis and opinions expressed here are solely those of the authors and do not necessarily reflect theviews of Oliver Wyman or the Global Financial Markets Association.

•

This report focuses on the effects of the rules already recommended by the Basel Committee, or which
are targeted for completion by the end of 2016, and the Total Loss Absorbing Capacity (TLAC) rules
proposed by the Financial Stability Board. We analyze primarily the long-term impacts and not thetransition costs of these rules. Nor do we analyze issues of national implementation, except to highlight a few
illustrative examples of how they can magnify or complicate the effects of the Basel rules. Readers shouldnote that national regulations, such as stress tests, add further costs and are, in some cases, morebinding than the Basel rules analyzed here.

© Oliver WymaniExecutive Summary

Post Crisis Basel Reforms

FIGURE A: POST CRISIS BASEL REFORMS AND TLAC
Basel Committee
mandated changes[1]Core capital requirements• Higher capital ratios• Regulatory buffers (capitalconservation andcountercyclical buffers)• Quality of capital (tangible equity)• RWA increase• Leverage ratio• Measuring and controlling large
exposures

Ongoing RWA requirement changes• Standardized approach for credit
risk, and operational risk
• Fundamental review of the
trading book[2]• Capital floors• Constraints on use of internal models• Interest rate risk in thebanking book[3]Liquidity requirements• Net stable funding ratio• Liquidity coverage ratio
Basel Committee and Financial
Stability Board requirements• Total Loss-Absorbing Capacity

Costs(based on literature review)
Lending channel –Predicted impacts• Studies show higher funding costs for banks(leading to higher costs for borrowers)
RegionMedian basis point increase
US84
Europe60
Japan66

Benefits(based on literature review)Benefits – Predicted impacts• Fewer financial crises• Smaller crises• Smaller effects of these crises on thewider economy• Likely to increase further due to ongoing
Basel workstreams and TLAC
• Lower loan volumes: Average of studies
shows 1% increase in required capital ratios
likely to drive volume decline of ~2.6%• Distributional consequences: some borrowers
or regions impacted more than others
Capital markets –Predicted impacts• Lower dealer capacity, reducing
market liquidity• Increased bid-ask spreads• Increased indirect transaction costs due tohigher price impact of large transactions• Higher borrowing costs• Higher market volatility and increased
instability especially during stressedmarket conditions
Capital markets –Predicted impacts[1] Not an exhaustive list
[2] FRTB reforms have been completed[3] IIRRBB reforms have been completed (largely Pillar 2)ii© Oliver Wyman

Post Crisis Basel Reforms

Executive Summary“Bank capital is not costless to society. If capital requirements are increased, some of those costs will be passed on
to households and businesses in the real economy”– M. Carney, Governor of the Bank of England,
to Treasury Select Committee, (2016)•

This report consolidates and interprets the large and growing base of research from official bodies,academics, think tanks, and others, as well as the many comments and analyses provided byparticipants in the financial sector. As part of our analysis we reviewed about 100 academic papers,
more than 100 letters or studies by the industry, and nearly 200 references and research papers fromofficial sources.

•

Impact on bank lending: Our analysis of the literature shows the potential for significant costs for the end
users of financial services, primarily households and businesses that borrow or invest.

•

There is very little empirical research yet available on the actual impact of the Basel reforms, leaving
the policy community to rely on best estimates based on quantitative models of what the impact islikely to be.
−

Bringing together the analyses of likely effects on loan pricing shows median estimates of potential
increases in credit spreads of 60 to 84 basis points, depending on the region (The range of estimates iswide, however, as will be discussed and illustrated further below).

−

Loan volumes on bank balance sheets are estimated to decline as well, with an average decline acrossthe studies of 2.6% for a 1 percentage point increase in required capital ratios.

−

Higher prices and lower volumes, all else equal, would serve as a drag on the economy, although it isdifficult to measure precise effects and potential offsets, such as from the rise of alternative intermediaries.

−

It is critical to recognize that the vast majority of studies do not include the additional impacts fromthe current round of Basel reforms. These revise the calculations of risk weighted assets (RWA), withexpected incremental increases across operational, credit and market risk frameworks. These further
changes will increase average bank RWAs, with a lower bound estimate of 10–30% for the proposals as
envisioned at the times of the various analyses and significantly higher for some specific financing
activities1. (We refer to this as a lower bound, as many of the studies analyze only a subset of the changes.)
More detailed analysis commissioned by the Institute of International Finance and the International Swap
Dealers Association, based on a detailed quantitative analysis of bank-level data, has reportedly showneven higher effects than the top of the 10–30% range of increase in average RWA. According to reports 2,
the study shows increases in RWA of roughly 70% on average in certain businesses. This would clearly
have substantial implications for banks and their customers. It should be noted that the Governors andHeads of Supervision (GHOS) of the Basel Committee have issued assurances that, upon finalization, thetotal increase in RWA will not be “significant” in the aggregate for the industry, which suggests they are
targeting a lower total effect.

1

Dawn (2015), Durand (2015), Keenan and Spick (2015), KPMG (2015), Macquarie Equities Research (2016), The Economist (2015), Turner (2012),
Graham, Li, and Kruse (2016), IIF (2016), BCBS(2015f), ISDA, GFMA, and IIF (2015), ORX Association (2016), J. P. Morgan Cazenove (2015), Oliver
Wyman and Morgan Stanley (2015), The Association of German Public Banks (2016), Risk Control (2016), McKinsey (2015)
2
POLITICO Pro Morning Exchange, July 20, 2016

© Oliver Wymaniii

Executive Summary•

Post Crisis Basel Reforms

Impact on capital markets: Actions by the Basel Committee will have a substantial impact on the structure ofcapital markets and on the costs for major participants. There is already evidence of significant changes inmarket structure, driven both by regulation and by other factors. For example, banks’ trading balance sheets
have contracted by 25–30% since 20103. As a result, overall market liquidity could suffer, especially after thefull effects of existing regulatory changes, and those still in process, play out in a more normal interest rateenvironment. The cost of regulation to be absorbed by capital markets is likely to be substantial. For instance,
one estimate is that the Leverage Ratio and NSFR requirements will impact bank costs in the 60bps–110bps
range in low margin market making activities.4−

Potential effects include higher direct transaction costs through wider bid-ask spreads, combinedwith a larger effect from higher indirect costs. The latter could come from bigger price movements
when there is buying or selling pressure from all but the smallest transactions along with the indirect
effects of greater overall volatility. Some portions of the markets are already showing such impacts, whileothers are not (see Section 5).

−

Markets could become less stable and more vulnerable to shocks, which may have adverse systemicrepercussions. There is already some evidence of reduced stability (including incidences of extreme
movement in prices such as the 2013 “Taper Tantrum” – see Section 5 for more detail), although it is notconclusive. Such instability, combined with higher transaction costs, could push up liquidity premiums
demanded by investors and, again, there is some evidence of this happening already.

•Quantifying benefits of the systemic stability resulting from these reforms is challenging. It requires, forexample, an economic analysis of the effects of increases in capital and liquidity at banks on the frequency andseverity of financial crises and the attendant implications for the wider economy, based on a sophisticatedmodel of the financial system and its place in the economy as a whole.

•

In view of the difficulties, complexities, and uncertainties of modeling the benefits, we have notconducted an independent analysis of the benefits, or therefore, of the balance of costs and benefits.
Our focus in this paper on the potential costs and risks should not be viewed as an overall cost-benefit
analysis. Instead, our goal is to highlight areas for the Basel Committee to pay particular attention as
they consider the trade-offs.

•

For the sake of completeness, the body of the report does contain a high-level discussion of analyses ofthe optimal level of capital done by official bodies and academics, which produce a wide range of
estimates. All of the studies show that significant net benefits are derived from capital levels considerably
higher than the pre-crisis required capital ratios. However, a number of the studies suggest that the revised
capital requirements could be sub-optimally high, particularly those that include analysis of Total Loss
Absorbing Capacity and the ongoing Basel workstreams. Judging whether the rules are mis-calibrated will
require policymakers to specify their preferred threshold for the balance between safety and soundness andthe effectiveness and pricing of lending and capital markets.

•

Whatever one’s view of the balance of the costs and benefits of the aggregate capital and liquidity levels,a review of the specifics of the financial reforms suggests it is likely that some of the costs areunnecessary and result from the problems inherent in such a large and complex regulatory process,including the potential issues outlined in Table A, the examples for which will be discussed later on.

3
4

Oliver Wyman and Morgan Stanley (2016)
AFME (2016)

iv© Oliver Wyman

Post Crisis Basel Reforms

Executive Summary

TABLE A: POTENTIAL ISSUES WITH REGULATORY REQUIREMENTSPOTENTIAL ISSUES
Inconsistent sets of rules

BRIEF DESCRIPTION

Mis-calibrated rules• Many of the rules involve decisions about minimum thresholds or otherquantitative criteria• It is possible for the chosen level of reforms to produce too great a cost for thedesired benefits• One-size-fits-all definition of thresholds may not allow appropriate consideration ofdifferences in regional financing structures, legal protections and bank balance
sheet compositions

Duplication or interactionof coverage• Rules may be appropriate taken individually, but their interaction results in an undue
regulatory burden on certain products or on the system as a whole• These rules drive bank behavior that may create substantial problems for particular
activities, services, and products that are important to customers and functioning of
the wider market, even if the calibration of overall capital or liquidity levels for thebanking system as a whole is broadly appropriate

Unintended
consequences• Reforms may create other unintended consequences for the broader economy, suchas the potential for homogenization of bank business models, concentration of
exposures in parts of the financial sector that are not regulated or regulated only
lightly (often referred to as “shadow banks”) or some of the changes in the market
structure and the way market participants interact• Two or more rules may pull in different directions• Potential to increase the total economic cost without a corresponding benefit interms of safety and soundness•

Given the potential for such issues, the Basel Committee’s coherence and calibration exercise should aim at
finding the optimal design and calibration of rules, whereby the BCBS stability objectives are met at theleast cost to society, particularly targeting areas of the framework where the same risks are addressed
multiple times by different rules.

•

The objective of this report is not to make recommendations, but to highlight key issues and to encourage afocus by policymakers on crucial questions such as:−

Have the reforms, taken as a whole, achieved the proper balance between financial stability andeconomic costs?

−

Will the price of various products (e.g. loans) be pushed up more than necessary to achieve the desired
stability due to the combined impact of regulation (including the leverage ratio, liquidity, credit risk, etc.)?
Will the supply of loans decrease to a degree that is detrimental to the growth of the economy?

−

Will the reforms have unintended consequences on market structure and the behavior of market
participants as a result of potentially reduced market liquidity, higher costs, increased volatility, andhigher contagion risk?

−

Are some customer groups, products, or regions disproportionally impacted by the balance of level ofcapital vs. risk even if the overall cost-benefit balance is right?

−

Do some of the regulations work at cross purposes, reducing the benefits and raising the costs? Are theright incentives being created?

−

Will the increased cost burden on banks create unintended regulatory arbitrage with an excessive shift ofsystemic activities into the less-regulated shadow banking sector?

−

Is there an unintended negative impact on global trade and financial flows?

© Oliver Wymanv

Executive Summary

Post Crisis Basel Reforms

The remainder of this Executive Summary explores the existing literature to examine the areas where potential
problems may lie, in order to suggest appropriate areas of focus for the Basel Committee and the Financial Stability
Board (“FSB”) in a structured fashion.

BACKGROUND
The global financial crisis and ensuing Great Recession emphasized the importance of the financial system and theneed to ensure its stability and effective operations. In response, members of the G20 agreed on principle toenhance the resilience and strength of the financial system.5 Leaders of the G20 nations deputized the FSB and theBasel Committee to reform the global standards for bank regulation and supervision to improve financial stability
by raising the quantity and quality of capital required, creating new global liquidity standards, fundamentallychanging risk modelling processes and taking certain other related actions. As a result, many complex rules
governing capital, liquidity, trading operations, derivatives, and securitizations have been adopted since the crisis.
Furthermore, some institutions were subject to particular scrutiny and regulation due to their size, complexity, andinterconnectivity.
There is a strong argument that reforms since the 2008 financial crisis will make the banking system more resilient.
However, the implementation of these rules has also created costs for the banking system and the broader
economy, leading to fundamental changes in bank balance sheets and business models, and arguably how a bankshould be governed and run. The structure of financial markets has also been impacted by the reforms, withresulting changes in their liquidity, efficiency and effectiveness. While in many cases changes to the businessmodels of banks were intended, in other areas it is likely that the cumulative impacts go beyond those intended
and may, negatively affect the functioning of the financial system. The potential for this is fueled by the multiple
layers of regulation, the analysis of which has frequently been performed, at least initially, in isolation.
The scale and scope of regulatory reform has led to calls for regulators to take stock of the cumulative effects ofthese changes and to assess whether unintended, undesirable consequences may mean that a recalibration ofregulatory changes is required. Both market participants and some officials have raised potential concerns over thecalibration of reforms. Calibration of both individual reforms (e.g. the overall level of leverage ratio requirements)
and the combined calibration of reforms (e.g. the interaction between risk-sensitive capital ratio requirements andrisk-insensitive leverage ratio requirements) have come into question.6
In particular, there is a concern among some observers that the ongoing Basel workstreams will
significantly add to banks’ capital requirements, may exceed appropriate levels, and counter some of thenational and regional initiatives to meet G20 growth commitments.
We believe that the need for recalibration of the reforms analyzed in this paper is inevitable when making
such sweeping and detailed changes to the rules for a huge and complex industry on a global basis.
The Basel Committee set up a workstream in its 2015–16 plan to examine the “interaction, coherence, and overall
calibration” of its reforms, and the Financial Stability Board (FSB) has undertaken similar efforts. This report is inlarge part intended to help inform those organizations as they weigh these issues and, ultimately, consider
remediation of problems that are uncovered. We do this primarily by pulling together and interpreting the large
and growing base of research from official bodies, academics, think tanks, and others, as well as the many
comments and analyses provided by participants in the financial sector. Although significant changes andadditions have been made since the initial Basel III rules were published, many of the studies are based on only the
initial set of Basel III rules (and do not include the ongoing or recently finalized workstreams) these initial proposals
and therefore likely underestimate the magnitude of the ultimate impacts.
5
6

G20 Leaders (2009)
Jones (2016), Kutler (2010)vi© Oliver Wyman

Post Crisis Basel Reforms

Executive Summary

Our primary focus is examination of the impact of the global rules already recommended by the Basel Committee
since the financial crisis and of the likely impact of ongoing workstreams that the committee intends to conclude in
2016. The Total Loss Absorbing Capacity (TLAC) rules proposed by the FSB are also included in the analysis, given
their close ties to the Basel Committee’s capital and liquidity standards. Additionally, stress testing requirements
are discussed at a high level, but not analyzed at a jurisdictional level, except in a few cases where interactions arenoted between Basel requirements and national stress tests. Exclusion of stress tests from the scope of this report
should not be construed as an indication of their impact, as they are often very important.7 In general, this report
does not include a detailed analysis of specific jurisdictional implementations of Basel reforms or bank structure
regulation. Please refer to Appendix A for a brief summary of rules included in this study.
In order to understand how Basel reforms impact banks and how these effects flow down to the customer, it isimportant to consider internal bank decision-making processes.

BANK DECISION-MAKING PROCESSES
There are a number of qualitative and quantitative considerations that should be taken into account whenassessing the impact of regulatory reforms. These include:
Capital and liquidity allocation and pricing within financial institutions. Accurate analysis of the
impact of financial reforms on end users requires an understanding of how financial institutions makeinternal allocation and pricing decisions about capital, liquidity, and other scarce resources, as these havea direct effect on the supply and price of the services they offer. The aggregate effect of the decision
processes of these intermediaries determines the provision of credit and other services to the wider
economy. Therefore it is critical to understand these allocation decision processes as policymakers set
capital, liquidity, and other regulations. Good cost-benefit analyses, for example, depend on an accurate
reading of the actions banks and other financial institutions will take in response to new regulations.
In practice, regulatory requirements are effectively replacing internal and rating agency criteria as
the drivers of internal pricing and allocation mechanisms. The reason for this is simple; regulations are
now virtually always considerably more constraining than the other methodologies in terms of the capitaland liquidity they require. This reflects a considered decision by policymakers globally that the economic
externalities of financial crises require that banks maintain more capital and liquidity for society’s benefit
than they would choose to for internal reasons or as a result of demands from their shareholders andfunders.
Thus, in practice, regulatory choices about capital and liquidity rules and in particular, the risksensitivity or lack thereof will affect choices about the pricing and availability of credit and otherservices in quite specific ways throughout the organization, as individual units and entire
organizations determine how to allocate their capital according to their strategic priorities andwhether the business they have traditionally done can still provide a reasonable return on capital
under the new capital and liquidity requirements. In a context where capital is a scarce, inelastic
resource, the internal allocation of capital is the primary constraint on business models.
Policymakers have made clear that they do not wish to dictate business models, except to eliminate a few
that they deem particularly dangerous, but the practical effects of various regulations and theirinteractions do, in fact, substantially influence business models for the future. This point is critical tounderstanding the future impact of Basel reforms.

7

Anderson (2016).

© Oliver Wymanvii

Executive Summary

Post Crisis Basel Reforms

SUMMARY OF FINDINGSThis subsection summarizes the effect of regulatory reforms on bank lending and capital markets.

IMPACT ON BANK LENDING
Reforms impose additional expenses for banks through an increase in funding costs (driven by higher capital andliquidity requirements). These higher costs may then be passed through to the wider economy through two key
impacts on end users: increases in the price of credit and reduced loan volume.

INCREASED PRICE OF CREDIT
As banks raise capital and TLAC levels for the same amount of risk, their total cost of funding goes up (while
Modigliani-Miller theorem states that higher capital requirements would not increase a bank’s funding costs, inSection 2 we discuss why these assumptions do not fully hold and banks experience higher funding costs). Givenshareholder expectations for market-consistent returns on capital, banks will be faced with a choice between
exiting certain business lines and passing on some or all of their increased funding costs by raising margins andfees for banking products. Pricing may impact some market segments more than others, creating an uneven
distribution of these costs. This is one of the main transmission channels through which the changes in capital,
liquidity, and TLAC regulations impact the wider economy.
We reviewed over 20 studies across multiple geographies to estimate the impact of Basel reforms on the price ofcredit. These academic, official, and industry group studies analyzed the overall effects of the main Basel capitaland liquidity reforms, without consideration of the many workstreams that some industry observers lump together
as “Basel IV”, such as the revisions to the standardized approach for credit risk, and included both theoreticalestimates and analysis of actual outcomes of the Basel reforms. These studies are discussed in Section 4 and in
Appendix B. Our analysis of these studies, in Figure B, that, when put on a common basis and with updated
assumptions on total capital requirements, estimates of the gross impact of the new Basel capital and liquidity
requirements on funding costs in the US range from 15–109 bps, with a median increase of 84 bps. The impact inEurope ranges from 9–97 bps, with a median increase of 60 bps. The estimated increase in funding costs in Japan
ranges from 29–105 bps with a median increase of 66 bps. Even with the larger basis point effect on the US, thehigher funding costs are likely to have a relatively larger aggregate impact in Europe and Japan, where the average
pre-tax rates of return on assets are lower than in the US and the banking systems are much larger in comparison to
the size of their economies.
The magnitude of impacts is driven largely by the differences in gap between starting and target capital ratios(larger for US and Japan than Europe) and differences in RWA density (higher RWA/Total Assets ratio in US than inEurope and Japan), as will be discussed in Section 4. Additionally, the impacts discussed in this report may vary
within more specific jurisdictions than described here (for example, within Europe).
These results are based on a series of assumptions we made to put the studies on a common basis and to reflect theaggregate impact of the relevant reforms on capital levels. This analysis does not normalize for the effects ofhistorically unprecedented monetary accommodation and consequent low rates, which have different impacts indifferent jurisdictions. Likewise, significant changes and additions have been made since the initial Basel III rules
were published, therefore many of the studies are based on only the initial set of Basel III rules (and do not include
the ongoing or recently finalized workstreams) and will likely underestimate the magnitude of the ultimate impacts.

viii© Oliver Wyman

Post Crisis Basel Reforms

Executive Summary

FIGURE B: GROSS IMPACT OF REGULATORY REFORMS ON BANK FUNDING COSTS
120
109
98
MedianBasis points

80
60

105

Max

97

100

97
75th percentile

88

84

MedianMedian

54

66
39

36

40

Median60
25th percentile
29

20
15

Min

9
0
US

EuropeJapan

Average pre-tax return on assets for 2014–2015 [1][1] Average of 2014–2015 return as (total net income before taxes)/(total assets); Source: SNL, Oliver Wyman analysis
Source: Oliver Wyman analysis. Refer to Section 5 and Appendix B for further details and references

The estimates would rise if they were to take into account two key recent regulatory changes: ongoing Baselreforms (likely to result in RWA increases) and TLAC. 8 Additional funding costs are expected to be driven by themost recent Basel Committee reforms (revisions to the standardized approach to credit risk and operational risk,
FRTB, limitations on the use of internal models and the imposition of capital floors on the output of models, etc.).
Some studies estimate that these additional changes will increase average bank RWAs, with a lower boundestimate of 10–30% for the proposals as envisioned at the times of the various analyses and significantly higher forsome specific financing activities9. (We refer to this as a lower bound, as many of the studies analyze only a subsetof the changes.) Similarly, bank funding costs are expected to be impacted by TLAC requirements, which havebeen estimated to increase lending rates by 5–15 basis points, according to the Experts Group for the FSB (2015).
Some have argued that TLAC requirements are mis-calibrated, as will be discussed further on: for the US, a 16%
TLAC requirement would produce total loss absorption capacity that is “4.4 times greater than the average losses
projected for US G-SIBs under the Federal Reserve’s severely adverse scenario for the 2014 Dodd Frank AnnualStress Testing (DFAST) stress testing and Comprehensive Capital Analysis and Review (CCAR) exercise.”10 The
ongoing nature of Basel work makes it more difficult to estimate the total impact of reforms than is true forcompleted regulations.11
The differences in estimates of total impact among the various academic and industry studies are driven by several
factors. First, studies differ in the scope of reforms analyzed: the majority of studies examine only increases incapital ratios, while some studies also consider liquidity reforms and other factors. Second, methodological

8

Covered in more detail in Section 4.
Dawn (2015), Durand (2015), Keenan and Spick (2015), KPMG (2015), Macquarie Equities Research (2016), The Economist (2015), Turner (2012),
Graham, Li, and Kruse (2016), IIF (2016), BCBS(2015f), ISDA, GFMA, and IIF (2015), ORX Association (2016), J. P. Morgan Cazenove (2015), Oliver
Wyman and Morgan Stanley (2015), The Association of German Public Banks (2016), Risk Control (2016), McKinsey (2015)
10
SIFMA (2015a)
11
Brooke et al. (2015), SIFMA (2015a), EBF (2015), EACB (2015)9© Oliver WymanixExecutive Summary

Post Crisis Basel Reforms

approaches vary significantly, with dynamic stochastic general equilibrium (DSGE) or generalized method of
moments (GMM) estimations tending to estimate lower impacts of the reforms. See Section 4 for more details.
It is important to note that some of the lending rate increases discussed above could be offset by a number offactors. Banks can reduce expenses, decrease expected credit losses through tighter loan conditions, restructurebusinesses, and take other capital actions. Additionally, there are a number of external factors that could mitigate
the impacts of reforms, including inherent offsets among reforms, changes to monetary policy, and reductions in
the return on equity required by equity holders due to the increased safety of the banks. The few studies estimating
the impact of these offsetting actions are discussed in further detail in Section 4.

DECREASED SUPPLY OF CREDIT
As a result of higher capital ratios, other technical changes increasing capital requirements, and changes in thedefinition of capital, banks may increase their credit standards and reduce their loan volumes, thus decreasing theamount of capital they have to hold for higher-risk loans. Additionally, customers could respond to higher loan
rates by reducing their demand for credit.
The literature we reviewed suggests that, as a result of a 1% increase in required capital ratios, lending volume inOECD countries would decrease by 0.3% to 8%, depending on the underlying macroeconomic model used, withan average decline of 2.6%. Since the impact is not necessarily linear, we cannot estimate the impact of the
cumulative increase in capital requirements without having access to the models used in the literature.
Overall, the decrease in availability of bank credit for both corporate end-users and retail customers, either due tohigher prices or lower supply, could impact the cost of capital for these end users and result in potentially lower
output.

DISTRIBUTIONAL IMPACTS
Additionally, there are a number of distributional consequences of the impact of these reforms. First, corporate
customers are likely to be impacted more than households, both through increased loan rates and in declines ofloan volumes. Small and Medium-sized Enterprises (SMEs) are expected to be particularly impacted as they are
more dependent on bank borrowing than larger firms. Second, banks will be affected by reforms in different ways
based on their geographic location, current practices (e.g. use of internal models), and business mixes. Finally,
emerging markets are likely to be impacted differently than developed markets. These issues are discussed in
Section 4.

CAPITAL MARKETSWe expect market changes caused by recent regulatory reforms to flow through to end users, resulting in adecrease in market liquidity and an increase in market volatility.

x© Oliver Wyman

Post Crisis Basel Reforms

Executive Summary

FIGURE C: OVERVIEW OF REGULATORY IMPACTS ON CAPITAL MARKETS
Constraints on entities subject toBasel rules

Impact on the activities
and change in behavior of
regulated entities

Impact on capital markets andend users• Higher capital requirements– Greater minimum capital ratios– Leverage ratio• Shrinkage in market making andtrading activities• Lower dealer capacity,
reducing market liquidity• Business restructuring and exits• Increased bid-ask spreads• Higher risk weights for
trading assets• Decline in securities
lending activities• Limits on the use of internal
models (FRTB)• Shift away from the repo market
for funding• Increased indirect transaction
costs due to higher priceimpact of large transactions• New liquidity and funding
requirements (LCR and NSFR)• Increased demand for High
Quality Liquid Assets• Margin requirement for noncentrally cleared derivatives• Higher borrowing costs• Higher market volatility
and increased instability
especially during stressedmarket conditions

CHANGES IN MARKET STRUCTURE AND BEHAVIOR OF MARKET PARTICIPANTS
Banks play a central role as intermediaries to facilitate liquidity in the markets through their market-making
activities. However, increases in capital and liquidity requirements have pressured the market-making businessmodel by increasing the cost of providing intermediation services and driving down profitability. In low margin
market making activities, the combined Leverage Ratio and NSFR costs are estimated to impact bank costs in the
60bps–110bps range for low margin market making activities.12
Banks’ balance sheets supporting traded markets have contracted by 50% in RWAs on a Basel III adjusted basis,
implying 25–30% in terms of total (non-risk weighted) balance sheets, since 201013. Table B shows historical andforecasted balance sheet reductions by product. This points to a significant reduction in dealers’ market making
ability, potentially leading to a major impact on market liquidity.
TABLE B: BALANCE SHEET REDUCTIONS, 2010–15 (% CHANGE)PRODUCT
Repo
Prime
Bonds, FX & commodities
Structured & securitized
Listed, flow & cleared products
Issuance & advisoryTotal

2010–15
Down ~50%
Up ~20%
Down ~25%
Down ~20%
Down ~20%~ Flat-25% to -30%

NEXT 3–4 YEARS
Down ~10%
Flat
Down ~10%
Down ~10%
Down ~5%
Down ~5%-5% to -10%

Source: Oliver Wyman and Morgan Stanley (2016)

While this situation may be indicative of a transition to a “new normal” in financial markets, and likely reflects
additional factors beyond regulation, there has been little or no academic study so far on where the new

12
13

AFME (2016)
Oliver Wyman and Morgan Stanley (2016)© Oliver WymanxiExecutive Summary

Post Crisis Basel Reforms

equilibrium lies and how markets and central banks can avoid any bumps in the road that may lead to more serious
systemic issues14.

INCREASE IN TRANSACTION COSTS
As a result of changes in dealer activity, end users may pay more to trade due to increased bid-ask spreads, havelowered ability to transact large trades as suggested by decline in average trade size, and take longer to complete
transactions.
Data on trade sizes does suggest that the ability to perform large transactions may have decreased. For example,
the average trade size for US treasuries, one of the most liquid markets, has shown a marked decline, more than 50
percent, (see Figure D) since 2010. Turnover ratios have also fallen significantly (see Figure E).
FIGURE D: AVERAGE TRADE SIZE IN US TREASURIES
4

US$ MM

3
2
1
0
2010

2011

2012

2013

2014

2015

Source: Trax (from GFMA, IIF and PWC (2015))

High grade US corp. bonds
12m traded volume/Amountoutstanding, Monthly
1.2

US Treasuries
Average daily traded volumes /Amount outstanding, Annual
0.14

UK government bonds
12m traded volume/Amountoutstanding, Annual
9

1.0

0.12

8
7

0.10

0.8

6

0.08

5

0.06

4

0.6
0.4

3

0.04

1

0.0

0.00

0

2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

0.02

2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

2

0.2

2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

Turnover ratio

FIGURE E: TURNOVER RATIOS

Source: MarketAxess , SIFMA, UK Debt Management Office14

Caruana, Kay, and Tucker (2016)xii© Oliver Wyman

Post Crisis Basel Reforms

Executive Summary

Analysis performed by the IMF in 2014 shows that the number of days required for liquidation of a US credit mutualfund has increased significantly post crisis (see Figure F)15. It is estimated that 50–60 days would be required for
liquidation of a high yield fund, compared to the 7 day limit for redemption payments.
FIGURE F: NUMBER OF DAYS FOR FULL LIQUIDATION OF US CREDIT MUTUAL FUNDS AND ETFS
7060

No. of days

50
40
30
20
10

2007 Q1
2007 Q2
2007 Q3
2007 Q4
2008 Q1
2008 Q2
2008 Q3
2008 Q4
2009 Q1
2009 Q2
2009 Q3
2009 Q4
2010 Q1
2010 Q2
2010 Q3
2010 Q4
2011 Q1
2011 Q2
2011 Q3
2011 Q4
2012 Q1
2012 Q2
2012 Q3
2012 Q4
2013 Q1
2013 Q2
2013 Q3
2013 Q4
2014 Q1
2014 Q20

US corporate bond total

US high yield

7-day limit for redemption payments

Note: The number of days to liquidate is the ratio of assets of mutual funds and ETFs (exchange-traded funds) per daily dealer inventories. Because
there are no data for US high-yield bond dealer inventories before April 2013, the high yield line assumes a constant ratio of this amount tototal corporate bonds before this date
Source: EPFR Global; Federal Reserve; and IMF calculations (from IMF (2014))

IMPACT ON SPREAD
With a decline in market liquidity, investors will demand a greater “liquidity premium” on bond spreads. As a result,corporates will find it increasingly expensive to obtain funding through the capital markets. As shown in Figure G,
spreads on US and Eurozone investment grade spreads have increased significantly since 2013. Although there has
been a reversal in this trend in recent months, spreads remain substantially elevated compared to the pre-crisis
period. This may be driven partially by lower market liquidity.

15

IMF (2014)© Oliver Wyman

xiiiExecutive Summary

Post Crisis Basel Reforms

FIGURE G: SPREADS ON INVESTMENT GRADE CORPORATE BONDS
700

Spread (Basis points)

600
500
400
300
200
100

US

Dec-2015

Dec-2014

Dec-2013

Dec-2012

Dec-2011

Dec-2010

Dec-2009

Dec-2008

Dec-2007

Dec-2006

Dec-2005

Dec-2004

Dec-2003

Dec-2002

Dec-2001

Dec-20000Eurozone

Source: Barclays

INCREASE IN MARKET VOLATILITY
The speed and extent of price movements in the capital markets is influenced by market liquidity. A large numberof participants with an ability to transact quickly and efficiently can ensure that price movements not aligned withthe market consensus are quickly nullified. Further, in a liquid market with a constant flow of transactions, largeblock trades would have a limited impact on price, resulting in lower price volatility.
There have been incidences of extreme movement in prices that may indicate structural illiquidity in some markets.
Examples of this include the “Taper Tantrum” in US treasuries in 2013, and the extreme fluctuation in European
sovereign bond prices in the first half of 2015:•

In October 2014, following negative news on the US economy, 10-year US Treasury yields dropped by 37 bps(“statistically 7 to 8 standard deviation move, an event that is supposed to happen once in every three billion
years or so”16), followed by a rebound to roughly the previous level, within a period of minutes. This
represented a very large move by historical standards in that market in a very short space of time.

•

In 2013, in response to news that the Fed might taper off its purchase of bonds in the markets more quickly
than expected, there was a rapid decrease in the price of governments bonds, which then impacted prices ofother bonds priced relative to government bonds.

•

In 2015, when the Swiss National Bank gave up its policy of capping the Swiss Franc – Euro exchange rate, thevalue of the Swiss Franc jumped by 30% within the first thirteen minutes of trading before partially reversing
the move over the course of the day. Some market observed believe that the extent of price movement would
have been more subdued in a more liquid market.

•

European sovereign bond prices fluctuated significantly in the first half of 2015. For instance, German 10-yr
government bond prices moved by 7–8% from peak to trough.17

16
17

J.P. Morgan Chase & Co. (2015)
Elliott (2015)xiv© Oliver Wyman

Post Crisis Basel Reforms

Executive Summary•

In 2015, rates in USD interest rate swaps dropped suddenly below corresponding Treasury yields, for the firsttime in more than 5 years.

•

In February 2016, Portuguese sovereign debt experienced a dramatic increase in yields to over 4.5%, thehighest since Portugal’s bailout exit in May 2014, despite stable economic fundamentals

OFFSETTING FACTORS
A number of factors may partially mitigate the impact of regulatory reform on end users. These include theexpansion of alternate providers of liquidity such as smaller dealers, hedge funds and high frequency traders aswell as growth in electronic trading. However, there are substantial limits to the ability of these alternative
providers and approaches to replace the reduced market making capacity of the major dealers. It should also be
noted that electronic trading platforms and high frequency traders cover only the most liquid instruments,
representing a fraction of the number of instruments issued by corporates and sovereigns.
Additionally, the impact on capital markets has not yet fully materialized and there is often limited,
quantitative evidence available to estimate the effects to date. The full impact has not yet materialized for atleast the following reasons:•Finalization of rules and full implementation of regulations is still in progress. Some of the key regulations have
not yet been implemented, are being phased in, or are still very new. Bilateral margin requirements, the Net
Stable Funding Ratio and the Fundamental Review of the Trading Book, for example, have not yet been
incorporated into national rules.

•

Unconventional monetary policies followed by many central banks have temporarily inflated market liquidity
and likely reduced volatility. These policies are not sustainable in the long run, so the benefits to market
liquidity should be temporary. The potential impact on the liquidity when these policies revert to normal could
be dramatic for the market.

•

Banks are still in the process of determining how to revamp their approaches in response to regulations,creating a delay in the resulting impact on market structure and liquidity.

•

Banks and large securities dealers are phasing in their increases in pricing and reductions in the supply ofservices, for both competitive reasons and as a result of internal structural processes that slow response times.
It should be noted that these moves could increase homogeneity of bank structures and concentrations of risk,
possibly leading to higher systemic risk.

•

Market participants have adjusted to the new market conditions in a number of ways, including investors
breaking up trades into smaller pieces and lengthening entry or exit timeframes, but this may not besustainable in the long term and may exacerbate market illiquidity, volatility, and stability during stressconditions.

Any reversal of these trends would likely increase other measures of illiquidity in markets, meaning that underlying
market liquidity may be worse than it currently appears.

EXAMPLES OF ISSUES WITH BASEL REFORMS
A number of concerns have been raised by academics and market participants about the calibration andimplementation of the reforms. These generally fall into four types of potential issues: 1) potentially inconsistent setof rules; 2) potentially mis-calibrated rules; 3) potential duplication or interaction of rules; and 4) potential
unintended consequences of rules.
The table below summarizes the issues discussed in Section 1 at a high level. Refer to that section for moredetailed discussion.

© Oliver Wyman

xv

Executive Summary

Post Crisis Basel Reforms

TABLE C: SUMMARY OF POTENTIAL ISSUES WITH BASEL REFORMS
TYPE OFPOTENTIAL ISSUE
Consistency

Mis-calibration

POTENTIAL ISSUE
Conflicting incentives of theleverage ratio versus other capitaland liquidity ratios
Inconsistency of incentives
created by structural and liquidity
reforms
Calibration of capital ratios

Calibration of TLAC

Calibration of the leverage ratio

Calibration of LCR
Calibration of sovereign debt
weights
Calibration of mortgage weights
Calibration of credit conversion
factors (CCF)
Calibration of Standardized
Approach leading to reduction inrisk sensitivity

Calibration of NSFR

xvi

DESCRIPTION
Risk insensitive leverage ratio produces divergent
incentives for the composition of a bank’s portfolio fromthe incentives produced by risk-sensitive capitalrequirements
Segregation of businesses due to structural reform could
impact consolidated entity’s stable funding, and could becreating conflicting incentives for banks
Limited consensus on optimal levels, especially in light of
expected RWA increases from current workstreams, atboth a consolidated and granular (activity) levels
The impact of TLAC requirements including internal TLAC
arrangements should be assessed further to ensure
appropriate calibration in the context of the cumulative
impact of TLAC, capital requirements, and expected RWA
increases from current workstreams
The LR could be the binding constraint for a large share ofbanks, potentially going beyond the intention of many
that it be a backstop; calibration needs also to be assessedat the activity level and how it may impact strategic
decisions, as, for example, the LR may be the binding
constraints for fully collateralized trades and market
making on government bonds
Assets included in and excluded from HQLA definition
may be mis-calibrated based on underlying risk
Standardized zero risk weight for sovereign debt
underestimates underlying risk in varying degrees
Mortgage risk weights could be misaligned with
underlying risk factors
Calibration of CCF for certain exposures (e.g. off-balance
sheet exposures, trade finance, infrastructure) could be
too punitive compared to historical experience
Calibration of proposed SA measures reduces risk
sensitivity for some asset classes and may create
distorting incentives; may also, in combination withcapital floors, duplicate the “backstop” role of theleverage ratio
NSFR requirements may impose unnecessarily high costs
on certain derivative trades and linked transactions© Oliver Wyman

Post Crisis Basel Reforms

TYPE OFPOTENTIAL ISSUE
Duplication orinteraction ofcoverage

Executive Summary

POTENTIAL ISSUE
NSFR, LCR, and US G-SIB buffer(addressing maturity mismatchand short-term wholesalefunding)
Capital floors

Step-in risk

CET1 ratio, leverage ratio, andstress testing

Unintended
consequences

Shadow banking

Procyclicality
Leverage ratio incentives fordeposits (held at central banks)

Impacts of liquidity reforms on
overall market liquidity
Impacts on market structure

HQLA Alternative liquidity
approaches (ALA)

Distributional consequences

DESCRIPTIONUS G-SIB buffer, and potentially the inclusion of G-SIB in
CCAR addresses liquidity and funding issues alreadyaddressed by NSFR and LCR
Capital floors may duplicate “backstop” role of theleverage ratio and are not consistent with robust
qualification test for internal models
Proposed conceptual framework for step-in risk could be
duplicative of other measures that have alreadyaddressed the underlying issue, e.g. prohibition ofsponsor support for money market funds
CET1 ratio, leverage ratio, and stress testing may each bea binding constraint depending on the year, which may
create complexity in banks’ determination of their binding
constraint and cause inconsistency in internal capital
allocation and internal transfer pricing mechanisms withinbanks
Regulatory reforms could push an increasing amount offinancial activity to a less regulated “shadow banking”
sector, thus potentially increasing systemic risk
Countercyclical capital buffer may not sufficiently address
cyclicality and could potentially be procyclical in practice
Leverage ratio creates a disincentive for custody (andother) banks to accept cash deposits, especially during a“flight to safety” in a crisis; leverage ratio may also create
other dis-incentives for products or activities, such as OTC
clearing
While liquidity reforms improve liquidity at the individualbank level, they may lead to a decline of overall market
liquidity
Reforms create incentives for alterations to market
structure, such as market or client exits, possibly limiting
provision of financial services
Low supply in government debt in some geographies has
led to ALAs that are not fully linked to central bankliquidity policies, which may reduce central bank ability torespond to a crisis
Reforms will impact some products or services more thanothers and may consequently impact end-users in waysthat were not intended. For example, corporate
customers and SMEs will be more impacted by lending
rate increases, primarily due to capital weight differentials

The number of concerns raised above point to the fact that even though regulatory reforms likely have hadsubstantial benefits for society in terms of increasing financial stability, there is potential for improvement. It is now
up to regulators to review the calibration and consistency of reforms and make a well-informed decision onwhether the current set of reforms can be improved.
Further research will be required to fully understand the impact of reforms. First, additional rigor could be applied
to evaluating costs and benefits of financial reforms at a higher level of granularity: for example, the impact ofliquidity reforms on a trading desk or product level. It will be critical to understand reforms’ impact on different
segments of the market to identify potential areas of undue burden or impairment of the efficient functioning of themarket. Second, the empirical research to date has focused primarily on the impact of capital, and to a lesser extent,© Oliver Wyman

xviiExecutive Summary

Post Crisis Basel Reforms

liquidity regulation and the joint impact thereof on banks. Other reforms, for example margin requirements, havereceived less attention and should be evaluated further. However, until all these reforms are finalized and fully
implemented, the full impact cannot be determined, though it would be desirable, as a matter of policy, to addresssome of the perceived negative impacts. Third, a holistic study of the RWA increases that could result from themost recent set of reforms is necessary. Fourth, the interactions among reforms will require additional attention tounderstand potentially competing incentives or countervailing impacts. This will become increasingly important as
the reforms currently under revision are implemented. Finally, study of the impact of reforms across multiple
jurisdictions would also be beneficial, as research to date has focused primarily on developed markets, especially
the US and Europe.18
The rest of the report is structured as follows:•

In Section 1, we set the scene by providing an overview of the Basel Committee’s post-crisis agenda andhighlight the scope of issues covered in this report.

•

In Section 2, we examine the important question of how the impact of the reforms can be measured,particularly its effects on bank lending and financial markets. In particular, we investigate the relevantmeasurements of costs and benefits.

•

In Section 3, we discuss the impact of post-crisis regulatory initiatives on the internal capital and liquidity
allocation and pricing mechanisms at financial institutions.

•

In Section 4, we discuss the overall impact of the post-crisis Basel Committee initiatives on the lending
channel.

•In Section 5, we discuss the overall impacts of the post-crisis Basel Committee initiatives on capital markets
including constraints on financial markets liquidity.

•

In Section 6, we focus on the overall coherence of the post-crisis Basel Committee initiatives and TLAC and thepotential for inconsistency, mis-calibration, and unintended consequences.

18

BCBS (2016h)

xviii© Oliver Wyman

Post Crisis Basel Reforms

Basel Committee’s post-crisis responses

1. BASEL COMMITTEE’S POST-CRISIS RESPONSES
The intent of the Basel Committee and the FSB is to reduce the frequency of and damage from financial crises while
minimizing the cost in non-crisis years that results from the added safety measures. This concept of a trade-off
between safety and economic efficiency is a crucial one, because the core Basel III reforms raise the funding andoperational costs for the affected financial institutions and have significant impacts on end-users. There are someoffsets that come from the benefits to the financial institutions themselves of greater safety and from potentialchanges to their cost structures, but a substantial portion of the costs are likely to flow through to customers andraise the cost of funding to the economy.
There are other important effects that are examined in this paper, but the most crucial impacts are on (1) lending
conditions and (2) the liquidity, stability, and overall functioning of financial markets, given the sheer size of thesefactors for the economy as a whole. This study is focused on estimating the impact of the following reforms:
TABLE 1.1: BASEL III REFORMS AND ONGOING WORKSTREAMS19
BASEL III• Quantity and quality of capital (minimum capitalrequirements and composition thereof)• Regulatory buffers (capital conservation buffer andcountercyclical buffer)• Counterparty credit risk capital requirements(Standardized approach for measuring counterparty
credit risk exposures, margin requirements)• Leverage ratio• Liquidity reforms (Net Stable Funding Ratio (NSFR)
and Liquidity Coverage Ratio (LCR))• Measuring and controlling large exposures

ONGOING AND RECENTLY COMPLETEDWORKSTREAMS• Standardized approach for credit risk, andoperational risk
• Capital floors• Constraints on use of internal models• Revised Leverage ratio• Interest rate risk in the banking book (IRRBB)• Fundamental review of the trading book (FRTB)• Securitization• Haircut floors for Securities Financing Transactions• Total Loss-Absorbing Capacity (FSB regulation)• Stress testing (primarily jurisdictional regulation)• Step-in risk

Note: See Appendix A for more detail on regulations/standards covered within scope of this report.

Evaluating regulatory impacts on credit pricing and availability and on the extent to which financial institutions
provide market liquidity, and at what price, requires an understanding of how banks and securities dealers allocate
capital, liquidity, and other scarce financial resources within their institutions. This is an important area of economic
analysis that has largely been neglected by academia and many policymakers, so this paper will also extend theliterature by describing these processes and some implications for judgments about the effects of regulation.
This report examines the important question of how the impact of the reforms can be measured. That is, what
are the relevant measurements in terms of costs and benefits? The most critical of these measures boil down to
two sets:
Effects on lending: changes in the price and supply of credit provided by financial institutions coveredby the Basel rules. In addition, tightened rules on these institutions compared to other credit providers
could produce a potential for concentration of exposures in parts of the financial sector that are notregulated or regulated only lightly (often referred to as “shadow banks”), which has important
implications in its own right.

19

List of issues covered by this report is non-exhaustive of the full list of Basel reforms since the crisis© Oliver Wyman

1Basel Committee’s post-crisis responses

Post Crisis Basel Reforms

Effects on capital markets: changes in bid-ask spreads, price movements due to large purchases/sales,
overall volatility in both normal and abnormal times, changes in pricing for new issuances, and changes inwhich clients are served with which products. These have implications for market structure and market
participants.
This report considers the findings of studies by academics, officials, and other industry observers, supplemented
with additional analysis where market data is available. Additionally, quantitative studies conducted by the BaselCommittee and by the industry are also discussed, as relevant. Studies published to date have been primarily
focused on the original Basel III reforms, and as such the baseline estimates discussed in this study are focused on
the impact of reforms such as increases in capital and liquidity requirements. The specific studies selected for thisreport are discussed in Section 3 and Section 5.
Critically, the studies described above omit an evaluation of ongoing Basel workstreams. Following the financial
crisis of 2008, the BCBS developed the Basel III framework but indicated that further work was required to help
develop the resiliency and the strength of the financial system, particularly in the event of financial stress. Basel set
up workstreams to address areas of concern, some of which are still outstanding, and leveraged QIS data andindustry comments in the development of the final rules. Broadly, the initiatives seek to not only better account forrisk in the financial system, but also aim to improve simplicity and comparability of regulation, particularly throughadjustments to the standardized and internal modelling approaches.
It is important to note that the Group of Central Bank Governors and Heads of Supervision (GHOS) has stated thatthe Basel “Committee will focus on not significantly increasing overall capital requirements.”20 While it is not thestated intent of the regulators to substantially increase capital requirements in aggregate across banks, but rather
to improve identification of risks and reduce variability of measures across banks, ongoing Basel workstreams will
have impacts on lending and capital markets channels beyond the effects of other Basel III reforms. In fact, theseongoing workstreams are expected to increase, or “inflate”, banks’ RWAs by revising the approach to calculation of
RWAs and, consequently, increase capital requirements.
Quantifying the impact of these ongoing and recently completed reforms is challenging, primarily due to the factthat calibration is not yet complete. For example, the calibration of the capital floors could range significantly andwill interact with the final rule on the limitations on use of internal models.
The BCBS itself has conducted reviews of the estimated impacts of reforms such as FRTB. In a November 2015
impact analysis of FRTB, they noted that “compared to the current market risk framework, the proposed market
risk framework would result in a weighted average increase of 74% in aggregate market risk capital charges (basedon the sample of 44 banks).” In its latest study, IIF (2016) shows somewhat smaller estimates which point to anincrease in market risk capital of 40–50% (if 100% of desk approvals given, otherwise, a larger increase) while ISDA,
the GFMA, and the IIF found, in a joint study, that the proposed FRTB framework’s capital charge using the SA
methodology is 4.2 times the total market risk capital that firms were holding at that time, though the analysis was
conducted prior to the January 2016 version of the market risk requirements. Estimates of operational risk RWA
increases appear close to 60%: IIF (2016) indicates that the shift from AMA to SMA will produce a median increaseof 60% in operational risk capital while ORX Association (2016) estimates that the mean change as a result ofreforms will be a 61% increase of operational risk capital requirements.21
A number of other market participants and industry analysts have evaluated the impact of multiple reforms onbanks. As discussed above, the exact impact of the reforms is not yet clear in part due to the fact that they have not
all been finalized or implemented, leading to a wide range of estimates, which indicate that the lower bound of
RWA inflation will be ~10–30%. The results are summarized in Table 1.2 below.
20
21

2

BIS (2016m)
BCBS (2015f), Risk Control (2016), IIF (2016)© Oliver Wyman

Post Crisis Basel Reforms

Basel Committee’s post-crisis responses

TABLE 1.2: SUMMARY OF STUDIES EXAMINING RWA INCREASES
SCOPE
FRTB

STUDY
IIF (2016)FRTBBCBS (2015f)

FRTB

ISDA, GFMA, and IIF(2015)

Operational risk (AMA to SMA)

IIF (2016)

Operational risk (move to
SMA)

ORX Association(2016)

Operational risk, market risk,sovereign risk, credit risk RWA
increases, Danish
compromise, AFS exclusion
Operational risk, credit risk,
market risk, capital floors

J.P. Morgan
Cazenove (2015)

FRTB and standardized capital
floorsOliver Wyman andMorgan Stanley(2015)
Keenan, O. andSpick, M. (2015)(Deutsche Bank)

Revisions to standardized
approach, Market risk – FRTB,
operational risk – revisions tosimpler approach, capital
floors27
Risk floors and convergence ofinternal models (Internal
Rating Based Approach) with
the Standardized Approach(SA) – includes credit risk;
FRTB

Graham, Li, andKruse (2016)(Autonomous)

Macquarie Equities
Research (2016)

ESTIMATE
Increase in market risk capital of 40–
50%, if 100% of desk approvals(otherwise, a larger increase), or 4–
5% increase in total capital22
74% weighted average increase of
market risk capital or ~7% increase intotal capital23
Capital charge is 4.2 times the total
market risk capital that banks were
holding in 2015, or ~ 42% increase intotal capital24
Median increase of 60% of
operational risk RWA, or ~12%increase in total capital25
The mean change would be anincrease of 61% for operational risk
capital requirement, or ~12%increase in total capital26
11.6% jump in RWAs

FOCUS

Total RWA inflation of 18% (9%operational risk, 6% credit risk and
3% market risk), when a RWA floor of
60% is considered, RWA inflation
increases from 18% to 23%
10–30% increase in risk weighted
assets (wholesale banking)Leading 40
European banks

Sector RWA inflation of 14% inbaseline scenario

European banks

More than 20% RWA inflation

ASEAN andmultinational
banks

Sample of 44
banks
Sample of 28
banks

Europe’s 35
biggest banks

Wholesalebanking

22

IbidAssuming market risk RWA ~10% of total RWA
24
Ibid
25
Assuming operational risk RWA ~20% of total RWA
26
Ibid
27
Other measures such as Danish compromise are discussed
23© Oliver Wyman

3Basel Committee’s post-crisis responses

Post Crisis Basel Reforms

SCOPE
Higher minimum leverage
ratio, less reliance on internal
models, revised standardized
approaches, capital floor,
stress testing, pillar 2, liquidity,
disclosure28
Revised standardized
approach for credit risk andoperational risk, FRTB, capital
floors, securitization, IRRBBBCBS 347 proposals (Revisions
to the Standardised Approachfor credit risk)
Revised standardized
approach for credit risk, andoperational risk, capital floors

STUDY
KPMG (2015)

ESTIMATE
Increase of ~25% of CET1 capital

FOCUS
Major UK banks

The Association ofGerman Public Banks(2016)

Increase RWA levels by at least 30%

German banks

Risk Control (2016)

39% increase in total bank capital

Swiss market

McKinsey (2015)

German banks

Revised standardized
approach for credit risk, andoperational risk, FRTB, capital
floors

McKinsey (2015)

Up to ~80% total RWA increase(“assuming risk weights of IRB
portfolios to be floored at 80% of theSTA”), and not including market risk
RWA inflation~50–100% increase29 in total RWA(“credit-risk RWA per portfolio may
increase by 10 to 80 percent, while
operational-risk RWA can more thandouble”, “market risk RWA may
increase by around 65 percent on
average across the industry”)30

European banks

As noted above, some studies estimate very significant increases of RWA requirements, ranging from ~10–100%.
Most studies fall within the range of ~10–30%, which we estimate to be the lower bound of RWA inflation. However,this could prove to be an underestimate, pending final calibration of reforms, absent steps by the BCBS to mitigate
the total impact. More detailed analysis commissioned by the Institute of International Finance and theInternational Swap Dealers Association, based on a detailed quantitative analysis of bank-level data, has reportedly
shown even higher effects than the top of the 10–30% range. According to Politico31, the study shows increases in
RWA of roughly 70% on average in some businesses. This would clearly have substantial implications for banks andtheir customers, although it is difficult to directly compare this to the 10–30% range for the industry as a whole
shown in the studies below.
Banks could react to these reforms in two ways: raise their CET1 levels to offset the increase in RWAs, if they do nothave sufficient CET1 already, or shrink the size of their RWAs through balance sheet reduction. We assume thatbanks increase their CET1 capital and show the estimated ranges of impact should RWAs increase by up to 30% as
a result of these reforms, based on our estimate of lower bound of RWA inflation.
The biggest drivers of this increase in RWAs would be the revisions to the SA for credit risk, FRTB, the revised
approach to operational risk, limitations on the use of internal models, and capital floors. In essence, the impact ofthese ongoing workstreams could be multiplicative (as discussed in Section 5) because these reforms will make it
more expensive for banks to meet their capital requirements. The composition of a typical large bank’s RWA,
according to a 2016 IIF study, is shown below.

28

Includes all regulatory requirements beyond Basel III
Assuming market risk RWA ~10% of total RWA, operational risk RWA ~20% of total RWA, credit risk RWA ~70% of total RWA
30
Does not reflect the potential impact of the application of the standardized approach for unapproved desks or as a floor
31
POLITICO Pro Morning Exchange, July 20, 201629

4

© Oliver Wyman

Post Crisis Basel Reforms

Basel Committee’s post-crisis responses

FIGURE 1.1: COMPOSITION OF A TYPICAL LARGE BANK’S RWA

US GSIBs excluding “custody banks”

US “custody” GSIBs (BNYM & SS)

European GSIBs

Japan GSIBs

0%

20%

40%

60%

Credit risk (including CVA, CCR, Equities risk)
Operational risk

80%

100%

Market risk
IRRBB

Source: Trax (from GFMA, IIF and PWC (2015))

Credit risk. According to industry research, proposals dealing with credit risk are likely to account for the bulk of
the potential increase in RWAs. This is intuitive, as credit risk RWAs represent the largest share of a bank’s RWAs. In
particular, credit weights of medium and large corporates are likely to see an increase. This may further increase
the lending spread for corporates, as will be discussed in further detail in later in this section.
Operational risk. Changes to operational risk standards could also increase operational risk RWAs by a significant
amount, second in scale to changes in credit risk RWA due to the fact that operational risk RWAs are the second
largest share of bank RWAs for a typical bank (as per figure above). Estimates discussed above point to a ~60%
increase in operational risk capital.32
Market risk. Revisions to market risk standards will also increase RWAs. Estimates for the increase in market risk
RWAs and, consequently need for capital, range between around 40% to well over 100%. The range is particularly
wide as at the time of the writing of this report it was difficult to predict the impact of internal model eligibility tests(a number of banks have not been able to pass such tests across all desks, driving significant systemredevelopment) and to quantify the impact on non-modellable risks (due to lack of data on such risks, which could
result in a number of products being subject to relatively punitive stress tests). Additionally, there are likely to be
distributional consequences for the increase in RWAs for market risk, as structured product, traded credit, andcovered bonds are likely to be some of the hardest hit products.
Other Basel reforms. Limitations on use of internal models and the introduction of floors could have a significant
impact on RWA, though impacts are likely to be highly uneven across the industry due to individual bank utilizationof internal models (distributional consequences will be discussed later in this section). As banks move towards
usage of standardized modeling approaches and apply floors, the risk weighted assets of banks using internal
models are likely to increase significantly.33
TLAC. In addition to the factors discussed above, TLAC is also likely to have a significant impact, particularly on thelending channel. For example, Deutsche Bank “expect[s] a direct impact of TLAC on the broader economy in terms
32
33

BCBS (2015f), Turner (2012), Macquarie Equities Research (2016), Keenan and Spick (2015), Risk Control (2016).
Macquarie Equities Research (2016), The Economist (2015), Keenan and Spick (2015)© Oliver Wyman

5Basel Committee’s post-crisis responses

Post Crisis Basel Reforms

of increased funding costs and the resulting effect on lending availability and pricing.”34 The extent of the impact is,of course, in question, and will be discussed in further detail in Section 4
The cumulative impact of all post-crisis Basel reforms and TLAC requirements on funding rates is not yet fully clear
due to multiple factors as discussed above. The calibration of some of these reforms, as well as interactions withother reforms, are discussed in further detail in Section 5. Comprehensive QIS studies of new proposals, as well as
the aggregate reforms, are necessary to understand the full implications of the reforms.
In addition to any inherent trade-off between safety and cost of Basel reforms discussed above, the complex web ofrules published by Basel and other governing institutions has introduced the risk of unexpected interactions andimplementation challenges of these rules.
Figure 1.2 illustrates the interconnectivity of proposed and finalized rules (partial list) on the broad financial system,
including rules both inside and outside the scope of this paper. This graph is illustrative, and does not include allconnections and all potential conflicts between regulations.
FIGURE 1.2 COMPLEX WEB OF REGULATIONS
1. Regulators
Multiple conflicting
objectives, different
political processes

EuropeanCommission
BCBS

2. Post-crisis regulation
Vast, thousands of pages, high impact, overlapping, conflicting,different across regions

Basel 2.5/III

Basel 2.5/III

SEC
Fed
FCA/PRAG20FSBOthers

Banks

FRTB

FRTB

Front office

IRRBB

IRRBB

Treasury

Capital floor
CFTC

3. Banks and the financial system
Revolutionizes wholesale business, newoperating models, front/mid/back officeredesign, disentangle and understandregulation to adapt

Capital floor

Risk

Standardized approach

Operations

TLAC

TLAC

Technology

gSIFI

gSIFI

Standardized approach

Collins Amend.

Collins Amend.

RRP living wills

RRP living wills

Retail ringfencing

Retail ringfencing

Volcker rule

Volcker rule

OTC execution

OTC execution

OTC clearing

OTC clearing

Business conduct

Business conduct

Skin in the game

Skin in the game

Rating agencies

Rating agencies
Connection

Exchanges
Clearinghouses
Data providers
Buy side
Corporates
RetailWithin the scope of this paper

Potential conflict

Source: Oliver Wyman analysis

34

6

Deutsche Bank to Svein Andresen, General Secretary of the Financial Stability Board (2015)© Oliver Wyman

Post Crisis Basel Reforms

Basel Committee’s post-crisis responses

The scope and extent of the post-crisis changes in banking regulation opens the door for potential calibration andimplementation challenges, along with some unintended consequences, the details of which will be discussed in
Section 6.
These errors may be particularly likely given that there are multiple layers of regulation, the impact analysis ofwhich has frequently been reviewed in isolation. This is further complicated by the interactions of Basel reforms
with a number of jurisdictional regulations, as listed on pages 8-9.
The findings of this paper fall into the following areas:
An analysis of the quantitative impacts of the Basel rules on credit pricing and availability, market
liquidity and other important variables. Since the literature shows a wide range of estimates for theseeffects, the analysis examines the key differences in assumptions that lead to such different results, giving
the reader a greater ability to judge the likelihood that one approach is more accurate than another.
A review of qualitative considerations and other practical difficulties raised in regard to various Baselrules. Experts have raised concerns about the practicality of a number of aspects of various rules (e.g.
deposit incentives created by the leverage ratio), some of which are listed in brief in this paper.
An analysis of competing incentives in key areas of Basel rules, such as the objective of certain rules toencourage less risky lending versus the incentives created by other rules (such as the leverage ratio andfloors on risk weights) that encourage relatively riskier lending. These competing incentives can beillustrated quantitatively in many cases, although overall impact analysis is difficult.
Other concerns about calibration and unintended consequences. There are areas whereknowledgeable observers have raised concerns about the calibration of effects on various market
segments, but where it is difficult to do a full quantitative impact analysis. For example, some regulatory
concerns are addressed by multiple reforms, leading to the possibility of overly punitive impacts forcertain products, but where it is too difficult to quantify the overall impact of these disparate efforts.
These issues will be discussed in the context of Basel rules since the financial crisis and TLAC. Please refer toAppendix A for a brief summary of rules included in this study. This report does not include a detailed analysis of
specific jurisdictional implementations of Basel reforms or bank structure regulation.

© Oliver Wyman

7

Basel Committee’s post-crisis responses

Post Crisis Basel Reforms

ADDITIONAL JURISDICTIONAL REFORM IMPACTING BANKS
In addition to the Basel and FSB reforms implemented since the crisis, banks are responsible for complying with anumber of jurisdiction-specific reforms. The list below is a non-exhaustive summary of key regulations and potential
for overlaps with Basel reform.
UNITED STATES REGULATIONCATEGORYREGULATORY TOPICPRIMARY ORIGINSDESCRIPTION

Dodd-Frank WallStreet Reform andConsumerProtection Act(“DFA”)• Various rules for US banks and foreign banks operating in
the US• In particular, mandatory creation of an Intermediate
Holding Company (IHC) to own all US subsidiaries; IHC
subject to Federal Reserve regulation• Possible interactions with GSIB requirements

DFA• Annual stress testing requirements, with mid-year“light” version• Could serve as a “binding constraint” for banks (vs. CET1or LR)

DFA• Requirement for “living wills” (i.e. recovery andresolution plans)• Potential for overlap with TLAC and stresstesting requirements

Volcker RuleDFA

• US ban on prop trading and hedge fund/private equity
investments for deposit taking institutions

OTC derivatives
reformDFA, BCBS• Shift towards Swap Execution Facilities (SEF)/OrganizedTrading Facilities (OTF), mandatory central clearing,increase in pre-trade and post-trade transparency• Potential for overlap with derivatives andsecuritization regulations

Securitization risk
retention

DFA• Risk retention requirements for securitization
issuers/originators• Potential for overlap with derivatives andsecuritization regulations

Compensation/
GovernanceDFA• Prohibition of compensation schemes that encourage
inappropriate risk taking

Heightened
expectations

DFA• Heightened expectations for Board oversight, personnel
management and risk appetite

Consumer Financial
Protection Bureau

DFA• New, independent branch of the Federal Reserve created
to develop and enforce consumer protection rules

Mortgage reformDFA• Customer protection rules against nonsustainable lending

ENHANCED
PRUDENTIAL
STANDARDS

CAPITAL

CCAR and DFASTRECOVERYAND
RESOLUTION
PLANS (RRPS)
MARKET
REFORM

BUSINESSPRACTICESCONSUMERPROTECTION

8© Oliver Wyman

Post Crisis Basel Reforms

Basel Committee’s post-crisis responses

ADDITIONAL JURISDICTIONAL REFORM IMPACTING BANKSEUROPEAN REGULATIONCATEGORYREGULATORY TOPICPRIMARY ORIGINSDESCRIPTIONCAPITAL,
LIQUIDITY
AND
LEVERAGEECB Single
Supervisory
Mechanism andstress testing

ECB, Bank ofEngland (BoE), EBA• ECB became lead supervisor of largest Eurozone banks in
Nov 2014• Stress testing requirements by multiple agencies (Bank ofEngland, EBA)
• Could serve as a “binding constraint” for banks (vs. CET1or LR)

BoE, BRRD• Recovery and resolution requirements from Bank ofEngland, EU Single Resolution Mechanism (annual
RRP requirement)• Potential for overlap with TLAC and stresstesting requirements

OTC derivatives
reform

EMIR, MiFID II• Central clearing of standardized Over the Counter (OTC)
derivatives, reporting requirements & post traderisk management• Mandatory trading on multilateral platforms• Infrastructure access and neutrality, mandated
trading platforms• Potential for overlap with derivatives andsecuritization regulations

Ring-fencing

ICB, Vickers,
Liikanen• Mandatory ring-fencing of retail business, withindependent funding, capital and operations• Liikanen proposals to ring-fence trading book
• Potential for interaction with liquidity reforms

Compensation

CRD IVBoE consultation• Compensation reforms: bonus caps, payout mechanisms,
clawbacks; EC challenges on variable allowances• Personal accountability of executives

Conduct

FCA conduct
agendaFair & Effective
Markets• Continuing implementation of Financial Conduct
Authority (FCA) principles-based regulation• Evolving FCA expectations on pre-sale/sale/postsale practices

MiFID II
MiFIR• Broad drive toward improved investor protection andcontrols mechanism• Precise definitions for some areas of conduct• Pre and post trade transparency (wide a range of topics
covered by MiFID II, including definitions of products,
liquidity, etc.)

RRP/SINGLERESOLUTIONMECHANISM

MARKET
REFORM

BUSINESSPRACTICESCONSUMERPROTECTION

As stated previously, the list of regulations discussed above is non-exhaustive. Banks face a number of additional
regulations such as tax regulations, disclosure requirements, etc.
Jurisdictional implementation is out of scope of this report, and as such will not be discussed in significant detail.

© Oliver Wyman

9Post Crisis Basel Reforms

How can regulatory impacts be measured?

2. HOW CAN REGULATORY IMPACTS BE MEASURED?
Analysts have used a number of approaches to measure the impact of financial regulations on the financial industry
and the wider economy. In evaluating these, it is useful to step back and review the role of the financial system insociety and consider the potential benefits and costs, in broad terms, of recent regulatory reforms undertaken by
the Basel Committee.

2.1.

ROLE OF THE FINANCIAL SYSTEM IN SOCIETY

The financial system principally plays the following important roles within the economy:
Credit allocation: acting as the primary source of credit for consumers and businesses that do not havedirect access to capital markets, Banks also facilitate efficient allocation of capital by monitoring
borrowers.
Financial market functions: operating and supporting debt, equity, foreign exchange, commodity, andother financial markets. This includes activities as market makers, where dealers use their own capital tosupport trading activities by their customers; as underwriters of new issuances of debt or equity; and theprovision of other services, such as clearing transactions.
Maturity transformation: transforming short-term deposit funding into long-term loans, by providing
savers with the ability to make deposits that are safe and can be withdrawn on short notice and using theaggregate stability of these deposits to fund the medium and long-term projects that drive economic
growth. Similarly, banks provide liquidity insurance to households and businesses through lines of credit.
Payment services: enabling the efficient flow of money across the economy, principally between buyers
and sellers of products and services.
Pooling of savings: accepting funds from numerous households and businesses to maximize their returns
and minimize risk by achieving efficient scale of operation.
Risk mitigation: providing insurance, futures, swaps, options, and other products that allow households
and businesses to hedge their risks.
Advice and other services: providing financial advice, including strategic advice to businesses, and amyriad of other finance-related services.
Although it is difficult to quantify the total contribution of financial institutions to economic growth, it is clear that
finance has a major effect on the wider economy. Efficient and effective lending and capital markets are importantdrivers of investment, economic growth and financial stability. The global equities and fixed income markets are
powerful sources of wealth creation, capital formation, and economic growth. However, the strength of thesemarkets is dependent on the ease with which investors can buy or sell securities. Financial models and the degree
to which banks provide each of the aforementioned services differ by jurisdiction. For example, European
corporates rely more on bank lending for financing than their American peers (this, and additional differences, will
be discussed in Sections 1 and 1). As such, impacts of the same regulatory reforms or other drivers of change forthe financial markets will differ across jurisdictions. Regardless of jurisdictional differences, the ability of financial
institutions to provide these services is clearly critical.
Problems in the financial sector, including financial crises, demonstrate this importance most clearly. The economy
suffers harshly when finance is unable to play its proper role. Banks play a critical role in maintaining wellfunctioning markets and depend on efficient funding to provide these services.

© Oliver Wyman

11How can regulatory impacts be measured?

Post Crisis Basel Reforms

The post-crisis regulatory initiatives are mainly aimed at increasing the resilience of financial institutions andmarkets to shocks such that they can continue to function effectively during stress periods. However, while
endeavoring to reduce the frequency and damage from financial crises, regulation must also avoid excessively
hampering the critical functions of financial institutions. In particular, the impact of regulatory reforms should not,to an undue degree, impact the ability of banks to provide credit and thus potentially stifle economic growth.
Additionally, market structure and market efficiency should not experience material collateral damage and market
liquidity and stability should not be harmed by excessive restrictions on financial institutions in their roles as market
makers. Financial stability and financial functionality need to be appropriately balanced in all cases to avoid what
George Osborne, the UK’s Chancellor of the Exchequer, has referred to as the “financial stability of thegraveyard,”35 while also avoiding the excessive fragility that was so damaging in the recent crisis.

2.2.

BROAD AREAS OF POTENTIAL IMPACTS

The Basel reforms primarily impact two broad areas: traditional lending markets and capital markets, both of which
are the focus of this study. There may be impacts on other services, e.g. advisory services, but these are outside of
the scope of this study. The analytical literature evaluates the impacts on the lending and capital markets byconsidering a number of potential or actual responses by banks to strengthened regulatory requirements.36
Absorbing costs by lowering returns to shareholders. Most of the Basel reforms increase funding orother costs for banks. In the long run, financial institutions could only absorb any incremental costs ofregulation if the returns to shareholders remain at or above the minimum required by investors.
Otherwise, the sector will shrink as shareholders withdraw their capital, unless there are offsetting factorsthat make shareholders accept a lower return. While shrinkage of the sector may be a desirable outcome
to some, it is certain that it would also produce adverse consequences for the economy. It is important tonote that some argue that the Modigliani-Miller theorem shows that there are no costs to the banks fromhigher capital (see box on page 13 for more details). In reality, as explained below, we believe it is clearthat the theorem only partially applies, leaving significant costs to be dealt with by the banks.

35
36

Parker and Masters (2011)
The bank responses to strengthened requirements are adopted from Elliott, Salloy, and Santos (2012). Some of the responses were also discussed in
IIF (2011), ECB (2015), AFME and PwC (2014c), Kashyap, Stein, and Hanson (2010), Hancock and Wilcox (1994), Nier and Zicchino (2005),
Gambacorta and Mistrulli (2004), Berrospide and Edge (2010), and De-Ramon et al (2012).

12© Oliver Wyman

Post Crisis Basel Reforms

How can regulatory impacts be measured?

MODIGLIANI-MILLER (M-M) THEOREM
In their seminal paper, Modigliani and Miller (1958) show that, under idealized conditions, it does not matter what
proportion of a firm’s funding comes from equity rather than debt, that is, a firm’s cost of funding is invariant to themix of funding. Adding more equity makes a firm less risky and reduces the cost of each unit of equity or debt by anamount that exactly offsets the switch to an otherwise more expensive mix of funding. This fundamental theory offinance is the core reason some theorists and their followers argue that there is no economic cost to forcing banks tofund themselves much more through common equity.
However, the real world differs from the idealized conditions under which the M-M theorem holds in various
significant ways. This has implications for bank capital requirements, which increase the share of equity on a bank’sbalance sheet.
Tax advantages for debt. Modigliani and Miller ignored corporate taxes in their initial work. In reality, interest
payments on debt and deposits are tax deductible in most countries, while dividends to shareholders are not,creating a major incentive for banks and other firms to fund with debt. Thus, an increase in common equity capitalrequirement would increase bank funding costs and some or all of this cost would be passed on to borrowers absent
some offsetting factor.
Deposit guarantees and other backstops. Bank deposits are guaranteed up to certain limits, and some argue thatgovernment policies provide protection to uninsured deposits and bank debt through implicit guarantees.
Guarantees of debt and deposits block the key mechanism of Modigliani-Miller, since there is little reason for
funders with guarantees to lower what they charge as banks become safer. A perfect risk-based pricing system forguarantees would offset the behavioral effect, but we do not have this in practice and are unlikely to achieve it, forboth political and technical reasons.
Issuance costs. Modigliani-Miller does not take transactional costs of raising funding into account. There are two
key reasons why these costs are higher for equities. First, the direct issuance costs for equity are significantly higher
than for debt or deposits. Second, investors tend to insist on a significant price discount if a bank wants to sell themstock, as there is a possibility that the management wants to sell stock for a particular reason (e.g. expecting theprice to decline). As such, it may make sense for banks to build equity slowly over time by retaining all profits andavoiding dividend distribution (though cutting dividends is difficult in practice due to its signaling effect) and sharebuybacks, thus eliminating the problem of issuance costs but creating potential for market distortion as some banks
build equity faster than others.
Investor reactions. The theorem relies on investors to lower their return requirements proportionally with the
reduction in risk implied by the increase in equity. In fact, many studies have cast doubt on the extent to which thisactually occurs in the market, creating a whole literature, and even investment category, around the “low risk
anomaly.” (Baker and Wurgler demonstrate this specifically for banks, as well as referencing the wider literature.) In
addition, for now, the market appears to have some skepticism as to exactly how much adding equity truly
increases bank safety. As such, investors may not drop their required return as much as Modigliani-Miller assumes
as banks raise more equity. This will create pressure for banks to avoid operating with significantly higher equity
levels.
Shadow banking. The higher costs that would be imposed on banks because of these “real world” issues would
create strong market pressure to move business out of the highly regulated banking system into various forms of
shadow banking. Dodd-Frank has given US regulators some powers to deal with shadow banking, but nothing likethe authority that would be needed to counteract a high level of market pressure. A financial system that reliedprimarily on shadow banking entities, which are less regulated and typically have lower capital levels, would be
more vulnerable to crises that would shake the wider economy.
Transition issues. Given the still-fragile global economy, there are a number of transition issues that may prevent
Modigliani-Miller from holding under idealized conditions.
Source: Modigliani and Miller (1958), and Elliott (2013b) for the violations of the M-M theorem in real world.

© Oliver Wyman

13

How can regulatory impacts be measured?

Post Crisis Basel Reforms

Raising prices. In credit markets, financial institutions could choose to pass through any increases infunding costs to borrowers in the form of increased interest rates. The rate of this pass-through is afundamental assumption in studies measuring the impact of regulation on the economy. Additionally, theincreased funding costs may be passed on to a different degree to the lending rates of risky borrowers,
compared with the lending rates of less risky borrowers. Similarly, in capital markets, financial institutions
could increase bid-ask spreads and transaction fees to pass on regulatory costs to other market
participants. This is one of the main transmission channels through which the change in capital andliquidity regulations impacts the wider economy.37
Reducing expenses. In responding to higher costs, banks could attempt to cut their expenses to maintaintheir margins. Banks have communicated their expense reduction programs, while acknowledging theincreased compliance and transition and transformation costs are linked to the implementation of new
regulations (e.g. prudential, markets, conduct, and financial crime). In particular, administrative andmarketing expenses could be targeted for reduction. In addition to the benefits of reducing theirexpense ratios, more efficient banks could also gain market share, lowering the overall industry’s average
expense ratio.
Decreasing expected credit losses. In order to reduce the probability and size of potential losses,
financial institutions can try altering lending terms and conditions without reducing their loan volumes orincreasing their prices. For example, banks could include tougher covenants at loan origination to reduce
the expected losses.
Reducing the regulatory impact through technical means. There is scope for banks to moderate theimpact of regulatory reforms by taking certain actions designed to meet the particular requirements
posed by regulations. For example, a bank could improve its data collection and management, as well as
modeling efforts, thereby enabling the firm to utilize a lower risk weighting under the internal modelingapproach. Additionally, banks will respond to regulatory changes by looking for the optimal structure
through which to offer a given product while maintaining compliance with applicable rules.
Rationing credit. Financial institutions could also choose to make fewer loans by rejecting those loan
applications that fail to meet newly heightened credit standards. This could be done at the individualloan level or by making a decision to withdraw from lines of business that do not meet minimum
profitability criteria.
Restructuring their businesses. Financial institutions may choose to exit certain lines of business,change the structure of their enterprises, or shrink the size of particular business lines to meet required
minimum ratios. A bank may choose to utilize a combination of strategies discussed above in addition tochanging their portfolio of business lines to optimize the overall profitability of the organization.38

2.3.

IMPORTANCE OF COST/BENEFIT ANALYSISThe concept of balancing the trade-off between safety and economic efficiency is critical, as core Basel reforms will
have implications for financial institutions and the overall economy, both positive (benefits) and negative (costs).39
Allocation of risks should be assessed separately, as concentration of risks within banks can be seen as negative,
while the diffusion of risks (e.g. execution risk, basis risk) to the wider economy can be seen as positive or negative(if the end users or investors are no longer able to hedge a risk that they do not want to bear).

37

BCBS (2012)
Elliott, Salloy, and Santos (2012), IIF (2011), AFME and PwC (2014c)
39
BCBS (2016h)
38

14© Oliver Wyman

Post Crisis Basel Reforms

How can regulatory impacts be measured?

There is very little empirical research yet available on the realized impact of the Basel reforms, leaving the policy
community to rely on best estimates based on quantitative models of what the impact is likely to be.
The literature suggests that higher capital and liquidity standards improve the resilience to shocks of individual
banks and the financial system as a whole. Improved resilience, in turn, reduces the likelihood of a financial crisisand the size of the economic loss if the crisis does occur. Thus, the primary benefit of the capital and liquidity
standards is a lower probability of a financial crisis and the associated reduction in the expected cost of such a crisisin terms of lost output.
However, the literature also highlights that higher capital and liquidity requirements pose significant costs to banks,
which are, in turn, passed on to the rest of society. Capital requirements impact bank funding costs which can drivebanks to reduce lending volumes and increase price of credit for both households and non-financial firms. Changes
to liquidity requirements reduce interbank lending and maturity transformation, which also impact the lending
channel and aggregate borrowing. Additionally, bank liquidity requirements may reduce overall market liquidity.40
Bank capital and liquidity regulations must strike a balance between costs and benefits, as the Basel Committee
itself readily acknowledges. BCBS (2012) states that higher capital and liquidity requirements may generate social
benefits by reducing the frequency and severity of banking crises and the accompanying loss of economic output,
and may generate costs by impacting the price and availability of credit and other financial services, and thereby
altering the level of investment and output in the economy.41
To comprehensively quantify the tradeoffs between costs and benefits of reforms, sophisticated modeling of thefinancial system and its place in the economy as a whole is required. Any such model has to make important
assumptions about whether some of the loss of economic growth from a financial crisis is permanent and how
quickly the transitory components return to normal. Studies differ considerably in their assumptions in this regard,with resulting wide divergences in their results. This analysis should also take account of important alterations in
the business models of banks as a result of the regulations and associated changes in the competitive environment
in the financial sector (including externalities), including a likely loss of market share to non-banks, such as thoseoften referred to as “shadow banks,” which are outside of the regulated sphere. However, these effects are notconsidered in most such models.

2.4.

POTENTIAL BENEFITS FROM ENHANCED REGULATIONAs discussed above, there are multiple benefits of capital and liquidity regulations. Capital regulations havereceived a great deal of analysis over the years and there is broad agreement that they bring benefits (as well as
costs). However, due to the relatively recent introduction of liquidity requirements, there have been a limited
number of academic studies assessing their benefits. Though there is some variability in opinions regarding thedegree of regulation required, as well as the implementation of these regulations, there is still a general consensus
in the industry that appropriate liquidity regulations have social benefits.
The most significant benefit of both capital and liquidity regulation is the decrease in the probability of a systemic
financial crisis and the decrease in expected cost of such a crisis. Specifically, capital requirements incentivize
banks to increase the quality and quantity of capital, thereby making banks less vulnerable to shocks anddownturns. Reforms also help moderate the effects of potential “runs” on banks and prevent the need for a fire saleof assets at low prices due to the need to raise capital. Additionally, by helping reduce the likelihood of a crisis,
capital and liquidity reforms also help avoid a decline in government revenues that typically follows a banking crisis.

40
41

BCBS (2016h), GFMA, IIF and PwC (2015)
BCBS (2012)© Oliver Wyman

15

How can regulatory impacts be measured?

Post Crisis Basel Reforms

If a severe crisis does occur, capital and liquidity requirements insulate taxpayers and the overall society fromhaving to bear banks’ unexpected losses by providing an ample supply of both capital and liquidity.42
Within periods of less severe downturn, a higher capital level enables banks to continue lending. Similarly, liquidity
buffers and reserves are expected to insulate banks’ balance sheets from any shocks in short-term funding as wellas to inhibit banks’ ability to take on excessive maturity transformation risk, which can be a major source of bankfailure. By insulating balance sheets from liquidity shocks, regulations limit the impact on aggregate output instressed periods by also reducing the contraction in bank credit supply, and lower the probability of systemic crises
by decreasing the degree of interconnectedness in the financial system. Thus, capital and liquidity regulations help
smooth out the lending cycle, making the provision of credit more stable, and help preserve long-term
relationships between banks and their customers.43
Finally, increased capital requirements have an impact on behavioral incentives and reduce moral hazard in several
ways. First, increased requirements may incentivize banks to invest in less risky assets (although there are someconcerns that the leverage ratio incentives counteract this). Second, capital strengthening provides an incentive
for the bank to reduce its probability of default by monitoring the borrowers to whom the loans were issued, further
preventing likelihood of high losses (this incentive, much discussed in the literature, is less important when
discussing increases in capital requirements above levels that already ensure the stockholders have real “skin in thegame”). Third, capital requirements may mitigate the incentives to develop risky and complex products, assumingthat risks are measured well for the capital test and that the complexity of regulations does not itself promotecomplexity.44

2.5.

POTENTIAL COSTS FROM NEW REGULATIONSRegulatory reforms also impose costs on financial institutions and the economy. First and foremost, reforms
impose additional costs for banks through an increase in total funding costs, which may then be passed to thewider economy through two key mechanisms.
Price of credit. Within the lending channel, banks are likely to pass some or all of their increased funding
costs to their consumers by increasing the lending rates, and fees for banking products. Pricing may
impact some market segments more than others, creating an uneven distribution of these costs. Banks
may raise the prices of riskier loans, such as corporate loans, more than the prices of less risky householdloans, in order to adjust their risk-weighted assets more efficiently. Or, there may be the opposite effect if
the leverage ratio, which is risk-insensitive, becomes the binding capital constraint. These impacts, in turnare carried through to the rest of the economy.45
Supply of credit. Higher capital and liquidity requirements may also impact the supply of credit; first,
through tightening of credit standards, which may also differ by market segment. Second, higher capitalrequirements tie up more of a bank’s capital, reducing its ability to utilize that capital to generate loans
without raising more capital.46
Second, reforms impose additional costs by forcing banks to use long-term funding for transactions that are wellfunded and short-term in nature. These changes may impose relatively high costs on short duration trades(especially derivatives) without improving liquidity management, and may potentially have a substantial impact on
the provision of products to investors, businesses, and the economy.

42

Reinhart and Rogoff (2009a), ECB (2015), BCBS (2016h), Gobat, Yanase, and Maloney (2014)
ECB (2015), BCBS (2016h)
44
ECB (2015), BCBS (2016h), De-Ramon et al (2012), Nguyen (2014), Berger and Bouwman (2013)45
De-Ramon et al (2012), Elliott, Salloy, and Santos (2012)46
Nier and Zicchino (2005), Gambacorta and Mistrulli (2004), Berrospide and Edge (2010), Van den Heuvel (2002)
43

16© Oliver Wyman

Post Crisis Basel Reforms

How can regulatory impacts be measured?

Transaction costs. The incremental cost of funding formerly short-term funded transactions long-term
will challenge the economics of many trades. The higher costs of long-term funding will be passed on toclients and capacity is likely to be withdrawn in many markets where the economics no longer work.
Price volatility. In segments of the market where the economics are no longer attractive, banks will
reduce capacity, adversely impacting market liquidity for end users and limiting market access. Execution
risk has been partially transferred to the end-users. Market liquidity will, in turn, impact the frequency andmagnitude of price movements.
Bond prices. As a result of a decline in liquidity, investors often demand a higher liquidity risk premium ascompensation for investing in less liquid securities. Increases in liquidity risk premiums drive up theoverall required rate of interest for bonds, which causes existing bonds prices to fall.
Availability and pricing of hedging instruments. Some OTC long term derivatives are no longer offeredor have been repriced as a result of higher capital requirements, uncertainty with regard to future
treatment thereof (including the capacity of the relevant trading desk to pass the qualifying test under the
new market risk framework), and differences in cost to each bank. As a result, end users may choose tobear an additional basis risk or alternatively may be forced to bear an additional basis risk.
Reduction in net interest margin (NIM). Banks may experience a reduction in their NIM47 as a result of
liquidity requirements. On the income side, the tilt towards holding a larger inventory of HQLA can resultin a reduction in interest income as these assets typically have lower yields commensurate with the lower
level of risk of these assets. On the expense side, the regulatory requirements of holding more stable
funding sources on the balance sheet can result in higher interest expenses as these funding sources are
typically more costly.48 Reduced profitability across the industry in the long run could even result insystemic instability of the banking sector.49
Interbank lending. Introduction of the LCR may result in less interbank lending in normal times, as banks
strive to maintain their own liquidity reserves.50
Lastly, reforms impose additional operational costs such as costs of having to run both modeled and standardized
calculations in parallel, and average leverage calculations for reporting, implementation of FRTB requirements, andcosts related to ring fencing.
Overall, the thrust of regulatory reforms is to impose relatively higher costs upon the largest and most complex
banks, especially those that operate globally (G-SIBs). The structure of banking and capital markets is being
reshaped through a combination of regulatory reforms and market forces, which will continue to drive change foryears to come. However, the impacts of the change of collective behavior of financial institutions and the change inthe structure of banking and capital markets on the functioning of the financial sector has not been fully assessed
and may result in unintended consequences.

47

Net interest income minus net interest expense
BCBS (2016h)
49
Tsomocos (2001)
50
BCBS (2016h)
48© Oliver Wyman

17How can regulatory impacts be measured?

Post Crisis Basel Reforms

Furthermore, it will take a much longer time period to fully assess the cost of these changes to the wider economy.
Some industry stakeholders and officials argue that we have not seen sufficient academic rigor in studying how all
the post-crisis regulatory reforms work or impact markets. The scale of change has led to calls for regulators to takestock of the cumulative effects of these changes and to assess what unintended consequences may mean for afurther round of regulatory changes (especially on the recalibration efforts of the some of the reforms) to set things
right. Now is the time for the industry, academia, and policymakers to engage in the detailed academic andpractical work to increase efficiencies and identify where unintended consequences arise.51

OFFSETS TO ECONOMIC COSTS
In calculating the net costs to society of the Basel reforms, analysts must also make a decision about the potential
for offsetting policy actions, in particular, the potential for central banks to reduce overall interest rates in theeconomy in order to offset increases in borrowing costs due to higher lending spreads or less liquid and more
expensive financial markets. Under most conditions, central banks do have the capability to move overall interest
rate levels downwards through rate setting, as well as open market operations, to offset higher effective borrowing
costs, should they choose to do so. Most studies do not attempt to quantify this impact, due to its subjective nature.
In addition, there are at least two major disadvantages or constraints on such moves by central banks. First, this ismuch less effective at the “zero lower bound”. As we have seen in much of the developed world in recent years,
monetary policy is more difficult and complicated and generally less effective when rates are very low or negative.
Second, there are potentially large distributional consequences of attempting to offset higher spreads on
borrowing by reductions in the base interest rate. Unless central banks wish to directly allocate credit by targeting
specific asset classes to buy, they are largely confined to moving overall interest rates. However, regulations tend
to affect certain types of loans or financial markets considerably more than others, as discussed below.
Additionally, other bank reactions discussed in Section 2.2 may also serve as offsets (e.g. banks reducing expenses).

DISTRIBUTIONAL CONSEQUENCES
As discussed earlier, impacts of Basel reforms are likely to be unequally distributed to end users. Within the lending
channel, product and customer segments will be impacted differently. While the majority of studies focus onaggregate impacts, a subset of studies is able to identify distributional consequences. In particular, authors such as
Mendicino et al (2015), de-Ramon et al (2012), and ECB (2015) note that corporate loan rates are more affected byBasel reforms.52 Additionally, similar impacts are expected for loan volumes: Mendicino et al (2015) and Meeks(2014) note that corporate loan volumes are impacted more than mortgage loan volumes. The asymmetric impact
on corporate and mortgage loan rates and volumes imply a larger impact on non-financial corporations in theEurozone, which finance close to 70% of their total debt through bank lending compared to US non-financial
corporations , which finance approximately 30% through banks.53
Studies focusing on the impacts of reforms on capital markets also provide insight into the impact of reforms on
different asset classes. For example, GFMA, IIF and PwC (2015) show that the extent of reduction in trading assets
held by banks has been most significant for credit and commodities since these asset classes have incurred thegreatest change in risk weighted assets in recent years. The IMF, in its semi-annual Global Financial Stability
Report54, has noted that the liquidity trends of investment grade and high yield corporate bonds in the US havediverged, with investment grade bonds recovering significantly more rapidly post crisis. Examination of market
effects necessarily uses historical data, but comprehensive analysis of the potential future policies and likely bankreactions to them is required to capture potential systematic risk.
51

Ludwig (2016), Anderson (2016)
Mendicino et al (2015), ECB (2015), de-Ramon et al (2012)
53
Galles and Vallas (2014)
54
IMF (2015b)
52

18© Oliver Wyman

Post Crisis Basel Reforms

2.6.

How can regulatory impacts be measured?

ATTRIBUTION ISSUES

Quantifying the costs and benefits of the Basel reforms poses multiple challenges. Various approaches andmethodologies have been used in the literature to assess the effects of the reforms, each with their own strengths
and limitations. Across all methodologies, assumptions play a critical role in quantifying the full impact ofregulations. A subset of these assumptions deals with attribution issues of reform. Four key issues are described
below.
First, a key consideration in any quantitative study of the impact of regulatory changes is the baseline
against which to compare. In conducting an empirical evaluation of the impact of reforms, one has multiple
choices about what time period or what level of capital ratios to use as a baseline. One may choose to use theregulatory minimum of Basel II capital requirements as the baseline, but that would fail to capture the reality of
most financial institutions.
Financial institutions determine their individual minimum target capital and liquidity levels based on factors aboveand beyond the regulatory requirements for several reasons. First, banks’ own risk models estimate the economic
capital that these institutions require to minimize the likelihood of adverse outcomes such as bankruptcy or being
in the position to be prevented from distributing variable pay or dividends. Second, rating agencies frequently
expect that financial institutions maintain certain levels of capital and liquidity in order to maintain the credit ratinglevel targeted by the institution. Third, counterparties, financial markets, and shareholders may expect anddemand levels above the regulatory minimum. This is particularly true as a result of the crisis, which drove up
market expectations of appropriate safety margins of capital and liquidity. Finally, the banks may choose tomaintain additional buffers to lower the risk of regulatory intervention should things go wrong. Thus, using the precrisis regulatory minimum as the baseline may overestimate the impact of reforms, as market forces would haveforced bank capital and liquidity ratios to have increased as a response to the financial crisis independently of new
regulatory requirements.55 In the new environment, regulatory requirements are generally substantially greaterthan those generated by banks’ internal models or rating agency models or pressure from funders. Thus, only thelast reason, the maintenance of buffers to reduce the risk of regulatory intervention, continues to be a significant
factor.
Second, it is difficult to isolate the impact of regulatory reforms from the market response. As noted,
counterparties and financial markets have reacted to the lessons of the crisis and demanded greater capital andliquidity from banks, independent of regulations. However, it could be argued that regulations have generally gone
well beyond what markets would demand today.
Third, it is challenging to attribute observed impacts solely to a specific regulation, be it Basel reforms,
other regulations or government interventions.56 For one, multiple government interventions and supervisory
actions have had a significant impact on the capital adequacy of banks. In Europe, supervisory stress tests at both
the regional and individual national level (e.g. EBA’s EU-wide capital exercise in 2012 and the ECB’s
Comprehensive Assessment (CA) exercise in 2014) have also helped drive an increase in capital and liquidity ratios.
Additionally, there were also cases of government interventions and supervisory actions that took place prior tobanks’ beginning to approach the minimum required level of capital: these interventions took place to support thebanks’ credit activity or to restore confidence in financial markets. Financial institutions in the US have seen asimilar wave of stress testing and supervisory activities above and beyond Basel standards. US regulators often
exercised supervisory judgment, driving banks to adjust capital and liquidity levels for additional safety andsoundness in the financial system.57

55

Elliott, Salloy, and Santos (2012)
Elliott, Salloy, and Santos (2012), ECB (2015)57
ECB (2015)
56© Oliver Wyman

19How can regulatory impacts be measured?

Post Crisis Basel Reforms

Fourth, the unusual economic and monetary policy conditions since the crisis have strongly influenced
banks’ behavior and results in ways which are unlikely to be good indicators of the long-term impact ofreforms. For example, the very high levels of liquidity provided by central banks to the economy may be offsetting
underlying changes in market liquidity driven by Basel reforms. Similarly, very low, and even negative, interest
rates have a variety of effects on banks that make it hard to determine the direct effects of regulatory changes.

2.7.

QUALITATIVE CONSIDERATIONSThere are a number of qualitative considerations that should be taken into account when assessing the impact ofregulatory reforms. These include:

SHADOW BANKING
Regulatory reforms will undoubtedly increase costs for traditional financial institutions subject to the Basel rules.
For example, Basel III increases the required tangible equity capital for banking activities multiple times in the US
compared to requirements prior to reforms. Most non-banking financial institutions will not have to face the higher
capital requirements, putting them at a competitive advantage for the activities in which they compete with banks.
As such, these non-banks could act as “shadow banks,” by providing similar services to end users at a lower cost.
For example, some credit activity may move to capital markets. Further, there is a strong natural demand formaturity transformation services that are expected to become significantly more expensive for traditional banks tofulfill due to the new liquidity rules, which will likely push banks to increase the maturity of their liabilities andreduce the term of their assets. This demand may be met by other non-banks.58
To date, the influence of shadow banks is not clear and has not been sufficiently studied. There are clearly potential
benefits from a shift in market share to non-banks. However, a shift towards shadow banking may increasesystemic risk as these institutions lack access to central bank deposits for short-term liquidity, may not provide
deposit guarantee schemes to investors, and provide volatile funding which can result in greater volatility in theeconomy.59 The full impact of shadow banks will depend on the scope and quantity of traditional banking activities
carried out by these institutions, as well as the extent to which their activities appropriately consider risks. It is clear,
however, that these institutions will not be bound by the same regulations that traditional financial institutions are
subject to, and the risks of the typical banking activities carried out by them may not be mitigated to the same
degree. Thus, regulatory reforms may result in the reallocation and not the mitigation of certain systemic risks, as a
portion of risks is shifted to the less regulated areas of the shadow banking sector.

IMPACT ON BANK INTERNAL PRICING MECHANISMS
Limited empirical study has been conducted on the impact of regulatory reforms on internal transfer pricing andcapital allocation mechanisms within a financial institution. However, these mechanisms have a significant impact
on business strategy and risk management decisions that impact bank operations. Due to the significance of theireffects on internal decision-making, these mechanisms are likely to have an impact on the end users. As such, theimpact on bank internal pricing mechanisms is covered in further detail in Section 2.

IMPACT ON EMERGING MARKETS
Research to date has focused primarily on developed markets, leaving the discussion of impacts on emerging
markets as primarily a qualitative consideration. In general, many analysts expect less of a direct impact, since thegreater risk of operating in emerging markets has usually caused banks in those countries to have substantiallyhigher capital levels than those required by the Basel Committee. Thus, the already existing higher levels of capitalallow emerging market banks to more easily meet the new Basel rules without adding capital.
58
59

BCBS (2016h), Elliott, Salloy, and Santos (2012), Kashyap, Stein, and Hanson (2010)
Monaghan (2014), Luttrell, Rosenblum, and Thies (2012), Ordonez (2015)20© Oliver Wyman

Post Crisis Basel Reforms

How can regulatory impacts be measured?

However, there are unintended effects of regulation that may spill over into emerging markets through both
domestic and cross border activities of global banks, such as movement of capital in and out of countries in
response to regulation. These markets are often faced with financial crises, and frequently experience spill-overeffects from the developed markets. Thus, there are expected benefits of Basel reforms for these markets throughprevention of financial crises. Additionally, increases in capital requirements under current consolidation and risk
management practices may disproportionately impact operations of subsidiaries of global banks in emerging
nations, particularly those where foreign banks have a large market share. This could lead to an underestimation of
the size of the costs for emerging countries.60 The Basel objective of simplification may also conflict with anappropriate treatment of emerging market exposures, the lack of granularity leading to cliff effect or the frequent
absence of external rating of corporates potentially leading to penal treatment.

PRODUCT AND GEOGRAPHIC INCENTIVES
Regulatory reforms create incentives that make some products and jurisdictions more attractive than others. As
discussed above, one example of this could be the relative attractiveness of developed and emerging markets.
Operations of subsidiaries in emerging markets could be more impacted than those in developed markets, making
emerging markets less attractive.61

60
61

Elliott, Salloy, and Santos (2012), BCBS (2016h), Reinhart and Rogoff (2009b)
BCBS (2016h), GFMA, IIF and PwC (2015)© Oliver Wyman

21

Post Crisis Basel Reforms

Importance of internal allocation and pricing mechanisms at financial
institutions

3. IMPORTANCE OF INTERNAL ALLOCATION AND PRICINGMECHANISMS AT FINANCIAL INSTITUTIONS
3.1.

CAPITAL AND LIQUIDITY ALLOCATION AND PRICING WITHIN FINANCIAL
INSTITUTIONS

Accurate analysis of the impact of financial reforms on end users requires an understanding of how financial
institutions make internal allocation and pricing decisions about capital, liquidity, and other scarce resources, asthese have a direct effect on the supply and price of the services they offer. The aggregate effect of the decision
processes of these intermediaries determines the provision of credit and other services to the wider economy.
Therefore it is critical to understand these allocation decision processes as policymakers set capital, liquidity, andother regulations. Good cost-benefit analyses, for example, depend on an accurate reading of the actions banks
and other financial institutions will take in response to new regulations.
Academics and some policymakers frequently treat banks and large securities dealers as if they were unitary
institutions, whereas a more accurate view is that they are internal markets of considerable dimensions, with manydifferent units, often of substantial size, competing for the bank’s scarce capital, liquidity, and other resources (forsimplicity, this section will generally refer to “capital” allocation, since this is the most important aspect of a larger
financial resource management process that also includes, at a minimum, allocation of liquidity, usually via funds
transfer pricing and limits.)
Large and complex financial institutions use internal pricing to allocate resources to lines of business
commensurate with their long-term risk-adjusted returns. Within lines of business, capital is usually allocated tothe opportunities and client relationships with the highest returns, taking account of capital usage, liquidity effects,
and other factors. In addition, absolute limits on usage of capital or liquidity are sometimes set for individual units.
The evolution of RWA is closely monitored by investors, including their granular evolutionary split between
business growth, regulatory changes, and management actions. Returns on RWA or returns on equity targets arealso communicated to investors and the public for the primary business lines of banks (typically for the global
banking and capital markets activities). The execution of the strategy and communication to analysts and investors
requires a strict, permanent, and granular management, including on these key metrics, by all businesses and unitsof a bank. Whatever the mechanisms for allocation of capital and liquidity, business units and, even individuals, arejudged on the returns they generate for the amount of capital that they use. Those that have more profitable
opportunities will push for more capital to be allocated to them and those with less profitable opportunities will
want to reduce their capital allocation so as to reduce their profit hurdles.
The allocation process is easiest to describe for lending, but operates in a similar manner for all products that needa significant amount of capital. All sophisticated banks use some version of a core loan pricing formula which
requires a loan to be priced to at least cover: expected credit losses, administrative costs, non-capital funding costs,
and the cost of the capital allocated to the transaction. Going forward, there is also likely to be an explicit credit or
charge for any effect on the bank’s liquidity position from the transaction.
The key question then becomes how that quantity of capital is determined. This has become much more
complicated, because there are now a number of capital calculations that could be used, all of which are relevant.
The capital requirements can broadly be classified as those driven by internal, rating agency, and regulatory
expectations, all of which must be managed simultaneously within the capital planning process. Further regulatory
requirements now break down into multiple potentially binding regulatory constraints:•••

Based on risk weighted calculations (standard or advanced)
Based on a leverage ratio
Based on stress tests (with variations based on end of test period criteria)© Oliver Wyman

23

Importance of internal allocation and pricing mechanisms at financial
institutions

Post Crisis Basel Reforms

In practice, regulatory requirements are effectively replacing internal and rating agency criteria as the drivers ofinternal pricing and allocation mechanisms. The reason for this is simple; regulations are now virtually always
considerably more onerous than the other methodologies in terms of the capital they require. This reflects a
considered decision by policymakers globally that the economic externalities of financial crises require that banks
maintain more capital and liquidity for society’s benefit than they would choose to for internal reasons or as a resultof demands from their shareholders and funders. As economic and regulatory capital diverge further due todecreases in the risk sensitivity of regulatory capital under the ongoing workstreams, the changes in businessincentives and models are going to be more significant.
The internal allocation mechanisms of banks, as described here, are designed to achieve the optimal usage of the
scarce resources of capital and liquidity. This is even clearer for banks that are balance sheet constrained. Since
regulatory requirements now exceed the requirements from other approaches, banks are inevitably reworking
their allocation procedures to use regulatory capital and liquidity as the constraints. This runs counter to the desireof many policymakers that banks continue to use internally generated pricing and allocation mechanisms based on
their own view of the risk inherent in different activities. This is ultimately a vain hope when the true limit on what
activities can be undertaken overall is actually determined by regulatory capital and liquidity requirements.
Thus, in practice, regulatory choices about capital and liquidity rules and in particular, the risk-sensitivity or lackthereof, will affect choices about the pricing and availability of credit and other services in quite specific ways
throughout the organization, as individual units and entire organizations determine whether the business they
have traditionally done can still provide a reasonable return on capital under the new, more binding constraints.
Policymakers have made clear that they do not wish to dictate business models, except to eliminate a few that they
deem particularly dangerous, but the practical effects of various regulations and their interactions do, in fact,
substantially influence business models for the future. Some are concerned that a “monoculture” is developing asbanks (especially large ones) are all being pushed into the same type of business model. This would increase risk
because there would be little diversity among the peer banks that can assist in normal times or a stress period via
purchase of a troubled bank or by providing deep markets for the sale of assets or to absorb activities that thetroubled bank can no longer conduct.

3.2.

INTERNAL ALLOCATION APPROACHES

Binding constraint allocation. Some banks base the quantity of capital for their loan pricing formula on whicheverof these constraints is most binding at the moment. This is generally also what academic theory implicitly or
explicitly assumes. Taken to the extreme, as it usually is in academic models for the sake of simplicity, this would
tend to produce a “corner solution.” That is, the bank would make decisions on the basis of the currently mostbinding constraint until and unless the effect of those decisions, or external circumstances, causes anotherconstraint to become binding.
This is a reasonable mode of operation for a bank, as long as one constraint is currently binding and is likely toremain the binding constraint for long periods. However, some banks find themselves in a situation where thebinding constraint will sometimes be a stress test, sometimes the risk-weighted approach, and sometimes theleverage ratio. This raises real problems of a practical nature, which are particularly well illustrated by the
conflicting incentives given by the leverage ratio and the risk-weighted approach.
The risk-weighted approach is specifically designed to impose higher capital requirements for higher risk loans andlower requirements for lower risk loans. Therefore, when this is the binding constraint, a bank tends to charge
more for higher risk loans than it would have based solely on expected credit losses and other economic
characteristics and to charge less for loans with lower risk weights. This may also reduce the volume of higher risk
loans that are made, unless the market will fully bear the higher required pricing.

24© Oliver Wyman

Post Crisis Basel Reforms

Importance of internal allocation and pricing mechanisms at financial
institutions

In contrast, the leverage ratio is intended to treat all assets the same, with no regard for risk levels. Therefore, when
the leverage ratio is binding, the required capital level is constant across all types of loans, making higher risk loans
more attractive, since they generally allow banks to charge a higher spread over the expected losses and othercosts. Low risk loans and activities can become difficult to sustain, unless all competitors and substitute products
are similarly bound by the leverage ratio, since the capital charge can be higher than the entire spread that would
have been charged if economic factors alone were taken into account. In particular, once a firm is meeting theaggregate threshold, there is clearly a marginal cost to do more activity. At this point, firms must either abstain
from doing additional business or raise equity, in which case the cost of capital becomes a serious constraint.
Thus, a bank which uses only the currently binding constraint in its pricing formula could find itself favoring lowrisk loans if the risk weighted approach is binding and therefore be moving its average risk weight downwards overtime, until it meets the point at which the leverage ratio became the binding constraint. At that point, the formula
would start to seriously penalize low risk loans compared to high risk ones. Loan officers could find themselves
bouncing back and forth between certain types of loans one day and the opposite types of loans the next day,switching back and forth as often as the formula is reset. Behaviorally, this is not an approach that will work for any
bank. From a branding perspective, the bank marketers and other employees need to maintain a reasonably
consistent strategy for long periods at a time in order to be effective in the marketplace.
Blended average allocation. Another approach is to use a blended average of the capital required by the mostimportant constraints. For example, a bank might require a loan to be priced with an assumed capital level equal to40% of that calculated using risk weights plus 40% of that calculated based on the leverage ratio plus 40% of that
estimated from a reverse engineering of the stress tests. This makes it less likely for the bank to find itself at a corner
solution, although it also creates a somewhat higher average capital level than if it tried harder to optimize capital
usage. Note that the total weights must add to more than 100%, otherwise the formula would lead to a lower
required capital than the single binding constraint, since it would be a weighting of the most binding constraint
with other requirements that are lower. Further, even if all the relevant constraints were initially at the same level, it
would not provide a buffer against shifting requirements unless it added to more than 100%.
The effects of using a blended average approach will depend heavily on the weighting chosen by the bank.
Decisions will look more like those taken under the leverage constraint if that is given a high weight or like thoseunder the risk-weighted approach if that has a high weighting in the pricing formula. The only certainty is that
average capital levels will be higher than those held when only the most binding constraint is considered, unlessthe simple approach is augmented by an ad hoc additional buffer to achieve a similar goal.
In the real world, competitive factors affect these decisions. This can strongly constrain how capital requirements
feed through into actual pricing. Banks are generally willing to accept lower than targeted returns on certain
products or businesses if they believe that the situation is temporary and if the relation with the client or
counterparty is well monitored. Competition for many banking products is strong enough that there is a real limit
to how far banks can increase their pricing without facing a sharp drop-off in volume. There are significant costs toshifting in and out of product lines, so bankers are generally loath to effectively pull out of a product line while
waiting for conditions to adjust. That is not to say that banks never select this option. For example, to reduceleverage amid investor pressures to increase profitability, some market participants have planned to cut their longdated derivatives business lines even in light of transition costs and loss of revenue. The opposite choice, of staying
in while doing a much lower volume of business, faces the problem that there are likely to be significant costs thatare effectively fixed for as long as the bank stays in that product line. Thus, operating leverage works against too
sharp a drop in business volumes unless a decision to abandon the line has been made. In practice, all of this meansthat individual decision-makers, and the credit committees and other higher bodies that constrain them, override
the pricing formulas from time to time, sometimes to a very significant extent. Senior management wants there to
be an alignment of the pricing formulas and the business decisions, so any period of divergence will be followed bychanges in the pricing models or mandated changes in actual behavior, depending on the ultimate view of the© Oliver Wyman

25

Importance of internal allocation and pricing mechanisms at financial
institutions

Post Crisis Basel Reforms

reasons for the gap between theory and reality. Additionally, in some jurisdictions there may be further pressure
from regulators to ensure that pricing tools are adequately calibrated.

3.3.

POTENTIAL REGULATORY IMPACTS

Ideally, it would be possible to observe how banks are actually setting their pricing and allocation policies and tosee what effects that has on customers and therefore the wider economy. However, banks and large securities
dealers are still in the early stages of evolution of their financial resource management processes, with some firms
more advanced than others. Why are they not further along, given the importance described above?
First, managers are still waiting to a significant degree for the regulators to put their pens down and reveal the final
version of key regulations and for some clarity on how those regulations will be implemented in practice. Therefore,
they have been making moves only on the basis of the major, clear trends, such as the increasing importance ofleverage ratios. We have seen some large changes in business models, such as the announced shift of Morgan
Stanley, UBS, and other banks towards asset management and away from securities operations as a result of thesefactors.
Second, there is not a consensus among analysts or within firms as to the right approach to the difficult analyticalissues described above. This has led to hesitancy in changing existing approaches and has also spurred different
firms to move in somewhat different directions. Some retain their capital allocation approaches based on risk
weights, while others have adopted a weighted average of multiple constraints as their approach. The overall
impact of rules such as the leverage ratio are directionally the same across banks, but how this plays through into
decisions can differ.
Third, there may be wider latitude than normal being exercised in regard to actual pricing as compared to theresults of pricing formulas. It has become clear that there are likely to be quite significant price shifts across lending
and capital markets products, due to sharp changes in regulatory requirements and market conditions. But, clientsare not yet willing to accept the full magnitude of the changes. In the UK, lenders reported that “widening funding
spreads had led to increases in their transfer prices — the internal prices charged to business units within eachbank to fund the flow of new loans. But there has been little evidence so far of this rise being passed through into
the interest rates charged on new lending.” 62 Since many competing banks are hoping to be among the last
standing in particular products, and therefore counting on others to fall away, clients are continuing to find banks
that are willing to move their pricing only modestly in order to retain customers while waiting for other banks towithdraw. In other words, there is a kind of “repeat game” being played out, in which the leaders in a given productmay introduce higher pricing, or ration the availability of currently underpriced capacity, but they can only movemodestly. They then need to sit back and watch the reactions of customers and competitors to determine whether
they can, and should, take the next step towards the ultimately required pricing.

3.4.

HIGH-LEVEL DISCUSSION OF POST-CRISIS CHANGES IN ALLOCATION AND
PRICING MECHANISMS

Senior bank executives have the ability to substantially affect capital allocation decisions across the firm by setting
the capital calculation in the pricing formula. Since there are a wide variety of methods they could use for thiscalculation, the effect of capital regulation on the real economy will be significantly affected by what the differentbanks choose to do. The results are likely to be substantially different than assumed in simple academic models
that lead to corner solutions.
Different banks are likely to choose different approaches to setting their capital requirements in their pricing
formulas. The variations will depend on many factors: different views of the underlying analytical questions, which
are far from settled, different underlying business models and customer bases, and varying internal political
62

Bank of England’s Bank Liabilities Survey conducted in 2015 Q3, as quoted in Bank of England (2015b)

26© Oliver Wyman

Post Crisis Basel Reforms

Importance of internal allocation and pricing mechanisms at financial
institutions

dynamics, among other factors. This variation in approaches may create a more diversified range of businessmodels, reducing the risk of a systemic problem if a particular business model runs into problems.
Some banks will choose to use an approach that blends multiple regulatory constraints, reducing the risk that any
one of them triggers extreme actions. For example, a straight leverage ratio as the binding constraint is feared topush banks to pull out of low risk areas and to push into higher risk loans. On the other side, there are fears that thezero risk weight for many sovereign bonds causes excessive concentration in this area, encouraged even further by
new liquidity requirements. If both constraints are applicable simultaneously in the internal capital markets, thereis less chance of incentives driving excessive concentrations in either direction.
However, a blended approach means that the leverage ratio has become partially binding immediately for a large
number of the banks that use this approach. This exacerbates a serious concern among many analysts that theleverage ratio is too simplistic and that taken on its own, it does not fully capture a bank’s risk position. These
analysts argue that it should not normally be the binding limit and that it is better suited to being a backstop that
becomes binding in unusual cases. There is, of course, a minority of analysts who would prefer to see the leverage
ratio be the most binding constraint, in which case they will see this as a positive development.
There may be disorder in the financial system as different banks alter their business models solely based on theirchoice of approach to dealing with the analytical difficulties of these multiple potentially binding capital constraints.
There could be short-term volatility of pricing and availability of credit and customers could find themselves having
to build new banking relationships for no underlying economic reason, if the differences in capital allocation are
sufficient on their own to significantly alter business models.
Another implication can be viewed as either positive or negative. The existence of multiple potentially binding
capital constraints creates a bias in favor of universal banks that may be able to offset constraints in one area withheadroom in others. Securities firms on their own are likely to find the leverage ratio their binding constraint, withplenty of room to increase their average risk weights, while traditional lenders would be in the opposite situation inmost cases. Operating in the same banking group might allow them to benefit from diversification by allowing one
unit to “borrow” spare capacity from the other in regard to an otherwise binding constraint in a way that could not
be done outside the group. This depends, of course, on whether the rules of the given jurisdiction impose the same
constraints on each unit as on the group as a whole, in which case the group might theoretically have more room,
but not be able to take advantage of it within any unit. Sometimes the constraints imposed by geographical or
business separation as a result of local rules (e.g. the implementation of the Vickers report in the UK), as a result of
the resolution strategy, the banking group’s structure, or internal business decisions will sharply limit any suchflexibility.
In sum, the issue of internal capital markets within banks and other credit intermediaries is a crucial one that needs
more study. The formulae used to guide these internal markets will be critical to the real world impact of thechanges to capital and liquidity regulations. Some conclusions are already clear, as discussed elsewhere in thisreport, while others are still developing.

© Oliver Wyman

27

Post Crisis Basel Reforms

Impact on the lending channel

4. IMPACT ON THE LENDING CHANNEL
The primary focus of this section is to discuss the findings of studies by academics, officials, and other industry
observers on the overall impact of Basel reforms on the lending channel, supplemented with additional analysis
where market data is available.
Post-crisis Basel reforms significantly affect the lending channel, primarily by increasing the quantity and quality ofcapital required and creating new quantitative liquidity requirements. Prior to discussing the impacts of reforms onbanks and end users, it is important to understand how banks have responded to new regulatory requirements –particularly minimum capital requirements. The figure below illustrates the actual capital ratios from 2006 to 2015
for the top 50 banks in Europe, North America and Asia Pacific, measured in the then-current regulatory
accounting standards, which understates the increase in capital in the most recent years, since Basel III’s stricter
definitions for Tier 1 Common Equity and Risk-Weighted Assets came into force. For example, according to thecomparison between initial 2010 Basel I/II common equity tier 1 capital ratios and Pro forma Basel III common
equity Tier 1 capital ratios (after RWA increase and capital deductions) as calculated by Elliott, Salloy, and Santos(2012) the difference between the two measures was 2.6% for Europe and Japan, and 3% for the US, which points
to the magnitude of change between Basel II and Basel III ratios.

15

15

Total Equity to Total Assets Ratio (%)

Tier 1 Common Equity (CET1) Ratio (%)

FIGURE 4.1: BANK CET1 RATIO AND TOTAL EQUITY TO TOTAL ASSETS RATIO, 2006–201563

14
13
12
11
10
9
8
7
6
5
2006

2008

2010

2012

2014

Europe2016

North America

14
13
12
11
10
9
8
7
6
5
2006

2008

2010

2012

2014

2016

Asia PacificSource: SNL

As illustrated above, the banking system is considerably better capitalized than it was before the crisis. This figure
aggregates the impacts across all banks within the respective regions, and thus CET1 trends could be more
pronounced for some market participants. For example, European banks have raised their ratio of CET1 to RWA
substantially higher, due, at least in part, to pressure from the leverage ratio requirements, which are more strongly
binding on many European banks given their low average risk weights. As the figure above indicates, North
American total equity to total asset ratios exceed those of their European peers.
63

Tier 1 common capital (Common Equity Tier 1) ratio as defined by the latest regulatory and supervisory guidelines. For US institutions during Basel III,
this will be transitional when applicable, and the lesser of the standardized and advanced approaches. For non-US institutions, this may betransitional or fully loaded, depending on availability. Includes top 50 banks in each geography.

© Oliver Wyman

29

Impact on the lending channel

Post Crisis Basel Reforms

While aggregation makes trends for particular market segments less pronounced, the ratios above indicate apattern of growth in bank capital, driven at least in part by Basel reforms. These reforms will increase banks’ total
cost of funding, despite the fact that Modigliani-Miller theorem shows that an increase in capital ratio should haveno impact on the cost of funding, under idealized conditions, as the unit costs of debt and equity decline due tolower insolvency risk to exactly offset the change in the proportion of (expensive) equity and (cheap) debt. In
Section 1, we discuss violations of the theorem’s underlying assumptions in the real world and provide an overview
of the limitations of the theorem.
Tougher capital requirements. Most of the Basel reforms focus on raising the level of required capital and shifting
more of it into tangible common equity and away from debt and preferred equity instruments. The minimum
capital levels rise in part from direct increases in required ratios and in part because most risk weights are higher in
Basel III than in Basel II. The latter effect will be increased by proposed limitations on the use of models andproposed floors on the model-based capital levels. Beyond this, the new leverage ratio requirement may force
some banks to have more capital than is needed under the risk-weighted approach.
New liquidity requirements. The LCR and NSFR push banks towards balance sheets with longer maturity
liabilities and shorter-term, safer, and more liquid assets than they might otherwise keep. This translates to more
expensive funding and/or lower returns on assets, and potentially, at least, transitory limits on the amount oflending and other activities that can be undertaken until asset and liability changes can be completed.
Interactions of capital and liquidity requirements. While the higher capital and new liquidity requirements bothincrease funding costs, the total impact is generally lower than the sum of the two individual effects. The two typesof requirements each indirectly move banks to take actions which assist in meeting the other requirement. Equity iseffectively treated as the most stable form of liability, so higher equity capital levels reduce the need to increaseother stable sources of funding. On the other side, assets that count as HQLA are generally lower risk, as well as
more liquid, and therefore carry lower risk weights, reducing risk-weighted capital requirements.
Total loss absorbing capacity requirement. TLAC also increases funding costs by requiring large banks to holdadditional long-term debt, which could be converted to equity, or written off, in the event a bank hits severe
problems.
There are two key impacts of post-crisis Basel reforms for the end users.
Increased price of credit. As banks move towards more equity, their total cost of funds increases. To offset thesehigher costs, banks will charge more for their loans, all else equal. Refer to Section 1 for a detailed discussion oftransmission mechanisms.64
Decreased supply of credit. As a result of higher capital ratios and requirements for higher quality capital, banks
could increase their credit standards and reduce the amount of loans they issue, thus decreasing the amount of
capital they deploy. Refer to Section 1 for a detailed discussion on transmission mechanisms.65

64

Elliott, Salloy, and Santos (2012), Modigliani and Miller (1958), IIF (2011), De-Ramon et al. (2012), BCBS (2012), Kashyap, Stein, and Hanson, (2010),
AFME and PwC (2014c), King (2010), Kisin and Manela (2015), MAG (2010), BCBS (2010a)
65
Elliott, Salloy, and Santos (2012), IIF (2011), Hancock and Wilcox (1994), Nier and Zicchino (2005), Gambacorta and Mistrulli (2004), Berrospide andEdge (2010), De-Ramon et al.(2012)30© Oliver Wyman

Post Crisis Basel Reforms

Impact on the lending channel

CHOOSING THE RELEVANT STUDIES
There are roughly twenty studies by academics, officials, and industry groups that analyzed the overall effects ofthe main Basel capital and liquidity reforms. The most comprehensive is the Institute of International Finance (IIF)
study,66 which showed a large effect on the overall economies of the advanced nations as a result of a very wide
range of regulatory and related policy actions, including proposed new taxes on financial institutions that were
under consideration at the time. We have excluded this study from our analysis because it includes far more thanthe Basel reforms and, by the nature of its design, does not allow the effects of different reforms to be broken out.
The next most comprehensive study is Elliott, Salloy, and Santos (2012), which projected the impact of the Baselreforms of capital and liquidity requirements, as well as changes in taxation and derivatives rules. We include thisstudy, because it generally broke out the effects, allowing us to focus on those changes relevant to the Baselreforms. There is a modest issue with the allocation of offsetting impacts shown in the study that include more thancapital and liquidity effects, but this is a relatively minor issue. It should be noted that the authors acknowledged
the considerable uncertainty in their projections and provide a range of sensitivity analyses that will not be
discussed here for the sake of brevity.
All of the other studies either focused only on capital (in the majority of cases) or on both capital and liquidity, andmost broke out the effects between them. Capital has been the prime focus both because it is better understoodand because it was generally assumed to have the greater effect.
The quantitative studies conducted by the Basel committee and by the industry also provide valuable informationon the expected impact of rules. The findings of these studies are shown in figures indicating estimated increases
to funding rates.
All of the studies of overall impacts on lending that are included here were conducted without consideration of themany workstreams that some industry observers lump together as “Basel IV”, such as the Fundamental Review of
the Trading Book and revisions to the standardized approach for operational risk, unless explicitly stated.

ACHIEVING COMPARABILITY ACROSS THE ANALYSESIn this section, we use the existing comprehensive analyses to estimate the cumulative impact on lending of thecore Basel III capital and, where possible, liquidity reforms. To do this, a number of assumptions have to be made,since many of the studies estimated the impact of a single point change in capital requirements, rather than the
cumulative impact. Fortunately, the studies all use approaches that explicitly or implicitly assume that additional
funding costs from higher capital levels are linear, so that it is reasonable to simply multiply the estimate by the
number of points by which capital requirements are raised.
However, this leaves the question of how large an increase in capital requirements results from the Basel reforms.
As discussed in Section 1, there are multiple choices one could make about a baseline. We have chosen to use theapproach from Elliott, Salloy, and Santos (2012), with updated figures. That is, we assume that capital levels as ofthe end of 2010 reflected market forces and that further increases in capital since then have been driven by Baselreforms.67 Return to the pre-crisis capital levels would not be acceptable to the markets and the bank themselves
even without any change in regulation. December 2010 provided enough time for banks and market forces toadjust to the lessons of the financial crisis and to move capital levels to their new target levels. At the same time, it
was sufficiently in advance of the implementation of Basel III that the prospect of the new and still somewhat
undefined capital rules would not have been the main factor in determining capital levels. There are clearly
potential objections to this choice of baseline, but we believe it provides a reasonable starting point for analysis.

66
67

IIF (2011)
Elliott, Salloy, and Santos (2012)© Oliver Wyman

31

Impact on the lending channel

Post Crisis Basel Reforms

Since the funding cost effects of capital are roughly linear (an assumption of this report and all, or virtually all, of theliterature), readers can adjust up or down if they view the baseline as inappropriate.
The change from this baseline is calculated by assuming that banks will target an average ratio of CET1 of 12%. Thistarget is 2 percentage points higher than in Elliott, Salloy, and Santos (2012) as a result of further Basel actions anda better estimate of targeted voluntary buffers above regulatory minimums, based on several additional years ofexperience.

4.1.

LOAN RATESAs previously discussed, the Modigliani and Miller theorem does not generally hold to the full extent in the realworld and banks therefore face higher costs due to higher capital requirements. Studies have shown that thetheorem does not hold in full at all times, and in reality higher equity levels do increase a bank’s costs. Thus, byincreasing the amount of equity at banks, capital requirements increase banks’ funding costs (liquidity
requirements add costs in a similar manner). This increase in the cost of funding may be passed on to the end users
in the form of higher loan rates.68
We focus on the cumulative impact of these reforms to aid comparability and because the aggregate effects areimportant to judging the calibration of the rules. In terms of comparability, some studies estimate the impact of aone percentage point increase in the capital ratio while others estimate the impact of the total increase in capital.
The following intermediary steps are needed to derive the cumulative impact:First, the increase in the total capital ratio due to regulatory changes will need to be calculated. However, this is not
as straightforward as it sounds as the calculation will need to factor in the change in the definition of capital (i.e. one
dollar of capital pre-crisis is not the same as one dollar of capital post-crisis) and factor out the increase in capitalrequired by market forces (i.e. banks would have to maintain more capital post- crisis even if the regulatory
requirements stayed constant). To address the former, we use the pro forma Basel III capital for all periods. The
average pro forma 2010 baseline Basel III CET1 levels were 6.7% for the US, 7.1% for Europe, and 6.6% for Japan.
These calculations are taken from Elliott, Salloy, and Santos (2012).
Next, we assume that, at a minimum, average capital ratios will increase to 12% in all regions by the end of 2019 asa result of regulatory reforms: reflecting requirements of 4.5% common tier 1 capital, 2.5% capital conservationbuffer, a 2% G-SIB surcharge, and a 3% buffer to account for additional tier 1 buffers held by banks. This
assumption has been tested against recent average CET1 ratios for the top 50 banks in Europe and North America,
which are reported to be 13–14% and ~11% for 2014–2015, respectively. While this assumption may not hold forall banks, we assume this to be a representative target that banks will have to reach by 2019.69
For studies that evaluate the impact of equity-to-RWA increases, we multiply the estimated loan rate increases per
one point of risk-weighted capital ratio by the difference between the baseline and target ratios for risk-weighted
assets. For example, the CET1 capital ratio in the US would need to increase by 5.3 percentage points, from 6.7
percent of RWAs in 2010 to the targeted 12%. The total impact on lending rates in the US is then calculated bymultiplying the increase in lending rates per one percentage increase in lending rates by 5.3. Another required
adjustment is for studies that estimated the impact for the increase in non-risk-weighted assets (i.e. total assets).
For these, we first calculate the change in the non-risk-weighted capital ratios by using average risk weights(RWA/Total Assets). We assume risk weights to be constant, as an explanation and forecasting of the complex topic
of average risk weights depends on a number of factors outside of the Basel reforms and as such lies outside thescope of this report.

68

Elliott, Salloy, and Santos (2012), Modigliani and Miller (1958), IIF (2011), De-Ramon et al. (2012), BCBS (2012), Kashyap Stein and Hanson (2010),
AFME and PwC (2014c), King (2010), Kisin and Manela (2015), MAG (2010), BCBS (2010a)
69
BCBS (2011b), BIS (2016e), SNL

32© Oliver Wyman

Post Crisis Basel Reforms

Impact on the lending channel

We calculate the gaps to target as described in the figure below.70
TABLE 4.1: TARGET CAPITAL RATIO AND CALCULATION OF THE GAP FROM BASELINEBASELINE (OBSERVED)TARGET (ASSUMED)

End-2010
pro forma
Basel III
CET1 ratio

Capital-to(non-riskweighted)
total assets
ratio

Average risk
weighting

Capital-tototal assets
ratio,
without risk
weighting

Average risk
weightingBasel III
CET1 ratio

Capital-to(non-riskweighted)
total assets
ratio

US

6.7

5.4

0.8

12

9.6

0.8

5.3

4.3

Europe

7.1

3.1

0.4

12

5.2

0.4

4.9

2.1

Japan

6.6

3.0

0.4

12

5.4

0.4

5.4

2.4

Target Basel
III CET1 ratio

GAP

As shown in the table above, the differential cost of meeting higher capital standards varied by region. Since
European and Japanese banks have an average risk weight of approximately half of the level of the US (~40% versus~80%), banks in these nations will need to raise less capital per dollar of total assets in order to meet an increase in
the ratio of capital to RWAs.71 The differences in average risk weighting are driven by a number of jurisdictional andbank-specific factors.72
Applying the gaps calculated above to the 1% increase in capital requirements estimated by academic and official
studies allows us to compare the gross impact of reforms on lending rates. We do not adjust the projected impacts
of increased liquidity requirements, because we have too little information to do so and cannot assume linearity.
Additionally, some studies include an estimation of offsetting factors that reduce the impact of reforms on banks.
The discussion of these offsetting factors will follow the discussion of gross impacts.

IMPACT ON GROSS LENDING RATESThe graphs below summarize the impact of reforms on funding costs (and therefore potentially loan rates) in the
US, Europe, and Japan, as reported by a number of academic and official studies. Some studies shown below
include multiple jurisdictions in their data sample. In these situations, the cumulative impact is scaled by theappropriate factor for each jurisdiction.

70

Elliott, Salloy, and Santos (2012)
Ibid72
According to IIF (2016), national factors (e.g. local laws, taxation, accounting standards, national ‘gold-plating’, local market tendencies), andinherent differences between banks (e.g. client characteristic, portfolio composition, and recovery strategies) contribute to 75% to the RWA
variability. An additional 25% of RWA variability is driven by modeling choices. Additionally, supervisory interpretation may play a role in RWA
variation.
71© Oliver Wyman

33

Impact on the lending channel

Post Crisis Basel Reforms

FIGURE 4.2: GROSS IMPACT OF BASEL REFORMS ON FUNDING COSTS IN US
200

Academic

Official

180
160

Basis points

140

Average pre-tax
return on assets
for 2014–2015 [3]

120
94

100
80

65

60

0

25

51

7

109

104
24

16
11
109

32
15

15

20

51

40
20

73

98

96

65

69

53

81
64

80

32

15
Kashyap,
Stein, &Hanson(2010)[1]Baker &
IMF (2011) MAG (2010a) IMF (2011)
Wurgler
Cosimano– BIS [1,2] Roger &[1,4](2015)& Hakura [1,2,5]
Vlček [1]CapitalLiquidity (LCR)

BIS – LEI MAG (2010b) IMF (2012) BIS (2010) OECD (2011)(2010) [1,2]–Elliott, Salloy,
King [1,2] Slovik && Santos [1]Cournede [1]BIS(interim) [1,2]Liquidity (NSFR)

Other

Liquidity (Total)[1] Average impact per 1 percentage point increase in capital is multiplied to account for total projected increase in ratios since 2010[2] Includes US, Europe, Japan[3] Average of 2014–2015 return as (total net income before taxes)/(total assets) for all banks; Source: SNL, Oliver Wyman analysis[4] Estimate of impact on lending spreads (basis points) of increasing ratio of capital to assets by one percentage point is taken from BCBS (2016)“Literature review on integration of regulatory capital and liquidity instruments”[5] Based on increase in the loan rate for the 100 largest banks

The gross impact of Basel reforms on funding costs in the US ranges from 15–109 basis points in these studies,using our baseline and target capital ratios. The impact is largely driven by an increase in capital requirements. The
median impact of increased regulatory requirements is 84 basis points and the mean is 74 basis points. Thispotential impact is highly significant compared to the average pre-tax return on assets, which averaged a little over
120 basis points in 2014 and 2015 and was lower historically (~1% for 1937–2015).73
We note that academic studies tend to estimate lower impacts on the markets than official studies, though thedifferences in results are mainly driven by differences in assumptions and factors such as the scope of research andconsideration of offsetting factors and methodological details. A discussion of these factors follows and theindividual studies are presented in further detail in the appendix.

73

SNL and Foran, Moszkowski, Elliott (2016)34© Oliver Wyman

Post Crisis Basel Reforms

Impact on the lending channel

FIGURE 4.3: GROSS IMPACT OF BASEL REFORMS ON FUNDING COSTS IN EUROPE
200

Academic

Official

180
160

Basis points

140
120
92

100

88

80

Average pre-tax return on
assets for 2014–2015 [3]

60
92

40

36
25

19
20

9

25

19

36

42
5

7
10

57

8
37

67

70

25

67

70

63

60

60

90

97

15

24

75

73

32

0
MendiSutorova
cino& Teplyet al(2013) [1][1,4](2015)

Total

ECB
[5]
(2015)IMF
BIS(2011)(2011)
Cosimano Schanz&
et al [1]Hokura [1,2,7]

Capital

IMF(2011)
Roger&
Vlcek [1]Liquidity (LCR)

IMF
MAG
FSA
OECD
BIS MAGBIS(2012)(2010a) (2012) De (2011)
LEI(2010b)(2010)[1,2][1,2]
Elliott,
– BIS
Ramon
Slovik(2010)– BIS
King [1,2]
Salloy,et al [6]&(interim) [1,2]&
Cournede [1]Santos [1]Liquidity (NSFR)

Other

Liquidity (Total)[1] Average impact per 1 percentage point increase in capital is multiplied to account for total projected increase in ratios since 2010[2] Includes US, Europe, Japan[3] Average of 2014–2015 return as (total net income before taxes)/(total assets) for all banks; Source: SNL, Oliver Wyman analysis[4] Estimate of impact on lending spreads (basis points) of increasing ratio of capital to assets by one percentage point is taken from BCBS (2016)“Literature review on integration of regulatory capital and liquidity instruments”[5] Based on increase in the loan rate for the 100 largest banks

The impact on Europe ranges from 9–97 basis points, with a median impact of 60 basis points and mean impact of
58 basis points. The magnitude is significant when compared with the average pre-tax return on assets, which has
averaged a little over 50 basis points in the last 2 years. Again, the majority of the effects are driven by an increase incapital requirements.

© Oliver Wyman

35

Impact on the lending channel

Post Crisis Basel Reforms

FIGURE 4.4: GROSS IMPACT OF BASEL REFORMS ON FUNDING COSTS IN JAPAN
200
180
160

Basis points

140
120

80
60
40
20

Average pre-tax return on assets for
2014–2015 [3]

15

24

83

81

MAG (2010a) –BIS (interim) [1,2]BIS (2010)
King [1,2]

25

66

105

98

96

100

46
33

29
1

29

11

66

71

MAG (2010a)– BIS [1,2]

BIS – LEI(2010) [1,2]

46

21

0
IMF (2011)
Cosimano &Hakura [1,2,4]

Total

Elliott, Salloy, &Santos (2012) [1]CapitalOECD (2011)
Slovik &Cournede [1]Liquidity (LCR)

Liquidity (NSFR)

Other

Liquidity (Total)[1] Average impact per 1 percentage point increase in capital is multiplied to account for total projected increase in ratios since 2010[2] Includes US, Europe, Japan[3] Average of 2014–2015 return as (total net income before taxes)/(total assets); Source: SNL, Oliver Wyman analysis[4] Based on increase in the loan rate for the 100 largest banks

The gross impact of Basel reforms on funding costs in Japan is expected to range from 29–105 basis points in thesestudies, using our baseline and target capital ratios. The impact is largely driven by an increase in capitalrequirements. The median impact of the increased regulatory requirements is 66 basis points and the mean impact
68 basis points. This potential impact is significant compared to the average pre-tax return on assets, which
averaged a little over 50 basis points in 2014 and 2015.
Additionally, Gambacorta and Shin (2016) find that a 1% increase in the ratio of equity to total assets leads to a 3basis point increase in the cost of funding. The estimate is smaller than other estimates discussed above as thestudy calculates a significant reduction in the cost of debt resulting in approximately a 50% Modigliani-Miller offset,
not taking account of the tax benefit of debt (which would lower the offset) or the reduction in required return on
equity, (which would raise the offset.)74
As observed above, the sheer magnitude of impacts differs regionally: our analysis of the literature shows that
estimates of the gross impact of the new Basel capital and liquidity requirements on funding costs in the US ranges
from 15–109 bps, with a median increase of 84 bps. The impact in Europe ranges from 9–97 bps, with a medianincrease of 60 bps. The estimated increase in funding costs in Japan ranges from 29–105 bps with a medianincrease of 66 bps. This is primarily driven by the fact that US banks have to close a larger gap to our chosen target
capital ratio, which may be in part an artifact of using the same target ratios for all regions and focusing on a target
ratio based on RWA, which is affected by the very different average risk weights across the regions. However, using
a different base for different regions introduces another layer of assumptions which the authors deemed not beworth the loss of comparability.

74

Gambacorta and Shin (2016)36© Oliver Wyman

Post Crisis Basel Reforms

Impact on the lending channel

Even with the larger basis point effect on the US, the higher funding costs are likely to have a relatively larger
aggregate impact in Europe and Japan, where the average pre-tax rates of return on assets are lower than in the US
and the banking systems are much larger in comparison to the size of their economies.

DRIVERS OF DIFFERENCES IN ESTIMATES OF IMPACT
There are several drivers of the variation of estimates of impacts. We summarize these trends and then discuss theunderlying studies in further detail in the appendix.
First, not all studies are fully comparable due to the scope of their research. Some of the studies incorporate theimpact only of capital reforms, while others also include the impact of liquidity reforms.
Second, the gross impact of the reforms ignores offsetting factors that could decrease the overall impact, which will
be discussed shortly. Some studies include offsets while others do not.
Third, the methodology used has an impact on the estimate. Approaches that rely on DSGE or GMM estimations(e.g. Roger and Vlcek (2011) and Cosimano and Hakura (2011)) tend to estimate lower impacts of the reforms,
likely due to the fact that these approaches are able to adjust for multiple interactive effects in the economy andcould include some inherent offsets.75 However, DSGE are highly complex and require researchers to make anumber of parametric assumptions and make decisions about which mechanisms that affect the dynamics of theeconomy should be incorporated into the model. As such these models rest on a number of assumptions that could
sway the results and are difficult to compare across studies.76 Approaches using the accounting method tend to
estimate higher gross impacts, as these approaches do not usually take into account the interaction between loan
pricing and market demand, and these models usually do not fully address the issue of how default risk affects thecost of funding.77 BIS studies that rely on a number of member models tend to imply estimates that are within the
middle to high range. This may be driven by the fact that these reflect an impact on the average economy, which
may differ significantly from the three regions that we focus upon, which are all developed economies.
Fourth, in general, academic studies tend to show a lower impact of reforms, driven in part by the fact that they
only show the effects of capital reforms. This is also driven by other methodological approaches and assumptions,which are listed above and discussed in further detail in the appendix.
Finally, it is important to note that the estimates of effects represent a lower bound on the gross impacts of theBasel reforms on loan rates, as these estimates do not include the effects of the post-2012 reforms expected to
impact banks’ RWA calculations (e.g. limitations on use of internal models, revisions to standardized approaches
for credit and operational risk, etc.). Nor is the leverage ratio assumed to be binding in any of the studies.
Detailed discussion of these studies and underlying assumptions can be found in the appendix.

EFFECTS OF MORE RECENT AND ONGOING BASEL REFORMS
As discussed earlier, the estimates of lending impacts shown in the studies above are focused on the increase incapital ratios or liquidity requirements. Thus, due to either the study design, or the fact that many of these reforms
are quite recent, the studies above do not capture the additional impacts of the more recent Basel reforms such asrevisions to standardized approaches for credit and operational risk, FRTB, limitations on use of internal models,and capital floors.

75

Roger and Vlcek (2011), Cosimano and Hakura (2011)
BCBS (2016h), Sbordone et al (2010), Fernandez-Villaverde (2009)
77
BCBS (2016h), De-Ramon et al (2012), King (2010), Slovik and Cournede (2011)76© Oliver Wyman

37

Impact on the lending channel

Post Crisis Basel Reforms

Quantifying the impact of these reforms is challenging, primarily due to the fact that not all reforms have been
finalized, and calibration is not yet complete. For example, the calibration of the capital floors could range
significantly and will interact with the calibration on the limitations on use of internal models. However, based on
industry and analyst research it is clear that these reforms will increase bank RWAs.78 However, it is important tonote that the Group of Central Bank Governors and Heads of Supervision (GHOS) has stated that the Basel“Committee will focus on not significantly increasing overall capital requirements.”79
As discussed above, the exact impact of the reforms is not yet clear in part due to the fact that they have not all been
finalized or implemented, leading to a wide range of estimates, the majority of which point to the lower bound of
RWA increase to be ~10–30%. These estimates are discussed in further detail in Section 1.80 Banks could react tothese reforms in two ways: raise their CET1 levels to offset the increase in RWAs, if they do not have sufficient CET1
already, or shrink the size of their RWAs through balance sheet reduction. In the table and figure below, we assume
that banks increase their CET1 capital and show the estimated ranges of impact should RWAs increase by up to
30% as a result of these reforms. To calculate the likely impact on gross funding costs, we assume that the target
capital ratio increases by 10–30% across all geographies.
TABLE 4.2: IMPACT OF BASEL REFORMS ON FUNDING COSTSSCENARIOUS
Basel III baseline
Baseline and 10% extra increase in RWA
Baseline and 20% extra increase in RWA
Baseline and 30% extra increase in RWA
EuropeBasel III baseline
Baseline and 10% extra increase in RWA
Baseline and 20% extra increase in RWA
Baseline and 30% extra increase in RWA
Japan
Basel III baseline
Baseline and 10% extra increase in RWA
Baseline and 20% extra increase in RWA
Baseline and 30% extra increase in RWA

MINIMUM
INCREASE(BASIS POINTS)

MEDIAN
INCREASE(BASIS POINTS)

MAXIMUM
INCREASE(BASIS POINTS)

15
18
22
25

84
97
111
125

109
134
158
183

9
10
11
12

60
74
80
87

97
115
137
159

29
36
42
46

66
81
96
110

105
123
141
159

78

Dawn (2015), Durand (2015), Keenan and Spick (2015), KPMG (2015), Macquarie Equities Research (2016), The Economist (2015), Turner (2012),
Graham, Li, and Kruse (2016), IIF (2016), BCBS(2015f), ISDA, GFMA, and IIF (2015), ORX Association (2016), J. P. Morgan Cazenove (2015), Oliver
Wyman and Morgan Stanley (2015), The Association of German Public Banks (2016), Risk Control (2016), McKinsey (2015)
79
BIS (2016m)
80
Dawn (2015), Durand (2015), Keenan and Spick (2015), KPMG (2015), Macquarie Equities Research (2016), The Economist (2015), Turner (2012),
Graham, Li, and Kruse (2016), IIF (2016), BCBS(2015f), ISDA, GFMA, and IIF (2015), ORX Association (2016), J. P. Morgan Cazenove (2015), Oliver
Wyman and Morgan Stanley (2015), The Association of German Public Banks (2016), Risk Control (2016), McKinsey (2015)38© Oliver Wyman

Post Crisis Basel Reforms

Impact on the lending channel

The figure below illustrates the components of a median increase in gross funding costs.
FIGURE 4.5: IMPACT OF ADDITIONAL BASEL REFORMS ON MEDIAN ESTIMATED INCREASE OF GROSSFUNDING COST
US140

Europe

Japan

140

140

120

120

121
120

11

100

107
100

26

92

84
80

11

80
60

100

66

60

40

40

40

20

20

20

60

0

0
Basel III

Other
TLAC
Basel
Committee
initiatives [1]

Total

29

80

21

60

0

11

Basel III

Other
TLAC
Basel
Committee
initiatives [1]Total

Basel III

Other
TLAC
Basel
Committee
initiatives [1]Total

Average pre-tax return on assets in 2014–2015[2][1] Revisions to standardized approach to credit risk, market risk, operational risk, IRRBB, limitations on use of internal models, capital floors.
Calculated as median estimate of 10% inflation scenario, 20% inflation scenario, and 30% inflation scenario[2] Average of 2014–2015 return as (total net income before taxes)/(total assets); Source: SNL, Oliver Wyman analysis

Figure 4.5 above demonstrates that an increase in RWA due to the most recent Basel reforms could increase
funding rates even further. For the US, this implies that if bank RWAs were to increase by the projected RWA
inflation ranges, the median estimate of impact on funding rates would approach the average pre-tax return on
assets. For Europe and Japan, the increase in funding costs would consistently exceed the average pre-tax returnon assets. Funding costs will further increase when the incremental effect of TLAC are added, as will be discussed
later on.
Revisions to SA for credit risk, FRTB, the revised approach to operational risk and other Basel reforms. The
biggest drivers of this increase in RWAs would be the revisions to the SA for credit risk, FRTB, the revised approachto operational risk, limitations on the use of internal models, and capital floors. In essence, the impact of theseongoing workstreams could be multiplicative (as discussed in Section 5) because these reforms will make it more
expensive for banks to meet their capital requirements.
TLAC. In addition to the factors discussed above, loan rates are also likely to be impacted by TLAC requirements. In
a November 2015 BIS study, an Experts Group for the FSB (2015) estimates that, depending on the calibration of
TLAC, loan rates could rise between 5.4 and 15.2 basis points (reflecting increases in funding costs). Experts Groupfor the FSB (2015) notes that “the size of the impact on lending rates is directly linked to the relationship between
the cost of eliminating the shortfall and the size of the loan book of the G-SIB (since this is the only source ofrevenue that is assumed to be impacted), and varies with the calibration of the TLAC requirement.” These are theestimates used to project possible increases in funding rates. FSB’s Summary of Findings from the TLAC Impact
Assessment Studies notes that applying a G-SIB market share of 40%, the median rates described above “translate© Oliver Wyman

39

Impact on the lending channel

Post Crisis Basel Reforms

into increases in lending rates for the average borrower of about 2.2 bps and 3.2bps,” depending on thecalibration.81
Additionally, the Federal Reserve estimated that the US proposed TLAC and LTD requirements would create ashortfall of approximately $120 billion for 6 US BHCs, which would translate into an aggregate increased cost offunding of $680 million to $1.5 billion. 82 This would imply that “BHCs would employ an increased lending rate of
1.3 to 3.1 basis points as a result of the proposed external TLAC and LTD requirements,” though it is noted that thisis a “conservative estimate of the effect.”83 The industry has had limited consensus around these numbers. In a
letter to the Board of Governors of the Federal Reserve System, The Clearing House, SIFMA, American Bankers
Association, Financial Services Roundtable, and Financial Services Forum estimate that “the covered BHCs will face
an aggregate shortfall in eligible TLAC and long-term debt relative to the TLAC and long-term debt requirements of$363 billion,” an estimate approximately 3 times larger than that of the Federal Reserve.84 As there are currently alimited number of comprehensive studies that evaluate the impact of TLAC on lending rates, particularly in concert
with other regulatory reforms, it is possible that the impact could be underestimated.
The cumulative impact of all post-crisis Basel reforms and TLAC requirements on funding rates is not yet fully clear
due to multiple factors. The calibration of some of these reforms, as well as interactions with other reforms, arediscussed in further detail in Section 5. Comprehensive QIS studies of new proposals, as well as the aggregate
reforms, are necessary to understand the full implications of the reforms.

OFFSETS TO INCREASES IN FUNDING COSTSAs discussed above, a number of the studies include an assumption of offsets to the gross impact of Basel reforms
on lending rates. These offsets help us calculate the net effect of reforms, as they capture factors that potentiallydecrease the impact of regulation on banks. Offsets can be driven by factors within or outside a bank’s control.
Offsetting factors within a bank’s control are actions that can be implemented by them to mitigate the impact ofreforms. These actions include:85
Reducing expenses. In responding to higher costs, banks could attempt to cut their expenses to maintain their
margins. Administrative or marketing expenses are likely candidates for these reductions. In practice, in a context
of low rates and increased market volatility, banks have widely communicated details of their cost cutting,including reductions of headcounts, transfer of jobs to lower-cost locations, outsourcing and technology. This will
be discussed further in Section 1. However, expense cuts have been offset to a substantial extent by the large
increase in compliance and risk management expenses in response to the crisis and the new regulations.
Decreasing expected credit losses through tighter loan conditions. Financial institutions can alter lending
terms and conditions, such as toughening covenants.
Restructuring their businesses. Banks may decide to exit products and business lines, restructure theirorganizations, or pursue other strategies to optimize profitability, potentially across multiple jurisdictions.
Other capital actions. Banks can execute mitigating actions such as asset run-offs, asset disposals, asset
impairments, and other actions such as RWA optimization.
Most of these actions are described in further detail in Section 1.
81

FSB and BCBS (2015)
Federal Reserve (2015b).
83
Federal Reserve (2015b).
84
The Clearing House, SIFMA, American Bankers Association, Financial Services Roundtable, and Financial Services Forum to Robert deV Frierson(2016)
85
Elliott, Salloy, and Santos (2012)82

40© Oliver Wyman

Post Crisis Basel Reforms

Impact on the lending channel

Additionally, there are a number of other factors outside of a bank’s control that could mitigate the impacts ofreforms.86
Offsets among reforms. Requirements and incentives created by some reforms, e.g. LCR and NSFR, can be met
through the same actions. In the case of LCR and NSFR, the joint requirements of both reforms can be met byincreasing HQLA holdings (in the case of NSFR, increasing HQLA holdings is not required but is highly beneficial for
meeting the overall requirements). Because some of the same HQLA holdings can be counted to meet both
requirements, a bank would need to raise less HQLA to meet both requirements simultaneously than if a bank had
to meet requirements using two separate stocks of HQLA.
Decrease in the returns demanded by equity and debt holders, reflecting increased safety. The
implementation of Basel reforms should lead to greater safety within the banking system, and for individual banks.
As such, equity holders may accept a lower return on equity (ROE) allowing the banks to operate at lower
profitability and purchasers of bank debt may accept lower interest rates.

IMPACT ON NET LENDING RATESThe estimated impact of these offsets and resulting projected net lending rate increases are illustrated in thegraphs below for US, Europe, and Japan. These estimates exclude the impact of reforms post-2012 (i.e. theongoing workstreams), since these were not addressed in any of the underlying studies.
FIGURE 4.6: IMPACT OF OFFSETTING FACTORS IN THE US
130

Average pre-tax return on assets for 2014–2015 [3]

120
104

110
100

Basis points

90

98

94

4
3
16

80
70

11

92

12
11

83

24

83

80

Net total

Gross impact

25
57

60
50

41

40
69

64

30

92

41

20
10
0
Gross impact

Offset

Net total

Gross impact

IMF (2012)
Elliott et al [1,4]CapitalLiquidity (LCR)

OffsetBIS – LEI(2010) [1,2]Liquidity (NSFR)

Liquidity (Total)

Offset

Net total

BIS (2010)
King [1,2]Derivatives

Taxes and fees

OffsetNet[1] Average impact per 1 percentage point increase in capital is multiplied to account for total projected increase in ratios since 2010[2] Includes US, Europe, Japan[3] Average of 2014–2015 return as (total net income before taxes)/(total assets); Source: SNL, Oliver Wyman analysis[4] Elliott, Salloy, and Santos (2012)

86

Ibid

© Oliver Wyman

41

Impact on the lending channel

Post Crisis Basel Reforms

FIGURE 4.7: IMPACT OF OFFSETTING FACTORS IN EUROPE
120
97

100
88

Basis points

80

85

12
11

77

24

77

73

Net total

Gross impact

25
Average pre-tax
return on assets
for 2014–2015 [3]

57

60
1

6
10

40

8

33
63

24
20

32

85

24

0
Gross impact

Offset

Net total

Gross impact

IMF (2012)
Elliott et al [1,4]Capital

OffsetBIS – LEI(2010) [1,2]Liquidity (LCR)

Liquidity (NSFR)

Liquidity (Total)

Offset

Net total

BIS (2010)
King [1,2]Derivatives

Taxes and fees

OffsetNet[1] Average impact per 1 percentage point increase in capital is multiplied to account for total projected increase in ratios since 2010[2] Includes US, Europe, Japan[3] Average of 2014–2015 return as (total net income before taxes)/(total assets); Source: SNL, Oliver Wyman analysis[4] Elliott, Salloy, and Santos (2012)

FIGURE 4.8: IMPACT OF OFFSETTING FACTORS IN JAPAN
120
97

100
88

Basis points

80

24

77

73

Net total

Gross impact

Average pre-tax
return on assets
for 2014–2015 [3]

57
1

6
10
8

33

32

85

63

24
20

77

25

60

40

85

12
11

24

0
Gross impact

Offset

Net total

Gross impact

IMF (2012)
Elliott et al [1,4]CapitalLiquidity (LCR)

OffsetBIS – LEI(2010) [1,2]Liquidity (NSFR)

Liquidity (Total)

Offset

Net total

BIS (2010)
King [1,2]Derivatives

Taxes and fees

OffsetNet[1] Average impact per 1 percentage point increase in capital is multiplied to account for total projected increase in ratios since 2010[2] Includes US, Europe, Japan[3] Average of 2014–2015 return as (total net income before taxes)/(total assets); Source: SNL, Oliver Wyman analysis[4] Elliott, Salloy, and Santos (2012)42© Oliver Wyman

Post Crisis Basel Reforms

Impact on the lending channel

The offsets calculated by a subset of papers lower the estimated impact of Basel reforms. In most cases though, thenet impact of the reforms, in Europe and Japan, remains above the average pre-tax return on assets.
The size of the offsets presented above is driven by the composition of such offsets. The Elliott, Salloy, and Santos(2012) study assumes the offsets to be driven by banks absorbing some of the cost increase of the capitalrequirements, the overlap of NSFR and LCR actions, banks executing expense cuts (at 5% for Europe, 10% for theUS), and executing other adjustments and capital actions.87 The largest of these effects is the decrease in required
profitability, consistent with a partial application of the Modigliani-Miller theorem. This is a critical difference that
distinguishes this estimate from others.
The Basel Committee’s Long-term Economic Impact (“the LEI study”)88 and King (2010) studies, on the other hand,assume a much smaller offset because they analyze only a subset of the offsets reported by Elliott, Salloy andSantos (2012). Both the LEI study and King (2010) derive their offset from the fact that there will be a decrease in
RWA and the corresponding lower regulatory capital needs associated with the higher proportion of low-risk assets,
which is the expected result of the capital reforms. As such, they expect that liquidity reforms, for their part, will nothave the full stand-alone impact estimated by these studies as the asset composition will already have changed to
produce greater liquidity.89

4.2.

LOAN VOLUMES

Another way in which the effects of Basel reforms may flow through to the end users is through impacts on loan
volumes.90 This impact on loan volumes could be estimated through several different approaches.
Demand. As loan rates increase, the demand for bank lending declines as some subset of the borrowers is nolonger willing to pay the higher loan prices.
Supply. Banks restrict the supply of credit to the economy, either on the intensive margin (i.e. the decision of how
much to lend conditional on lending at all), or on the extensive margin (i.e. the decision to extend a loan or not
irrespective of its amount).91 Banks could also restrict credit supply across both margins.
General equilibrium. Overall volume of credit is impacted by both the change in supply and demand.
The studies discussed below report the impact for each percentage point increase in the capital ratio. Because theassumption of linearity of impact may not hold for credit volumes, we do not scale the loan impacts to a cumulative
amount.92

87

Elliott, Salloy, and Santos (2012)
Cited in the bibliography as BCBS (2010a)
89King (2010), BCBS (2010a)
90
Elliott, Salloy, and Santos (2012)91
Fraisse et al (2015)92
De Nicolo et al (2014)88© Oliver Wyman

43

Impact on the lending channel

Post Crisis Basel Reforms

FIGURE 4.9: IMPACT OF REFORMS ON LENDING VOLUMES

Mendicinoet al (2015) [1,2]

Sutorova& Teply(2013) [1,2]Bank ofEngland
FSA (2009a)
et al (2014)
Francis &Meeks [2,3]Osborne [3]MAG(2010a) [4]FSA (2012)
De-Ramonet al [3]

-1.4

-1.6

Bank ofBank ofEnglandEngland
Bank of France(2014) Bridges (2014) Noss (2015) Fraisse
et al [3]& Toffano [3]et al [5]

0%
-1%

-0.3

-0.4
-1.2

-2%
-3%

-2.5

-4%

-3.5

-5%

-4.5

-6%
-7%
-8%
-9%

Academic

Official-8.0[1] Europe[2] Estimate of impact on lending volumes (basis points) of increasing ratio of capital to assets by one percentage point is taken from BCBS (2016)“Literature review on integration of regulatory capital and liquidity instruments”[3] UK only
[4] US, Europe, and Japan[5] France only; impact on extensive margin is shown

The majority of studies examining the impact of these reforms have been based on European data, though studies
based on OECD estimates point to an average impact that can also be applied to the US and Japan.
As evidenced from the graph above, the overall reduction in lending volumes varies from a 0.3% to 8% decline inbaseline levels. On average, Basel reforms could drive an overall reduction of around 2.6% per 1 point increase inrequired capital ratios. This average impact is somewhat skewed by the highest estimate. When we exclude thehighest and lowest estimates, we find an average impact of 2.1%. On the other hand, Gambacorta and Shin (2016)
find that a 1% increase in equity to total assets ratio is associated with a 0.6 percentage point increase in annual
loan growth as banks with higher capital levels are likely to lend more.93 However, it is important to note that
Gambacorta and Shin find a correlation, but do not show causation. It is likely that the correlation reflects the factthat when banks have the capacity to deploy capital, they will make more loans unless loan conditions are notably
unfavorable. Thus, there is a major difference between evaluating actual capital levels versus the effects ofminimum capital requirements.
In addition to the figures presented above, Cosimano and Hakura (2011) find that a “1.3 percentage point increasein the equity-to-asset ratio required by Basel III is predicted to reduce loans for the 100 largest banks by 1.3 percent
in the long run.”
There are several key findings in the comparison of estimates of impacts. We first summarize these trends and thendiscuss each of the research findings in further detail in the appendix.
First, the studies discussed in this report estimate the impact of capital reforms alone on volume, and as such likely
underestimate the total impact of post-crisis Basel reforms. Additionally, as discussed in the impact on loan rate
sub-section, these estimates do not account for more recent reforms likely to impact banks’ risk weighted assets(e.g. limitations on use of internal models, revisions to standardized approaches for credit and operational risk,

93

Gambacorta and Shin (2016)44© Oliver Wyman

Post Crisis Basel Reforms

Impact on the lending channeletc.). Similarly, monetary policy is also likely to contribute to movements in loan supply, and these effects are notconsidered here.94
Second, the methodology used has an impact on the findings. Studies that use DSGE or equilibrium approaches(e.g. Mendicino et al (2015)) tend to estimate lower impacts while regression and reduced-form models tend to
estimate higher impacts of reforms. As discussed previously, this is likely due to the fact that DSGE studies are able
to adjust for multiple interactive effects in the economy and could include some inherent offsets. However, DSGE
are highly complex and require researchers to make a number of parametric assumptions and make decisions
about which mechanisms that affect the dynamics of the economy should be incorporated into the model. As suchthese models rest on quite a number of assumptions that impact the outputs of the studies.95
Third, the conceptual approach to estimating the impact on loans also seems to have an impact on the magnitudeof findings. Studies that approach loan volume from a bank supply point of view (e.g. Fraisse et al (2015))) tend to
estimate higher impacts.
Fourth, some studies estimate the impact of capital increases on the lending growth rate, pointing to declines of
1.2–4.6% from the baseline. However, this estimate is somewhat different from impacts on loan volume and assuch is not shown in the comparative chart above.96
Detailed discussion of these studies and underlying assumptions can be found in the appendix.

4.3.

DISTRIBUTIONAL CONSEQUENCES

The factors discussed above will not impact all banks and all end-users the same way: there will be distributional
consequences for market segments and products, for individual banks, and for certain jurisdictions. For example,
researchers such as ECB (2015), Mendicino et al (2015), and de-Ramon et al (2012) note that impacts on lending
rates and lending volume will not be consistent for all market segments and products.97
FIGURE 4.10: IMPACT ON LENDING RATE MARKET SEGMENTS DUE TO INCREASE IN CAPITAL REQUIREMENTS
30

Basis points

25
20
15
24

10
5

14

0
Mortgages

Corporates

Notes:
Euro area.
Estimate of impact on lending rates (basis points) of increasing ratio of capital to assets by one percentage point is taken from BCBS (2016)“Literature review on integration of regulatory capital and liquidity instruments”.
Reported impact is multiplied by 0.4 to adjust for the difference in impact of an increase in capital to risk weighted assets ratio and an increase incapital to total assets ratio.
Source: Mendicino et al (2015), BCBS (2016h)

94

BCBS (2012)
BCBS (2016h), Sbordone et al (2010), Villaverde (2009)96
Mesonnier and Monks (2014), Aiyar, Calomiris and Wieladek (2014)
97
Mendicino et al (2015), ECB (2015), de-Ramon et al (2012)95© Oliver Wyman

45

Impact on the lending channel

Post Crisis Basel Reforms

As shown above, the results of Mendicino et al (2015), which are scaled for our estimated gap between initial andtarget capital ratios, but do not factor in RWA inflation due to ongoing Basel workstreams, imply that an increase incapital requirements will impact corporate lending almost twice as much as mortgage lending. Since European
corporates rely more on bank lending for financing than their American peers, this may result in higher impacts for
European corporates. Similarly, de-Ramon et al (2012) find that while, on average, the credit spread for the UK
economy will rise by 67 basis points once banks have fully adjusted to the capital requirements, in the short term,
the corporate wedge will rise by 126 basis points prior to falling to the long-run average while householdborrowing costs will increase continuously over the period. De-Ramon et al (2012) explain that this is driven by thefact that, on average, corporate lending has a higher regulatory risk weight than lending to households (primarily
mortgages). Thus, following an increase in capital requirements, banks could raise the prices of the comparatively
riskier corporate loans more than the prices of household loans, as in the short run this will allow banks to adjust
their risk-weighted assets more efficiently. This disparity could be concerning, as higher rates on corporate loans
will raise the cost of funds for non-financial firms and as such could produce negative effects on output while higher
household borrowing costs will have an impact on overall welfare through consumption but are not likely tosignificantly impact output in the long term. Additionally, a widening of bank lending spreads (particularly forcorporate end-users) could also reduce investment, especially if wider spreads feed into lending rates available incapital markets or through other non-bank lenders.98
These distributional differences are likely to be exacerbated further by the most recent Basel reforms. A study
estimates that under BCBS 347 proposals (Revisions to the Standardised Approach for credit risk) bank spreads forcorporate loans increase by between 63 and 103 basis points, with significantly smaller increases expected forresidential mortgages. Additionally, the impact of other ongoing workstreams such as revisions to Leverage Ratio(LR) treatment of deposits (see Section 5 for details) is also expected to be significant for corporates. 99
Similar impacts can be observed in lending volumes.

98
99

Mendicino et al (2015), de-Ramon et al (2012), Barrel et al (2009), Meeks (2014), Cohen and Scatigna (2014).
Risk Control (2016)46© Oliver Wyman

Post Crisis Basel Reforms

Impact on the lending channel

FIGURE 4.11: IMPACT ON LENDING VOLUME MARKET SEGMENTS DUE TO INCREASE IN CAPITALREQUIREMENTS
Mendicino et al (2015) [1,2]Meeks (2014) [2,3]Mendicino et al (2015) [1,2]Meeks (2014) [2,3]

0.0%
-0.1%
-0.2%

-0.15
-0.20

-0.3%
-0.4%
-0.43

-0.5%

-0.50
-0.6%

Mortgages

Corporate[1] Euro area
[2] Estimate of impact on lending rates (basis points) of increasing ratio of capital to assets by one percentage point is taken from BCBS (2016)“Literature review on integration of regulatory capital and liquidity instruments”[3] Reported impact is multiplied by 0.4 to adjust for the difference in impact of an increase in capital to risk weighted assets ratio and an increase incapital to total assets ratio
Source: Mendicino et al (2015), BCBS (2016h), Meeks (2014)

As indicated above, the findings of Mendicino et al (2015) and Meeks (2014) point to higher drops in volume ofcorporate than mortgage loans as an increase in capital requirements. Other researchers have been able to identify
more granular impacts on the decline in corporate loan volumes. The lending volume to SME’s is expected to be
more impacted than corporate lending because the higher capital requirements impact instruments with higher
risk weights.100 Similarly, Pessarossi and Vinas (2014) found that small or more opaque firms are particularly hit by
the reduction in loan supply for long-term loans, as banks tend to ration loans to these firms while continuing tolend at the same pace to medium and large firms. Furthermore, if safe, but small and opaque, firms are also facedwith higher loan rates they may be tempted to turn down the offers and banks may end up attracting only risky
counterparties.101 Trade finance and infrastructure financing may also be particularly impacted. Trade finance is
crucial to international trade but may be adversely affected by the increase in capital requirements, as well as anincrease in equity requirements if the leverage ratio became the binding constraint. Additionally, NSFR RSF factors
for trade finance loans could further discourage banks from making trade finance loans (vs. other lending) or could
drive banks to increase their pricing. Some believe that trade finance products should be differentiated from otheroff-balance sheet instruments due to their relatively low risk and short term nature. Though the Basel Committee
has issued some adjustments to account for the characteristics of trade finance, many believe that the rules still do
not fully acknowledge the low-risk nature of trade finance products. The impact of a shrunken trade finance market
is a particular concern for emerging countries. A discussion on the differing impacts across regions is expanded
later in this section.102
Reform may also reduce infrastructure financing, which is a long-term asset that requires banks to obtain the more
expensive long-term funding, at least when viewed on a stand-alone basis. In situations when capital requirements
and NSFR rules could discourage banks from maintaining long-term funding, banks may become unwilling to issue
infrastructure loans, which are, again, particularly important to countries that are not fully developed. Additionally,
100

Sheng (2013)
Mendicino et al (2015), Meeks (2014), and Pessarossi and Vinas (2014)
102
Sheng (2013), Brandi, Schmitz, and Hambloch (2014), Malesova (2015), BAFT to BCBS (2014)
101© Oliver Wyman

47

Impact on the lending channel

Post Crisis Basel Reforms

large haircuts may apply to the underlying collateral, which may further dissuade banks from participating in thismarket.103
The impairment of bank intermediation, with higher loan prices or lower loan volumes, may drive customers to theshadow banking sector. This issue is discussed in further detail in Section 5.
Second, reforms will not impact all banks in the same way. Researchers find that banks that are harder hit byregulatory requirements (i.e. banks with a low existing capital buffer or banks with a higher existing liquidity risk)
are likely to have a stronger response in terms of rise in loan prices or reduction in bank loan supply. Impact forbanks will also differ based on current practices. For example, banks that are heavy users of favorable internal
models to measure credit risk will be much more impacted by limitations on the use of internal models than banks
that use standardized approaches. Cosimano and Hakura (2011) find that banks in countries affected by the recent
financial crisis will be more impacted than banks in non-affected countries. Thus, the impacts to end-users would
be different based on which bank they are engaged with.104
Third, the impact of reforms could differ based on economic level of development of a particular country.
Comparatively less research has focused on impact of reforms on developing nations, as banks in developing
nations frequently already operate above the minimum capital and liquidity requirements ratios due to higher
expected volatility and higher losses (e.g. significantly higher non-performing loan rates in Africa.) For these banks,
the increase in minimum capital requirements and the countercyclical capital buffer are likely to be too low to bind
as a constraint to excessive credit growth.105
However, others researchers have noted that capital reforms could also pose unique challenges for emerging
markets. For example, Sabunwala (2012) notes that for emerging markets the regulatory reform agenda is closely
linked to the financial development agenda. The author notes that higher capital requirements may come at a costof slower economic development as banking will become modestly more expensive (loans will become costlier andharder to get). In developing markets this may be particularly challenging. Additionally, a Basel study indicatedthat emerging markets and developing economies (EMDEs) continue to indicate that some reforms, e.g. policy
measures for G-SIBs, liquidity reforms, etc., could have potential adverse implications. For example, EMDEs could
have less access to HQLAs required by liquidity reforms, leading them to adopt alternative liquid asset (ALA), which
would present unique challenges. This is further discussed in Section 5.106
Additionally, impacts on emerging markets will be compounded by other direct and indirect effects. First, theprovision to exclude minority interests from capital raises operating costs for many developed nation banks
operating in emerging markets. This may make maintaining emerging market presence less attractive fordeveloped nation banks and could lead to possible reductions in operations or even withdrawals from thesemarkets. A Basel study noted that deleveraging by internationally active banks is a continued concern for EMDEs.
Second, transmission mechanisms of cross-border capital flows could further exacerbate the effects on emerging
markets. All in all, it is clear that impacts of Basel reforms are likely to differ across jurisdictions and levels ofdevelopment.107

103

Sheng (2013)
Cosimano and Hakura (2011), Memmel and Raupach (2007), Pessarossi and Vinas (2014), Macquarie Equities Research (2016)
105
Kasekende, Bagyenda, Brownbridge (2011)106
Kasekende, Bagyenda, Brownbridge (2011), Sabunwala (2012), BCBS (2014l)
107
Ibid
104

48

© Oliver Wyman

Post Crisis Basel Reforms

Impacts on capital markets

5. IMPACTS ON CAPITAL MARKETSThe primary focus of this section is to discuss the findings of studies by academics, officials, and other industry
observers on the overall impact of Basel reforms on capital markets, supplemented with more detailed analysis
where market data is available108.
Academics have focused their analysis so far on market liquidity given its significance for the efficient functioning of
capital markets. An adverse impact on market liquidity could result in rising transaction costs for investors, higher
price volatility, lower prices for existing bonds, more expensive fund raising for businesses, governments, and,indirectly, households, and, a greater potential for periods of market instability.109
Higher direct transaction costs may come about as a result of banks passing on higher costs to end users, which
could be exacerbated by lower market liquidity forcing dealers to recover fixed costs over a smaller activity base.
The speed and extent of price movements (volatility) could be increased if it is more expensive or harder to tradeand volumes are consequently lower. Lower liquidity could reduce the return for investors who are buying or
selling in large size. Bond prices could also fall as investors increase the liquidity risk premium that they demand,raising the overall required interest rate. Similarly, an increase in the liquidity premium would mean that investors
would demand higher interest rates on new issues, resulting in increased cost of funding for non-financial
corporates.110
Other types of impacts on capital markets have not been analyzed extensively in academic and industry
publications. As a result, the impacts covered in this report are not exhaustive. For example, the following, among
others, are not studied in this report:•

Increased client segmentation by market makers and narrowing of service offerings to select customer
segments, resulting in increased concentration risk for end users.

•

Decreased product choice, with products being discontinued or offered at a prohibitive cost, resulting in theretention of basis risk by end users unable to adequately hedge their transactions.

A comprehensive analysis of the impact on capital markets is challenging for multiple reasons. The impact ofreforms has not yet fully materialized, in part due to the reasons described below, and as a result, empiricalevidence based on existing market conditions likely understates the ultimate effects of these reforms:•

The impact of Basel reforms on capital markets are masked to some extent by how recently some key reforms
have been introduced, such as the Liquidity Coverage Ratio. Other reforms, such as the Leverage Ratio, theNet Stable Funding Ratio, margin requirements for non-centrally cleared derivatives and the FRTB are yet to be
implemented across jurisdictions. Banks and large dealers are likely to make more significant changes as full
implementation occurs.

•

The unconventional monetary policies followed by central banks across the globe have continued to injectunprecedented amounts of liquidity into the economy with spillovers into capital markets, further
complicating this analysis.

•

Much of the impact on the volume and price of market liquidity offered by banks and large dealers isdependent on changes to capital allocation and internal pricing mechanisms for capital and liquidity. Industry
participants have remarked that banks are still in the process of determining how to revamp their approaches,creating a response delay.

108

The scope of the report excludes therefore the interaction of the Basel rules with the evolution of market structures rules (such as MIFID II in Europe
for instance)
109
Elliott (2015)
110
Ibid

© Oliver Wyman

49

Impacts on capital markets

Post Crisis Basel Reforms•

It appears likely that the necessary changes in prices and other conditions offered to customers in regard tomarket liquidity are too drastic for banks and large dealers to achieve in one step. Experience has shown overmany years that if an industry leader changes their offering too radically in one step, they permanently lose
some of their customers to competitors who get to the same place by taking it more slowly. As a result, it
seems likely that price and other changes are being spread over time for these competitive reasons as well.

•

Market participants have adjusted to the new market conditions in a number of ways, including investors
breaking up trades into smaller pieces and lengthening entry or exit timeframes. This may not be sustainable in
the long term, particularly under more volatile conditions when large volumes may need to be rapidlytransacted. One possible consequence is a pro-cyclical increase in market illiquidity when least desirable.

GFMA, IIF and PwC (2015) studied the aggregate impacts of recent regulations on global capital markets,
highlighting the important linkages between financial services regulation and capital markets liquidity, with a focus
on the impact on end users. However, due in part to the reasons discussed above, the evidence collected by thestudy points to a range of effects on capital markets, with varying degrees of impact across products and segments.
Other studies such as CGFS (2016), Mizrach (2015), and the Joint Staff Report on the US Treasury market111 havestudied specific market segments and found that price-based metrics such as bid-ask spreads do not generally
point to liquidity issues, whereas volume based measures indicate changes in market structure and functioningthat may be symptoms of reduced market liquidity. Observations from industry participants, however, suggest
substantially greater impacts than these more formal reports do.
There is an active policy debate about the quantitative impact of financial regulation on market liquidity, but thereis broad agreement among observers regarding the expected directional impact of Basel reforms on thefunctioning and liquidity of capital markets, if not the magnitude of effects.
Large banks and dealers subject to the Basel rules have traditionally been major participants underpinning financial
markets. The new regulations have already caused a sharp pullback in their activities in certain market segments,
as shown by levels of trading inventories and other measures. All else equal, this clearly reduces market liquidity.
This is supported by analysis performed by some regulatory bodies. For example, the Bank of England’s recent
Financial Stability Report finds that “there has been some reduction in the liquidity of some government andcorporate bond markets in recent years” and that “post-crisis regulation, including the leverage ratio, haveprobably been one driver of these developments”112. There are some offsets that may be triggered by theseregulations, such as giving room for smaller dealers to compete more effectively and therefore grow, but theywould be only partial. The debate therefore centers on whether other unrelated changes in the market
environment can sufficiently fill the remainder of the gap so as to ensure orderly, well-functioning two-way markets
in both normal and volatile conditions.
Another element of the debate is the question of the proper level and price of liquidity from a societal point of view.
Virtually everyone accepts that liquidity risks were underpriced prior to the crisis and therefore, the goal should not
be to turn back the clock to those levels of availability and price. However, there is no agreed upon standard forwhat represents an appropriate level of market liquidity. Comparisons will often be made in the rest of this section
between current and pre-crisis levels, to provide historical perspective, but this is not meant to imply that a returnto those levels is the desired policy outcome.
During the 14th BIS Annual conference, where regulators debated the “new normal” in financial markets, theformer Deputy Governor of the Bank of England, Paul Tucker deemed that the adaptation of markets participants
and infrastructure to today’s environment would take “quite a long time, perhaps five to ten years” 113. He also
noted that “in the meantime, markets might occasionally be very bumpy and it would be reckless to assert that111

US Department of Treasury, Board of Governors of the Federal Reserve, Federal Reserve Bank of New York, US SEC, and CFTC (2015).
Bank of England (2016)
113
Caruana, Kay, and Tucker (2015)
112

50© Oliver Wyman

Post Crisis Basel Reforms

Impacts on capital markets

none of those bumps would do economic harm”. It is not clear that public authorities and academics havedetermined the targeted end state, together with the transition path.
For the reasons mentioned above, we encourage authorities and the industry to look beyond liquidity and extend
the scope of analysis to include structural impacts on the functioning of markets, the products that are needed andoffered, concentration risk, and basis risk for end users.
Since the impact of regulatory reform has only partially fed through into observable impacts on end users, adetailed analysis of the pressures on regulated entities and their expected downstream effects is necessary toassess the future impact of these reforms. Therefore, the remainder of this section follows the structured analysis
outlined in Figure 5.1.
FIGURE 5.1: OVERVIEW OF THE DIFFUSION OF REGULATORY IMPACTS ON CAPITAL MARKETS

1Constraints onentities subject
to Basel rules• Basel standards haveincreased capital requirements
through higher risk weights
for trading assets, greater
minimum capital ratios andleverage ratio requirements

2

Impact on theactivities ofregulated entities• These regulations are
expected to have a significant
impact on the activities andbehavior of regulated entities• In addition, new liquidity
ratios (LCR and NSFR)
mandate the amount andtype of funding required3

Offsetting factors• However, a number of factors
may mitigate the impact on
end-users• These include the expansion ofalternate providers of liquidity(smaller dealers, hedge funds,
high frequency traders) andgrowth in electronic trading

4

Impact on
capital markets• In spite of the existence ofoffsetting factors, a significant
net impact on capital markets
may occur• Other regulations such as
margin requirements for noncentrally cleared derivatives
further increase costs

5.1.

CONSTRAINTS ON BANKS AND LARGE SECURITIES DEALERS

In the post-crisis environment, financial institutions have faced very significant changes to regulatory standards
and additional revisions are on the horizon. The new Basel regime imposes greater capital as well as liquidity
standards on regulated financial institutions that are internationally active and some jurisdictions extend the rules
to be more stringent.

CAPITAL REQUIREMENTS
The global financial crisis demonstrated that trading book assets were not as liquid as previously believed bymarket participants and regulators. As market liquidity dried up during the financial crisis, some banks were unable
to offload their risk positions and incurred large losses. As a result, Basel 2.5 introduced significantly higher risk
weights to the trading book, differentiated by product. More recent Basel initiatives, such as the FRTB, will further
increase the risk weights across most products.
In addition to altering risk weights, Basel III rules increase minimum capital ratios and introduce new capital buffers,
thus requiring banks to have greater capital as a proportion of risk weighted assets. Further, recently finalized or
ongoing workstreams, such as FRTB and IRRBB, are expected to result in an additional increase in capitalrequirements. However, given the fact that some of these reforms are not yet finalized or implemented, it is difficult
to quantify their impact, especially at the product level. For G-SIBs, an additional surcharge calculated based onsize, interconnectedness, and global scope is added to the capital requirements in order to reduce the probability© Oliver Wyman

51

Impacts on capital markets

Post Crisis Basel Reforms

and the impact of their failure.114 Regulators have also proposed additional rules around the total loss absorbing
capacity (TLAC) to be maintained by G-SIBs, setting minimum levels for instruments that can be legally, feasiblyand effectively written down or converted into equity in case of resolution. These rules have raised capitalrequirements for all banks, especially for large banks as shown in Figure 5.2.
FIGURE 5.2: BASEL III CAPITAL REQUIREMENTS115
11.5–14%

Total capital ratio

10.6–12.5%
9.8–11.0%
8.9–9.5%
8.0%

8.0%

4%

3.5%

8.0%

8.0%

0.6%

2.5%

2%

2%

1.5%

1.5%

1.5%

1.9%

2.5%

2%

2%

2%

1.5%

1.5%

1.5%

1.3%

8% Total capital ratio(stated minimum)
6% Tier 1 capital ratio(stated minimum)

1%
2%
3.5%

4%

4.5%

4.5%

4.5%

4.5%

4.5%

2013

2014

2015

2016

2017

2018

2019

2%
Basel II

GSIB Surcharge (varies by bank) [1]

Tier 2 Capital

Capital Conservation Buffer [1]Additional Tier 1 Capital

Common Tier 1 Capital[1] GSIB surcharge and Capital Conservation Buffer are to be met with CET1 capital
Source: BCBS (2013c), Board of Governors of the Federal Reserve System (2015)

Basel III also introduces a non-risk sensitive “leverage ratio” requirement, and for many banks, this will result in afurther increase in capital requirements. In fact, a survey commissioned by the GFMA and The Clearing House
showed that the leverage ratio was expected to become the binding capital constraint for more than half of thebanks surveyed globally.116 Further, it should be underlined that the leverage ratio is the primary constraint fortrading on government bonds and fully collateralized and/or centrally cleared derivatives, when evaluated on astand-alone basis. This could directly affect activity levels and pricing for those firms for whom the leverage is abinding constraint. For completeness, it should be noted that in some jurisdictions, the binding capital constraint
may come from stress tests and not the Basel rules.
Additional detail on Basel risk weights and capital requirements is provided in Appendix A.

114

BCBS (2013g)
US G-SIB buffer shown
116
Basel III leverage ratio survey, September 2013, commissioned by the GFMA and The Clearing House as part of industry response to the consultative
document on the leverage ratio framework released by the BCBS on September 20, 2013. The study showed that the leverage ratio becomes thebinding requirement for over 54% of institutions for a leverage ratio of 3% and rises to 90% for a leverage ratio of 5%. The study covered 26 banks
across Europe, US, Canada, and Japan, including 18 G-SIBs
115

52© Oliver Wyman

Post Crisis Basel Reforms

Impacts on capital markets

LIQUIDITY REQUIREMENTS
Basel III introduced two new mandatory liquidity ratios – the LCR (Liquidity Coverage Ratio) and the NSFR (Net
Stable Funding Ratio). In order to maintain a sufficient inventory of high quality liquid assets (HQLA) to meet the
LCR requirements, banks will have to sharply increase their inventory of HQLA compared to pre-crisis levels. Figure
5.3 below shows that cash as a percentage of the banking system assets in the US has gone from a pre-crisis low of
3% to a post-crisis high of 20%. Though this observed increase in HQLA is not distributed equally across banks andis particularly concentrated in foreign banks operating in the US, trust banks, G-SIBs, and brokers117, a possible
linkage may still exist between the increase and banks ramping up their liquidity reserves in an effort to becompliant with the LCR requirements.
FIGURE 5.3: CASH AS A % OF ASSETS – ALL BANKS
25%
20%
15%
10%
5%

1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016

0%

Source: Foran, Moszkowski, and Elliott (2016)

The NSFR aims to reduce banks’ reliance on short-term funding by ensuring that a sufficient amount of stable longterm funding is held to match funding-weighted assets based on the maturity characteristics of a bank’s balance
sheet components. NSFR and LCR requirements force banks to hold low return assets, creating a drag on
profitability since the higher credit quality and greater liquidity of those assets imply lower returns than alternatives.
Other potential issues relating to NSFR and LCR requirements are discussed in section 5. And, additional detail on
Basel liquidity requirements is provided in Appendix A.

117

Foran, Moszkowski, and Elliott (2016)© Oliver Wyman

53

Impacts on capital markets

5.2.

Post Crisis Basel Reforms

IMPACT ON THE ACTIVITIES OF BANKS AND LARGE SECURITIES DEALERS

The implications of regulatory changes discussed in Section 5.1 span beyond banks’ profitability, and are resulting
in changes to market structures. The rest of this section discusses the impact on capital markets in more detail.

SHRINKAGE IN MARKET MAKING AND TRADING ACTIVITIES
Traditionally, banks have played a central role as intermediaries to facilitate liquidity in the markets through theirmarket-making activities. However, increases in capital and liquidity requirements have pressured the marketmaking business model by increasing the cost of providing intermediation services and driving down profitability.
For example, the increase in capital consumption per dollar of revenue due to changes in the Basel capital regime isdemonstrated in Figure 5.4. Oliver Wyman and Morgan Stanley (2015) predict that resource consumption willcontinue to increase across asset classes in 2016 and 2017, with the exception of rates and repos where banks are
expected to streamline the business through lower capital allocation for segments generating low returns. And, in
low margin market making activities, the combined Leverage Ratio and NSFR costs are estimated to impact
funding costs in the 60bps–110bps range.118
FIGURE 5.4: ESTIMATED DEALER FINANCIAL RESOURCE CONSUMPTION/REVENUES, 2006–2017E

x5–6

Rates & repo

FX, Emerging Markets [1] & Commodities

x1.5–2

x4–5

Credit & securitisation~x2

Equities
2006–07

2013–142016–17 estimate[1] Includes emerging market rates, FX and credit. 2006–07 based on Basel II RWA, 2013–14 and 16–17 based on a blended average of leveragebalance exposure and Basel III RWA; Revenue outlook based on OW base case revenue projections to 2017; 2017 Includes impacts of FRTB,
leverage ratios, and structural reform in rates
Source: Oliver Wyman and Morgan Stanley (2015)

In a context of increased costs of engaging in market-making activities and high regulatory uncertainty,
shareholders, boards and the executive management of banks are less inclined to allocate more capital to trading
activities, resulting in decisions to scale back on their activities or to exit certain markets altogether. Accordingly,
the expected increase in regulatory requirements has driven a pro-active downsizing of inventories and risks. Somefirms have already taken both these types of actions. The impact is likely to be most acute for capital and fundingheavy areas of the business, such as making markets in fixed income products.
Ring-fencing of trading activities in Europe and an outright prohibition on proprietary trading under the Volcker
Rule have led to a further decline in banks’ holdings of trading assets. Curtailing banks’ trading activities could lead
118

AFME (2016)54© Oliver Wyman

Post Crisis Basel Reforms

Impacts on capital markets

to a reduction in the size of markets for these assets, with negative consequences for market liquidity. According toOliver Wyman (2012), the impact on market liquidity would be most evident in corporate bonds, private ABS, andOTC derivatives.
Figure 5.5 shows that net positions of corporate bond assets for key dealers in the US corporate bond market havesignificantly declined post-crisis and have not yet returned to the pre-crisis levels. What is perhaps moreconcerning is the continuous decline in inventories since 2011. Similarly, corporate bond holdings of financial
institutions in Japan and the euro area have declined by more than 25% in both economies over the past five
years119. The ramifications of this decline in the access of non-financial firms to capital markets should be analyzed
further.
FIGURE 5.5: NET POSITIONS OF PRIMARY DEALERS – US CORPORATE BONDS300

US$ BN

200

100

0
2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Source: CGFS (2016)

More broadly, according to Oliver Wyman and Morgan Stanley (2016), “global wholesale banking balance sheets
supporting traded markets have contracted by 50% in RWAs on a Basel III adjusted basis, implying 25–30% in
terms of total balance sheets, since 2010”. Table shows historical and forecasted balance sheet reductions byproduct. This points to a significant reduction in dealers’ market making capacity, potentially leading to a
substantial impact on market liquidity.
TABLE 5.1: BALANCE SHEET REDUCTIONS, 2010–15 (% CHANGE)PRODUCT
Repo
Prime
Bonds, FX & commodities
Structured & securitized
Listed, flow & cleared products
Issuance & advisoryTotal

2010–15
Down ~50%
Up ~20%
Down ~25%
Down ~20%
Down ~20%~ Flat-25% to -30%

NEXT 3–4 YEARS
Down ~10%
Flat
Down ~10%
Down ~10%
Down ~5%
Down ~5%-5% to -10%

Source: Oliver Wyman and Morgan Stanley (2016)

119

CGFS (2016)© Oliver Wyman

55

Impacts on capital markets

Post Crisis Basel Reforms

Recent events in the US CMBS120 market illustrate a decline in market liquidity that may be caused in part by thesechanges. In February 2016, fears surrounding China’s economic performance and oil prices triggered a sudden
sell-off in CMBS by hedge funds. But, due to significantly reduced dealer inventories, banks were unable to provide
liquidity, resulting in a sudden drop in prices of ~20% within a few weeks121. As shown in Figure 5.6, lower rated
securities were particularly impacted, with high price volatility in the first half of 2016.
FIGURE 5.6: CMBS PRICE VOLATILITY AND LIQUIDITY
50

14

45

12

35

10

30

8

25
20

6

15

4

US$ BN

Basis points per week

40

10
2

5
0

10 Yr AAA 3-month rolling volatility (Left scale)
Primary dealer holdings (Right scale)

May-16

Mar-16

Jan-16

Nov-15

Sep-15

Jul-15May-15Mar-15Jan-15

Nov-14

Sep-14Jul-14May-14Mar-14Jan-14

Nov-13

Sep-13

Jul-13May-130

10 Yr BBB 3-month rolling volatility (Left scale)

Source: J.P. Morgan, Federal Reserve Bank of New York (from Western Asset (2016))

The Bank of England’s recent Financial Stability Report also finds that market makers in US corporate bonds havebecome less willing to absorb demand shocks and that the volatility of spreads has increased as a consequence.122
As shown in Figure 5.7, during the pre-crisis period, in response to a one standard deviation reduction in demandfor corporate bonds, dealers absorbed the shock by continuing to buy bonds, thereby increasing their inventory bymore than 1.5 bps of the market size in the first week. A shock of this magnitude resulted in a 9 bps increase in
spreads. However, in the post crisis period, in response to a similar shock, dealers only increased their inventories
by 0.2 bps, thus absorbing very little of the excess supply. Furthermore, the post-crisis shock resulted in a spreadincrease of 18 bps, which was twice as much as the spread increase observed in the pre-crisis period.

120

Commercial Mortgage Backed Securities
PIMCO (2016)
122
Bank of England (2015b)
121

56© Oliver Wyman

Post Crisis Basel Reforms

Impacts on capital markets

2.5

20

2.0

16

1.5

12

1.0

8

0.5

4

0.0

0

-0.5

-4

-1.0

-8

-1.5

Basis points

Basis points

FIGURE 5.7: DEMAND SENSITIVITY OF US$ HIGH YIELD CORP. BOND SPREADS AND DEALER INVENTORY

-12
0

1

2

3

4

5

6

7

8

9

Weeks since market shock (decline in demand)
Inventory – Pre-crisis, left-hand scale
Spread – Pre-crisis, right-hand scale

Inventory – Post-crisis, left-hand scale
Spread – Post-crisis, right-hand scale

Notes: Changes in US dollar-denominated high-yield corporate bond spreads and US primary dealers’ inventory in these securities due to a one
standard deviation decline in demand for corporate bonds from asset management companies; Changes in inventory measured as fraction ofmarket size; Pre and post-crisis defined as 2004–06 and 2012–February 2015 respectively
Source: BofA Merrill Lynch Global Research, Dealogic, EPFR Global, Federal Reserve Bank of New York, and SIFMA data (from Bank of England(2015b))An analysis of the distribution of global securities revenues by market participants (Figure 5.8) shows that sell-side
revenues fell by 20% ($55 BN) between 2006 and 2014 while buy-side revenues grew by 45% ($135 BN) during thesame period. This provides additional evidence of reduction in the market share of banks and large securities
dealers.123

123

Industry revenues are not necessarily perfectly correlated with trading activity; nevertheless revenues are used as a proxy demonstrating thedeclining market share of the regulated institutions. However, we acknowledge that there were other significant factors as well, for example, huge
flows into fixed income funds (partly a byproduct of expansionary monetary policy) drove assets under management (AUM) higher, which in turndrove fees higher. Further, decreasing sell-side revenues may be driven by changes in pricing in addition to a reduction in trading activity.

© Oliver Wyman

57

Impacts on capital markets

Post Crisis Basel Reforms

FIGURE 5.8: GLOBAL SECURITIES REVENUE POOLS BY PLAYER (2006–2014)$750 BN$675 BN$670 BN+5%95

Market infrastructure [1]

95

-5%

90

295

+10%

320

+35%

430

Buy-side [2]

280

-5%

265

-15%

225

Sell-side

2006

2010

2014

[1] Includes execution venues (exchanges, inter-dealer brokers, clearing houses, CCPs), CSDs, custodians and data providers[2] Includes Asset Managers and Hedge Funds
Source: BofA Merrill Lynch Global Research, Dealogic, EPFR Global, Federal Reserve Bank of New York, and SIFMA data (from Bank of England(2015b))

BUSINESS RESTRUCTURING AND EXITS
Banks are likely to reassess their business strategy and optimize their capital and liquidity resources to increase
efficiency and maintain competiveness in the new, increased regulatory cost environment. This is often
accomplished by employing strategies to focus away from non-core activities, or reevaluating the product andasset mix offering, which may lead to exits from certain segments of the market. This may in turn increase “liquidity
bifurcation” with liquidity concentrating in the most liquid instruments as banks focus their activities on similar
products and segments.
Figure 5.9 contains analysis from a study by AFME and PwC (2014b) summarizing changes in organization
structure and market exits by major global banks between 2009 and 2014. A vast majority of global banks studied
have undergone significant restructuring, exited certain products or regions, or redefined and reduced focus on
non-core activities. Table 5.2 contains some noteworthy examples that highlight these changing dynamics.

58© Oliver Wyman

Post Crisis Basel Reforms

Impacts on capital markets

FIGURE 5.9: CHANGES IN STRUCTURE AND ACTIVITIES OF MAJOR BANKS (2009–2014)124
30
25
4

4

No. of firms

20

6

7

17

16

Jurisdictional/
regional exits

Non-core
activities

15
10

20

20

5
0
Organizational
restructuring

Product/
asset exits
Significant change observed

Some change observed

Source: AFME and PWC (2014b)

TABLE 5.2: EXAMPLES OF GLOBAL BANKS EXITING OR SHRINKING WHOLESALE BUSINESSESNAMEMorganStanley

Bank of New
York Mellon

EXITS
Reduced fixed income risk-weighted assets from
US$370 BN in 2011 to US$132 BN in 2016125
Sold oil trading business in 2015126
Sold in-house quantitative trading unit in 2013127
Shutting down derivatives sales and tradingbusiness128

State Street

Announced closure of swaps business in 2014129

BNP Paribas

In 2011, made plans to cut corporate- andinvestment-banking balance sheet by US$82 BN,
mostly in capital-markets activities130
Cut assets by curbing lending and through sales
and other business disposals131
Announced decision to scale down prime
brokerage unit132

Credit Suisse

STATED RATIONALE
Strategic changes due to regulatory pressuresand changing market dynamics
Regulatory restrictions on proprietary trading
To streamline operations and remaincompetitive in a new regulatory landscape,specifically related to new capital and liquidity
requirements
Changes in market and regulatory factors
driving decline in demand for OTC derivatives
Efforts to increase CET1 capital ratio under BaselIII rule

Improve leverage ratios and boost profitability

124 No. of banks included in study: 24
125
Morgan Stanley (2015), Morgan Stanley (2016)126
Meyer, G. and Hume, N. (2015)
127
AFME and PwC (2014b)
128
Brush, S. (2014)
129
Ibid.
130
Choudhury, A., Griffin, D. and Xydias, A. (2011)131
Benedetti-Valentini, F. (2011)132
Srivatsava, S., Bart, K., Miles, T. (2014)© Oliver Wyman

59

Impacts on capital markets

NAME

CréditAgricole
Citigroup
RBS

UBS

Goldman
Sachs

Barclays

HSBC

JP Morgan

EXITS
Announced plans to reduce leverage exposure
from trading operations by US$74 billion133
Announced exits from European securitized
product trading, distressed debt, and long-term
illiquid funding markets134
Exited commodities in October 2011135
Announced sale of margin foreign exchange
business (including CitiFX Pro and Tradestream
platforms)136
Exiting MBS, commercial real estate, commercial
mortgage-bond sales and trading, andsignificantly reducing other investment banking
activities137
Exiting automated US options market-making
activities138
Exited FICC Asset Securitization, FICC Complex
Structured Products, and FICC Macro Directional
Trading in 2011, and scaled back FICC Global
Correlation139
Sold its aluminum business140
Reduced asset size by 24% from 4Q07 to
4Q14141
Reduced its repo activity by about US$42 billion
in the first six months of 2014142
Exited global commodities activities143

Reduced repo lending by ~US$25 billion in thefirst half of 2014144
Reduced Global Banking and Markets RWA by
31% by exiting legacy credit and managing
down long dated rates and low returning
portfolios; Reduction in the GBM client base by
20%145
Reduced non-op deposits by US$100 billion in
2015146

Post Crisis Basel Reforms

STATED RATIONALE

Cost reduction
Increased regulatory requirements
Strategic sale to streamline its operations
To stay below US$50 billion asset trigger forheightened FRB capital requirements and otherrestrictions. Other foreign banks expected torestrain growth that would take them over thelimit
New regulatory requirements and fragmented
exchange structure have made the business too
costlyPortfolio optimization driven by capitalrequirements
Regulatory scrutiny
Post-crisis regulatory pressures to shrink
New capital requirements
In line with “objective to actively evaluate andmanage our businesses, ensuring they meetstrict economic and strategic criteria within the
new regulatory environment”
New capital requirements
Anticipation of regulation driven growth;
Simplify GBM business; Allocation of more
capital to strategic priorities
Product is non-core to its customers withoutsized operational risk and capital charges

133

Forbes (2014)
Credit Suisse (2016)135
Hamaide, S. and Johnson, C. (2011)136
Bases , D. (2015)137
Sharma, A. (2014)138
Krouse, S. and Vaishampayan, S. (2015)
139
UBS (2011)140
Berthelsen, C. and Iosebachvili, I. (2014)141
Goldman Sachs (2014)142
Tracy, R. (2014)
143
Kolesnikova, M. (2014)
144
Tracy, R. (2014)
145
Slater, S. (2015)146
Moore, M. and Dexheimer, E. (2015)
134

60© Oliver Wyman

Post Crisis Basel Reforms

Impacts on capital markets

DECLINE IN SECURITIES LENDING ACTIVITIESSecurities lending plays a critical role in the capital markets and has been identified by the Bank of Canada as one of
the five core funding markets147. The uses of securities loans include the following:•

Market-making: In order to meet customer demand to buy and sell securities, market makers hold aninventory of securities and borrow securities as needed.

•

Short-selling: Due to restrictions on “naked” short selling, institutions must borrow securities before entering
into a short position on those securities. This is a critical function of securities lending, and contributes
significantly to market liquidity.

•

Trade settlement: Securities loans help institutions in covering settlement failures arising fromoperational issues.

•

Collateral upgrades: Banks use securities loans to borrow high quality, liquid securities. The
borrowed securities can then be used to raise cash in the repo market or as collateral for swaps and derivativetransactions.

In addition, securities lending provides important benefits to buy-side investors, such as pension plans and mutual
funds, by enabling the generation of low-risk, incremental returns on investment assets to enhance performanceand offset costs. This can be particularly significant for public funds, which tend to have limited budgets and whichface intense pressure to address structural funding shortfalls. As an example, a recent study of a large sample of US
public pension funds shows that those funds with active securities lending programs generated average
cumulative returns of 34 bps from this activity over an eight year period (2006–2013)148.
The securities lending market is characterized by a number of risk controls. This includes the use of mastersecurities lending agreements to specify each party’s legal rights and obligations, the overcollateralization of loans
with cash or other high quality assets (with levels ranging from 101% for government bonds to 115% for equities
and corporate bonds), the daily marking of positions to market, and daily adjustments in collateral in response tochanges in market prices designed to ensure continued over-collateralization. The safeguards provided by thecollateral mitigate the counterparty credit risk exposure, and therefore these transactions are generally regarded
as low risk. Despite this relative safety, capital requirements have increased significantly for the indemnification of
securities loans due to the application of the highly risk-insensitive haircut-based comprehensive approach149,
leading to an increase in costs. As a result, according to some market estimates, a decline of 30–50% in securities
lending activities from already substantially diminished post crisis levels is expected.150
Given the critical role of securities lending in the capital markets in generating liquidity, facilitating price discovery
and ensuring trade settlement, this decline in lending volumes could result in a significant adverse impact on theliquidity and efficiency of financial markets.

SHIFT AWAY FROM THE REPO MARKET FOR FUNDING
Capital and liquidity regulations are likely to make it harder for banks to finance balance sheet expansion throughrepurchase agreements by increasing the capital requirements for collateralized financing and increasing theamount of stable (and, therefore more expensive) funding required. For example, the NSFR imposes a 10% funding

147

Bank of Canada (2010); Other core funding markets include the market for treasury bills and bonds, the repo market, the market for bankers’
acceptances, and spot and swap foreign exchange markets
148
Galper, J. (2015).
149
See BCBS (2015k) for the comprehensive approach for the treatment of collateral.
150
Ibid

© Oliver Wyman

61

Impacts on capital markets

Post Crisis Basel Reforms

charge on reverse repos secured by Treasuries, thus making it costly for banks to provide financing despite thehigh quality of the collateral.151
This is supported by the Bank of England’s report on Financial Stability152 which states that “reductions in repo
activity have gathered pace in recent months, leading to wider bid-offer spreads and decreasing availability ofrepos.” Thus, market participants may become less willing or able to borrow in repo markets, which would in turnhave adverse implications for the efficiency and liquidity of financial markets. This would be further exacerbated ina severe stress scenario, where market participants may find it difficult to raise cash through the repo of securities
other than for the highest quality collateral e.g. sovereign securities.
The significant contraction in repo volumes in the US and Europe are shown in Figure 5.10. Repo balances ofEuropean banks have declined by ~40% since 2011 and those of US banks have declined by ~12%.
FIGURE 5.10: REPO BALANCES HELD BY BANKS (BY REGION)
Repo balances of European banks

Repo balances of US banks
1,400

1,200

1,000

€ BN

800

154
174

200

1,200
147
186

163

117

160

107

600
400

1,039

126
120
182

146
125
211

1,268 1,245
24 5 39

914

166

69
75

104
57

138

224

1,000

758

165

92

361

-40%

152

643

$ BN

1,080

132

46
62

83

132

169

54
102

0

1,194
29 9 1,124 1,111
42 20 51

338
301

312

326

311

257

243

220

-12%

24

800
378

415
360

600

46 115

134

287

7

400

276

261

200
225

236

201

192

192

2011

2012

2013

2014

2015

0
2011

2012

2013

2014

2015

BNP Paribas

HSBC

Wells Fargo

JPMorgan Chase

Deutsche BankThe Royal Bank of Scotland

Bank of New York Mellon

Citigroup

Credit Suisse

Barclays

Goldman Sachs

Bank of America

UBS
Notes: Chart uses 3Q15 data for Deutsche Bank and Credit Suisse;2015 data updated by authors to include Barclays repobalances designated at fair value
Source: Company Data, Morgan Stanley Research(from Oliver Wyman and Morgan Stanley (2016));
Barclays PLC (2015)

Source: Company Data, Morgan Stanley Research(from Oliver Wyman and Morgan Stanley (2016))

Since the financial crisis, regulatory reforms have aimed to decrease the need for regulatory intervention by shifting
the onus to banks to absorb the shocks associated with disruptions in the capital markets. However withheightened capital and stable funding requirements for collateralized financing faced by banks as a result of thesereforms, the repo markets have not rebounded to their pre-crisis levels even with the Federal Reserve tapering its
purchases. A possible explanation for this could be that the lower volumes in repo market are the new normal and
151
152

GFMA and IIF to the Federal Reserve System (2016)
Bank of England (2015b)

62© Oliver Wyman

Post Crisis Basel Reforms

Impacts on capital markets

that repo funding has permanently become a less efficient form of financing. In fact, some market participants
expect that volumes may decrease even further as the new liquidity rules take full effect.
Furthermore, the contraction observed in the repo market also raises the question whether in the event of anothercrisis, and in the absence of official sector intervention, the repo market will be able to sustain capital market
shocks and continue to provide the required financing, particularly if a further reduction is observed in market
liquidity.

INCREASED DEMAND FOR HIGH QUALITY LIQUID ASSETS
Regulatory requirements such as the Liquidity Coverage Ratio (LCR) stipulate the amount and quality of assets
required to be held as liquidity reserves. As a result, banks will have to build reserves of High Quality Liquid Assets(HQLA) to comply with regulatory guidance for minimum levels of liquidity. Figure 5.11 shows the dramaticincrease in HQLA holdings by major US banks in the last 5 years.
FIGURE 5.11: INCREASE IN HQLA HOLDINGS BY US GSIBS

+48%

2,500

2,097

US$ TN

2,000

1,770
1,420

1,500

491

496

JP Morgan

379

Citigroup

203
188

Morgan Stanley

262
1,000

354

322

182
172

171
168

500

78

83
2010

149

2012

Bank of America
BNY

372

336
0

504

Goldman Sachs

51

218
109

State Street

2015

Source: SEC filings

Further, mandatory clearing and margin requirements for non-centrally cleared derivatives will remove the highquality assets used for those requirements from circulation. The BCBS, in its QIS, estimated that the initial margin
that would result from applying the regulatory proposal to derivative portfolios that would remain uncleared
globally would be roughly €0.7 trillion153.
As a result of these regulations, circulation of HQLA in the market will decrease, leading to a corresponding decline
in liquidity of these assets.154 Since these assets are used as collateral for financing transactions, a decline in theirliquidity will lead to further decline in repo market activity and activity in markets for collateralized instruments.
The reduction in circulation of HQLA poses a particular concern since markets have already observed a decline inturnover ratios for some assets. US Treasury and Agency MBS turnover ratios have declined since the financial crisis,
as illustrated in Figure 5.12. Based on the experience of the recent crisis, turnover ratio could be expected to drop
further in the event of a future stress environment.
153
154

BCBS (2013k)
GFMA, IIF and PwC (2015)© Oliver Wyman

63

Impacts on capital markets

Post Crisis Basel Reforms

FIGURE 5.12: DAILY TURNOVER RATIO FOR US TREASURIES FROM 2005–2015
0.14
Pre-crisis

Crisis

0.12
0.10
0.08
0.06
0.04
0.02
0.00
2005

2006

2007

2008

2009
Treasuries

5.3.

2010

2011

2012

2013

2014

2015

Agency MBS

OFFSETTING FACTORS

While the overall impact of Basel regulatory reforms is expected to be a decline in the efficiency and liquidity ofcapital markets, a number of recent trends may partially mitigate this impact.

INCREASED ACTIVITY BY OTHER MARKET PLAYERS
An expansion of alternate providers of liquidity in capital markets may help compensate for the decrease in market
making activity by larger regulated entities. Below are examples of such providers:•

Smaller dealers: In some jurisdictions, mid-sized and smaller dealers are not subject to the same regulatory
constraints as larger dealers, providing them with a competitive advantage which they have used to expand
market share. While this trend is expected to continue, they are unlikely to fully compensate for the reductionin activity from larger regulated entities due to limited balance sheet capacity, weaker credit ratings, higher
funding costs, and the inability to provide a wide range of integrated services to customers.

•

Hedge funds: As larger dealers withdraw from the market, hedge funds may step in to fill the liquidity gap
partially. However, they have limited balance sheet capacity and may not be able to adequately replace theliquidity provided by banks, particularly for less-liquid assets. Further, hedge funds do not have theestablished client relationships that traditional dealers do, and therefore have less of an incentive to stay in themarket and provide liquidity during periods of instability.

•

High frequency traders: High frequency, automated trading has increased considerably in recent years andhas, to some extent, offset reductions in liquidity provision by banks and larger dealers. However, thesestrategies are most suited to highly liquid instruments (e.g. on-the-run sovereign bonds). Further, there issome uncertainty regarding the role of these traders in creating or perpetuating significant market volatility
and these firms will face increasing regulatory scrutiny in the future, as exemplified by MiFiD II provisions forhigh frequency trading activities.

As discussed above, it may be difficult for these providers to offer sufficient liquidity in the absence of traditional
market makers, especially in periods of market stress. In particular, most alternate providers lack the scale, capital,

64© Oliver Wyman

Post Crisis Basel Reforms

Impacts on capital markets

risk management infrastructure, global integration and multi-product client relationships to fully substitute for the
reduced market making activity of larger banks.

GROWTH OF ELECTRONIC MARKETSThe “electronification” of markets can help improve liquidity by removing traditional barriers posed by geography,
allowing multilateral interaction, and matching buyers and sellers more quickly. According to Oliver Wyman andMorgan Stanley (2015), market participants are currently pursuing four broad areas of focus:•

Data and network: Using technology and data to help dealers more efficiently link potential buyers andsellers, reducing the need for inventory to “rest” on dealer balance sheets.

•

Automated principal: Accelerating the evolution of the existing client-dealer relationship towards electronic
platforms, allowing automation of elements of price distribution, construction and risk management.

•

Agency trading: Fundamentally changing the role of the dealer from one of market-maker offering committed
pricing and liquidity in return for a spread, to one of a broker offering connection to a liquidity pool in return for
a commission.

•

Pure buy-side to buy-side platforms: Removing the role of the dealer as intermediary, and allowing clients totrade directly with each other (or potentially also dealers) through an electronic platform.

However, such trading platforms are best suited to standardized and highly liquid products and smaller sizetransactions for which a sufficiently large number of orders can be matched on a regular basis. Given the different
structures of markets, penetration of electronic platforms varies widely. Table 5.3 provides an overview of the shareof volume traded on electronic platforms for each asset class. While there is significant penetration across asset
classes such as FX, listed futures, options and cash equities, penetration is low for interest rate swaps and corporate
bonds. Further penetration of electronic platforms in the corporate bond market may be limited by the highheterogeneity and low liquidity of corporate bonds.
TABLE 5.3: SHARE OF GLOBAL VOLUME TRADED ON ELECTRONIC PLATFORMS, BY ASSET CLASSASSET CLASS
Listed futures and options
Cash equities
FX spots and forwards
Government bonds
Interest rate swaps
Corporate bonds

SHARE OF VOLUME TRADED ON ELECTRONIC PLATFORMS>80%
50–70%>80%
50–60%
20–30%
15–20%

Source: Oliver Wyman and Morgan Stanley (2015), Wholesale & Investment Banking Outlook.

5.4.

IMPACT ON CAPITAL MARKETSWe expect the net impact of the changes in activities of regulated entities discussed in Section 5.2 to be a decline in
the liquidity of capital markets and an increase in market volatility. While the existence of offsetting factors(discussed in Section 5.3) will mitigate this impact, they are unlikely to fully compensate for the decline in liquidity
coming from banks and dealers subject to the Basel regulations. In addition there may be other impacts, such as
client and product segmentation, and an evolution in execution and basis risks for end users.
The remainder of this sub-section discusses the impacts on market users to date, as well as some discussion of how
this may change over time.

© Oliver Wyman

65

Impacts on capital markets

Post Crisis Basel Reforms

INCREASE IN TRANSACTION COSTS
A decrease in liquidity would result in an increase in transaction costs for investors. The impact is likely to be in theform of both direct and indirect costs.

DIRECT COSTSAs discussed in Section 5.2, investors may face higher bid-ask spreads as banks widen spreads to offset the cost
impact of increased regulatory requirements. Further, lower market liquidity itself can also result in wider bid-ask
spreads since dealer inventories cannot be sold as quickly and efficiently resulting in greater risk of adverse asset
price movements and therefore the need for higher spreads to protect from losses.

INDIRECT COSTS
In addition to an increase in direct transaction costs, decreased market liquidity would also result in adverse effects
on market depth155 and immediacy.156 These in turn would increase indirect costs for market participants. In amarket with lower liquidity, large transactions may significantly change prices in the direction of the trade (increaseduring a purchase and decrease during a sale) to the detriment of the participant initiating the transactions. For
example, analysis performed by the IMF (2015b) shows that the price impact of a €100 MM purchase of five year
on-the-run government bonds has increased significantly post-crisis across all countries studied (see Figure 5.13).
While the European sovereign debt crisis almost certainly contributed to this increase, many market participants
believe regulatory constraints were also a factor and may become more so.
FIGURE 5.13: PRICE IMPACT COEFFICIENT – 5 YR EUROPEAN SOVEREIGN BONDS (IN PERCENTAGE POINTS)

Percentage points

0.25
0.20
0.15
0.10
0.05
0.00
Belgium

FrancePre-crisis

Italy

Spain

Post-crisis

Notes: The figure shows the estimated price impact associated with €100 MM purchase of five-year on-the-run government bond for Belgium,
France, Italy and Spain. Impacts are statistically significant at least at the 10 percent level with the exception of the pre-crisis impacts for
Belgium, France, and Spain.
Source: Bloomberg, L.P., Markit, MTS, and Thomson Reuters Datastream data (from IMF (2015b))

Similarly, the price impact of large transactions in the US Treasuries market significantly increased in 2015
according to the CGFS (see Figure 5.14).

155
156

High depth is characterized by large flows of trading flows on both the buy side and sell side
High immediacy is characterized by low transaction times

66© Oliver Wyman

Post Crisis Basel Reforms

Impacts on capital markets

FIGURE 5.14: PRICE IMPACT – US TREASURIES
12

32nd of a point

9
6
3
0
-3
2011

2012

2013

2-year5-year2014

2015

10-year

Notes: Price change per $1 BN net order flow, monthly averages
Source: CGFS (2016)

As a result of the price impact of large transactions, dealers may be forced to break up big transactions into
multiple smaller transactions. There is evidence to show that this has occurred across a number of products. For
example, Figure 5.15 and Figure 5.16 show that the average trade size in US Treasuries and European corporate
bonds has decreased significantly since 2010. Declines in larger transactions (block-trades) in US corporate bonds
from pre-crisis levels indicate a shift in trading patterns, with liquidity now associated with smaller trade sizes. A
similar trend is also observed for equities, with a decline in transaction sizes in major stock markets (Figure 5.18).
While the trend is clear, it should be noted that establishing causality is difficult due to the growth of other market
participants such as high frequency traders whose business models are based on small and frequent trades.
FIGURE 5.15: AVERAGE TRADE SIZE IN US TREASURIES
4

US$ MM

3

2

1

0
2010

2011

2012

2013

2014

2015

Source: Trax data (from GFMA, IIF and PWC (2015))© Oliver Wyman

67

Impacts on capital markets

Post Crisis Basel Reforms

FIGURE 5.16: AVERAGE TRADE SIZE – EUROPEAN CORPORATE BONDS
1.2

US$ MM

1.0
0.8
0.6
0.4
0.2
0.0

2010

2011

2012

2013

2014

2015

Source: Trax data (from GFMA, IIF and PWC (2015))

FIGURE 5.17: LARGE TRANSACTIONS IN THE US CORPORATE BOND MARKET (PERCENT)
0.30% of trades >$ MM

0.25
0.20
0.15
0.10
0.05
0.00
2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Note: The figure shows the fraction of large trades in the US corporate bond market as a percent of total transactions. A large trade is defined as larger
than $1 million
Source: Bloomberg, L.P., Markit, MTS, and Thomson Reuters Datastream data (from IMF (2015b))68© Oliver Wyman

Post Crisis Basel Reforms

Impacts on capital markets

FIGURE 5.18: AVERAGE TRANSACTION SIZES FOR EQUITIES – NYSE AND EURONEXT (2004–2015)
35
30

US$ MM

25
20
15
10
5
0
2007

2014
NYSE

Euronext

Source: WFE

A second source of indirect cost is the time required to sell a security. The longer a buyer/seller must wait tocomplete a transaction, the higher the risk that prices may move against them. The turnover ratio, defined as theratio of transaction volumes to the total value of securities outstanding, provides one indirect measure oftransaction times. Higher turnover ratios imply that a large number of buyers/sellers are available to transact at any
given point in time. Across a number of financial markets, an increase in size due to issuance activity has not beenmatched by an increase in trading volumes, resulting in a decrease in turnover ratio as shown in Figure 5.19. As
noted above, this decrease in transaction volumes may result in increased transaction costs. This trend isparticularly evident for government securities and corporate bonds.
It should be noted, however, that turnover ratios can also be influenced by factors such as a change in the types ofasset holders and consequently their average holding period for these assets. Since the turnover ratio combines
the activities of long-term investors as well as short-term traders, understanding the implications of liquidity may
warrant further analysis of turnover ratios specific to short-term traders.

© Oliver Wyman

69

Impacts on capital markets

Post Crisis Basel Reforms

FIGURE 5.19: TURNOVER RATIOSHigh grade US corp. bonds
12m traded volume/
Amount outstanding, Monthly

US Treasuries
Average daily traded volumes/
Amount outstanding, Annual

UK government bonds
12m traded volume/
Amount outstanding, Annual

1.2

0.14

9

1.0

0.12

8
7

Turnover ratio

0.10
6

0.8
0.08

5

0.06

4

0.6
3

0.4
0.04

2
0.02

0.0

1
0

2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

0.00

2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

0.2

Source: MarketAxess , SIFMA, UK Debt Management Office

The decline in turnover ratio combined with the decrease in dealer inventories could result in liquidity mismatcheswith significant consequences for end users. For example, analysis performed by the IMF in 2014 shows that the
number of days required for full liquidation of a US credit mutual fund has increased significantly since the precrisis period (see Figure 5.20) 157. It is estimated that 50–60 days would be required for liquidation of a high yield
fund, compared to the 7 day limit for redemption payments.

157

IMF (2014)70© Oliver Wyman

Post Crisis Basel Reforms

Impacts on capital markets

FIGURE 5.20: NUMBER OF DAYS FOR FULL LIQUIDATION OF US CREDIT MUTUAL FUNDS AND ETFS
70
60

Number of days

50
40
30
20
10

2007 Q1
2007 Q2
2007 Q3
2007 Q4
2008 Q1
2008 Q2
2008 Q3
2008 Q4
2009 Q1
2009 Q2
2009 Q3
2009 Q4
2010 Q1
2010 Q2
2010 Q3
2010 Q4
2011 Q1
2011 Q2
2011 Q3
2011 Q4
2012 Q1
2012 Q2
2012 Q3
2012 Q4
2013 Q1
2013 Q2
2013 Q3
2013 Q4
2014 Q1
2014 Q20

US corporate bond total

US high yield

7-day limit for redemption payments

Note: The number of days to liquidate is the ratio of assets of mutual funds and ETFs (exchange-traded funds) per daily dealer inventories. Because
there are no data for US high-yield bond dealer inventories before April 2013, the high yield line assumes a constant ratio of this amount tototal corporate bonds before this date
Source: EPFR Global; Federal Reserve; and IMF calculations (from IMF (2014))

IMPACT ON SPREAD
As shown in Figure 5.21, spreads on investment grade corporate bonds in the US and the Eurozone have trended
upward in recent years. Pre-crisis investment grade bond spreads in the US were close to 100 bps while in theEurozone, they were around 50 bps. Although spreads witnessed a steady decline between 2011 and 2013, they
increased considerably in 2014 and 2015, breaching the 150 bps level generally associated with an economic
downturn. While there has been a dip in recent months, spreads remain significantly elevated above thoseobserved in the pre-crisis period.

© Oliver Wyman

71Impacts on capital markets

Post Crisis Basel Reforms

700
650
600
550
500
450
400
350
300
250
200
150
100
50
0

US

Dec-2015

Dec-2014

Dec-2013

Dec-2012

Dec-2011

Dec-2010

Dec-2009

Dec-2008

Dec-2007

Dec-2006

Dec-2005

Dec-2004

Dec-2003

Dec-2002

Dec-2001

150 basis points

Dec-2000

Spread (basis points)

FIGURE 5.21: SPREADS ON INVESTMENT GRADE CORPORATE BONDS

Eurozone

Source: Barclays

An increase in bond spreads can have a significant impact on the ability of non-financial corporates to access
capital. This is particularly important for high yield borrowers who rely on more volatile retail funding. As shown in
Figure 5.22, US high yield issuance has dropped by 31% since 2013.
FIGURE 5.22: US HIGH YIELD CORPORATE BOND ISSUANCE
400
350
300

-31%

US$ BN

250
200
150
100
50
0
2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Note: 2016 figures are annualized based on data from January to May
Source: SIFMA

72© Oliver Wyman

Post Crisis Basel Reforms

Impacts on capital markets

There is reason to believe that the widening of spreads in recent years is tied to deteriorating liquidity conditions in
the market. The “credit spread” is the difference between corporate bond rates and government bond rates. It
includes compensation for estimated credit losses, but also for liquidity risk and potentially other factors, including
risk aversion. Given the absence of a significant deterioration in the macro-economic outlook or a meaningfulincrease in default rates, the widening of spreads is likely due to a decline in liquidity and a consequent increase in
the “liquidity premium” demanded by investors. While it is difficult to estimate how much of the increase in
spreads can be attributed to liquidity, this hypothesis is supported by analysis performed by the IMF158 showingthat observed high-yield spreads have deviated significantly from those predicted using a fair-value model (Figure5.23). Further, the IMF analysis shows a high correlation between the deviation in spreads and market illiquidity159
indicating that worsening liquidity conditions may have contributed to the widening of spreads beyond
fundamentals.
FIGURE 5.23: DEVIATION OF US HIGH YIELD CORPORATE BOND SPREADS FROM FUNDAMENTALS
400

3.0

300

200
2.0
100

Basis points

Basis points

2.5

1.5
0

1.0

-100
Jan. May Sep. Jan. May Sep. Jan. May Sep. Jan May Sep. Jan. May Sep. Jan.
2011

2012

2013

Deviation of high-yield spreads
from modeled fair value (LHS)

2014

2015

2016

High-yield illiquidity metric (RHS)

Note: High-yield illiquidity metric = Barclays Liquidity Cost Score
Source: Barclays data (from IMF (2016))

158
159

IMF (2016)
Represented by the Barclays Liquidity Cost Score© Oliver Wyman

73

Impacts on capital markets

Post Crisis Basel Reforms

INCREASE IN MARKET VOLATILITY
The speed and extent of price movements in the capital markets is influenced by market liquidity. A large numberof participants with an ability to transact quickly and efficiently can ensure that price movements not aligned withthe market consensus are quickly nullified. Further, in a liquid market with a constant flow of transactions, largeblock trades would have a limited impact on price, resulting in lower price volatility. There have been a number ofrecent incidences of extreme movement in prices that may indicate potential illiquidity in some markets. For
example:•In October 2014, following negative news on the US economy, 10-year US Treasury yields dropped by 37 bps,
followed by a rebound to roughly the previous level, within a period of minutes. This represented a very large
move by historical standards in that market in a very short space of time.

•

In 2013, in response to news that the Fed might taper off its purchases of bonds in the markets more quickly
than expected, there was a rapid decrease in the price of governments bonds, which then impacted prices ofother bonds priced relative to government bonds.

•

In 2015, when the Swiss National Bank gave up its policy of capping the Swiss Franc – Euro exchange rate, thevalue of the Swiss Franc jumped by 30% within the first 13 minute of trading before significantly reversing themove over the course of the day. Some market observers believe that the extent of price movement would
have been more subdued in a more liquid market.

•

European sovereign bond prices fluctuated dramatically in the first half of 2015. For instance, German 10-yr
government bond prices moved by 7–8% from peak to trough.160•

In 2015, rates in US$ interest rate swaps dropped suddenly below corresponding Treasury yields, for the firsttime in more than 5 years.

•

In February 2016, Portuguese sovereign debt experienced a dramatic increase in yield to over 4.5%, thehighest since Portugal’s bailout exit in May 2014, despite stable economic fundamentals.

These incidents may have been less extreme in the presence of greater market liquidity. Further, there areconcerns that these incidents are indicators of an increased frequency of extreme episodes of volatility rather thansimply one-off events.161 But, given the existence of multiple competing drivers, it is difficult to ascertain the extent
to which these incidents were caused by a lack of market liquidity driven by changes in regulation.

160
161

Elliott (2015)
Ibid.

74

© Oliver Wyman

Post Crisis Basel Reforms

5.5.

Impacts on capital markets

POTENTIAL FUTURE IMPACTS ON MARKET LIQUIDITY AND MARKETSTRUCTURE

Going forward, we see a substantial risk of a further deterioration in market liquidity for the following reasons:•Finalization and full implementation of regulations such as NSFR, Leverage Ratio, margin requirements and
FRTB will result in increased regulatory costs for banks and large dealers, forcing them to exit businesses orpass on costs to end users.

•

Monetary policy has supported market liquidity in a number of regions. But, central banks are expected togradually tighten monetary policy going forward, potentially exposing liquidity issues that were previously
masked by accommodative policies.

•

Banks will refine internal pricing and capital allocation mechanisms for capital and liquidity, more effectively
passing on the true cost of regulation onto the appropriate business units, and thereby onto end users.

•

Re-pricing of products will gradually gather steam as banks make efforts to improve return on equity.

It is also likely that there will be a non-linear increase in effects, as banks and dealers tend to make the easiest
adjustments and those that hurt customers least before they move on to more painful moves. In addition, market
structures will continue to evolve with an increase in electronic trading and changes in bank business models andthese shifts will likely become more permanent.
Given these considerations, analysis of the impact on capital market functioning should continue to be a highpriority for regulators in the design, calibration and implementation of regulations. In order to have a holistic andaccurate view, the interaction with evolving markets rules (such as MIFID II in Europe for instance) should also betaken into account. Finally, regulators should also aim to develop measures to smooth the path to the “new normal”
in financial markets, and ensure that implementation timelines for new regulations are suited to the adoption ofthese measures.

© Oliver Wyman

75

Post Crisis Basel Reforms

Overall coherence and potential issues with Basel reforms

6. OVERALL COHERENCE AND POTENTIAL ISSUES WITHBASEL REFORMS
In analyzing the impact of post-crisis Basel reforms, it is important to understand the cumulative impact andinteraction of regulations in order to achieve the optimal design and calibration for a financial system that
promotes stability and works to support economic growth.162 There is consensus that changes in the regulatory
requirements were needed and the capital ratios (especially the higher quality CET1) were too low prior to the crisis.
However, a number of concerns have been raised by academics and market participants about the calibration andimplementation of the reforms.
TABLE 6.1: POTENTIAL ISSUES WITH REGULATORY REQUIREMENTSPOTENTIAL ISSUES
Inconsistent sets of rules

BRIEF DESCRIPTION

Mis-calibrated rules• Many of the rules involve decisions about minimum thresholds or otherquantitative criteria• It is possible for the chosen level of reforms to produce too great a cost for thedesired benefits• One-size-fits-all definition of thresholds may not allow appropriate considerationof divergent regional financing structures, legal protections and bank balance
sheet compositions

Duplication or interactionof coverage• Rules may be appropriate taken individually, but their interaction results in an undue
regulatory burden on certain products or on the system as a whole• These rules drive bank behavior that may create substantial problems for particular
activities, services, and products that are important to customers and functioning of
the wider market, even if the calibration of overall capital or liquidity levels for thebanking system as a whole is broadly appropriate

Unintended
consequences• Reforms may create other unintended consequences for the broader economy, suchas the potential for concentration of exposures in parts of the financial sector that are
not regulated or regulated only lightly (often referred to as “shadow banks”) or someof the changes in the market structure and the way market participants interact• Two or more rules may pull in different directions• Potential to increase the total economic cost without a corresponding benefit interms of safety and soundness

As outlined in Table 6.1: Potential issues with regulatory requirements, there are four types of potential issues with
the Basel reforms:1) potential inconsistency in rules; 2) potential mis-calibration of rules; 3) potential duplication orinteraction of rules; and 4) potential unintended consequences of rules. Although some of these problems could
arise in regard to a single rule taken by itself, many of the tougher challenges arise from the combined effects ofmultiple rules. Table 6.2: Interaction of regulatory requirements below highlights the different ways in which rules
can interact.

162

GFMA, IIF and PwC (2015)© Oliver Wyman

77

Overall coherence and potential issues with Basel reforms

Post Crisis Basel Reforms

TABLE 6.2: INTERACTION OF REGULATORY REQUIREMENTS
INTERACTIVE
EFFECTS
Additive

BRIEF DESCRIPTION AND EXAMPLES• Combined effect is assumed to be the simple addition of the impacts of the individual reforms.
This is generally chosen because it is an easy and seemingly neutral assumption• In some limiting cases, an additive impact may take the form of the following:– Prohibiting. In some cases, two or more regulations may be additive in their effects until athreshold is crossed where some activities cease to be competitive for the bank to conduct- For example, if the combined effects of higher capital and liquidity requirements on banks
make it sufficiently cheaper to operate as a non-bank, then activities will migrate over time
towards shadow banking. Smaller scale changes to capital and liquidity might have nosuch effect, because the competitive advantages of being a bank might still outweigh thedrag of more expensive funding– Distributional. A less severe version of “prohibiting” regulations are the ones that shift therelative attractiveness of different types of business. In the first instance, two regulations
might be additive in their impacts. However, taken together, they may create incentives for a
substantial shift of business from one activity to another, changing the overall impact on thebank in multiple ways

Offsetting• In some cases, one regulation partially offsets the cost of another– For example, the aggregate cost of meeting the LCR and NSFR requirements should be lessthan the sum of the two individual rules. Specifically, moving from short-term funding to debt
with a maturity of over one year would help meet both requirements, so the cost should not
be double-counted

Alternatively
binding• Two regulations may aim at the same broad goal and be binding in different circumstances– For example, both the leverage ratio and the risk-weighted capital requirements are aimed atensuring sufficient total capital– A bank might find that the requirements under the leverage ratio are initially considerably
below the capital levels needed under the risk-weighted approach– Thus, a small increase in the leverage ratio would have no impact on total capitalrequirements. But, a sufficiently large rise would turn the leverage ratio into the binding
constraint (at the bank or even business line level), such that each additional increase in thatratio would add to total capital needs

Multiplicative• The requirements of one regulation may make it even more expensive to meet the requirementsof another– For example, the leverage ratio can make it expensive to hold short-term high quality
securities, potentially making it more difficult and costly to meet the LCR by increasingholdings of HQLA, yet other ways of meeting the LCR requirement may be more expensive.
The combined effect could be greater than the two individual effects, depending onmarket conditions

SUMMARY OF POTENTIAL ISSUES
Research to date has addressed these potential issues through a combination of empirical analysis and theoreticalresearch. In particular, the potential issue of mis-calibration has received the most attention from academic andofficial literature: studies such as Basel Committee’s Long-term Economic Impact (hereafter “the LEI study”),163
ECB (2015), Miles, Yang, and Marcheggiano (2012), Begenau (2015), Nguyen (2014), Kato (2010), and others
evaluated the calibration of some key reforms.164 However, given the recent nature of many of these reforms andthe fact that not all have been fully implemented to date, there frequently is little opportunity to develop aquantified approach to issues such as inconsistency, implementation difficulties, and duplication of regulation.

163
164

Cited in the bibliography as BCBS (2010a)
BCBS (2010a), ECB (2015), Miles, Yang, and Marcheggiano (2012), Begenau (2015), Nguyen (2014)78© Oliver Wyman

Post Crisis Basel Reforms

Overall coherence and potential issues with Basel reforms

Thus, a number of trade associations,165 as well as individual firms, have submitted comments on a variety of
regulations, focusing on conceptual and practical issues, though some academic non-empirical research also
discusses potential issues with reforms. These comments address a number of potential issues with Basel reforms
and with their national implementations.
The table below summarizes the issues discussed in this section, at a high level. These are some of the key issues
the authors identified during their research and literature review, but are not intended to be an exhaustive list. The
authors have not formed their own judgments on the severity of these issues, but do believe that they should beconsidered by regulatory bodies examining the interaction, coherence, and overall calibration of reforms. Some ofthese issues are discussed in or quantified in earlier sections.
TABLE 6.3: SUMMARY OF POTENTIAL ISSUES WITH BASEL REFORMS
TYPE OFPOTENTIAL ISSUE
Consistency

Mis-calibration

POTENTIAL ISSUE
Conflicting incentives of theleverage ratio versus othercapital and liquidity ratios
Inconsistency of incentives
created by structural andliquidity reforms
Calibration of capital ratios

Calibration of TLAC

Calibration of the leverage
ratio

Calibration of LCR
Calibration of sovereign
debt weights
Calibration of mortgage
weights
Calibration of credit
conversion factors (CCF)
Calibration of Standardized
Approach leading to
reduction in risk sensitivity
Calibration of NSFR165

DESCRIPTION
Risk-insensitive leverage ratio produces divergent incentives forthe composition of a bank’s portfolio from the incentives
produced by risk-sensitive capital requirements
Segregation of businesses due to structural reform could impact
consolidated entity’s stable funding, and could be creating
conflicting incentives for banks
Limited consensus on optimal levels, especially in light of
expected RWA increases from current workstreams, at both aconsolidated and granular (activity) levels
The impact of TLAC requirements including internal TLAC
arrangements should be assessed further to ensure appropriate
calibration in the context of the cumulative impact of TLAC,
capital requirements, and expected RWA increases from current
workstreams
The LR could be the binding constraint for a large share of banks,
potentially going beyond the intention of many that it be abackstop; calibration needs also to be assessed at the activity
level and how it may impact strategic decisions, as, for example,
the LR may be the binding constraints for fully collateralized
trades and market making on government bonds
Assets included in and excluded from HQLA definition may be
mis-calibrated based on underlying risk
Standardized zero risk weight for sovereign debt underestimates
underlying risk in varying degrees
Mortgage risk weights could be misaligned with underlying risk
factors
Calibration of CCF for certain exposures (e.g. off-balance sheet
exposures, trade finance, infrastructure) could be too punitive
compared to historical experience
Calibration of proposed SA measures reduces risk sensitivity forsome asset classes and may create distorting incentives; mayalso, in combination with capital floors, duplicate the “backstop”
role of the leverage ratio
NSFR requirements may impose unnecessarily high costs on
certain derivative trades and linked transactions

We reviewed comments submitted by the following associations in writing up this report: Global Financial Markets Association (GFMA), Securities
Industry and Financial Markets Association (SIFMA), Asia Securities Industry and Financial Markets Association (ASIFMA), Association for Financial
Markets in Europe (AFME), Institute of International Finance (IIF), and The Clearing House (TCH). Comments from other organizations werereviewed at times as well.

© Oliver Wyman

79

Overall coherence and potential issues with Basel reforms

TYPE OFPOTENTIAL ISSUE
Duplication orinteraction ofcoverage

POTENTIAL ISSUE
NSFR, LCR, and US G-SIB
buffer (addressing maturing
mismatch and short-term
wholesale funding)
Capital floors

Step-in risk

CET1 ratio, leverage ratio,
and stress testing

Unintended
consequences

Shadow banking

Procyclicality
Leverage ratio incentives fordeposits (held at central
banks)
Impacts of liquidity reforms
on overall market liquidity
Impacts on market
structure
HQLA Alternative liquidity
approaches (ALA)
Distributional
consequences

Post Crisis Basel Reforms

DESCRIPTIONUS G-SIB buffer, and potentially the inclusion of G-SIB in CCAR
addresses liquidity and funding issues already addressed by
NSFR and LCR
Capital floors may duplicate “backstop” role of the leverage ratio
and are not consistent with robust qualification test for internal
models
Proposed regulation for step-in risk could be duplicative of othermeasures that have already addressed the underlying issue, e.g.
prohibition of sponsor support for money market funds
CET1 ratio, leverage ratio, and stress testing may each be abinding constraint depending on the year, which may create
complexity in banks’ determination of their binding constraint
and cause inconsistency in internal capital allocation andinternal transfer pricing mechanisms within banks
Regulatory reforms could push an increasing amount of financial
activity to a less regulated “shadow banking” sector, thus
potentially increasing systemic risk
Countercyclical capital buffer may not sufficiently address
cyclicality and could potentially be procyclical in practice
Leverage ratio creates a disincentive for custody (and other)banks to accept cash deposits, especially during a “flight tosafety” in a crisis; leverage ratio may also create other disincentives for products or activities, such as OTC clearing
While liquidity reforms improve liquidity at the individual banklevel, they may lead to a decline of overall market liquidity
Reforms create incentives for alterations to market structure,such as market or client exits, possibly limiting provision offinancial services
Low supply in government debt in some geographies has led to
ALAs that are not fully linked to central bank liquidity policies,
which may reduce central bank ability to respond to a crisis
Reforms will impact some products or services more than others
and may consequently impact end-users in ways that were notintended. For example, corporate customers and SMEs will be
more impacted by lending rate increases, primarily due tocapital weight differentials

The rest of this section provides a conceptual overview of the types of issues with Basel reforms and provide
examples of how these issues could materialize.

80© Oliver Wyman

Post Crisis Basel Reforms

6.1.

Overall coherence and potential issues with Basel reforms

POTENTIALLY INCONSISTENT SETS OF RULES

In a similar manner to most regulatory bodies, the Basel Committee rules are developed by specialized working
groups that report to the Policy Development Group within the Basel Committee.166 These specialized working
groups are made up of subject matter experts who are focused on specific policy issues such as the trading book,securitization, the leverage ratio, etc. As a result, reforms are initially developed by distinct bodies, although teams
do communicate across the groups. This separation of the development of reforms can create a potential forinconsistencies between rules or the incentives that they create, despite the Basel Committee’s best efforts tosmooth out inconsistencies before rules are finalized. National and regional regulatory reform efforts face similarrisks of “silo” effects, especially when working under time pressure.
Inconsistencies among rules may increase the total economic cost of achieving the desired financial sector stability
or, in the extreme, actually reduce the stability of financial markets despite increasing costs.
Potential for inconsistencies are discussed further below. It should be emphasized that quantitative impact studies
should also be done at a granular level paying attention to the internal capital allocation processes and practices inbanks.

6.1.1.

CONFLICTING INCENTIVES OF THE LEVERAGE RATIO VERSUS OTHER
CAPITAL AND LIQUIDITY RATIOSOne example of this is the potentially inconsistent incentives created by the risk sensitive capital ratios (such as
CET1/RWA), liquidity reforms, and the leverage ratio. Since the leverage ratio does not make a distinction between
different types of bank assets based on their underlying risk, it implicitly encourages banks to hold relatively riskier
assets and could penalize banks with large portfolios of low yielding and comparatively liquid assets like cash. On
the other hand, risk sensitive capital ratios and liquidity reforms pull banks in the opposite direction. Risk
weightings and liquidity requirements drive banks to build up assets with a lower risk weight and higher liquidity,
such as those designated as high quality liquid assets.
Risk weighting and liquidity reforms effectively incentivize banks to lower the RWA denominator of the equity torisk assets ratio, while the leverage ratio incentivizes banks to increase it. This can either be viewed as a carefulbalancing act or as the creation of inconsistencies that reduce the effectiveness of the reforms, depending on thedetails of the implementation and one’s viewpoint. Practically, the conflicting incentives can lead banks to “barbell”
their balance sheets by holding higher risk/higher yielding assets to balance out the capital charge from the large
amount of lower risk/lower yielding assets required by the LCR, as illustrated in the figure below, taken from IIF(2016).

166

BIS (2016b)© Oliver Wyman

81

Overall coherence and potential issues with Basel reforms

Post Crisis Basel Reforms

FIGURE 6.1: “BARBELL” EFFECT BY TYPES OF ASSETS
Leveraged
loans

300%

250%
Subprime
mortgages

Risk weight200%
Investmentgrade corporates

150%

Unsecuredretail100%

50%Treasuries,
cash

Trade
financePrimemortgages0%
Low-risk

Individual borrower’s risk characteristics

High-risk

Assets required for
HQLA under LCR

Regulated banks are deterred by lower returns

Banks incentivized to lend tothese high-risk segments

IRB-based capital recruitment

Leverage ratio

Source: IIF(2016)

This issue of conflicting incentives is exacerbated by the fact the binding ratio may shift over time between either
the risk-sensitive capital ratio or the leverage ratio (or potentially national stress tests). This issue and otherconcerns related to the leverage ratio are discussed further in this section.167

6.1.2.

INCONSISTENCY OF INCENTIVES CREATED BY STRUCTURAL AND
LIQUIDITY REFORMS

There are concerns that proposed and instituted structural reforms could impact stable funding, particularly in the
UK Market participants argue that if banks were required to segregate or “ring fence” the part of their business witha stable retail deposit base away from other business lines, this would impact the consolidated entity’s stable
funding. Additionally, segregation of certain business lines would require institutional banking operations to be
funded from long-term wholesale debt to be compliant with LCR/NSFR. The lack of consistency in incentives
presented by LCR/NSFR and structural reforms could add pressure for banks to increase their holdings of liquid
assets. As this issue deals primarily with jurisdictional implementation of reforms, it is not discussed further in thisreport.168

6.2.

POTENTIALLY MIS-CALIBRATED RULES

Many of the rules involve decisions about minimum thresholds or other quantitative criteria where it is possible forthe chosen level to produce too great a cost for the desired benefits. Misalignment of economic risks andregulatory measures could result in end users paying the costs of reforms without receiving commensurate
benefits. Significant work has been done on evaluating the optimal calibration of capital ratios, though otherreforms such as NSFR and LCR have received less attention, and there is still considerable uncertainty about thecalibration of the ongoing Basel workstreams and their effect on capital requirements.

167
168

Avgouleas (2015), AFME (2016), European Commission (2016) – based on summary of comments
AFME and PwC (2014c)

82© Oliver Wyman

Post Crisis Basel Reforms

Overall coherence and potential issues with Basel reforms

OVERALL CALIBRATION OF REFORMS
Overall calibration of reforms has been subject to much debate, given the underlying tradeoffs between stability(e.g. bank default rates) and potentially slower economic growth. Additionally, overall calibration of reforms has
been urged for re-consideration by some observers, as joint effects of reforms may go beyond the intended
benefits.

6.2.1.

CALIBRATION OF CAPITAL RATIOSThe overall level of capital requirements has been one of the key concerns with calibration of reforms. The
increased regulatory burden impacts banks’ funding costs, which may be passed on to the end users in the form ofeither higher loan rates or decreased loan volume in the lending market, and potentially increased transaction
costs in capital markets.169 The calibration must then balance these costs against the benefits that these reforms
create for society. As noted, numerous studies have focused on understanding the optimal level of capital.170
Research to date has shown a wide range of results about the optimal calibration of capital reforms, leaving thecorrect answer unclear. Differences in methodology and underlying assumptions have resulted in estimatedoptimal levels that range from 8% to over 20% of RWA. As an example of the lower end of calibration, Nguyen(2014) calibrated a model that indicated the optimal capital requirement to be 8% of Tier 1 capital over RWA, while
Begenau (2015) identified 14% CET1 as the optimal capital requirement. Researchers from the Federal Reserve
Bank of New York found that the buffer adopted by the Basel Committee is “generally consistent with the actual
losses experienced by large banks during the recent and past financial crises” and is therefore calibrated for crisis
losses.171 On the other hand, in its 2010 study of the long-term economic impact of stronger capital and liquidity
requirements,172 the BCBS found that there are significant positive benefits to increased capital ratios, outweighing
the costs, in their view. The study in fact concluded that the capital ratios were too low and opportunity remained toincrease capital while generating positive benefits. Some academic and official studies have also argued forincreases in bank capital levels (e.g. Miles, Yang and Marcheggiano (2012) and Admati and Hellwig (2013)).173
Using a dataset of almost 200 years from a number of countries, Miles, Yang and Marcheggiano (2012) found an
optimal calibration of bank capital to be around 16–20% Tier 1 capital over RWA based on the then prevailingdefinitions (this is important as changes to RWA definition impact the capital ratio). Finally, Dagher et al (2016) findthat capital requirements of 15–23% of RWA would have been sufficient to “absorb losses in the majority of pastbanking crises.”174 The majority of the studies examined capital levels without differentiating between CET1 andother forms of capital. Thus it may be most appropriate to compare the levels with TLAC rather than just equity
capital. Ranges of optimal calibration are shown in the figure below.

169

Elliott, Salloy, and Santos (2012)
BCBS (2010a), ECB (2015), Barrel et al (2009), Begenau (2015), Nguyen (2014)
171
Hirtle (2011)
172
BCBS (2010a)
173
Admati et al (2013), Miles, Yang and Marcheggiano (2012)
174
BCBS (2010a), ECB (2015), Barrel et al (2009), Miles, Yang and Marcheggiano (2012), Begenau (2015), Nguyen (2014), Hirtle (2011), Dagher et al(2016)
170© Oliver Wyman

83

Overall coherence and potential issues with Basel reforms

Post Crisis Basel Reforms

FIGURE 6.2: ESTIMATES OF OPTIMAL CALIBRATION OF CAPITAL REQUIREMENTS
25%

23

Optimal capital requirement

Upper estimate
20
20%
14

15%
10%

16

Lower estimate
15

8

5%
0%
Nguyen(2014)

Begenau(2015)

Miles, Yang andMarcheggiano (2012)

Dagher et al(2016)

Some studies note that the optimal level may vary across and within banks. Analysis by Clerc et al. (2014) impliedthat the optimal steady-state regulatory capital ratios are different for different types of exposures: about 10% forbusiness loan exposures, and about 5% for real estate exposures. Further, Kato (2010) found that the optimal levelof bank capital would vary considerably “depending on the level of liquidity indicators both on the asset andliability sides of banks’ balance sheets as well as macroeconomic conditions, typically represented by housing
market inflation.”175
As evidenced by the wide range of optimum capital levels in the literature, the overall calibration of Basel capitalreforms will continue to be an open question. ECB (2015) therefore argues that “it will be appropriate for[governing bodies] to continually review the calibration of post-crisis regulations in order to maintain regulatory
calibrations at levels that maximize net benefits to society. Such reviews should be holistic in scope – ensuring thatthe interactions between different strands of the regulatory architecture are captured.”176
The majority of these analyses have been conducted at a macro (or consolidated bank) level, while the specificimpacts on an asset class, a product or a business line need to be assessed at a granular level in order tounderstand the impact on the real economy according to the specific prevailing economic conditions of eachregion or country. For example, the impact on mortgage lending may be quite different depending whether
exposures are generally held on banks’ balance sheets or not. Similarly, the impact of export finance capitalrequirement increases will be more detrimental to open economies.
The potential need for review of the overall calibration of capital reforms is further highlighted by the layering ofother regulations which themselves have been subject to concerns about calibration.
First, the final calibration of the current workstreams of Basel reforms (limitations on use of internal models, capital
floors, risk weights, etc.) is still forthcoming. However, as discussed earlier, some market participants have pointed
to the fact that these reforms are expected to increase RWAs, sometimes referred to as “RWA inflation”. As
discussed in Section 1, revisions to the SA for credit risk, and operational risk calculations, FRTB, and limitations on
use of internal models, combined with capital floors, could create aggregate RWA inflation with a lower bound of~10–30%, with a commensurate increase in capital requirements.177 As noted, however, the GHOS of the Basel
175

Kato, Kobayashi and Saita (2010), Clerc et al (2014)
ECB (2015)
177
Dawn (2015), Durand (2015), Keenan and Spick (2015), KPMG (2015), Macquarie Equities Research (2016), The Economist (2015), Turner (2012)
176

84© Oliver Wyman

Post Crisis Basel Reforms

Overall coherence and potential issues with Basel reforms

Committee have issued assurances that the total increase in RWA will not be “significant” in the aggregate for theindustry, which most observers interpret to mean a ceiling of 10% or perhaps lower. If this carries through inpractice, then the calibration risk is considerably reduced. Bearing in mind the nature and scope of the ongoing
and recently completed Basel workstreams, even an overall zero or near-zero increase at the global level could
have uneven impacts across regions. Additionally, an overall zero or near-zero increase at the bank level mightmask a significant increase at a more granular level (e.g. business line), creating potential unintended distributional
consequences. Thus, some observers have called for a pause in reforms that are not currently finalized to give time
for an adequate implementation of Basel III rules, to understand the real impacts of recent reforms, to give visibility
to both banks, their shareholders, and debtholders, and to promote growth in a context of reduced regulatory
uncertainty. On the other hand, some observers would rather promote a rapid finalization of the ongoingworkstreams in order to reach the same objectives: diminishing uncertainty, giving clarity and reaching a neutralityof coming reforms on business models and economic growth.
Second, the calibration of capital requirements needs to consider the impact of structural reforms and the resulting
benefits to financial soundness and the presumably diminished need for higher capital requirements.
Third, the calibration of capital requirements needs to consider the impact of TLAC (as will be discussed shortly).
Consideration of these factors jointly may merit a review of the total calibration of capital requirements.

6.2.2.

CALIBRATION OF TLAC

Optimal calibration of TLAC, when considered jointly with calibration of regulatory capital, has also come into
question. While TLAC is intended to serve a primary different purpose than capital (ensuring post-default lossabsorbing capacity vs. lowering the risk of default, respectively), it is worth mentioning that, as Dagher et al (2016)
note, TLAC can fulfill part of the function that equity capital has traditionally fulfilled.178 As discussed in Section 4,
the calibration of TLAC requirements has an impact on overall amounts of capital, and consequently will have an
impact on bank funding costs. An estimated total capital requirement for G-SIBs is shown below.

178

Dagher et al (2016)© Oliver Wyman

85

Overall coherence and potential issues with Basel reforms

Post Crisis Basel Reforms

FIGURE 6.3: G-SIB CAPITAL REQUIREMENTS, INCLUDING BASEL REQUIREMENTS AND TLAC
30%
25%
20%
15%
10%
5%
0%
Required CET1
Minimum CET1
GSIB surcharge [1]Additional Tier 1
Long-term unsecured debt (other TLAC)

Required total capital
Capital conservation buffer
Countercyclical capital buffer [1]Tier 2[1] GSIB surcharge (2%) and countercyclical buffer (2%) are illustrative; actuals are calculated by banks individuallySource: FSB (2015), BCBS (2013c), and Oliver Wyman analysis

TLAC requires substantial amounts of long term debt as part of the capital structure and is expected to generate
substantial issuance for long-term debt. This is especially significant for deposit-funded banks, which have not
traditionally relied on debt obligations to manage their balance sheets. As shown in the figure below, the majorbanks subject to TLAC in the US need long term debt equal to 9% of RWA on average.

86© Oliver Wyman

Post Crisis Basel Reforms

Overall coherence and potential issues with Basel reforms

FIGURE 6.4: CAPITAL REQUIREMENTS FOR US GSIBS
25%

23.5%
21.5%

20.5%

20.5%

20.5%

20%

18.5%
10.5%
9.5%

15%

9.0%

9.0%

17.5%

16.5%

9.0%
8.0%

7.5%

7.0%

10%
13.0%
5%

12.0%

11.5%

11.5%

11.5%

Citigroup

Bank of
America

Goldman
Sachs

MorganStanley

10.5%

10.0%

9.5%

0%
JPMorgan
Chase

LTD

Wells Fargo State Street Bank of New
York Mellon

Tier 1 Capital

Note: This chart does not depict 1) the amount of external TLAC that would be required under the proposed rulemaking, or 2) any higher amountof LTD that could be required if calibrated under the proposed external LTD requirement's leverage approach (4.5% of the firm’s total
leverage exposure)
Source: Federal Reserve System (2015a)

As shown in the figures above, when the existence of CET1 requirements is considered, the overall level of TLAC will
be around 20% for the US G-SIBs. For example, analysis conducted by The Clearing House pointed to the fact thatthe “FSB’s proposed TLAC requirement of 16–20% of risk-weighted assets, plus the 2.5% capital conservationbuffer and the G-SIB surcharge is in excess of the loss absorbency necessary to prevent against [sic] even the mostextreme historical or stress loss estimates.” For the US, a 16% TLAC requirement would produce total loss
absorption capacity that is “4.4 times greater than the average losses projected for US G-SIBs under the Federal
Reserve’s severely adverse scenario for the 2014 Dodd Frank Annual Stress Testing (DFAST) stress testing andComprehensive Capital Analysis and Review (CCAR) exercise … [and] 2.6 times greater than average historicallosses experienced at the largest failed US financial institutions.” Similarly, European market participants (e.g.
European Association of Co-operative Banks) have argued that TLAC requirements are too high. 179
Some official sources have also indicated that the optimum level of capital in the banking system, in fact, would belower once the additional TLAC requirements are taken into consideration. The Bank of England’s Brooke et al.
(2015) estimates that “once resolution requirements and standards for additional loss-absorbing capacity that canbe used in resolution are in place, the appropriate level of capital in the banking system is significantly lower thanthese earlier estimates, at 10–14% of risk-weighted assets.” The authors’ findings show that considering TLAC
guidelines on minimum levels and eligible asset types as a part of an optimal capital analysis may lower theestimated necessary Tier 1 capital ratios, in this study from the previously estimated 16–19% to 10–14%.180
It must also be noted that the previously discussed RWA inflation is likely to impact bank TLAC needs, as TLAC
calculations are also dependent on RWAs. Thus, these reforms may essentially push TLAC out beyond the current
calibration.181
179

Brooke et al. (2015), SIFMA (2015a), EBF (2015), EACB (2015)
Ibid
181
Dawn (2015), Durand (2015), Keenan and Spick (2015), KPMG (2015), Macquarie Equities Research (2016), The Economist (2015), Turner (2012)180© Oliver Wyman

87

Overall coherence and potential issues with Basel reforms

Post Crisis Basel Reforms

Finally, the calibration of “internal TLAC” may also warrant a review. Some believe that it is too high and that thesum of 75–90% of the individual internal TLAC requirements of subsidiaries will likely be greater than the 100%
TLAC requirement for the consolidated balance sheet of some parent companies. This may occur if the subsidiaries
have varying constraints and business models, for example if some rely on external debt instruments and others
operate with funding surpluses. When the constraints used to calculate the TLAC requirement are also applied tointernal TLAC, even scaled down to 75–90%, the sum of internal TLAC may exceed consolidated external TLAC.182

6.2.3.

CALIBRATION OF THE LEVERAGE RATIOIn addition to the overall calibration of risk-based capital reforms, there are concerns with the calibration of theleverage ratio (LR). Even though the calibration is ongoing, market participants have raised concerns about
incentives created by the LR (as discussed earlier in the chapter), and the fact that the LR could be a binding
constraint for a large share of banks. The figure below illustrates the conditions under which the LR becomesbinding.
FIGURE 6.5: HOW THE LEVERAGE RATIO IS LINKED TO THE TIER 1 RISK-WEIGHTED CAPITAL REQUIREMENT

Leverage ratio

Bank B
RWR
is binding

RWR is constraining
Bank ALR is constraining

Minimum
requirement
LR and RWR
are binding

LR is binding

Minimum requirement
Risk-weighted capital ratio
Note: The red diagonal line represents combinations of the LR (T1/EXPLR) and the risk-weighted capital ratio (T1/RWA) for which the banks density
ratio (DR) is exactly equal to the threshold DR (i.e. the minimum LR requirement divided by the minimum RWR). Bank A, for example, meetsboth minimum requirements (i.e. it is not bound by either of them). Yet Bank A is constrained by the minimum LR requirement, which meansthat the regulatory capital required to meet this requirement is higher than the amount due to the minimum RWR. For Bank B, by comparison,
the RWR is constraining.
Source: Fender and Lewrick (2015a)

The darker blue area in the figure represents the combinations of the LR and risk-weighted capital ratio for which abank (or a department/business line in a bank) would be bound by the LR. The light blue area in the figure above
represents the conditions of the LR and risk-weighted capital ratio for which the risk-weighted ratio is binding.
Whether the LR is constraining (as indicated by the red line in the figure above) is dependent on how banks RWA
density compares with the threshold RWA density (or “critical” average risk weight) implied by the combination of
the minimum LR and risk-weighted capital ratio requirements. The RWA density “denotes the average risk weight
per unit of exposure for any given bank.” 183
182
183

EBF (2015)
Fender and Lewrick (2015a)

88© Oliver Wyman

Post Crisis Basel Reforms

Overall coherence and potential issues with Basel reforms

The BIS has stated that the leverage ratio is intended to “reinforce the risk-based requirements with a simple, nonrisk-based backstop” 184 and indicated that “target shares of up to 50% would be consistent with the backstop
concept underpinning the LR,” 185 thus indicating that the LR may have been intended to impact a significant
number of banks. The leverage ratio is expected to only impact banks or activities with a low average risk-weight.
However, some research points to the fact that the LR may be binding for a higher share of banks than intended.
For example, a March 2016 EBA monitoring exercise indicates that the leverage ratio at 3% serves as a binding
constraint for a large proportion of EU regulated banks due to RWAs and EU market structures. According to thereport, nearly 90% of European G-SIBs would be constrained by the LR (vs. Tier 1 risk-based minimum
requirements).186 The share of banks constrained by the LR appears to decline with decreasing bank size for nonG­SIBs. Additionally, the LR continues to be a binding factor for banks even when the capital conservation bufferand G-SIB buffer are taken into effect: even with these requirements the LR continues to be a binding factor for over
44% of G-SIBs. Additionally, a Basel III leverage ratio survey, commissioned by GFMA/The Clearing House, showedthat the leverage ratio becomes the binding capital ratio for ~50% of institutions for a leverage ratio of 3% (44% of
G-SIBs and 56% of non G-SIBs) and rises to ~90% (93% of G-SIBs and 88% of non G-SIBs) for a leverage ratio of 5%.
It is important to note that such studies are based on LR definitions prior to the 2016 revisions to the leverage ratio
framework. This indicates that the leverage ratio may function as more than a backstop. Analyzed at a moregranular level, the leverage ratio acting as a binding constraint could also have potential negative consequences formarket liquidity, as it poses a high cost to conducting low-risk repo transactions and to carrying market-making
inventory, as discussed in Section 5.187
There may also be some distributional consequences to the LR, as an AFME study finds that “for a universal bankthe leverage ratio presents a greater constraint than for a broker-dealer.”188 Additionally, a European Commission
summary of responses to a call for evidence on the EU regulatory framework for financial services noted that some
respondents “also argued that the leverage ratio could reduce diversity, as it would have a disproportionate impact
on low risk-weighted business models such as specialized community banks, building societies and mortgage
banks.”189 Thus, it is worth considering if the LR could create potentially significant distributional differences that
reduce diversity and could thus drive higher concentrations of risk.190

PARTIAL MIS-CALIBRATION OF REFORMS
Even if the overall calibration of capital and liquidity is appropriate, there could be issues with partial miscalibration of reforms when certain components of the rule are inappropriate. This can become particularly
apparent in the calibration of risk weights, definitions of assets eligible for inclusion in capital or liquidity buffers,
or the results of methodological assessments (e.g. Standardized Approach, Internal Ratings-Based (IRB)
Approach, etc.).

6.2.4.

CALIBRATION OF LCR

As an example of a potential partial mis-calibration of eligible assets, we consider the case of assets included in the
LCR. The LCR has been criticized as a rigid rule given its assumptions that the trigger factors such as downgradedratings will remain constant during the full stress period. A European Commission study191 discusses the argument
184

BCBS (2013f)
Fender and Lewrick (2015a)
186
EBA (2016b) indicates that the degree of binding power of risk-based vs leverage Tier 1 capital requirements on G-SIBs Group 1 banks is 88.9%(proportion of banks constrained by the LR)
187
Fender and Lewrick (2015a), EBA (2016b), AFME (2011a), BCBS (2013f), European Commission (2016) – based on summary of comments, GFMA
and The Clearing House (2013a), GFMA and The Clearing House (2013b); IIF (2014).
188
AFME (2011a).
189
European Commission (2016) – based on summary of comments.
190
Fender and Lewrick (2015a), EBA (2016b), AFME (2011a), BCBS (2013f), European Commission (2016) – based on summary of comments, GFMA
and The Clearing House (2013a), GFMA and The Clearing House (2013b); IIF (2014).
191
European Commission (2014a).
185© Oliver Wyman

89

Overall coherence and potential issues with Basel reforms

Post Crisis Basel Reforms

that the asset pools considered for LCR inclusion may be too prescriptive and restrictive. Liquidity definitions forLevel 2B Assets have allowed only for the inclusion of RMBS to calculate the HQLA stock. However, corporate
bonds, covered bonds, and other components of the highly liquid asset-backed securitization (ABS) asset classes,
such as ABS backed by auto loans and credit cards, were not included in the liquidity definitions. This is a possible
case of mis-calibration, as the rule may not treat underlying risk associated with these assets consistently.
Additionally, since liquidity arises from refinancing in the public market, interbank market, and with central banks,
there is an argument that there is little reason to differentiate between RMBS and other types of ABS. Consequently,
since some high-quality ABS are an important long-term financing instrument available to investors, it is argued
that they should receive a different treatment under the LCR. According to the same European Commission study,
a counter-argument to this example of mis-calibration is that “it is well known that some securities can be highly
illiquid and there is no market price on a continuous basis.” As such, there could be good reasons to limit theeligible assets. This issue is also related to national implementation, as the specific calibration differs by region.192

6.2.5.

CALIBRATION OF SOVEREIGN DEBT WEIGHTS

The calibration of risk weights for different asset classes has also been questioned by market participants. First, risk
weights for sovereign debt are potentially mis-calibrated and may be lower than appropriate given their underlying
risk. The first Basel Accord stipulated a zero risk-weighting for many sovereign exposures, which is supported intheory by the assumption that sovereigns are able to collect taxes and to print money to repay debt. Thoughsubsequent Basel frameworks modified the rule to determine risk-weights based on an external risk rating, the final
risk determination for sovereigns often remains at zero or slightly above zero. This is due in part to a sparse or blankhistory of default but is also due to the greater regulatory leniency towards the prescription of risk weights forsovereigns. For example, sovereign debt is exempt from a 3-bp PD floor in internal calculation of risk weights andsovereign jurisdictions have the prerogative to allow lowered risk weights on their own debt. Banks using the IRB
approach rely on their own assessments. Some within the industry have raised concerns about standardized
approach potentially underestimating sovereign risk for some nations.193 At the time of drafting of this report, thetreatment of sovereign risk was a part of the BCBS’ 2015–2016 program.194

6.2.6.

CALIBRATION OF MORTGAGE WEIGHTS

Market participants have also raised concerns with the calibration of risk weights for mortgage loans. The BCBS’sframework for risk weightings of mortgage loans may not fully consider important jurisdictional differences. For
example, mortgage risk may be affected by local differences of market conditions (supply and demand formortgages), taxation, legal considerations (recourse vs. non-recourse), and other structural differences as reflectedby historical default rates. As such, mortgage risk weightings could be mis-calibrated if they do not accuratelyreflect the differences in underlying risk of loans. This limits the current comparability of risks across different
jurisdictions, areas, and systems. The figure below points to the difference in loss rates during the last crisis. 195

192

European Commission (2014a)

193

Visco (2016), Harris (2015), ESRB (2015), Jones (2015), Turner (2011), Jenkins (2016), Council on Foreign Relations (2015)

194

Liu and Morley (2013), Jenkins (2016), Visco (2016), Harris (2015), ESRB (2015), Jones (2015)

195

EBA (2016c), IIF, GFMA, ISDA, and IACPM to BCBS (2016)90© Oliver Wyman

Post Crisis Basel Reforms

Overall coherence and potential issues with Basel reforms

FIGURE 6.6: NON-PERFORMING HOUSING LOANS1
6%
5%
4%
3%
2%
1%
0%
2005

2006
Spain

2007
UK [3]

US [2]

2008
Canada [2]2009Australia [2][1] Percent of loans by value. Includes “impaired” loans unless otherwise stated. For Australia, only includes loans 90+ days in arrears prior to
September 2003
[2] Banks only
[3] Percent of loans by number that are 0-+ days in arrears
Sources: APRA, Bank of Spain, Canadian Bankers’ Association, Council of Mortgage Lenders, FDIC, and RBA data (from Lea (2010))

There are additional concerns with the calibration of risk weights based on the LTV buckets. Currently, risk weights
for exposures are determined primarily based on the LTV range (or “bucket”) of the loan. The significant differencesin risk weights between buckets could create potential cliff effects, where a small increase in LTV can result in alarge increase in risk weight if the loan is pushed to the next bucket.

© Oliver Wyman

91

Overall coherence and potential issues with Basel reforms

Post Crisis Basel Reforms

FIGURE 6.7: RESIDENTIAL REAL ESTATE LTV BUCKETS
Residential Real Estate LTV buckets
Not materially dependent on cash flows

Residential Real Estate LTV buckets
Materially dependent on cash flows
130%

SA risk weights

SA risk weights

55%

35%

110%

90%

70%

15%

50%
0%

20%

40%

60%

80%

100%

0%

20%

40%

LTV

60%

80%

100%

LTV

Source: BCBS (2015k)

As such, it is likely that loans would cluster around the border of LTV buckets, reducing the risk-sensitive value oflower LTVs within the existing LTV bands. This would indicate insufficient granularity in LTV bucket calibration.
Some market participants also argue that the overall calibration of LTV buckets could be improved to account forinteractions with other measures, such as the countercyclical buffer. This will be discussed in further detail later inthis section.196

6.2.7.

CALIBRATION OF CREDIT CONVERSION FACTORS (CCF)

There are concerns with the calibration of CCFs in the BCBS’s review of the standardized approach for credit risk.
The BCBS consultative document proposed to calibrate CCF for all unfunded commitments (except retailunconditionally cancellable) at between 50% and 75%. Market participants have emphasized that this calibration issignificantly above the historical levels experienced in the industry. This includes unfunded commitments toregulated investment funds, such as US mutual fund and EU UCITS, where industry data shows cumulative drawdown rates, even at the height of the financial crisis, of less than 10%.197
There are a number of other concerns with the calibration of CCFs, including for retail unconditionally cancellable
commitments (UCCs). In a 2016 study, The Clearing House conducted a study using data from large US bankholding companies and found that the “aggregate CCF for all retail UCCs of the Retail Participating Banks… issignificantly lower (7.4%)” than the 10–20% range currently proposed by the BCBS.198 Any potential for miscalibration of CCFs could be passed onto the end user in the form of higher pricing or reduced availability of credit

196

Ibid

197

State Street to Robert de V. Frierson, Secretary Board of Governors of the Federal Reserve System (2013)
The Clearing House (2016), aggregate CCF estimate “uses current amount for exposures and risk-weighted assets (RWA) to calculate the implied
CCF that makes undrawn exposures RWA under the Standardized Approach equal to undrawn RWA under the Advanced Approaches (AA-implied
CCF)”

198

92

© Oliver Wyman

Post Crisis Basel Reforms

Overall coherence and potential issues with Basel reforms

or other financial services.199 For example, mis-calibration of CCFs could pose some concerns for project andexport finance.

6.2.8.

CALIBRATION OF STANDARDIZED APPROACH LEADING TO REDUCTION IN
RISK SENSITIVITY

There are concerns that the calibration of the latest credit risk standards may reverse the progress made towards amore risk-sensitive capital framework by reducing risk sensitivity. As indicated in Figure 6.8, taken from IIF (2016),
Basel III broadly increased the required capital levels proportionally across the credit spectrum.
FIGURE 6.8: CAPITAL ACROSS ASSETS: BASEL III IMPACT SO FAR
14%Core equity required

12%
10%
8%
6%
4%
2%
0%
FX
CrossTrade
Prime
A+
Forward Currency FIN LC, mortgages Corporate
Swap
AA bank
Basel II (IRB)

Trade
Fin LC,BBB+
bank

BBBLowCorporate geared
SME

Creditcards

SubBBHighlyprime Corporate gearedmortgages
SME

Basel III (IRB)

Source: IIF (2016)

Internal models currently used by banks enable them to adequately compensate for risk and generate a return by
varying pricing of products based on underlying risk. However, changes to the credit risk approach (and related
capital floors) actually reduce sensitivity for some asset classes, as indicated in Figure 6.9. This may create
distortions to the relationship between risk and capital and could impact bank pricing and the shape of a bank’s
portfolio. For example, the differentiation of treatment of highly-geared SMEs and low-geared SMEs is reducedwith the proposed standardized approach. This would create an incentive for banks to invest more of their capital inhighly-geared SMEs given the opportunity for higher returns. 200

199

BCBS (2015k), BCBS (2015k), IFF, GFMA, ISDA, and IACPM to BCBS (2016), The Clearing House, SIFMA, and FSR to BCBS (2016), ICC to BCBS
(2015)
200
IIF (2014), IIF (2016)© Oliver Wyman

93

Overall coherence and potential issues with Basel reforms

Post Crisis Basel Reforms

FIGURE 6.9: CAPITAL ACROSS ASSETS: POTENTIAL NEW CHANGES
14%Core equity required

12%
10%
8%
6%
4%
2%
0%
FX
CrossTrade
Prime
A+
Forward Currency FIN LC, mortgages Corporate
Swap
AA bank
Basel III (IRB)

Trade
Fin LC,BBB+
bank

BBBLowCorporate geared
SME

Creditcards

SubBBHighlyprime Corporate gearedmortgages
SME

Proposed standardized approach

Source: IIF (2016)

6.2.9.

CALIBRATION OF NSFR

Some of the NSFR requirements relating to derivatives may have material detrimental effects on the hedging costsof end clients. Recent quantitative work by the Joint Trade Associations on derivatives indicates that the current
treatments under the NSFR would lead to a total estimated additional funding requirement of around €750 BN
leading to an annual cost of between €12–15 BN that would need to be passed to end-users201. Around half of thisadditional requirement is due to the application of stringent Basel III leverage ratio netting criteria to variation
margin whereby collateral must fully match the exposure before it may be considered for netting. The applicationof leverage ratio criteria, which is aimed at capturing a bank’s non-risk-adjusted exposure to NSFR, which is aimed
at assessing a bank’s funding sources and requirements, may result in an overly conservative estimate of long-term
funding required. Further, NSFR rules require collateral to be in the form of cash only, which is inconsistent with thedefinition of liquid assets under the LCR.
NSFR rules may also have potential unintended or disproportionate impacts on banks’ ability to provide market
services which facilitate client financing, investing and hedging, in particular through the exemption or nonexemption of interdependent assets and liabilities as per the provisions of Paragraph 45202 of the new standard.
BCBS guidelines on qualification criteria are not sufficiently prescriptive, due to which interpretation of Paragraph
45 may differ between national regulators. As a result, a number of linked transactions, including derivatives
market risk hedges, client clearing transactions, and client short facilitation trades may end up being excluded
from paragraph 45 exemption.

201
202

GFMA, ISDA and IIF (2015)
Paragraph 45 of the BCBS NSFR standards allows for setting RSF (Required Amount of Stable Funding) and ASF (Available Amount of Stable
Funding) to zero on transactions which qualify as linked transactions according to certain criteria

94© Oliver Wyman

Post Crisis Basel Reforms

6.3.

Overall coherence and potential issues with Basel reforms

POTENTIAL DUPLICATION OR INTERACTION OF COVERAGE

A special case of mis-calibration can occur when rules may be appropriate taken individually, but their interaction
results in undue regulatory burden on certain products or on the system as a whole. Given the sheer volume of
regulatory changes since the crisis, there may be specific cases where reforms overlap, potentially creating a
duplication of requirements. According to GFMA, IIF, and PwC (2015), these tensions between different reforms
can “stifle the effectiveness of individual reforms and add complexity and unintended consequences.” In particular,
the report notes that there could be cases where a given market participant “is required to meet similar obligations
resulting from different pieces of legislation, or where different legislation appears to pursue the same objectives.”
These interactions may have unintended adverse impacts on the lending channel and financial markets liquidity.

6.3.1.

NSFR, LCR, AND G-SIB BUFFER (ADDRESSING MATURITY MISMATCH AND
SHORT-TERM WHOLESALE FUNDING)

One example of a potentially unintended interaction of reforms is the interaction of NSFR, LCR, and the US G-SIB
buffer. NSFR and LCR are aimed at reducing liquidity risk and were calibrated with the understanding that maturity
mismatch is not addressed by other rules. However, in the US the G-SIB surcharge method 2 methodology is also
designed to encourage banks to fund with long-term liabilities (by focusing on a firm’s reliance on short-term
wholesale funding). Thus, liquidity funding is thus actually addressed multiple times, leading to overallrequirements that could be excessive in aggregate.203

6.3.2.

CAPITAL FLOORS

There are concerns that the leverage ratio and capital floors may be duplicative. As discussed earlier in the section,
the leverage ratio is intended to function as a backstop. Capital floors (based on the standardized approach),though still pending final calibration, essentially serve the same function by ensuring that the capital levels within
the banking system do not drop too low based on risk-weighted calculation. Based on the design, these measureswould act as a backstop to bank’s risk-weighted capital ratio calculations by being a “floor” on the minimum
calculation of risk-weighted assets (and reducing the sensitivity of internal model approaches). However, capital
floors would then duplicate the purpose of the leverage ratio, which is intended as a backstop, leading someindustry participants to question why a second backstop is needed. 204 This issue is further exacerbated by the“proposal to have both an output capital floor and the series of parameter input floors as well,” which would further
increase complexity.205

6.3.3.

STEP-IN RISK

Some market participants have noted that there is potential for duplication in the Basel Committee’s proposedguidance on identification and measurement of step-in risk. Furthermore, in the case of sponsored funds, market
participants have objected to what they see as the use of inappropriate indicators for the identification of step-in
risk, the lack of recognition for the broad range of legal, regulatory and contractual mandates which limit the ability
to provide financial support to a sponsored fund, and the Basel Committee’s undue reliance on regulatory capital
as a means of addressing any residual concerns. The industry has argued that capital requirements for step-in risk
are unnecessary because changes to accounting standards, regulatory capital rules, new requirements for liquidity
management, and other regulations have either imposed new requirements on banks to recognize implicit risks inactivities covered by the step-in risk regulation, or have in essence prevented banks from performing those203

GFMA, IIF and PwC (2015), GFMA and IIF to the Federal Reserve System (2016), Tarullo, D. to Board of Governors (2015).
Schwartzkopff (2015), Glover (2016),
205
IIF to Mr. William Coen (2016)204© Oliver Wyman

95

Overall coherence and potential issues with Basel reforms

Post Crisis Basel Reforms

activities. As such, the proposed requirements for step-in risk could be duplicative of the regulation that has
already addressed this risk.206

6.3.4.

CET1 RATIO, LEVERAGE RATIO, AND STRESS TESTING

There are likely to be unintended interactions between the CET1 risk-weighted capital requirement ratio, theleverage ratio, and stress testing. All of these regulatory requirements may act as binding constraints on banks
depending on calibration and the portfolio composition of a bank. This becomes a concern when the binding
constraint changes every year due to re-calibration of reforms, additional reforms increasing a bank’s RWA, orchanges in stress-testing requirements (the last example in particular is prone to change as regulators generally
vary stress testing scenarios annually).
The shifting binding constraint could make it very challenging for banks to optimize their portfolio and could leadto erratic buying and selling behavior year-to-year. This would be a particular concern in capital markets.207

6.4.

POTENTIAL UNINTENDED CONSEQUENCES

6.4.1.

SHADOW BANKING

An example of the potential for unintended consequences of Basel reforms is the incentive for growth ofconcentration of exposure in non-regulated or lightly regulated entities, commonly referred to as shadow banking.
As banks reduce their supply of some products and services due to regulatory burdens, these services may moveinto the shadow banking sector.208 There is debate as to whether this poses a concern for overall market stability.
The primary issue is that increased market share for unregulated market participants may lead to a decrease of
overall market stability by pushing activities to the less visible and controllable sectors of the financial system.209
For example, unregulated entities, such as financial technology firms, are not “subject to the same regulatory
requirements even when offering identical services.” 210
Some researchers have begun to examine the growth of shadow banking. For example, Meeks, Nelson, andAlessandri (2014) find that high leverage in the shadow banking system makes the economy particularly vulnerable
to aggregate disturbances. Other studies, such as Kashyap, Stein, and Hanson (2010) discuss the presence of
shadow banking, but do not quantify the impacts of the shadow banking sector. The growth of the shadow banking
sector is particularly concerning, as it could be both the result of, and a driver of, end-users moving away from theregulated to the unregulated banking sector.211
It could be argued that the shadow banking system has developed and grown without the influence of Baselreforms. While that may be true, if implementation of reforms effectively pushes certain activities out of regulationand increases the quantity of unregulated activity (which may include lower quality loans), this may pose significant
risks and create instability within the financial system.212 For example, uninsured funding in the shadow banking
sector opens up the risk of runs. Additionally, studies have found that tail risk may be systematically underpriced inshadow banking transactions which may lead to accumulation of systemic risk.213
That said, not all movement of activities away from banks into more lightly regulated entities is inappropriate or
dangerous, as there are potential benefits of the shadow banking. If shadow banks increase the availability of credit
206

The Clearing House to BCBS (2015b)
J.P. Morgan Chase (2013), Gallardo, Schuermann, Duane (2015)
208
Nier and Zicchino (2005)
209
Meeks, Nelson, and Alessandri (2014); Kashyap, Stein, and Hanson (2010)
210
Kashyap, Stein and Hanson (2010), European Commission (2016) – based on summary of comments
207

211
212
213

Meeks, Nelson, and Alessandri (2014), Kashyap, Stein, and Hanson (2010)
Kashyap, Stein and Hanson (2010), IMF (2014), Meeks, Nelson, and Alessandri (2014)
Adrian and Ashcraft (2012)96© Oliver Wyman

Post Crisis Basel Reforms

Overall coherence and potential issues with Basel reforms

to consumers, their existence may improve the stability of the financial system. Shadow banks may also be more
efficient than traditional banks in certain ways, such as through specialization in niche credit types. Additionally,
the shift of lending activity from traditional banks to shadow banks may actually reduce the concentration offinancial activity in systemically important institutions, therefore reducing systemic risk and correlation of risk.214
Judgment must be exercised by policymakers as to whether a given activity carries sufficient systemic risk that it isbetter kept within the regulatory perimeter of banks and other highly regulated institutions.

6.4.2.

PROCYCLICALITY

There are concerns that procyclicality is an unintended consequence of Basel reforms. This concern is not new: anumber of previously issued Basel regulations (including Basel III) were considered procyclical. For example,
during periods of stress and as bank capital levels begin to decrease, banks may reduce their lending in order tomaintain their Tier 1 and total capital ratios. However, reduced lending across the market as a whole may result infurther contraction and instability.215
Basel III identified and sought to address the procyclicality through regulations such as the countercyclical capital
buffer (CCyB). The countercyclical capital buffer is designed to create additional capital buffer requirements forperiods when credit growth exceeds a certain limit. The dual function of the CCyB is to first, require banks tomaintain a larger capital buffer during peak periods that can be used during economic downturns and second, toslow the excessive credit growth during booms. To determine the appropriate time to apply the CCyB, supervisors
exercise discretion but consider as a key indicator the gap between credit-to-GDP ratio and its trend.216
However, some argue that the effectiveness of the CCyB may be reduced if there is a lag in the application of thebuffer such that the usage of the buffer overlaps with a portion of an economic downturn. The potential issue may
be caused by, first, a misalignment between the credit-to-GDP gap trigger and the economic peak period, andsecondly, a built-in delay between the trigger and the actual implementation of the buffer in order to give banks
enough time to adjust. However, regulators have the ability to initiate the buffer ahead of the credit-to-GDP gap
trigger and can shrink the adjustment window to reduce the potential for procyclicality.217

6.4.3.

LEVERAGE RATIO INCENTIVES FOR DEPOSITS (HELD AT CENTRAL BANKS)

Recently factors such as market volatility, increased regulation, and monetary policy, have driven a strong influx oflarge cash deposits into the US banks, and especially custody banks. The figure below highlights the growth inliquid assets held by mutual funds since 2007, and therefore growth in deposits at custody banks which provide
safekeeping, asset administration and banking services to such funds.

214
215

ICMA (2012)
Kowalik (2011), Arjani (2009)

216

Repullo and Saurina (2011), Repullo and Suarez (2012), McDonnell (2013), Athanasoglou and Daniilidis (2011)

217

Ibid

© Oliver Wyman

97

Overall coherence and potential issues with Basel reforms

Post Crisis Basel Reforms

FIGURE 6.10: TOTAL LIQUID ASSETS OF MUTUAL FUNDS
900
800
700

US$ BN

600
500
400
300
200
100
0
2007

2008

2009

2010

2011

2012

2013

2014

2015

Source: Federal Financial Analytics (2015), Investment Company Institute. Dollars in billions. Liquid assets reflects cash, receivables, and short-term
securities minus liabilities)

Excess deposits held by custody banks are usually placed at national central banks, thus making these deposits
essentially riskless to the overall financial system. However, a leverage capital charge is still applied to theplacement of these deposits. This creates an incentive for the custody banks to reject cash deposits if they areapproaching the desired (or dictated) LR minimums. As a bank approaches the leverage ratio minimum, it has toevaluate the cost of additional capital against the return on an asset (expected to be relatively low), and whether
returns are sufficient to meet shareholder expectations.
The table below illustrates the impact of funds held at central banks on the leverage ratio of the three major standalone US custody banks.
TABLE 6.4: INFLUENCE OF CENTRAL BANK PLACEMENTS ON CUSTODY BANKS’ LEVERAGE RATIOINSTITUTION

TIER 1 CAPITALCENTRAL BANKPLACEMENTTOTAL ASSETS FOR
THE LEVERAGE
RATIO

LEVERAGE RATIO

LEVERAGEWITHOUT CENTRALBANK PLACEMENTS

BNY Mellon

17,693,169

93,211,368

309,371,472

5.72%

8.19%

Northern Trust

7,354,033

14,725,470

106,550,955

6.90%

8.01%

State Street

13,919,961

74,036,647

248,021,789

5.61%

8.00%

Source: Federal Financial Analytics (2015), FDIC call reports for 1Q2015. Dollars in thousands. The leverage ratio is calculated as Tier 1 divided by total
assets for the leverage ratio; the last column removes Central bank placements from the assets counted for the leverage ratio denominator

Inclusion of these arguably risk-free deposits in the LR is essentially limiting the total amount of deposits a custodybank could accept without breaching the LR requirements in their national jurisdictions. In particular, Federal
Financial Analytics (2015) found that if the LR charge did not apply to such deposits held at central banks, then “atleast an additional $182 billion in cash-deposit capacity” would become available. This becomes particularly
important under stressed conditions when flight-to-cash deposits are brought to custody banks. If custody banks
are not able to accept these deposits and hold them at national central banks, this could create conditions whereend users are not able to safely store safe assets during times of stress.
Additionally, other banks not traditionally considered pure custody banks are likely to experience a similar increasein deposits and may also not be able to take these deposits in. For example, during the last financial crisis JPMorgan

98© Oliver Wyman

Post Crisis Basel Reforms

Overall coherence and potential issues with Basel reforms

Chase’s deposits increased by over $100 billion as investors fled to safety. However, in an annual report the bankstated that it is “unlikely that [JP Morgan Chase] would want to accept new deposits the next time around because
they would be considered non–operating deposits (short term in nature) and would require valuable capital underboth the supplementary leverage ratio and G–SIB.” Thus, investor inability to deposit cash into banks, custodial orotherwise, could drive these cash deposits into possibly less safe alternatives, including shadow banks discussed
above.218
In addition to the concern about the incentives that the leverage ratio creates for deposits, there are concerns
about other incentives for particular types of products. For example, there are concerns that the capital that banks
have to hold against OTC positions (due to the fact that collateral that banks collect from clients to cover the initiallosses is treated as an exposure) makes it uneconomical for banks to act as clearing members. As such, someclearing members have already stepped back from providing such services, which could reduce investor access to
OTC markets.219

6.4.4.

IMPACTS OF LIQUIDITY REFORMS ON OVERALL MARKET LIQUIDITY

One potential unintended consequence may arise from the incentives created by the LCR and NSFR. While theserules work to increase stability and ensure liquidity at individual banks, this may happen at the expense of overallmarket liquidity. This issue is discussed in further detail and quantified to the degree possible in Section 5.

6.4.5.

IMPACTS ON MARKET STRUCTURE

Some market participants have raised concerns about potential unintended consequences such as evolution inmarkets structure, particularly the exits from certain markets or products by regulated entities and the subsequent
reduction in market liquidity, possibly limiting provision of financial services. These impacts on banks and end
users are discussed in Section 5.

6.4.6.

HQLA ALTERNATIVE LIQUIDITY APPROACHES (ALA)

One potentially unintended consequence of reforms arises from the definition of HQLA. One of the key
components of HQLA is government securities. While in a number of jurisdictions this definition of HQLA poses noproblem, there are some jurisdictions where government issued debt is in short supply (e.g. Australia, South Africa,Hong Kong, and Norway). For banks based in those jurisdictions, meeting NSFR and LCR’s HQLA requirements
poses a particular challenge, as an already limited supply of public sector securities is frequently locked away inlong-term investment portfolios. BCBS has considered these challenges and presented three alternative liquid
asset (ALA) options to satisfy HQLA within the applicable jurisdictions: 1) Committed liquidity facilities (CLFs) fromthe central bank for a fee; 2) Foreign currency HQLA, with haircuts to account for currency risk; and 3) Additional
usage of level 2A assets, with higher haircuts.220
While these ALA approaches do help account for jurisdictional differences in availability of HQLAs, they present
their own potential issues. Specifically, the second and third variant of ALAs discussed above, while expanding thenumber of assets eligible for HQLA status, do not link these assets to central bank liquidity policies. For example,
level 2A assets are currently expected to be eligible as central bank collateral instruments whereas this is not thecase for level 2B assets. Therefore, while these ALA arrangements allow banks to satisfy regulatory requirements
they may reduce the ability of local central banks to respond to crisis conditions.221

218

Federal Financial Analytics (2015), J.P. Morgan Chase & Co. (2014), J.P. Morgan Chase & Co (2015)
Rennison (2015), Acworth (2014)
220
Spencer (2014), Yanase (2013)
221
Ibid
219

© Oliver Wyman

99

Overall coherence and potential issues with Basel reforms

6.4.7.

Post Crisis Basel Reforms

DISTRIBUTIONAL CONSEQUENCES

Unintended consequences may arise when some products or services are impacted by reforms more than otherproducts or services. These distributional consequences may have significant impacts on the end users, andpossibly on the overall economy. These issues are discussed in further detail and quantified to the degree possible
in Sections 4 and 5.
As discussed above, there are possible issues with national implementation of Basel reforms. Reforms could be
implemented in a sub-optimal way, or jurisdictional differences could create undue burdens for some market
participants. However, jurisdictional implementation falls outside of the Basel Committee’s control and as such is
not discussed in significant detail in this report.
Moreover, this report does not address the interaction of Basel Committee regulations for banks and regulations ofpension funds, insurance companies and mutual funds rules. In order to have a holistic view of potential issues,these should be taken into account by a comprehensive review conducted by regulators. For example, asset
managers whose funds are subject to daily subscriptions and redemptions manage the liquidity risk by increasing
cash buffers; however, the NSFR is a strong disincentive to receive these deposits by banks as they create a needfor HQLA and accordingly a cost in leverage exposure.

100© Oliver Wyman

Post Crisis Basel Reforms

Conclusions

7. CONCLUSIONSThe new and revised requirements related to bank capital, liquidity, and TLAC promulgated by the BaselCommittee and the FSB represent major changes to a large, complex, and heterogeneous global financial system.
The rules themselves run to thousands of pages including many technical calculations. Given all this, it is not
surprising that there are a number of areas where knowledgeable observers are concerned about potential
problems of duplication, harmful interactions between different rules, unintended consequences, and the suboptimal calibration of requirements or the formulas for intermediate calculations. Indeed, it would be astonishing if
there were no need for some re-evaluation and re-calibration.
The Basel Committee is to be commended for establishing a workstream to consider the “interaction, coherence,and overall calibration” of their reforms, as is the FSB for its own separate re-evaluation. As this report shows, there
are many areas where it is possible that the reforms do not work as intended, either because the marginal costs ofcertain aspects outweigh the marginal benefits or because there are other undesirable and unintended
consequences. The authors of this report are not able to do a full cost-benefit analysis and therefore we havechosen not to make specific recommendations, but we hope that the Basel Committee and FSB will look carefully at
the potential problems that we have highlighted.
Additionally, the authors note that further research will be required to fully understand the impact of reforms. First,
additional rigor could be applied to evaluating costs and benefits of financial reforms at a higher level of
granularity: for example, the impact of liquidity reforms on a trading desk or product level. It will be critical tounderstand reforms’ impact on different segments of the market to identify potential areas of undue burden or
impairment of the efficient functioning of the market. Second, the empirical research to date has focused primarilyon the impact of capital, and to a lesser extent, liquidity regulation and the joint impact thereof on banks. Other
reforms, for example margin requirements, have received less attention and should be evaluated further. However,until all these reforms are finalized and fully implemented, the full impact cannot be determined, though it would
be desirable, as a matter of policy, to address some of the perceived negative impacts. Third, a holistic study of the
RWA increases that could result from the most recent set of reforms is necessary. Fourth, the interactions amongreforms will require additional attention to understand potentially competing incentives or countervailing impacts.
This will become increasingly important as the reforms currently under revision are implemented. Finally, study ofthe impact of reforms across multiple jurisdictions would also be beneficial, as research to date has focused
primarily on developed markets, especially the US and Europe.222

222

BCBS (2016h)© Oliver Wyman

101

Post Crisis Basel Reforms

Appendix A

APPENDIX A.

SCOPE OF REGULATIONS COVERED BY
THE REPORTThe post-crisis reforms, which are still running their course, introduced many complex rules governing capital,
liquidity, trading operations, derivatives, and securitizations, and have already contributed to a dramaticstrengthening of bank balance sheets globally.

A.1.

BASEL III REFORMS

The table below summarizes the major themes of the Basel III regulations, which are discussed in rest of this section.
Nevertheless, this is not an exhaustive list of all Basel reforms.
TABLE A.1: KEY COMPONENTS OF BASEL III
THEME
Tier 1 capital

PHILOSOPHY

KEY COMPONENTS• Stricter rules governing acceptable
forms of capital to ensure banks are in abetter position to absorb losses• Minimum common equity requirement set at
4.5% in addition to Tier 1 ratio of 6%• Various deductions to common equity where
capital is not deemed to be loss absorbing

Cyclicality• Countercyclical framework to encourage
the building of capital buffers• Forward-looking provisioning totransparently capture actual losses andreduce pro-cyclicality• Capital conservation buffer of 2.5% added tocommon equity, and 0–2.5% countercyclicalbuffer on top of this depending on national
circumstances• Expected Loss-based provisioning

Systemic risk

• To reduce the probability and impact offailure of systemically important banks• Additional Common Equity Tier 1 (CET1)
capital requirement for global systemicallyimportant banks (G-SIBs), ranging from 1% to
2.5%, depending on a bank’s systemic
importance (higher in some jurisdictions, e.g.
US)

Counterparty
credit risk
coverage(CCR)• Stricter capital requirements forcounterparty credit risk exposures• Capital incentives to move “Over-thecounter” (OTC) derivative exposures tocentral counterparties• Credit Valuation Adjustment (CVA) capitalcharge for mark to market credit losses• Increase of counterparty credit risk charges for
trades with other financials• Use of stressed expected positive exposures(EPE)• New charges for wrong way risk
• Capital incentives to move OTC derivative
exposures to central counterparty (CCP)

Leverage• Aim to contain the build-up of excessive
leverage, protect against gaming of riskbased requirements and help addressmodel risk

• Initial 3% minimum Tier 1 capital/assets ratio(maximum leverage 33:1)• Basel II netting of derivatives allowed

Liquidity• Improved management and monitoringof banks – and system-wide liquidity risk

• 30-day Liquidity Coverage Ratio requirement• Net Stable Funding Ratio requirement• Common set of monitoring metrics to assist
supervisors in identifying bank/system-wide trends

Sources: BIS (2016e), BCBS (2011a), BCBS (2015d), BIS (2016d), Oliver Wyman analysis© Oliver Wyman

103

Appendix A

Post Crisis Basel Reforms

A.1.1. QUANTITY OF CAPITAL
The crisis revealed that many banks were undercapitalized, making it a priority to increase the quantity of capital.
The minimum requirement for CET 1 was increased to 4.5% from 2%, and total Tier 1 was increased to 6% from 4%.
The minimum requirement for total regulatory capital has not changed and kept at 8%.223
A capital conservation buffer (2.5%) and a countercyclical buffer (0 – 2.5%) were also established, and will be
discussed below.

A.1.2. QUALITY OF CAPITAL
The failure of some forms of bank capital to absorb losses during the financial crisis revealed that the definition ofcapital under the existing capital framework was no longer adequate. Increasing the quality of capital, and not
merely the quantity, was therefore seen as priority. In order to ensure that banks are in a better position to absorb
losses on both a going-concern and gone-concern basis, Basel III redefined capital as follows:••

Tier 1 capital must help a bank to remain a going concern.
Tier 2 capital must provide loss absorption on a gone-concern basis.

Tier 1 capital predominantly consists of common shares and retained earnings, Tier 2 is simplified to just one
category and Tier 3 has been abolished to ensure that market risks are covered with the same quality of capital ascredit and operational risks.224
The increase in capital requirements and the transition period are illustrated in the figure below. The
countercyclical buffer is not shown in the figure as the calibration is dependent on circumstances. Similarly, otheradditional buffers may apply, such as buffers to meet stress testing requirements. The maximum G-SIB buffer
shown below is the maximum US buffer.

223
224

BCBS (2011b)
Ibid

104

© Oliver Wyman

Post Crisis Basel Reforms

Appendix A

FIGURE A.1: BASEL III CAPITAL REQUIREMENTS
11.5–14%

Total capital ratio

10.6–12.5%
9.8–11.0%
8.9–9.5%
8.0%

8.0%

4%

3.5%

8.0%

0.6%

1.3%

1.9%

2.5%

8.0%
2.5%

2%

2%

2%

2%

2%

1.5%

1.5%

1.5%

1.5%

1.5%

1.5%

8% Total capital ratio(stated minimum)
6% Tier 1 capital ratio(stated minimum)

1%
2%
3.5%

4%

4.5%

4.5%

4.5%

4.5%

4.5%

2013

2014

2015

2016

2017

2018

2019

2%
Basel II

GSIB Surcharge (varies by bank) [1]

Tier 2 Capital

Capital Conservation Buffer [1]Additional Tier 1 Capital

Common Tier 1 Capital[1] GSIB surcharge and Capital Conservation Buffer are to be met with CET1 capital
Source: BCBS (2013c)

A.1.3. REGULATORY BUFFERS
Basel III incorporates various counter-cyclical measures to ensure that banks prepare adequately during the benign
parts of the cycle for the inevitable downturn(s) ahead. Basel III introduced two new capital buffers: a capitalconservation buffer of 2.5% and a countercyclical buffer of 0–2.5% depending on the state of the economy.

CAPITAL CONSERVATION BUFFER
A capital conservation buffer above the regulatory minimum capital requirements has been incorporated in orderto ensure that the banking sector as a whole adopts best practices on capital conservation. When a bank erodes its
capital conservation buffer, limits are imposed on distributions (principally dividend payouts, share repurchases,
discretionary Tier 1 payments and bonus payments to staff), allowing the bank to rebuild the buffer and strengthen
its capital position. The capital conservation requirements will increase in severity as the bank continues to erode
its buffer and its capital levels approach the minimum requirement.
Calibration for the capital conservation buffer has been set at 2.5% of risk-weighted assets (RWA), to be met with
common equity after regulatory adjustments are applied. This raises Basel III’s total CE requirement to 7% of
RWAs.225

COUNTERCYCLICAL CAPITAL BUFFER
The purpose of the countercyclical capital buffer is to ensure that firms have a sufficient capital base, accumulated
during periods of credit growth, to absorb losses in stressed periods. The countercyclical buffer rate is set by thecompetent authority in each jurisdiction.226 The size of the countercyclical capital buffer is to be defined as a
225
226

BCBS (2011b)
BCBS (2010d)© Oliver Wyman

105

Appendix A

Post Crisis Basel Reforms

percentage of RWA and determined by regulators in each jurisdiction; the buffer may be expanded or reduced
according to credit exposure levels.
The countercyclical capital buffer will be calibrated within a range of 0–2.5%, to be met by common equity or otherfully loss absorbing capital. 227
In practice, many banks have developed additional buffers to avoid being restricted in their capital management
decisions.

G-SIB SURCHARGE
The global systemically important banks (G-SIBs) surcharge intends to capture the “cross-border negative
externalities created by G-SIBs” that are not fully addressed by the other regulatory frameworks. These negative
externalities stem from the role of G-SIBs in the global financial system and their potential to cause system-wide
impacts that these institutions may not fully account for when making cost-benefit optimizing choices. Moreover,“the moral hazard costs associated with implicit guarantees derived from the perceived expectation of government
support may amplify risk-taking, reduce market discipline and create competitive distortions, and further increase
the probability of distress in the future.” Thus, a surcharge calculated based on size, interconnectedness, lack ofreadily available substitutes, and global scope is added to the capital requirements for G-SIBs in order to reduce
the probability and the impact of their failure.228

A.1.4. COUNTERPARTY CREDIT RISK CAPITAL REQUIREMENTSCounterparty credit risk was identified as an area with insufficient capital. As individual financial institutions (e.g.
Lehman Brothers) began to fail, counterparty exposures caused a ripple through the industry as losses on those
exposures were taken by other banks. In other cases (e.g. AIG), the counterparty credit exposures were a key
rationale for government assistance, to avoid catastrophic, industry-wide contagion. Post-crisis Basel Committee
initiatives add more stringent requirements for measuring counterparty exposures; capital incentives for banks touse central counterparties for derivatives; and higher capital for inter-financial sector exposures.
BCBS has released guidance that aims to establish a capital treatment that ensures banks’ exposures to central
counterparties are adequately capitalized. Most notably, the final standard on capital requirements for bank
exposures to central counterparties include a “single approach for calculating capital requirements for a bank’s
exposure that arises from its contributions to the mutualized default fund of a qualifying CCP (QCCP), [employ] thestandardized approach for counterparty credit risk (as opposed to the Current Exposure Method) to measure thehypothetical capital requirement of a CCP, and [include] an explicit cap on the capital charges applicable to abank’s exposures to a QCCP.” BCBS established these standards based on its work in consultation with theCommittee on Payments and Settlement Systems (CPSS) and the International Organization of Securities
Commissions (IOSCO).229

STANDARDIZED APPROACH FOR MEASURING COUNTERPARTY CREDITRISK EXPOSURESThe standardized approach for measuring counterparty credit risk exposures (SA-CCR) was established by BCBS toaddress several limitations in the Current Exposure Method (CEM) and the Standardized Method (SM) for
measuring counterparty credit risk. The objectives of guidance released by BCBS are to devise an approach
suitable for application to a wide variety of derivatives transactions (margined, un-margined, bilateral, cleared), tominimize discretion used by national authorities and banks, and to improve the risk sensitivity of the capital
227

BCBS (2011b), BIS (2016i)
BCBS (2013g)
229
BCBS (2014e)
228

106

© Oliver Wyman

Post Crisis Basel Reforms

Appendix A

framework without creating undue complexity. SA-CCR applies to Over the Counter (OTC) derivatives, exchangetraded derivatives and long settlement transactions.230

MARGIN REQUIREMENTS FOR NON-CENTRALLY CLEARED DERIVATIVESThe BCBS aims to reduce systemic risk by imposing a margin requirement for non-centrally cleared derivatives.231
Additionally, the framework has been designed to “reduce systemic risks related to OTC derivatives markets, aswell as to provide firms with appropriate incentives for central clearing while managing the overall liquidity impactof the requirements”.232

A.1.5. LEVERAGE RATIOThe leverage ratio – the ratio of high quality capital to assets – is intended to be a simple, transparent, non-riskbased measure that is calibrated to act as a credible supplementary measure to the risk based requirements ofBasel III.
Using the new definition of Tier 1 capital (after regulatory adjustments) as the relevant capital measure, a minimum
3% ratio of Tier 1 capital to exposure (gross assets plus off balance sheet exposures and derivatives) has been
proposed for a “parallel run” period from January 2013 to January 2017, and will be subject to testing and studies
relative to risk-based requirements.
In calculating the exposure measure, all assets are to be included using the accounting balance sheet. Repo styletransactions will be included according to the accounting measure of exposure, netted as in Basel II. All derivatives(including credit derivatives) will be netted as in Basel II and measured using a modified version of the SA-CCR.233
The process of calibration of the leverage ratio is ongoing prior to rules becoming binding in 2018. The commentson the revisions to the Basel III leverage ratio framework will be due in July 2016.

A.1.6. LIQUIDITY PROPOSALS
Liquidity was a key missing element from the earlier Basel accords. While regulators and banks were aware of this,the crisis highlighted the urgent need for liquidity standards as liquidity issues led to the failure or rescue of various
financial institutions during the crisis. In order to raise the resilience of banks to potential short-term and long-term
liquidity shocks, two new standards have been established for liquidity risk supervision for internationally active
banks: the Liquidity Coverage Ratio,234 a short-term measure of liquidity calculated under a specified acute stressscenario, and the Net Stable Funding Ratio, a longer-term complement that addresses structuralliquidity mismatches. The BCBS has published the final standards for both Liquidity Coverage Ratio and Net Stable
Funding Ratio rules.235

LIQUIDITY COVERAGE RATIO (LCR)
The Liquidity Coverage Ratio (LCR) is defined as the ratio of an institution’s stock of unencumbered, high quality
liquid assets (HQLA) to net cash outflows over a 30-day stress period.
For an asset to qualify as part of the stock of HQLA it must be unencumbered, freely available to the consolidated(parent) entity in times of stress, and ideally, central bank eligible. The asset must also satisfy a set of fundamental
230

BCBS (2014j)
BCBS and IOSCO (2013)232
BIS (2016f)
233
BCBS (2014b), BCBS (2016d), BCBS (2016f)
234
BCBS (2013d), BCBS (2014g)
235
BCBS (2014d), BCBS (2013d)
231© Oliver Wyman

107

Appendix A

Post Crisis Basel Reforms

and market-related characteristics for liquidity and be available to be converted into cash in the currency andjurisdiction where liquidity is required in the event of stress.
Net cash outflows in the denominator of the LCR are cumulative cash outflows net of cumulative cash inflows(capped at 75% of outflows) during the specified stress period. Calculating the cumulative cash outflows consists of
two parts: the outstanding balances of various types of liabilities are multiplied by specified percentages that are
expected to run off and various off-balance sheet commitments are multiplied by specified draw-down amounts.
Contractual cash inflows are also included for fully performing retail, wholesale and reverse repos secured byilliquid assets.

NET STABLE FUNDING RATIO (NSFR)
As part of Basel III, the net stable funding ratio (NSFR) is a new liquidity requirement that aims to reduce liquidity
mismatches and maturity transformation risk. The NSFR is designed to reduce the “the likelihood that disruptions
to a bank’s regular sources of funding will erode its liquidity position in a way that could increase the risk of its
failure and potentially lead to broader systemic stress”.236
The NSFR is defined to be the ratio of the Available Stable Funding (ASF) to the Required Stable Funding (RSF). ASF
is broadly defined as the portion of capital and liabilities expected to be reliable over a one-year time horizon. RSF is
defined as the amount of stable funding required based on an institution’s liquidity risk profile of assets andexposures.237
The ASF and RSF are calculated by first classifying the carrying value of an institution’s equity and liabilities into
categories, then applying relevant weights (called “factors”) and finally taking the sum of the weighted amounts.

A.1.7. MEASURING AND CONTROLLING LARGE EXPOSURESThe BCBS has published a framework for measuring and controlling large exposures in April 2014. The framework“protects banks from significant losses caused by the sudden default of an individual counterparty or a group ofconnected counterparties” and is designed so “that the maximum possible loss a bank could incur if such a default
were to occur would not endanger the bank’s survival as a going concern.” The final version of the frameworkextends the coverage to exposures to funds, securitization structures and collective investment undertakings,
thereby “strengthening the oversight and regulation of the shadow banking system.”238

A.2.

ONGOING BASEL REFORMS

Additionally, there are a number of other ongoing Basel workstreams that are discussed within the scope of thisdocument.

A.2.1. INTEREST RATE RISK IN THE BANKING BOOK (IRRBB)The BCBS aims to help ensure that banks have appropriate capital to cover potential losses from exposures tochanges in interest rates and to reduce capital arbitrage between the trading book and banking book. The updated
standard uses an enhanced Pillar 2 framework, expands the guidance on a bank’s IRRBB management process,enhances disclosure requirements to promote greater consistency, transparency, and comparability, and updates
the standardized framework.239

236

BCBS (2014d), BIS (2016c)
BCBS (2014d)
238
BIS (2014), BCBS (2014m)
239
BCBS (2015b), BCBS (2016i)
237

108

© Oliver Wyman

Post Crisis Basel Reforms

Appendix A

A.2.2. STANDARDIZED APPROACH FOR CREDIT RISK
The standardized approach for credit risk has been updated as part of a review of capital framework “in order tobalance simplicity and risk sensitivity and to promote comparability by reducing variability in risk-weighted assets
across banks and jurisdictions.” A set of proposed changes was published on December 2014, which notably
suggested removal of external ratings from risk-weight calculation and instead assigned risk weights based onalternative risk drivers. Based on comments and further development of the revisions, a second consultative
document was published on December 2015. This document proposed revisions to the standardized approach
which include the reintroduction of external ratings for exposures to banks and corporates, in a non-mechanisticmanner. Additionally, the revised proposal included alternative approaches for jurisdictions that, for regulatory
purposes, do not allow the use of external rating. The revised approach will be an important determinant of capitalrequirements given its likely use as a floor underpinning the Advanced Internal Ratings Based (IRB) approach forcredit risk. The comments on the second consultative document were due in March 2016, and a final standard isanticipated.240

A.2.3. FUNDAMENTAL REVIEW OF THE TRADING BOOK (FRTB)
Basel 2.5 was put in place as a quick response to a perception that capital requirements for trading book assets had
been far too low under Basel II. However, the Basel Committee believed a Fundamental Review of the Trading Book
was necessary to truly tackle the issues appropriately for the long run. The FRTB has produced the RevisedStandards for Minimum Capital Requirements for Market Risk. This reflects BCBS’s final changes to the market risk
capital framework. The revised framework aims to further reduce incentives for arbitrage between the regulatory
banking and trading books through a revised boundary, and revises the internal and standardized model
approaches.241

A.2.4. OPERATIONAL RISKIn March 2016, the Basel Committee proposed revisions to the standardized approach for measuring operationalrisk capital as a part of its review of the Basel III framework. In addition to streamlining the framework, the new
approach will address weaknesses identified in the existing approach: the Advanced Measurement Approach(AMA). The Committee has proposed to remove the Advanced Measurement Approach (AMA) due to its “inherent
complexity, and the lack of comparability arising from a wide range of internal modelling practices.” The newframework will be based on a non-model-based method for the estimation of operational risk capital: theStandardized Measurement Approach (SMA). This framework “builds on the simplicity and comparability of astandardized approach, and embodies the risk sensitivity of an advanced approach.” The comments on the
consultative document will be due in June 2016, and a final standard is anticipated thereafter.242

A.2.5. REDUCING VARIATION IN CREDIT RISK-WEIGHTED ASSETS –CONSTRAINTS ON THE USE OF INTERNAL MODEL APPROACHESIn March 2016 the Basel Committee issued a consultative document that outlined its proposed changes to theadvanced internal ratings-based (IRB) approach and the foundation IRB approach. The proposal includes a number
measures that aim to “(i) reduce the complexity of the regulatory framework and improve comparability; and (ii)address excessive variability in the capital requirements for credit risk.” Specifically, the Basel Committee proposed
to “remove the option to use the IRB approaches for certain exposures, where it is judged that the model
parameters cannot be estimated sufficiently reliably for regulatory capital purposes; adopt exposure-level, modelparameter floors to ensure a minimum level of conservatism for portfolios where the IRB approaches remain
240

BCBS (2015k)
BCBS (2016g)
242
BCBS (2016b), BIS (2016h)241© Oliver Wyman

109

Appendix A

Post Crisis Basel Reforms

available; and provide greater specification of parameter estimation practices to reduce variability in risk-weighted
assets (RWA) for portfolios where the IRB approaches remain available.” The design of this proposal is intended tocomplement BCBS’ proposal on capital floors. The calibration of this proposal is ongoing at the time of drafting of
this report and will be informed by a comprehensive quantitative impact study and “by the Committee’s aim to notsignificantly increase overall capital requirements.”243

A.2.6. CAPITAL FLOORS
Capital floors have been established to “ensure that the level of capital across the banking system does not fall
below a certain level; mitigate model risk and measurement error stemming from internally modelled approaches;
address incentive-compatibility issues; and enhance the comparability of capital outcomes across banks.” In
December 2014, the Committee published a consultative document that outlined a revised framework for thecapital floor that is proposed to replace the current transitional floor, which is based on the Basel I standard. The
revised framework calls for banks using the internal ratings based (IRB) approach to maintain a certain percentage
of capital that they would if they had used the standardized approach. Importantly, the calibration of the capital
floor was not finalized as a part of the December 2014 standards. BCBS has stated that it will “consider thecalibration of the floor alongside its work on finalizing the revised standardized approaches to credit risk, market
risk and operational risk, and its ongoing review of the capital framework and its balance of simplicity,
comparability and risk sensitivity.” The comments on the consultative documents were due in March 2015, and a
final standard is anticipated.244

A.2.7. SECURITIZATIONThe 2008 financial crisis brought to light several weaknesses in the Basel II securitization framework, including
mechanistic reliance on external ratings, lack of risk sensitivity, cliff effects and insufficient capital for certain
exposures. BCBS has revised the framework by 1) simplifying the hierarchy of approaches and reducing reliance on
external ratings; 2) introducing and revising the risk drivers used in each approach; 3) enhancing the framework’s
calibration, by changing the amount of regulatory capital banks must hold for exposures to securitizations and 4)
revising the criteria for identifying simple, transparent and comparable securitizations.245 The final framework
document was issued in July 2016.

A.2.8. HAIRCUT FLOORS FOR SECURITIES FINANCING TRANSACTIONSIn order “to strengthen oversight and regulation of shadow banking”, BCBS seeks to set “significantly higher
capital requirements for transactions with haircuts traded below the haircut floors” for non-centrally cleared
securities financing transactions. The goal is to “create incentives for banks to set their collateral haircuts above thefloors rather than hold more capital.” The comments on the recently issued consultative document (“Haircut floors
for non-centrally cleared securities financing transactions”) were due in January 2016.246

243

BCBS (2016c)
BCBS (2014f)
245
BCBS (2014a), BCBS (2015a)
246
BCBS (2015n)
244

110

© Oliver Wyman

Post Crisis Basel Reforms

Appendix A

A.2.9. STEP-IN RISKThe BCBS has issued a proposed framework intended to address the risk that a bank will be required to provide
financial support to an entity beyond, or in the absence of, its contractual obligations should the entity experiencefinancial stress (e.g. a risk that a bank may provide financial support to another entity to which it has capital ties,
sponsorship, and decision-making or operational input.) The intent of the guidance is to develop an approach for
identifying, assessing and addressing step-in risk.247 The comments on the previously issued consultative
document were due in March 2016.

A.2.10. STRESS TESTING
Stress testing has been implemented in multiple jurisdictions (such as the Comprehensive Capital Analysis andReview (CCAR) and the Dodd-Frank Act Stress Test (DFAST) mandated by the Federal Reserve in the US, European
Banking Authority’s stress tests in Europe, and Bank of England’s stress tests in the UK) to ensure that systemicallyimportant banks are adequately capitalized to sustain operations during a stress period. Stress testing is now
viewed as a central part of the capital adequacy assessment in the US and Europe. Stress tests have the capacity to
impose higher capital charges upon banks that otherwise satisfy solvency requirements of standard capital,
liquidity, and leverage ratios, and they have emerged as the binding regulatory constraint for many of the largest
global banks, thus further increasing capital requirements.248

A.2.11. TOTAL LOSS-ABSORBING CAPACITY (TLAC)249
We have included one rule from outside the Basel Committee’s direct work within our scope given its close
connection with the Basel capital and liquidity rules. TLAC has been established in order to ensure that “sufficient
loss-absorbing and recapitalization capacity available in resolution to implement an orderly resolution thatminimizes any impact on financial stability, ensures the continuity of critical functions, and avoids exposing
taxpayers (that is, public funds) to loss with a high degree of confidence.” In addition, it is intended to reduce theperception that systemically important banks are “too big to fail”, so that these firms will be incentivized to
discipline risk-taking and to reduce outsized growth. TLAC requirements are set at the firm level and include aminimum “external TLAC which applies at each resolution entity within a G-SIB group and requirements for internal
TLAC in the form of intra-group liabilities to certain subsidiaries in the group.” The intent of internal TLAC
requirements is to enable “effective cross-border resolution strategies by ensuring an appropriate distribution ofloss absorbing capacity within the group” and to ensure that losses can be transferred from the subsidiary to theresolution entity in the event of resolution. Internal TLAC “should be between 75% and 90% of the minimum
external TLAC requirement that would apply to the material sub-group if it were a resolution entity.” Breaches to
the TLAC minimum should be treated as severely as a breach of minimum capital requirements. Final compliancefor the FSB guidance is required by 2022, with interim requirements by 2019.250
In November 2015, the Basel Committee published a consultative document to specify the treatment of bankdeductions “from their regulatory capital [of their] holdings of TLAC instruments, subject to thresholds.” This isintended to discourage banks from holding TLAC instruments in other banks. The document proposed thatinternationally active G-SIBs and non-G-SIBs deduct net TLAC holdings from their Tier 2 capital. Additionally, theconsultative document proposed that CET1 used to meet the TLAC minimum “may not be used to meet Basel III
regulatory buffers.” The comments on the consultative document were due in February 2016, and a revised
consultative document is anticipated.251
247

BCBS (2015h), Christie and Glover (2015)
BCBS (2009b), Board of Governors of the Federal Reserve System (2016), EBA (2016a), Bank of England (2015c)
249
TLAC is a joint initiative between the Basel Committee and FSB
250
FSB (2015), AFME (2015)
251
BCBS (2015c)
248© Oliver Wyman

111

Appendix A

Post Crisis Basel Reforms

A.2.12. COVERAGE OF RISK TYPES
Basel III reforms have been developed to address a wide spectrum of risk types. The coverage of risk types byreforms to date is illustrated in the table below.
TABLE A.2: POST-CRISIS REFORMS/PROPOSALS: PRIMARY COVERAGE OF RISK TYPESRISK TYPE

CreditCounterparty
creditCapitalmarkets

Derivatives
andsecuritization

CapitalBasel IIIOperational

Liquidity

Other















CCB



CCP Exposure









Counterparty
Credit Risk
Securitization









IRRBB








FRTB
CVA
















Step-in risk






TLAC


Op Risk
Leverage ratioLiquidity
LCR





NSFR
Other
Margin req’s



























Stress testing
















Resolution
planning















Source: BCBS consultative documents, Oliver Wyman analysis

112© Oliver Wyman

Post Crisis Basel Reforms

Appendix A

A.2.13. IMPLEMENTATION STATUS
Implementation of Basel III reforms commenced in 2013. However the implementation timelines and deadlines areoutstanding for a number of proposed reforms which have not yet been finalized (e.g. standardized measurement
approach for operational risk) or which have built-in transition periods. The figure below illustrates theimplementation timeline for key reforms for which the timeline has been released.
FIGURE A.2: BCBS AND FSB POST-CRISIS REFORMS IMPLEMENTATION TIMELINE
2013

2014

2015

2016

2017

2018

2019

2020

CapitalBasel III
CCyB
CCP Exposure
Counterparty credit risk [1]GSIB surcharge [2]FRTB [3]IRRBB
TLAC
Liquidity
LCR
NSFR
Leverage ratio [4]Margin requirements[1] Final standard will apply on 1 Jan. 2017. Until then, interim rules issued in July 2012 are in effect[2] Requirements will be introduced between 1 January 2016 and year end 2018 and will become fully effective on 1 January 2019[3] Final rules for the market risk framework will be implemented by 1 Jan. 2019. Regulatory reporting by banks based on the revised framework aredue by 31 Dec 2019[4] The parallel run period began 1 Jan. 2013, public disclosure requirements were effective as of 1 Jan. 2015, and final calibration of Basel III leverage
ratio is planned for implementation by 1 Jan. 2018
Source: BCBS (2011b); BCBS (2015m); BCBS (2014e); BCBS (2016g); BCBS (2016i); BCBS (2015c); BCBS (2013d); BCBS (2014d). BCBS (2016d);
BCBS and IOSCO (2015)© Oliver Wyman

113

Appendix A

Post Crisis Basel Reforms

A.2.14. ONGOING AND FUTURE WORKThe Basel Committee is expected to continue to finalize the remaining post-crisis reform initiatives. BCBS’s current
agenda252 is focused on four core workstreams, as outlined below.

POLICY DEVELOPMENTBCBS aims to “continue to pursue its post-crisis reform agenda, with a focus on restoring confidence in capitalratios.” BCBS will address three policy related issues: First, BCBS will be assessing interaction, coherence andoverall calibration of reform policies. BCBS will consider “how the various regulatory metrics interact and whether
the calibration and design of the various elements of the framework are consistent with their intended objectives.”
Second, BCBS will be reviewing the regulatory treatment of sovereign risk and considering policy options. Third,
BCBS will investigate the role of stress testing in relation to the current Basel III Pillar 1 (minimum requirements)
regulatory framework. This work is driven by “the increasing importance of stress testing in many countries, bothas a supervisory tool and as a method for determining bank capital requirements.”

SIMPLICITY, COMPARABILITY AND RISK SENSITIVITY
BCBS’s work on simplicity, comparability, and risk sensitivity “combines the issues emerging from the Committee’s
top-down review of the framework along with the bottom up work on risk-weighted asset variability, which weredetailed in the Committee’s November 2014 report to the G20 Leaders.” BCBS will be working on ensuring balance
between simplicity, comparability and risk sensitivity across regulatory framework.

MONITORING AND ASSESSING IMPLEMENTATIONBCBS will continue to leverage its Regulatory Consistency Assessment Programme (RCAP) to evaluate member
jurisdiction’s implementation of its proposed standards. The scope of RCAP will “be expanded to also coverBasel III’s liquidity standards and the frameworks for global and domestic systemically important banks.”

IMPROVING THE EFFECTIVENESS OF SUPERVISIONBCBS will focus on improving the effectiveness of its supervision. In particular, “the Committee will focus onsupervisory practices related to stress testing, valuation practices and the role of Pillar 2 in the capital framework.”

252

Information on Basel Committee’s ongoing workstreams is available at BIS (2016g)

114© Oliver Wyman

Post Crisis Basel Reforms

Appendix B

APPENDIX B.

SUMMARY OF KEY STUDIES MEASURING IMPACT OF REGULATORYREFORM ON LENDING AND CAPITAL MARKETS

Aiyar, Calomiris Cost
and Wieladek(2014)



Baker &
Cost
Wurgler (2015)



BIS – LEI
254
(2010)

CostandbenefitMAG (2010a) – Cost
BIS



Cost

Cosimano and
Hakura (2011)

Cost

De-Ramon et al Costand(2012)
benefit
ECB (2015)

Cost

Elliott, Salloy,
and Santos(2012)

Cost

Fraisse et al(2015)

Cost

Francis andOsborne(2009a)Cost

GFMA, IIF and
PwC (2015)

Cost

IMF (2015a)

Cost

IMF (2015b)
IMF (2016)

254

Other/multiregulation

Unspecified

Other Baselreforms

TLAC

Liquidity (total)

Liquidity (NSFR)

Liquidity (LCR)













Cost
and
benefitElliott (2015)

253





MAG (2010b) – Cost
BIS (Interim)

Bridges et al(2014)

Leverage ratio

STUDY

FOCUS
OF
STUDY

Basel capital

COVERAGE OF BASEL REFORMS

Liquidity
regulations

COVERAGE OF
253
NATIONAL
REFORMS
Capitalregulations

B.1.

SUMMARY OF KEY STUDIESACCOUNTSFOROFFSETS/
INTERACTIONS OF
REFORMS SAMPLE APPROACH
No

UK

Panel
regression,
VAR

No

US

Regression

Yes

OECD

Uses
membermodels

No

OECD

Uses
membermodels

No

OECD

Uses
membermodels

No

UK

Panel
regressions

No

OECD

GMM
estimation

Unknown

UK

NIGEM
model

Unknown

EuropeFixed-effectpanel
regression,
DSGE












Yes

Global

NA

Yes

US

Long-term
steadystate
analysis of alending
formulaNo

FranceRegression
s

No

UK

General
Method ofMoments(GMM)

Yes

GlobalNANotspecified

Global

NA

Cost



Not
specified

Global

NA

Cost



Not
specified

Global

NA





























National regulations are implementations of Basel reforms
Cited in the bibliography as BCBS (2010a)© Oliver Wyman

115

Appendix B

Post Crisis Basel Reforms

Kashyap et al.
(2010)

Cost

King (2010)

Cost

Meeks (2014)

Cost

Other/multiregulation

Liquidity
regulations

Unspecified

Other Baselreforms

TLAC

Liquidity (total)

Liquidity (NSFR)

Liquidity (LCR)

Leverage ratio

STUDY

FOCUS
OF
STUDY

Basel capital

COVERAGE OF BASEL REFORMS

Capitalregulations

COVERAGE OF
253
NATIONAL
REFORMSACCOUNTSFOROFFSETS/
INTERACTIONS OF
REFORMS SAMPLE APPROACH
No

US

Reducedform modeland model
calibration
approach

Yes

OECD

Balancesheet
modeling

No

UK

Monetaryvector auto
regression
(VAR)

No

EuropeDSGE

No

EuropeRegression

Not
specified

US

NA

No

UK

Reducedform
modelsYes

GlobalNA

Yes

US andEurope

DSGE

Yes

UK

Balancesheet
modeling

No

OECD

Accounting

No

EuropeSimultaneous
equations
model

Yes

OECD

OLS, GMM








Mendicino et al Cost
2
and(2015)
benefit

Mesonnier and Cost
Monks (2014)



Mizrach (2015) Cost

Noss andToffano (2014)

Cost

Oliver Wyman
and Morgan
Stanley (2015)

Cost

Roger & Vlcek(2011)

Cost

Schanz et al(2011)

Costandbenefit

Slovik andCournede(2011)

Cost

Sutorova and
Teply (2013)

Cost

Gambacorta
and Shin(2016)

Cost

116






















© Oliver Wyman

Post Crisis Basel Reforms

B.2.

Appendix B

DETAILED DESCRIPTION OF STUDIES ON THE IMPACT OF REFORMS ON
THE LENDING CHANNEL

IMPACT ON LOAN RATES
The majority of the academic research to date has been focused on estimating the impact of only the capitalreforms. However, there are some studies that address the comprehensive impact of reforms. The results of thesestudies are discussed first. Studies conducted by the Basel Committee and Bank for International Settlements are
discussed first, following by studies conducted by other multilateral bodies, followed by studies conducted bynational and Europe-wide regulators (ECB and FSA). The impacts discussed below reflect the baseline impact
estimate without additional RWA inflation.
The first study that addresses the comprehensive impact of reforms is BIS’s LEI (2010),255 one of the major studies
released by the BCBS and its sister bodies. It provides an analysis of the long-term economic impact (LEI) of theBasel Committee’s proposed capital and liquidity reforms, focusing on their impact on output. Utilizing member
nation models, and adjusting for our baseline and target capital ratios, the LEI results imply an 69 basis point
increase in the US, a 63 basis point increase in Europe, and an 71 basis point increase in Japan due to an increase intotal common equity to risk-weighted assets. Second, the additional cost of meeting the liquidity standard
amounts are estimated to be 25 basis points in lending spreads when risk-weighted assets (RWA) are left
unchanged. The study considers an additional offset taking account of the fall in RWA as a result of complying withthe liquidity requirements and the resulting lower regulatory capital needs. This offset is discussed in Section 1 on
the lending channel. LEI (2010),256 like many other studies, assumes a full pass-through of costs to the customer.
To estimate the impacts of liquidity reforms, it examines primarily the effects of the NSFR and not the LCR, though
its methodology likely captures most effects of reforms. However, the effects of liquidity reforms may not be fully
captured.257
The MAG (2010) is a BIS Basel Committee on Banking Supervision and FSB study that evaluates the transitional
impact of increased capital requirements. As in the LEI,258 the MAG utilizes member models to understand impactsof reforms for an “average” economy. The final version of the MAG report produced findings, adjusted for ourbaseline and target capital ratios, that imply a 65 basis point increase in the lending rates in the US, a 60 basis point
increase in the lending rates in Europe, and 66 basis point increase in lending rates in Japan following an increase in
the equity to RWA ratio. The MAG also released an interim study that showed a somewhat different estimate of
impacts, primarily driven by the fact that effects are shown over a different time horizon (35 and 48 quarters in the
final report, vs. 18 and 32 quarters in the interim report). The interim report findings imply a 81 basis point increasein lending rates in the US, 75 basis point increase in lending rates in Europe, and a 83 basis point increase in Japanby the end of the simulation when reforms are implemented in two years. Additionally, the interim study estimatesa 15 basis point increase in lending rates due to a 25% increase in liquidity requirements by the end of thesimulation when reforms are implemented in two years. The MAG estimates focus on shorter-term impacts thanmost other studies discussed which accounts for much of the magnitude of the findings. In order to make estimates
more comparable to the other studies discussed in the report, the longer-term estimate is selected (the end of thesimulation period). The MAG analysis relies on models developed by member nations, and as such rests on a large
number of varying assumptions.259

255

Cited in the bibliography as BCBS (2010a)
Cited in the bibliography as BCBS (2010a)
257
BCBS (2010a), Elliott, Salloy and Santos (2012)
258
Cited in the bibliography as BCBS (2010a)
259
MAG (2010a), MAG (2010b)
256© Oliver Wyman

117

Appendix B

Post Crisis Basel Reforms

King (2010) is a BIS Working Paper that examines the impact of increases in capital and liquidity requirements
proposed under Basel III on bank lending spreads. King uses a balance sheet modeling approach to evaluate theimpacts of a representative bank’s capital ratio being raised by increments of 1 percentage point in capitalrequirements. The King study points to an increase in 80 basis points in the US, 73 basis points in Europe, and 81
basis points in Japan due to the increase in capital requirements (using our projected total increase). King’s study
also points to a 24 basis point increase due to liquidity requirements when RWA are left unchanged. King, too,
assumes that the costs of capital reforms are fully passed through to the end users. Like the LEI260, King calculates
an offset taking account of the fall in RWA and the resulting lower regulatory capital needs. This offset and theunderlying assumptions are discussed in Section 1 on the lending channel.
Elliott, Salloy, and Santos (2012) evaluate the impact of Basel III capital and liquidity requirements, derivatives
reforms, and higher taxes and fees on lending rates. The authors use a long-term steady-state analysis of a lending
formula to estimate the impact of multiple components of the total impact of Basel reforms. Their estimates are as
follows, adjusted for our baseline and target capital ratios:
TABLE B.3: ESTIMATES OF GROSS IMPACTS OF REFORMS FOUND BY ELLIOTT, SALLOY, AND SANTOS (2012)

CapitalLCR
NSFR
Derivatives
Taxes and Fees
Total

EUROPE
32
8
10
1
6
57

JAPAN
21
1
11
0
0
33

US
64
11
16
3
4
98

Unlike many other studies, Elliott, Salloy, and Santos (2012) do not assume a 100% pass through of the costs to theend user from the capital increase: they assume a 50% pass-through, based on a modified version of the
Modigliani-Miller theorem, which decreases the overall impact (this is discussed further in Section 1). However, thefigures above do not reflect this adjustment, as we wish to discuss all offsets together in Section 1. Elliott, Salloy,
and Santos (2012) make a number of other assumptions such as the baseline level of capital ratios and target ratiosthat impact the size of the overall estimate of the reforms.261
In another IMF study, Roger and Vlcek (2011) assess the medium-term macroeconomic costs of increasing capitaland liquidity requirements. They use a dynamic stochastic general equilibrium (DSGE) model to estimate theimpact of a 2 percentage point increase in the equity-to-RWA ratio and an increase in liquidity requirements. They
distinguish their results between peak and long-run impacts, where the peak estimates are significantly higher. In
the long run, their estimates suggest that capital requirements will increase lending spreads by 53 basis points in
US, and 37 basis points in Europe, using our baseline and target capital assumptions. They also estimate thatliquidity requirements will increase lending spreads by 20 basis points in the US and 5 basis points in Europe in thelong-run. Roger and Vlcek assume a pass-through of the costs and expect monetary policy to respond to regulatorychange.
De-Ramon et al (2012) measure the impact of prudential policy on the macroeconomy in the UK. Leveraging theNiGEM model, De-Ramon et al suggest that the lending wedge for the UK economy increases by 67 basis points asa result of full adjustment to Basel III requirements. The study also finds that the shorter term impact on thecorporate lending wedge is much higher: lending rates increase by 126 basis points before slowly declining to thelong-run average of 67 basis points. Household borrowing costs, on the other hand, increase continuously over the260
261

Cited in the bibliography as BCBS (2010a)
Ibid

118

© Oliver Wyman

Post Crisis Basel Reforms

Appendix B

study period. While the authors provide a cumulative estimate of the overall impact of reforms, they do not provide
sufficient detail for the authors of this report to scale the impact to the “gap to target” estimates provided above. As
such, the cumulative estimate provided by De-Ramon et al is used as the cumulative impact of the analysis. Like
many other studies, De-Ramon et al assume that the M-M proposition does not hold in full. They also assume thatbanks maintain the existing level of voluntary capital buffers above the minimum requirements, and as such anincrease in the minimum capital ratios translates to a one-to-one increase in individual banks’ holdings. This may
overestimate the impact of reforms in this analysis, as banks may lower their buffers given an increase in theregulatory minimums. Additionally, the authors assume that the structural parameters of the economy estimatedfrom the historical period do not change.
The ECB (2015) analysis evaluates the impact of the proposed European CRR and CRD IV reforms on bankfinancing in Europe. Using fixed-effects panel regressions and DSGE, this study finds that the introduction of theaforementioned reforms contributed to a 0–15 basis points increase in lending rates across different loan products,
where the average increase for households and firms combined amounted to 9 basis points. This study provides anevaluation of a regional implementation of reforms, but the impact captured by it is highly specific to the European
region and the implementation approach. Additionally, the study is not fully transparent about the underlying
assumptions, which makes it difficult to compare it to peer estimates.
Gambacorta and Shin (2016) evaluate the impact of 1 percentage point increase in ratio of equity-to-total assets on
cost of debt financing, and consequently the cost of funding using OLS regression and GMM. They find that a 1%
increase in equity to total assets ratio leads to a 3 basis point increase in cost of funding. The estimate is smaller
than other estimates discussed above as the study calculates a significant reduction in the cost of debt resulting inapproximately a 50% Modigliani-Miller offset, not taking account of the tax benefit of debt (which would lower theoffset) or the reduction in required return on equity (which would raise the offset).
IIF (2011) is another study assessing the impact of multiple reforms on the lending channel. Like the ECB (2015),
the IIF study evaluates the impact of Basel reforms, including the jurisdictional variations in implementation. The
impacts found by the IIF study were significantly higher than all other peer estimates: In the US, they find a 243
basis point increase in lending rates for 2011–2020 and a 468 basis point increase in lending rates for 2011–2015.
In Europe they find a 328 basis point increase in lending rates for 2011–2020 and a 291 basis point increase inlending rates for 2011–2015. In Japan they find a 181 basis point increase in lending rates for 2011–2020 and a 202
basis point increase in lending rates for 2011–2015. The findings of the study evaluate the impact of many morereforms than other peer studies: for example, they include considerations of other reforms specific to eachjurisdiction, such as ring-fencing in the UK. Additionally, the significantly larger estimates are also driven by anumber of assumptions. First, the IIF baselines are more similar to the levels of safety margins held by financial
institutions pre-crisis than following the market movement towards holding more capital in light of the lessons
learned from the financial crisis, which suggests a larger “gap to target” than is likely. Second, the study assumes
that the expected return demanded by investors is heavily impacted by the overall volume of securities being
issued, which appears to be a significant driver of the results. Given these differences, this study is not included inour graphical comparison or other analysis.262
In addition to the studies described above, a number of other official and academic studies focus specifically on theimpact of capital requirements on loan rates. We first discuss official studies on the subject, and then turn toacademic studies.
Cosimano and Hakura (2011) evaluate the impact of the new capital requirements introduced under the Basel III
framework on bank lending rates and loan growth. Using a generalized method of moments approach based on
OECD country data, the authors’ findings imply an increase of 51 basis points in the US, 25 basis points in Europe,and 29 basis points in Japan due to increases in capital requirements (using our projected total increase). The
262

IIF (2011), Elliott, Salloy, and Santos (2012)© Oliver Wyman

119Appendix B

Post Crisis Basel Reforms

authors also find that banks in countries that did not experience the recent financial crisis are less impacted thanthose that did experience the banking crisis. The authors of this study also assume that the M-M proposition does
not hold and that costs will be passed through to customers. They also assume that loan demand declines as loan
rates go up, which impacts their estimate of loan volume decline (discussed in a subsequent section).
Schanz et al (2011) develop a framework for assessing long-term costs and benefits of increasing capitalrequirements for the overall economy based on UK data. Using a balance sheet modeling technique, they find a 36
basis point increase in lending rates due to a 1% rise in capital to risk-weighted assets ratio. The authors estimate
accounts for taxes, and is thus shown as cumulative impact. The authors assume that banks’ funding costs increase
when their capital levels increase (i.e. the M-M theorem does not hold). The authors also estimate other scenarioswith different assumptions for levels of passthrough of funding costs.
Slovik and Cournede (2011) assess the impact of higher capital requirements on the economy through an increasein lending spreads. Using an accounting approach, the researchers’ findings imply a 109 basis point rise in lending
rates in the US, 70 basis point rise in Europe, and 46 basis point rise in Japan due to an increase in equity to risk
weighted assets ratio (using our projected total increase). The authors assume a full pass-through of the cost
increases, and that banks would maintain the same discretionary capital buffers above regulatory minimums asthese minimums are increased. This may overestimate the impacts of reforms in this analysis, as banks may lower
their buffers given an increase in the regulatory minimums.
Kashyap, Stein, and Hanson (2010) evaluate the impact of heightened capital requirements on large financial
institutions, and on their customers through an increase in loan rates. Using a reduced form model and model
calibration approach, the authors’ findings point to a 15 basis point increase in the long-run steady-state loan rates
due to an increase in capital requirements in the US (using our projected total increase). The authors estimate three
scenarios, varying their assumptions about the violation of the M-M theorem across the scenarios. The modelingapproach used (essentially a reduced-form model) opens the work up to the Lucas critique, which notes that the
optimal decisions of economic participants could change as a result of policy changes, and thus reduced-form
models based on estimates of past behavior are not fully suitable for analyzing regulatory changes. The authors’estimates are on the lower end of the estimates discussed in this report, even when we consider that they include
the impacts of only the capital reforms.263
Mendicino et al (2015) characterize social welfare maximizing capital requirement policies using a macroeconomic
model with household, firm and bank defaults calibrated to Euro area data. The authors use a DSGE approach thatpoints to a relatively modest impact of an increase in capital requirements. Their estimates point to a loan rateincrease of 19 basis points (using our projected total increase). They do however find that there will be
distributional differences to this impact. On a per 1% increase in capital ratio requirements level, mortgages will
see a 14 basis point increase while corporates will see a 24 basis point increase in loan rates, without any additional
RWA inflation.264 Mendicino et al (2015) assume that the M-M theorem does not hold, and make a number of otherassumptions specific to individual participants in their model, e.g. saving households are assumed to maximize
their present value of utility subject to the budget constraint. The DSGE approach allows the authors to capture amore holistic view of reforms albeit with a great deal of simplifying assumptions.
Baker and Wurgler (2015) also estimate relatively low impacts on loan rates when they examine the impact of
capital reforms in the US They use a regression-based approach and quantify an impact that implies that anincrease in capital requirements will increase the lending rates by 32 basis points (using our projected total
increase).265 In their analysis the authors assume that the low risk anomaly holds and that costs will be fully passed
on to the customer.
263

Kashyap, Stein, and Hanson (2010), BCBS (2016h)
Estimate of impact on lending spreads (basis points) of increasing ratio of capital to assets by one percentage point is taken from BCBS (2016h)
265
Estimate of impact on lending spreads (basis points) of increasing ratio of capital to assets by one percentage point is taken from BCBS (2016h)
264

120

© Oliver Wyman

Post Crisis Basel Reforms

Appendix B

Finally, Sutorova and Teply (2013) measure the impact on lending rates of capital reforms in Europe. Using asimultaneous equations model where banks choose the optimal level of capital, the authors’ findings imply that anincrease in the equity to risk weighted assets ratio should lead to an increase in lending rates of 92 basis points(using our projected total increase). The authors assume that costs of the reforms will be passed through to thecustomer as banks display oligopolistic behavior and enjoy some price-setting market power.

IMPACT ON LOAN VOLUMES
A number of studies estimate the impact of capital requirement increases on lending volumes.
Mendicino et al (2015) characterize social welfare maximizing capital requirement policies in a macroeconomic
model with household, firm and bank defaults calibrated to Euro area data. Based on a DSGE approach, theirfindings point to an average decline of loans of 0.3% due to a 1% increase in capital requirements. Their findings
point to an impact that differs for different market segments. For mortgages, the decline will be only 0.15% while
for corporates the decline is expected to be over 2 times that amount: 0.43%.266 The DSGE approach allows
Mendicino et al (2015) to capture both the demand and the supply drivers of the decrease in loan volumes.
However, the complexity of the DSGE forces the authors to make a number of other assumptions specific toindividual participants in their model, e.g. saving households are assumed to maximize their present value of utility
subject to the budget constraint. As such, a variety of factors could be driving the comparative low estimate.
Meeks (2014) develops a monetary vector autoregression (VAR) augmented with aggregate banking system andregulatory variables to study the impact of capital requirements on banks. The authors find that an increase incapital requirements leads to a 0.4% decrease in loan volume on average. This impact is uneven for mortgages andcorporates: mortgage loan volume decreases by 0.2% and corporate loan volume decreases by 0.5%. The authors
assume that macroeconomic news does not drive regulatory action and that bank lending is the only transmission
mechanism to the wider economy.
Francis and Osborne (2009a) study the bank capital channel, where shocks to a bank’s capital are assumed to havean effect on the level and composition of the bank’s assets. The study’s results imply that changes in bank capital
regulation have implications for macroeconomic outcomes, as banks can respond by altering credit supply or
making other changes to the asset mix. Based on general method of moments (GMM) procedures, the authors findthat a single percentage point increase in capital requirements in 2002 would have reduced lending by 1.2%. The
authors evaluate a 65% and a 100% pass through of the impact of capital requirements (65% would make theirestimates lower than some peers). They also assume that the responses of the banking sector as a whole are thesame as estimated for individual banks.
MAG (2010) evaluates the transition impact of increased regulatory requirements based on member country
findings. In the final version of the MAG, findings imply that the median estimate is for a decline of lending of 1.4%.
The MAG estimates focus on shorter-term impacts than most other studies discussed, and thus may overestimate
long-term steady state impacts.
De-Ramon et al (2012) measure the impact of prudential policy on the macroeconomy in the UK. Based on anumber of approaches including the NiGEM model, the findings imply a 1.6% decrease in loans from baseline
levels after 5 years. Like many other studies, De-Ramon et al assume that the M-M proposition does not hold. They
also assume that banks maintain the current level of voluntary capital buffers above the minimum requirements,
and as such an increase in the minimum capital ratios translates to a one-to-one increase in individual banks’holdings. This may overestimate the impacts of reforms in this analysis, as banks may lower their buffers given an
increase in the regulatory minimums. Additionally, the authors assume that the structural parameters of theeconomy estimated from the historical period do not change.
266

Estimate of impact on lending spreads (basis points) of increasing ratio of capital to assets by one percentage point is taken from BCBS (2016h)© Oliver Wyman

121

Appendix B

Post Crisis Basel Reforms

Cosimano and Hakura (2011) study the impact of the new capital requirements introduced under the Basel III
framework on bank lending rates and loan growth. Using a generalized method of moments approach based on
OECD country data, the authors’ findings imply that an increase in capital requirements is “predicted to reduceloans for the 100 largest banks by 1.3 percent in the long run.” The authors assume the loan volume decline isdriven by an increase in loan rate. The estimated impact is relatively small because of the small assumed elasticity ofdemand for loans. The authors note, however, that some sub-sets of the market are likely to see a bigger impact:
for the crisis countries, a 1.3 percentage point increase in capital requirements is estimated to have a more
substantial impact on loans (4.6%), since the elasticity of demand for loans is estimated to be about eight times
larger than in the case of the 100 largest banks. All in all, the estimated elasticity of demand drives the overall
estimate.
Sutorova and Teply (2013) first measure the impact of reforms on loan rates, and then determine the impact of thereforms on loan volume. Using a simultaneous equations model, the authors find that an increase in equity to RWA
ratio will lead to a lending reduction of 1.4%–3.5% (average of 2.5%).267 This impact is somewhat higher than the
majority of other estimates discussed in this paper, as it identifies a significant increase in lending rates due tocapital requirements. This large increase in lending rates drives a large impact on volume.
Bridges et al (2014) estimate the effect of changes in microprudential regulatory capital requirements on bankcapital ratios and bank lending in the UK. The authors use panel regressions to arrive at findings that imply that anincrease in total regulatory capital as a proportion of total risk-weighted assets requirements will lead to a loan
volume decrease of about 3.5%. The authors’ work implicitly tests the violation of the Modigliani-Miller theorem.
They also assume that banks react symmetrically, i.e. banks’ responses to an increase in capital requirements are
the mirror image of their response to a decrease. Should this assumption not hold, the impact of the change incapital requirements may differ.
Fraisse et al (2015) measure the impact of bank capital requirements on corporate borrowing and business activity.
The authors use accounting data to estimate the impact of an increase in capital requirements on intensive andextensive margin of loans. The authors find that a one percentage point increase in capital requirement leads to a
1% reduction in lending at the intensive margin and an 8% reduction in lending at the extensive. The authors
assume that different decisions about extensive margin (whether to extend a loan) vs. intensive margin (how muchto loan). While the authors’ results point to deviation from the M-M theorem in the short run, they assume thatM­M theorem should hold in the long-run.
Noss and Toffano (2014) estimate the effect of changes in capital requirements on lending. The authors use
reduced form models to find that an increase in the ratio of capital to risk-weighted assets leads to a loan volume
decrease of 4.5%. The authors assume that the Modigliani-Miller theorem does not hold perfectly. They also take asupply-driven approach by assuming that the demand for credit is constant. Like many other papers using similar
methodologies, their paper is open to the Lucas critique, which notes that the optimal decisions of economic
participants could change as a result of policy changes, and thus reduced-form models based on estimates of past
behavior are not fully suitable for analyzing regulatory changes.
Gambacorta and Shin (2016) evaluate the impact of 1 percentage point increase in ratio of equity to total assets on
cost of debt financing, and loan growth using OLS regression and GMM. They find that a 1% increase in equity tototal assets ratio leads to a 0.6 percentage point increase in annual loan growth, as banks with higher capital are
likely to lend more. The study calculates a significant reduction in cost of debt (4 basis points) resulting inapproximately a 50% Modigliani-Miller offset, not taking account of the tax benefit of debt (which would lower theoffset) or the reduction in required return on equity (which would raise the offset).
Additionally, a number of studies estimate the impact of capital increases on the lending growth rate.
267

Estimate of impact on lending spreads (basis points) of increasing ratio of capital to assets by one percentage point is taken from BCBS (2016h)

122© Oliver Wyman

Post Crisis Basel Reforms

Appendix B

Aiyar, Calomiris and Wieladek (2014) study the interaction of monetary policy and capital requirements, and theirimpact on lending rates in the UK. Using panel regression and VAR analysis, the authors find that an increase incapital requirements will lead to a decline of the growth rate in real lending to the economy of about 4.6% upon
impact. The authors assume that change in capital requirements impacts real lending with a lag. This study issomewhat different from others covered in this report, as it focuses on the decline in growth rate of lending, rather
than a decline in real volume. As such, it is not shown in the comparative chart.
Mesonnier and Monks (2014) study the impact of an increase of capital on loan growth, utilizing a dataset ofbalance sheet of banks subject to EBA’s 2011/12 Capital Exercise, during which banks had to increase their capital
within a short time frame. Using a regression, the authors find that banks that had to increase their capital by 1% ofrisk-weighted assets tended to have annualized loan growth between 1.2% and 1.6% lower than banks that did nothave to increase their capital ratios (over the 9 month period of the exercise). The authors assume that in the shortrun, M-M theorem does not hold, and assume that an identified capital shortfall at the group level in the data
sample had a uniform impact on the lending growth of all entities within the group.

© Oliver Wyman

123

Post Crisis Basel Reforms

APPENDIX C.

Appendix C

DETAILED SUMMARY OF MEASUREMENTAPPROACHES USED IN QUANTITATIVE STUDIES

A number of official and academic studies have been conducted to evaluate the impact of Basel reforms, utilizing
various methodologies. The most common approaches are discussed below.
Balance sheet/accounting approach
The balance sheet/accounting approach estimates the spread between the cost of equity and the cost ofdebt using balance sheet data. Studies utilizing this approach evaluate the impact of increasing capitalratios on a bank’s cost of funding using estimates of the long-run return on equity and the required rate of
return on debt, including an adjustment for the effects of taxation. As a second step, studies use bankbalance sheet data to calculate the extent to which interest rates on loans would need to rise to offset theincrease in funding costs. This approach usually assumes that banks re-price only their loans, as banks
have less ability to re-price deposits (and less need to do so in the post-crisis environment), bonds, etc.
The degree to which banks pass through this increase in pricing is one of the critical assumptions that
dictate the magnitude of findings.
One of the greatest strength of this approach is its intuitiveness, transparency, and availability of datarequired for the calculations. However, accounting models have a number of drawbacks, such as thefact these models do not take into account the interaction between loan pricing and market demand,and they usually do not fully address the issue of how default risk affects the cost of funding. Despite
these drawbacks, a number of studies utilize this approach, such as Slovik and Cournede (2011) andKing (2010).268
Simulation-based approaches
Researchers employ simulations, such as the Vector Error Correction Model (VECM), to use bank data toevaluate the impact of regulation. The VECM model is used to estimate a long-term relationship between asmall set of macro-variables. VECMs model are built upon the Error Correction Model (ECM), a multiple
time series model used for studies that include data with underlying variables that have a long-run
stochastic trend. One of the key strengths of this approach is that it allows the researcher to disentangle
demand and supply factors within the lending market in a steady-state. However, this model is vulnerable
to the Lucas critique, which states that the decisions of economic agents could change in response topolicy changes, and therefore “reduced-form” models based on estimates of past behavior are not fully
capable of analyzing regulatory change. The VECM approach is utilized in studies including Gambacorta(2011) and Angelini et al (2011).269
The Generalized Method of Moments is also a simulation-based model that estimates parameters using
both data and constraints from economic theory called “moment conditions”. The parameters are thenused to estimate the target metric. GMM is a commonly used approach for econometric modelling, as it
overcomes a number of difficulties present in other models. A key strength is its low reliance on
assumptions, including assumptions about the distribution of a variable. The GMM approach is utilized instudies including Cosimano and Hakura (2011) and Francis and Osborne (2009a).270

268

BCBS (2016h), De-Ramon et al (2012), King (2010), Slovik and Cournede (2011)

269

BCBS (2016h)

270

Zsohar (2012), Simply Statistics (2013)© Oliver Wyman

125

Appendix C

Post Crisis Basel Reforms

Partial Equilibrium models
Partial Equilibrium models evaluate the impact of regulations in the directly affected markets. Thesemodels are less complex than general equilibrium models, which seek to examine impacts in several
markets simultaneously rather than a single market in isolation. Since Partial Equilibrium models look at asingle market in isolation and, relatedly, because they do not take price effects into consideration, theirresults may not always capture the full impact of regulation. However, partial equilibrium models are
frequently used in the evaluation of the impacts in studies such as De Nicolò, Gamba, and Lucchetta(2014).271
Dynamic stochastic general equilibrium (DSGE) models
Like other general equilibrium models in economics, DSGE models are used to model the behavior of theeconomy as a whole by analyzing the interaction of multiple variables. DSGE models are dynamic,
evaluating effects on the economy over time, and stochastic, taking into account the random shocks suchas changes in macroeconomic policy-making. These models are built around a demand block, a supply
block, and a monetary policy equation.
Due to their multi-faceted analysis, DSGE models are able to generate a broadly consistent picture of thesteady-state impact of an increase in capital requirements on bank lending, activity, and general welfare.
However, DGSE272 are highly complex and require researchers to make a number of parametricassumptions and make decisions about which mechanisms that affect the dynamics of the economy
should be incorporated into the model. These assumptions and decisions have a significant impact on theoutcome of the results. Examples of studies utilizing this approach include Angelini and Gerali (2012) andCovas and Driscoll (2014).273
NIGEM model
The NiGEM incorporates many components of a DSGE model while using a “New-Keynesian” framework.
While the New Keynesian model is not equivalent to a DGSE model as it uses a small number of equations,estimated in a VAR and specified in logarithms, many of the characteristics are similar. This model isstructured around the national income identity, which can accommodate forward looking consumer
behavior. The NiGEM model utilizes historical data, enabling its use for policy analysis and forecasting.
Like many of the other approaches described above, the NiGEM model is heavily reliant on a number ofcritical assumptions that impact the magnitude of the results. The NIGEM model is used by studies such as
De Ramon et al (2012).
Top-Down Stress Testing Models
Top-down stress testing models are used as part of stress testing, in part to evaluate the impact of stressscenarios on solvency of the banks. Some of the stress testing frameworks incorporate liquidity andsolvency risks, and assume that banks are first faced with solvency shocks, which are then potentiallyfollowed by withdrawals of short-term funding driven by investors’ concerns about the future solvency of
individual banks.274
Other Models/Approaches
Apart from the approaches described above, multiple other econometric and other approaches are usedin impact studies, e.g. time series, panel regression, other econometric techniques, as well as simpler
approaches like evaluation of market trends. Each of these techniques includes its own set of strengths
and drawbacks that researchers trade off in their evaluations.
271

BCBS (2016h), Covas and Driscoll (2014) is another example.
There are multiple variations to DSGE models. For example, the 3D model approach introduces financial intermediation and three layers of default
into a dynamic stochastic general equilibrium (DSGE) model. Used by Clerc et al (2015), this model provides a rationale for capital regulation as awelfare improving response to distortions, including undesired effects of safety net guarantees and bank funding cost externalities.
273
BCBS (2016h), Sbordone et al (2010), Villaverde (2009), Angelini and Gerali (2012), Covas and Driscoll (2014)
274
BCBS (2016h)
272

126

© Oliver Wyman

Post Crisis Basel Reforms

Appendix C

MEASUREMENT APPROACHES USED IN BCBS STUDIESThe BCBS and sister organizations conducted several impact studies: Basel Committee’s Long-term Economic
Impact275 and Macroeconomic Assessment Group (MAG 2010) reports are the key studies focused on quantitative
impacts across multiple reforms.
The MAG (2010) focuses on estimating the transitional costs of moving to higher capital ratios in terms of the
reduction in lending and impact on the GDP for an advanced economy, drawing on analytical work conducted bymember countries. The study drew on forecasting and other analytical models developed by member countries toestimate the impact of a single percentage point rise in bank capital ratios. It evaluates lending spread and volume
impacts of reforms using a number of satellite models, which utilized a variety of approaches. As a second step, theMAG uses these lending impacts to evaluate GDP impacts of capital reforms using macroeconomic models.276
The LEI study focuses on estimating the steady-state costs and benefits of the stronger capital and liquidity
requirements. It draws on analysis from a number of sources and derives the benefit as the reduction in theprobability of crisis due to the higher capital requirements, and derives the costs as the reduction in output due tohigher lending spreads driven by higher bank funding.277 First, the study utilized an accounting approach toevaluate the impact of increased requirements on lending rates. Second, the study utilized a suite of models
including dynamic stochastic general equilibrium (DSGE) models, semi-structural models, and reduced-form
models to evaluate the impact of increases in bank capital and liquidity on the steady-state levels of output.
Wherever possible, the study utilized the same models as the MAG (2010). Critically, the study assumed that theincrease in funding costs are fully passed through to the borrowers, and that the cost of capital does not fall despitebanks becoming less risky (in other words, the study assumed that the Modigliani-Miller theorem does not hold or
is precisely offset by some set of other non-modelled factors).
The Basel Committee has also conducted a number of more detailed quantitative impact studies on individualreforms, including studies on the revised market risk framework and on Total Loss Absorbing Capacity
requirements (TLAC).
The BCBS has recently released the final rule on capital requirements for market risk278 which follows the proposed
framework on market risk that was initially posed in the 2013 Fundamental Review of the Trading Book (FRTB)
consultative document.279 As part of the development for the final rule, the BCBS conducted a study in 2014 toevaluate the proposed framework, which included analysis on the variability of risk metrics, consistency of the rules,
and change between the updated and previous framework. In the study, the BCBS runs a hypothetical portfolio
exercise (HPE) in which banks provided information, such as risk metrics for their trading books, based on the
hypothetical application of the new framework. Data is analyzed to determine variability of risk measures ascompared to the previous framework.280 The FRTB Interim Analysis study published in 2015 also reviews the
proposed revision of the market risk framework, and focuses on evaluating the framework’s impact to bank capitalratios under both the proposed standardized approach and the internally-modelled approach. The BCBS performssummary statistics and data analytics on information that banks volunteered to provide, which includes bankcapital charges calculated based on the new guidelines.281
Other studies evaluate the Total Loss Absorbing Capacity (TLAC) requirements, which are set out by the Financial
Stability Board (FSB) as a safety measure against systemic risk. In one study, the Economic Impact Assessment
275

Cited in the bibliography as BCBS (2010a)
BCBS (2016h), MAG (2010a, 2010b)
277
BCBS (2010a)
278
BCBS (2016g)
279
BCBS (2013j)
280
BCBS (2014k)
281
BCBS (2015f)
276© Oliver Wyman

127

Appendix C

Post Crisis Basel Reforms

Group (EIAG) evaluates the micro- and macroeconomic costs and impacts associated with TLAC requirements. The
study derives measures such as change to lending rates and GDP.282 FSB and BCBS also published a Summary of
Findings from the TLAC Impact Assessment Studies, which includes a summary of findings about the impacts of
TLAC, including a 2015 QIS. The BCBS (and FSB) published a TLAC Quantitative Impact Study Report that evaluates
whether G-SIBs will be able to meet TLAC requirements. For the study, a sample of banks was asked to provide riskbased ratios and leverage ratios that were calculated in accordance with the basic TLAC framework guidelines aswell as three variations on the basic framework that was proposed at the time. The data was then aggregated andanalyzed.283
BCBS has published other impact studies such as those in the Regulatory Consistency Assessment Programme(RCAP) and continues to evaluate the impacts of proposed regulation for the revision and finalization of new rules.

MEASUREMENT APPROACHES USED IN OTHER STUDIES
While some studies utilize a single model approach, the majority uses a combination of approaches and relies on anumber of critical assumptions. For example, AFME and PwC (2014c) examines the impact of regulatory reforms
on bank’s efforts to recapitalize and re-shape. In addition to approaches described above, the researchers also
examine bank responses to regulation in the shape of cost savings programs that have been launched at financial
institutions across Europe, and bank exits from non-core business areas. GFMA, IIF and PwC (2015) also trackmarket trends, such as the contraction in the repo market. While these studies aim to capture the effects ofregulations on the market, they are not always able to establish a cause-effect relationship with confidence, as theycannot isolate impacts of underlying market trends.284

CHALLENGES OF IMPACT MEASUREMENT APPROACHESStudies that attempt to quantify the benefits from a decline in the frequency and severity of financial crises as aresult of the reforms generally use one or more of the methodologies discussed above, though some utilize simpler
approaches. These studies can be particularly challenging for two reasons. First, macroprudential policy isimplemented in response to signs of growing risks, imbalances, or decline in the financial system and it is therefore
difficult to evaluate how these trends would have played out in the absence of the policy. Second, these policies areusually implemented in conjunction with other policies, such as expansionary monetary policies. Thus, it is difficult
to disentangle the impacts. Despite these challenges, researchers supplement macroeconomic techniques withmethodologies such as calculating the annual savings from reductions in the frequency of financial crises.285

282

Experts Group for the FSB (2015)
BCBS (2015l), FSB and BCBS (2015)
284
AFME and PwC (2014c), GFMA, IIF and PwC (2015)
285
Freixas, Laeven and Peydro (2015), BCBS (2016h)
283

128

© Oliver Wyman

Post Crisis Basel Reforms

APPENDIX D.
ACRONYM
ABS
ALA
AFME
AMA
ASF
ASIFMA
AUM
BAFT
BCBS
BoE
CA
CCAR
CCF
CCP
CCR
CCyB
CE
CEM
CET1
CFO
CFTC
CLF
Coco bonds
CPSS
CSRBB
CVA
DFA
DFAST
DRC
DSGE
EACB
EBA
EBF
EC
ECB
EIAG
ECM
EMDE
EMIR
EPE
ES
ESRB
EU
EVE
FCA
FRTB
FSB
GFMA
GMM
G-SIBs© Oliver Wyman

Appendix D

GLOSSARY OF ACRONYMS
TERMAsset-Backed Securities
Alternative Liquid Asset
Association for Financial Markets in Europe
Advanced Measurement Approach
Available Stable Funding
Asia Securities Industry and Financial Markets Association
Assets Under Management
Bankers Association for Finance and Trade
Basel Committee On Banking Supervision
Bank of EnglandComprehensive Assessment
Comprehensive Capital Analysis And Review
Credit Conversion Factors
Central Counterparty
Counterparty Credit Risk
Countercyclical Capital Buffer
Common Equity
Current Exposure Method
Common Equity Tier 1
Chief Financial Officer
Commodity Futures Trading Commission
Committed liquidity facilities
Contingent convertible bonds
Committee On Payments And Settlement Systems
Credit Spread Risk In The Banking Book
Credit Valuation Adjustment
Dodd-Frank Act
Dodd-Frank Act Stress Test
Default Risk Charge
Dynamic Stochastic General Equilibrium
European Association of Co-operative Banks
European Banking Authority
European Banking Federation
European Commission
European Central Bank
Economic Impact Assessment Group
Error Correction Model
Emerging Markets and Developing Economies
European Market Infrastructure Regulation
Expected Positive Exposures
Expected Shortfall
European Systemic Risk Board
European Union
Economic Value of Equity
Financial Conduct Authority
Fundamental Review Of The Trading Book
Financial Stability Board
Global Financial Markets Association
General Method Moments
Global Systemically Important Banks

129

Appendix D

HQLA
IACPM
ICC
ICMA
IIF
IHC
IMM
IMS
IOSCO
IRB
IRRBB
ISDA
LC
LR
LCR
M-M
MiFID
NFC
NiGEM
NII
NIM
NMRF
NSFR
OECD
OTC
P&L
PD
PFE
PSE
QCCP
QIS
RC
RCAP
RMBS
RoRWA
RRP
RSF
RWA
SA
SA-CCR
SEC
SBA
SEF
SIFMA
SM
SMA
SME
SPE
TCH
TLAC
UCC
VaR
VAR
VECM

130

Post Crisis Basel Reforms

High Quality Liquid Assets
International Association of Credit Portfolio Managers
International Chamber of Commerce
International Capital Market Association
Institute of International FinanceIntermediate Holding Company
Internal Model Method
Internal Measurement System
International Organization Of Securities Commissions
Internal Ratings Based
Interest Rate Risk In The Banking Book
International Swaps and Derivatives Association
Letter of Credit
Leverage Ratio
Liquidity Coverage Ratio
Modigliani-Miller
Markets in Financial Instruments Directive
Non-Financial Corporation
National Institute Global Econometric ModelNet Interest Income
Net Interest Margin
Non-Modellable Risk Factors
Net Stable Funding Ratio
Organization for Economic Co-operation and Development
Over-The-Counter Derivative
Profit and Loss
Probability of Default
Potential Future Exposure
Public Sector Entities
Qualifying Central Counterparty
Quantitative Impact Study
Replacement Cost
Regulatory Consistency Assessment Programme
Residential Mortgage-Backed Securities
Return on Risk-Weighted Assets
Recovery and Resolution Plan
Required Stable Funding
Risk-Weighted Assets
Standardized Approach
Standardized Approach For Measuring Counterparty Credit Risk Exposures
Securities and Exchange Commission
Sensitivity Based Approach
Swap Execution Facility
Securities Industry and Financial Markets Association
Standardized Method
Standardized Measurement Approach
Small and Medium Enterprise
Special Purpose Vehicles
The Clearing House
Total Loss-Absorbing Capacity
Unconditionally Cancellable Commitments
Value-At-Risk
Vector Autoregression
Vector Error Correction Model© Oliver Wyman

Post Crisis Basel Reforms

Appendix D

BIBLIOGRAPHY
Acharya, V. and Viswanathan, S. (2010). ‘Leverage, Moral Hazard, and Liquidity’, NBER Working Paper.
ACLI (2014a). Statement for the Record US Senate Committee on Banking, Housing & Urban Affairs Subcommittee on
Financial Institutions and Consumer Protection Hearing titled “Finding the Right Capital Regulations for Insurers”.
ACLI (2014b). Statement of the American Council of Life Insurers Before the Subcommittee on Housing and Insurance of
The House Committee on Financial Services on Legislative Proposals to Reform Domestic Insurance Policy.
Acworth, W. (2014) ‘Rethinking the Cost of Clearing: Capital Standards Weigh on FCM Business Models.’ Futures
Industry Magazine
Admati, A. (2013). ‘Financial Regulation Reform: Politics, Implementation, and Alternatives’, North Carolina
Banking Institute Special Edition, 18, pp.71-81.
Admati, A. (2014). ‘The Compelling Case for Stronger and More Effective Leverage Regulation in Banking’, The
Journal of Legal Studies, 43(3), pp.35-61.
Admati, A. (2015). ‘Rethinking Financial Regulation: How Confusions Have Prevented Progress’, Stanford Graduate
School of Business.
Admati, A. (2016). ‘The Missed Opportunity and Challenge of Capital Regulation’, National Institute Economic
Review, 235(1), pp.R4-R14.
Admati, A. and Hellwig, M. (2013). The Bankers' New Clothes: What's Wrong with Banking and What to Do about It.
Princeton: Princeton University Press.
Admati, A., DeMarzo, P., Hellwig, M. and Pfleiderer, P. (2013). ‘Fallacies, Irrelevant Facts, and Myths in the
Discussion of Capital Regulation: Why Bank Equity is Not Socially Expensive’, University School of Stanford BusinessWorking paper, (2065).
Adrian, T. and Ashcraft, A. B. (2012). ‘Shadow Banking: A Review of the Literature’, Federal Reserve Bank of New York
Staff Reports, (580).
Adrian, T., Boyarchenko, N. and Shin, H. (2015). ‘The Cyclicality of Leverage’, Federal Reserve Bank of New York Staff
Reports, (243).
Adrian, T., Fleming, M., and Schaumburg, E. (2015a). ‘Introduction to a Series on Market Liquidity’, Federal Reserve
Bank of New York Liberty Street Economics.
Adrian, T., Fleming, M., and Schaumburg, E. (2015b). ‘Introduction to a Series on Market Liquidity: Part 2’, Federal
Reserve Bank of New York Liberty Street Economics.
Adrian, T., Fleming, M., Goldberg, J., Lewis, M., Natalucci, F. and Wu, J. (2013). ‘Dealer Balance Sheet Capacity andMarket Liquidity during the 2013 Selloff in Fixed-Income Markets’, Liberty Street Economics.
Adrian, T., Friedman, E. and Muir, T. (2015). ‘The Cost of Capital of the Financial Sector’, Federal Reserve Bank of
New York Staff Reports, (755).
AFME (2011a). Leverage Ratio Case Study.
AFME (2011b). Market Analysis, The Nature and Scale of OTC Equity Trading in Europe.
AFME (2012a). Accurately measuring & allocating capital: the need for risk sensitive capital requirements.
AFME (2012b). AFME response to Call for Evidence – EU regulatory framework for financial services.
AFME (2012c). An analysis of fixed income trading activity in the context of MiFID II.
AFME (2012d). CRD IV Central Counterparties (CCPs) - Non-finalised Capitalisation Rule on Exposure to CCPs.
AFME (2014). The proposed treatment of ABCP conduits under the CRR; issues raised by the Basel FAQs on the LCR
framework published in April 2014.
AFME (2015). AFME Briefing Note: Total Loss-Absorbing Capacity (TLAC).
AFME (2016). AFME: EBA Leverage Ratio Meeting.

© Oliver Wyman

131

Appendix D

Post Crisis Basel Reforms

AFME and GFMA (2012). Briefing Note: Global Systemically Important Financial Institutions.
AFME and ISDA (2015). European Commission Consultation on the possible impact of the CRR and CRD IV on bankfinancing of the economy.
AFME and PwC (2014a). Bank structural reform study: Supplementary report 1 Is there an implicit subsidy for EU banks?
AFME and PwC (2014b). Bank structural reform study: Supplementary report 2 Inventory of bank responses toregulatory change.
AFME and PwC (2014c). Impact of bank structural reforms.
Aiyar, S., Calomiris, C. and Wieladek, T. (2014). ‘How does credit supply respond to monetary policy and bankminimum capital requirements?’ Bank of England Working Paper, (508).
Alfon, I., Argimon, I. and Bascunana-Ambros, P. (2004). ‘What determines how much capital is held by UK banks
and building societies?’ Financial Services Authority Occasional Paper Series, (22).
Allen, F. and Carletti, E. (2013). ‘Deposits and Bank Capital Structure’, Economics Working Papers from European
University Institute, (ECO2013/03).
Andersen, L., Duffie, D., and Song, Y. (2016). ‘Funding Value Adjustments’.
Anderson, N., Webber, L., Noss, J., Beale, D. and Crowley-Reidy, L. (2015). ‘The resilience of financial market
liquidity’, Bank of England Financial Stability Paper, (34).
Anderson, R. (2016). ‘Is regulation changing the structure of banking?’, The Clearing House Quarterly Journal, 4(1),pp. 53-59.
Anenberg, S.A., Delaney, T.J., and Taft, J. (2015). ‘Developments in Bank Regulation’, Mayer Brown, The Continuing
Impact of Dodd-Frank.
Angelini, P. and Gerali, A. (2012). ‘Banks’ Reactions to Basel-III’, Bank of Italy Working paper, (876).
Angelini, P., Clerc, L., Curdia, V., Gambacorta, L., Gerali, A., Locarno, A., Motto, R., Roeger, W., Van den Heuvel, S.,
and Vlcek, J. (2011). ‘Basel III: Long-Term Impact on Economic Performance and Fluctuations’, BIS Working Papers,(338).
Archarya, V., Mehran, H., Schuermann, T. and Thakor, A. (2012). ‘Robust Capital Regulation’, Federal Reserve Bankof New York, 18 (42012).
Arjani, N. (2009). ‘Procyclicality and Bank Capital’, Bank of Canada Report.
Arseneau, D. M., Rappoport, D. E. and Vardoulakis, A. (2015). ‘Secondary Market Liquidity and the Optimal Capital
Structure’, Federal Reserve Board Finance and Economics Discussion Series.
Asquer, A. and Krachkovskaya, I. (2015), ‘Do Central Counterparts Improve the Stability of Derivatives Market?
Some Evidence from an Agent-Based Model’.
Athanasoglou, P.P and Danilidis, I. (2011). ‘Procyclicality in the banking industry: causes, consequences andresponse’, Bank of Greece Working Paper, (139).
Avgouleas, E. (2015). ‘Bank Leverage Ratios and Financial Stability: A Micro- and Macroprudential Perspective’,
Levy Economics Institute of Bard College Working Paper, (849).
BAFT to BCBS (2014). Re: Basel III: The Net Stable Funding Ratio.
Baily, M.N. and Elliott, D.J. (2012). ‘Evaluating the Proposed Rules on Single Counterparty Credit Limits’.
Baker, M. and Wurgler, J. (2015). ‘Do Strict Capital Requirements Raise the Cost of Capital? Bank Regulation,
Capital Structure, and the Low-Risk Anomaly’, American Economic Review, 105 (5), pp.315-320.
Balluck, K. (2015). ‘Investment banking: linkages to the real economy and the financial system’, Bank of England
Quarterly Bulletin, (2015 Q1).
Banerjee, R. and Mio, H. (2014). ‘The Impact of Liquidity Regulation on Banks’, BIS Working Papers, (470).
Bank of Canada (2010). Financial System Review.

132© Oliver Wyman

Post Crisis Basel Reforms

Appendix D

Bank of England (2013a). Financial Stability Report June 2013.
Bank of England (2013b). Financial Stability Report November 2013.
Bank of England (2014a). Financial Stability Report June 2014.
Bank of England (2014b). Financial Stability Report December 2014.
Bank of England (2015a). Financial Stability Report July 2015.
Bank of England (2015b). Financial Stability Report December 2015.
Bank of England (2015c). The Bank of England’s approach to stress testing the UK banking system.
Bank of England (2015d). Supplement to the December 2015 Financial Stability Report.
Bank of England (2016). Financial Stability Report July 2016.
Barclays PLC (2015). Return to Stability: Annual Report 2015.
Barrell, R., Davis, E., Fic, T. and Karim, D. (2011). ‘Tier 2 Capital and Bank Behaviour’, NIESR and Brunel University.
Barrell, R., Davis, E., Fic, T., Holland, D., Kirby, S. and Liadze, I. (2009). ‘Optimal regulation of bank capital andliquidity: how to calibrate new international standards’, Financial Services Authority Occasional Paper Series, (38).
Barrell, R., Davis, E., Karim, D. and Liadze, I. (2009a). ‘Banking Crises and Optimal Bank Regulation’, NIESR and
Brunel University.
Barrell, R., Davis, E., Karim, D. and Liadze, I. (2009b). ‘The Effects of Banking Crises on Potential Output in OECDCountries’, NIESR and Brunel University.
Barth, J. and Sau, M. (2015). ‘Designating Bank SIFIs: An Arbitrary Threshold for Risk’, Viewpoints.
Bases , D. (2015). ‘Citigroup selling retail online FX trading platform to FXCM, Saxo Bank’, Reuters
Bayoumi, T. and Melander, O. (2008). ‘Credit Matters: Empirical Evidence on US Macro-Financial Linkages’, IMF
Working Papers, 08(169).
BBA to BCBS (2015). Capital floors: The design of a framework based on standardised approaches.
BCBS (2009a). Consultative Document Guidelines for computing capital for incremental risk in the trading book.
BCBS (2009b). Consultative Document Principles for sound stress testing practices and supervision.
BCBS (2009c). Revisions to the Basel II market risk framework.
BCBS (2010a). An assessment of the long-term economic impact of stronger capital and liquidity requirements.
BCBS (2010b). Basel III: International framework for liquidity risk measurement, standards and monitoring.
BCBS (2010c). Consultative Document Countercyclical capital buffer proposal.
BCBS (2010d). Guidance for national authorities operating the countercyclical capital buffer.
BCBS (2011a). Basel Committee on Banking Supervision reforms - Basel III.
BCBS (2011b). Basel III: A global regulatory framework for more resilient banks and banking systems.
BCBS (2012). Working Paper No 20.The policy implications of transmission channels between the financial system andthe real economy.
BCBS (2013a). Annex 1 Summary Description of the LCR.
BCBS (2013b). Basel Committee on Banking Supervision (BCBS) Charter.
BCBS (2013c). Basel III phase-in arrangements.
BCBS (2013d). Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools.
BCBS (2013e). Consultative Document Capital requirements for banks’ equity investments in funds.
BCBS (2013f). Consultative Document Revised Basel III leverage ratio framework and disclosure requirements.
BCBS (2013g). Global systemically important banks: updated assessment methodology and the higher loss absorbency
requirement.

© Oliver Wyman

133

Appendix D

Post Crisis Basel Reforms

BCBS (2013h). Report to G20 Finance Ministers and Central Bank Governors on monitoring implementation of Basel III
regulatory reform.
BCBS (2013i). Report to G20 Leaders on monitoring implementation of Basel III regulatory reforms.
BCBS (2013j). Consultative Document Fundamental review of the trading book: A revised market risk framework.
BCBS (2013k). Margin requirements for non-centrally cleared derivatives.
BCBS (2014a). Basel III Document Revisions to the securitisation framework.
BCBS (2014b). Basel III leverage ratio framework and disclosure requirement.
BCBS (2014c). Basel III Monitoring Report.
BCBS (2014d). Basel III: the net stable funding ratio.
BCBS (2014e). Capital requirements for bank exposures to central counterparties.
BCBS (2014f). Consultative Document Capital floors: the design of a framework based on standardised approaches.
BCBS (2014g). Frequently Asked Questions on Basel III’s January 2013 Liquidity Coverage Ratio framework.
BCBS (2014h). Implementation of Basel standards, A report to G20 Leaders on implementation of the Basel III regulatory
reforms.
BCBS (2014i). Reducing excessive variability in banks' regulatory capital ratios.
BCBS (2014j). The standardised approach for measuring counterparty credit risk exposures.
BCBS (2014k). Analysis of the trading book hypothetical portfolio exercise.
BCBS (2014l). Working Paper No 27. Impact and implementation challenges of the Basel framework for emerging
market, developing and small economies
BCBS (2014m). Supervisory framework for measuring and controlling large exposures.
BCBS (2015a). Consultative Document Capital treatment for “simple, transparent and comparable” securitisations.
BCBS (2015b). Consultative Document Interest rate risk in the banking book.
BCBS (2015c). Consultative Document TLAC Holdings.
BCBS (2015d). Consultative Document Review of the Credit Valuation Adjustment Risk Framework.
BCBS (2015e). Eighth progress report on adoption of the Basel regulatory framework.
BCBS (2015f). Fundamental review of the trading book – interim impact analysis.
BCBS (2015g). Guidelines for identifying and dealing with weak banks.
BCBS (2015h). Identification and measurement of step-in risk released by the Basel Committee.
BCBS (2015i). Ninth progress report on adoption of the Basel regulatory framework.
BCBS (2015j). Regulatory Consistency Assessment Programme (RCAP) - report on risk-weighted assets for counterparty
credit risk (CCR).
BCBS (2015k). Second consultative document Revisions to the Standardised Approach for credit risk.
BCBS (2015l). TLAC Quantitative Impact Study Report.
BCBS (2015m). Frequently asked questions on the Basel III Countercyclical Capital Buffer.
BCBS (2015n). Consultative Document Haircut floors for non-centrally cleared securities financing transactions.
BCBS (2016a). Basel III Monitoring Report.
BCBS (2016b). Consultative Document Standardised Measurement Approach for operational risk.
BCBS (2016c). Consultative Document Reducing variation in credit risk-weighted assets – constraints on the use ofinternal model approaches.
BCBS (2016d). Consultative Document Revisions to the Basel III leverage ratio framework.
BCBS (2016e). Explanatory note on the revised minimum capital requirements for market risk.

134© Oliver Wyman

Post Crisis Basel Reforms

Appendix D

BCBS (2016f). Frequently asked questions on the Basel III leverage ratio framework.
BCBS (2016g). Minimum capital requirements for market risk.
BCBS (2016h). Working paper No. 30 Literature review on integration of regulatory capital and liquidity instruments.
BCBS (2016i). Interest rate risk in the banking book.
BCBS and IOSCO (2013). Margin requirements for non-centrally cleared derivatives.
BCBS and IOSCO (2015). Margin requirements for non-centrally cleared derivatives.
Begenau, J. (2015). ‘Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model’, Harvard
Business School, (15-072).
Benedetti-Valentini, F. (2011). ‘BNP Paribas to Boost Capital Ratio Through US Asset Cuts’, Bloomberg
Berger, A. and Bouwman, C. (2013). ‘How does capital affect bank performance during financial crises? ’ Journal of
Financial Economics, 109, pp.146-176.
Berrospide, J. and Edge, R. (2010). ‘The Effects of Bank Capital on Lending: What Do We Know, and What Does it
Mean?’, International Journal of Central Banking, pp.5-54.
Berthelsen, C. and Iosebachvili, I. (2014). ‘Goldman Sachs Sells Aluminum Business to Swiss Firm’, The Wall Street
JournalBirn, M., Dietsch, M., and Durant, D. (2015). ‘How banks proceed to reach the four Basel III ratios at the same time?
Modeled and observed analysis’.
BIS (2014). Press Release: Final standard for measuring and controlling large exposures published by the BaselCommittee. [online] Available at: http://www.bis.org/press/p140415.htm [Accessed 29 Jun. 2016].
BIS (2016a). About the Basel Committee. [online] Available at:https://www.bis.org/bcbs/about.htm?m=3%7C14%7C573 [Accessed 1 Apr. 2016].
BIS (2016b). Basel Committee groups. [online] Available at: http://www.bis.org/bcbs/groups.htm [Accessed 1 Apr.
2016].
BIS (2016c). Basel III: the net stable funding ratio. [online] Available at: http://www.bis.org/bcbs/publ/d295.htm[Accessed 1 Apr. 2016].
BIS (2016d). History of the Basel Committee. [online] Available at: https://www.bis.org/bcbs/history.htm [Accessed
1 Apr. 2016].
BIS (2016e). International regulatory framework for banks (Basel III). [online] Available at:
http://www.bis.org/bcbs/basel3.htm [Accessed 1 Apr. 2016].
BIS (2016f). Margin requirements for non-centrally cleared derivatives - final document. [online] Available at:
http://www.bis.org/publ/bcbs261.htm [Accessed 1 Apr. 2016].
BIS (2016g). The Basel Committee's work programme for 2015 and 2016. [online] Available at:
http://www.bis.org/bcbs/about/work_programme.htm [Accessed 1 Apr. 2016].
BIS (2016h). Operational risk - Revisions to the simpler approaches - consultative document. [online] Available at:
http://www.bis.org/publ/bcbs291.htm [Accessed 2 Apr. 2016].
BIS (2016i). Countercyclical capital buffer (CCyB). [online] Available at: http://www.bis.org/bcbs/ccyb/ [Accessed 3
Apr. 2016].
BIS (2016j). Comments received on the “TLAC Holdings - consultative document”. [online] Available at:
http://www.bis.org/bcbs/publ/comments/d342/overview.htm [Accessed 4 Apr. 2016].
BIS (2016k). Revisions to the Basel II market risk framework - updated as of 31 December 2010. [online] Available at
http://www.bis.org/publ/bcbs193.htm [Accessed 5 Apr. 2016].
BIS (2016l). The global policy reform agenda: completing the job. [online] Available at
http://www.bis.org/speeches/sp160405.htm [Accessed 10 Apr. 2016]© Oliver Wyman

135

Appendix D

Post Crisis Basel Reforms

BIS (2016m). Revised market risk framework and work programme for Basel Committee is endorsed by its governing
body. [online] Available at http://www.bis.org/press/p160111.htm [Accessed 16 June 2016]
Blackrock (2016). The “New Normal” For Fixed Income Liquidity - Implications for Insurance Companies.
Blagov, B., Funke, M., and Moessner, R. (2015). ‘Modelling the Time-Variation in Euro Area Lending Spreads’, BIS
Working Paper (526).
Board of Governors of the Federal Reserve System (2015). Press Release: Federal Reserve Board approves final rule
requiring the largest, most systemically important US bank holding companies to further strengthen their capital
positions. [online] Available at: https://www.federalreserve.gov/newsevents/press/bcreg/20150720a.htm[Accessed 10 June 2016].
Board of Governors of the Federal Reserve System (2016). FRB: Stress Tests and Capital Planning. [online] Available
at: https://www.federalreserve.gov/bankinforeg/stress-tests-capital-planning.htm [Accessed 1 Apr. 2016].
Bonner, C. (2012). ‘Liquidity Regulation, Funding Costs and Corporate Lending’, DNM Working paper, (526).
Bonner, C. (2014). ‘Preferential Regulatory Treatment and Banks Demand for Government Bonds’, Tilburg
University Center Discussion Paper, (2015-056).
Bonner, C. and Eijffinger, S. (2012). ‘The impact of the LCR on the interbank money market’, DNB Working Paper,(364).
Bordeleau, E. and Graham, C. (2010). ‘The impact of Liquidity on Bank Profitability’, Bank of Canada Working Paper,(2010-38).
Botero, D. (2015). ‘Basel and Securitization: Conflicting Incentives and Rationales’, Verba Iuris, pp.17-36.
Brana, S. and Lahet, D. (2009). ‘Capital Requirement and Financial Crisis: The Case of Japan and the 1997 Asian
Crisis’, Japan and the World Economy 21, no. 1 (2009): 97-104.
Brandi, Schmitz, and Hambloch (2013). ‘The Availability of Trade Finance: A Challenge for Global Economic
Governance’, German Development Institute.
Bridges, J., Gregory, D., Nielsen, M., Pezzini, S., Radia, A., and Spaltro, M. (2014). ‘The impact of capitalrequirements on bank lending’, Bank of England Working Paper, (486).
Brooke, M., Bush, O., Edwards, R., Ellis, J., Francis, B., Harimohan, R., Neiss, K., and Siegert, C. (2015). ‘Measuring
the macroeconomic costs and benefits of higher UK bank capital requirements’, Bank of England Financial Stability
Paper, (35).
Brunnermeier, M. and Pedersen, L. (2009). ‘Market Liquidity and Funding Liquidity’. Review of Financial Studies,
22: 6, 2201–2238
Brush, S. (2014). ‘State Street Exiting Swaps Clearing Business, Citing New Rules’, Bloomberg
Calomiris, C.W. (2013). ‘Reforming Banks Without Destroying Their Productivity and Value’, Journal of Applied
Corporate Finance, 25(4), pp. 14-20.
Cappiello, L., Kadareja, A., Sorensen, C. K., and Protopapa, M. (2010). ‘Do Bank Loans and Credit Standards Havean Effect on Output?’, European Central Bank Working Paper Series, (1150).
Carlson, M., Shan, H., and Warusawitharana, M. (2011) ‘Capital Ratios and Bank Lending: A Matched Bank
Approach’, Federal Reserve Board Finance and Economics Discussion Series, (2011-34)
Carney, M. to Treasury Select Committee, (2016). Letter from Mark Carney, Governor, Bank of England, to Rt Hon
Andrew Tyrie MP, 5 April 2016.
Caruana, J., Kay, J. and Tucker, P. (2015) ‘Towards a “New Normal” in financial markets?’ BIS Papers (84)
Castren, O. and Kavonius, I. K. (2009). ‘Balance sheet interlinkages and macro-financial risk analysis in the euroarea’, European Central Bank Working Paper Series, (1124).
Central Bank of Luxembourg (2013). Impact assessment of the new liquidity rules on Luxembourg banks.

136© Oliver Wyman

Post Crisis Basel Reforms

Appendix D

Cetina, J. (2015). ‘Incorporating Liquidity Shocks and Feedbacks in Bank Stress Test’, Office of Financial Research
Brief Series.
Cetina, J. and Gleason, K. (2015). ‘The Difficult Business of Measuring Banks’ Liquidity: Understanding the Liquidity
Coverage Ratio’, Office of Financial Research Working Paper.
CGFS (2011). The macrofinancial implications of alternative configurations for access to central counterparties in OTC
derivatives markets. BIS, (46).
CGFS (2012). Operationalising the selection and application of macroprudential instruments. BIS, (48).
CGFS (2013). Asset encumbrance, financial reform and the demand for collateral assets. BIS, (49).
CGFS (2014a). EME banking systems and regional financial integration. BIS (51).
CGFS (2014b). Market-making and proprietary trading: industry trends, drivers and policy implications. BIS, (52).
CGFS (2015a). Central bank operating frameworks and collateral markets. BIS, (53).
CGFS (2015b). Regulatory change and monetary policy. BIS, (54).
CGFS (2016). Fixed income market liquidity. BIS, (55).
Choi, D.B. and Choi, H. (2016). ‘Would Monetary Tightening Increase Bank Wholesale Funding?’, Federal Reserve
Bank of New York Liberty Street Economics.
Choudhury, A., Griffin, D. and Xydias, A. (2011). ‘Finance Job Losses Near 200,000 as BNP, Citigroup Cut Staff’,
Bloomberg
Christensen, I., Meh, C. and Moran, K. (2011). ‘Bank Leverage Regulation and Macroeconomic Dynamics’, Bank of
Canada Working Paper, (2011-32).
Christie, R. and Glover, J. (2015). ‘Shadow-Bank Ties to Lenders in Crosshairs of Basel Supervisors’, Bloomberg.
Clark, B., Jones, J. and Malmquist, D. (2015). ‘Leverage and the cost of capital: Testing the relevance of the
Modigliani-Miller theorem for US banks’, Office of the Comptroller of the Currency Working Paper.
Clerc, L., Derviz, A., Mendicino, C., Moyen, S., Nikolov, K., Stracca, L., Suarez, J. and Vardoulakis, A. (2014). ‘Capital
Regulation in a Macroeconomic Model with Three Layers of Default’, Banque de France Document De Trevail, (533).
Cline, W. R. (2016). ‘Benefits and Costs of Higher Capital Requirements for Banks’, Peterson Institute for National
Economics, 16(6).
Cohen, B. H. (2013). ‘How have banks adjusted to higher capital requirements?’, BIS Quarterly Review, (September2013).
Cohen, B. H. and Scatigna, M. (2014). ‘Banks and capital requirements: channels of adjustment’, BIS Working Paper(443).
Copeland, A., Duffie, D., Martin, A., and McLaughlin, S. (2012). Key Mechanics of the US Tri-Party Repo Market
Corbae, D. and D’Erasmo, P. (2014). ‘Capital requirements in a quantitative model of banking industry dynamics’,
Federal Reserve Bank of Philadelphia Working Paper, (14-13).
Corwin, S.A. and Schultz, P. (2012). ‘A Simple Way to Estimate Bid-Ask Spreads from Daily High and Low Prices’,
The Journal of Finance, 67(2), pp. 719-760.
Cosimano, T. and Hakura, D. S. (2011). ‘Bank Behavior in Response to Basel III: A Cross-Country Analysis’, IMF
Working Papers, 11(119).
Council on Foreign Relations (2015). The Credit Rating Controversy.
Covas, F. and Driscoll, J. (2014). ‘Bank Liquidity and Capital Regulation in General Equilibrium’, Federal Reserve
Board, Finance and Economics Discussion Series.
Credit Suisse (2016). Press Release: Credit Suisse Accelerates its restructuring. [online] Available at:https://www.credit-suisse.com/us/en/about-us/media/news/articles/media-releases/2016/03/en/acceleratesrestructuring-global-markets.html [Accessed 19 July 2016].

© Oliver Wyman

137

Appendix D

Post Crisis Basel Reforms

Dagher, J., Dell’Ariccia, G., Laeven, L., Ratnovski, L. and Tong, H. (2016). ‘Benefits and Costs of Bank Capital’,
International Monetary Fund, 16(4), pp.1-38.
Danielsson, J., James, K., Valenzuela, M. and Zer, I. (2015). ‘Can We Prove a Bank Guilty of Creating Systemic Risk?
A Minority Report’, The London School of Economics and Political Science SRC Discussion Paper, (47).
Davis, J., Smith, B., Wagner, M., O’Kelly, R. (2013). ‘The Impact of the EU-11 Financial Transaction Tax on EndUsers’, Oliver Wyman.
Dawn (2015). Europe’s next banking headache: Basel IV. [online] Available at:
http://www.dawn.com/news/1183220 [Accessed 1 April 2016].
de Bandt, O., Camara, B., Pessarossi, P., and Rose, M. (2014a). ‘Does the capital structure affect banks’profitability? Pre- and post-financial crisis evidence from significant banks in France’, Autorité de Contrôle Prudentiel
et de Resolution Banque de France Debats Economiques et Financiers, (12).
de Bandt, O., Camara, B., Pessarossi, P., and Rose, M. (2014b). ‘Regulatory changes and the cost of equity:
evidence from French banks’, Autorité de Contrôle Prudentiel et de Resolution Banque de France Debats Economiqueset Financiers, (11).
De Marco, F. and Wieladek, T. (2015). ‘The Real Effects of Capital Requirements and Monetary Policy: Evidence
from the United Kingdom’, Bank of England Staff Working Paper, (573).
De Nicolo, G. (2015). Revisiting the impact of bank capital requirements on lending and real activities.
De Nicolo, G., Gamba, A. and Lucchetta, M. (2014). ‘Microprudential Regulation in a Dynamic Model of Banking’,
Review of Financial Studies, 27(7), pp.2097-2138.
DeAngelo, H. and Stulz, R. (2013). ‘Why High Leverage is Optimal for Banks’, NBER Working Paper,(19139).Demirguc-Kunt, A. and Huizinga, H. (1999), ‘Determinants of commercial bank interest margins andprofitability: Some international evidence’, The World Bank Economic Review, 13(2), pp. 379-408.
de-Ramon, S., Iscenko, Z., Osborne, M., Straughan, M., and Andrews, P. (2012). ‘Measuring the impact ofprudential policy on the macroeconomy: A practical application to Basel III and other responses to the financial
crisis’, Financial Services Authority Occasional Paper Series, (42).
Deutsche Bank to Svein Andresen, General Secretary of the Financial Stability Board (2015). Deutsche Bank
response to Financial Stability Board consultation on adequacy of loss-absorbing capacity of global systemicallyimportant banks (G-SIBs) in resolution.
DeYoung, R. and Jang, K.Y. (2015). ‘Do banks actively manage their liquidity?’, Journal of Banking & Finance, 66.
Diamond, D., Kashyap, A. (2015). ‘Liquidity requirements, liquidity choice and financial stability’, University of
Chicago Booth School of Business and National Bureau of Economic Research.
Dib, A. (2010). ‘Capital requirement and financial frictions in banking: macroeconomic implications’, Bank of
Canada Working Paper, (2010-26).
Distinguin, I., Roulet, C. and Tarazi, A. (2013). ‘Bank regulatory capital and liquidity: Evidence from US andEuropean publicly traded banks’, Journal of Banking & Finance, 37(9), pp. 3295–3317.
Drehmann, M. and Gambacorta, L. (2011). ‘The effects of countercyclical capital buffers on bank lending’, Applied
Economics Letters, 19(7), pp. 603–608.
Duane, M. and Fine, A. (2014). ‘The Liquidity Coverage Ratio Proposal’, Oliver Wyman.
Dubecq, S., Mojon, B. and Ragot, X. (2009). ‘Fuzzy capital requirements, risk-shifting and the risk taking channel ofmonetary policy’, Banque de France Working Paper, (254).
Duffie, D. (2010). ‘The Failure Mechanics of Dealer Banks’, Journal of Economic Perspectives, 24(1), pp. 51-72.
Duffie, D. (2012a). Market Making Under the Proposed Volcker Rule.
Duffie, D. (2012b). Replumbing Our Financial System: Uneven Progress.
Duffie, D. (2013). ‘Capital Requirements with Robust Risk Weights’, The Brookings Institute.

138© Oliver Wyman

Post Crisis Basel Reforms

Appendix D

Duffie, D., Scheicher, M., and Vuillemey, M. (2014). ‘Central Clearing and Collateral Demand’, European Central
Bank Working Paper Series, (1638).
Duprey, T., Klaus, B. and Peltonen,T. (2015). ‘Dating Systemic Financial Stress Episodes in the EU Countries’,
European Central Bank Working Paper Series, (1873).
Durand, H. (2015). ‘Market frets as Basel turns up heat on risk weights’, Reuters.
EACB (2015). EACB position paper FSB Consultative Document on Adequacy of loss-absorbing capacity of global
systemically important banks in resolution.
EBA (2013). Report on impact assessment for liquidity measures under Article 509(1) of the CRR.
EBA (2014). Second report on impact assessment for liquidity measures under Article 509(1) of the CRR.
EBA (2015a). Overview of the potential implications of regulatory measures for banks’ business models.
EBA (2015b). Report on Net Stable Funding Requirements under Article 510 of the CRR.
EBA (2015c). Risk Dashboard Data as of Q4 2015.
EBA (2016a). EU-wide stress testing - European Banking Authority. [online] Available at:
http://www.eba.europa.eu/risk-analysis-and-data/eu-wide-stress-testing [Accessed 1 Apr. 2016].
EBA (2016b). CRD IV – CRR/Basel III Monitoring Exercise.
EBA (2016c). Consultation on BCBS/D347 on “Revisions to the Standardised Approach for Credit Risk”.
EBF (2015). EBF Response to the FSB’s consultative document on Total Loss Absorbing Capacity (TLAC).
ECB (2014). Collateral Eligibility and Availability.
ECB (2015). The impact of the CRR and CRD IV on bank financing.
Elliott, D. J. (2009). ‘Quantifying the effects on lending of increased capital requirements’, The Brookings Institution.
Elliott, D. J. (2010a). ‘A Further Exploration of Bank Capital Requirements: Effects of Competition from Other
Financial Sectors and Effects of Size of Bank or Borrower and of Loan Type’, The Brookings Institution.
Elliott, D. J. (2010b). ‘A Primer on Bank Capital’, The Brookings Institution.
Elliott, D. J. (2013a). ‘Higher bank capital requirements would come at a price’, The Brookings Institution.
Elliott, D. J. (2013b). ‘Excessive Bank Equity Rules Would Slow the Economy’, The Brookings Institution.
Elliott, D. J. (2015). ‘Market Liquidity: A primer’, The Brookings Institution.
Elliott, D., Salloy, S, and Santos, A. (2012). ‘Assessing the Cost of Financial Regulation’, IMF Working Papers,
12(233).
Elliott, D.J., Feldberg, G., and Lehnert, A. (2013). ‘The History of Cyclical Macroprudential Policy in the UnitedStates’, Office of Financial Research Working Paper, (0008).
ESRB (2015). ESRB report on the regulatory treatment of sovereign exposures.
Euromoney. (2016) ‘AT1: Banks suffer a fundamental sell-off.’ [Online]. 31 May 2016.
Europe Economics (2016). The Uses (and Abuses) of Modelling Adjustments: Modelling adjustments in Internal ratings
Based models of Risk Weights.
European Commission (2014a). Economic Review of the Financial Regulation Agenda.
European Commission (2014b). Proposal for a Regulation of the European Parliament and of the Council on structural
measures improving the resilience of EU Credit Institutions.
European Commission (2014c). Proposal for a Regulations of the European Parliament and of the Council on reporting
and transparency of securities financial transactions.
European Commission (2015). DG FISMA Consultation Paper on the Possible Impact of the CRR and CRD IV on Bank
Financing of the Economy.
European Commission (2016). Summary of contributions to the ‘Call for Evidence’.

© Oliver Wyman

139

Appendix D

Post Crisis Basel Reforms

Experts Group for the FSB (2015). ‘Assessing the Economic Costs and Benefits of TLAC implementation.’ BIS.
Federal Financial Analytics, Inc. (2015). Where The Money Goes and Why it Matters: The Market and Policy Impact ofReduced Custody-Bank Deposit Capacity.
Federal Reserve Bank of Cleveland (2014). What’s Behind the Decline in Tri-party Repo Trading Volumes?
Federal Reserve Bank of New York (2016a). Primary Dealer Statistics Historical Search. [online] Available at:
http://nyapps.newyorkfed.org/markets/gsds/search.html [Accessed 1 April 2016].
Federal Reserve Bank of New York (2016b). Triparty Repo. [online] Available at: https://www.newyorkfed.org/dataand-statistics/data-visualization/tri-party-repo#interactive/volume [Accessed 19 May 2016].
Federal Reserve System (2015a). Depiction of Proposed LTD Requirement + Fully Phased-in Tier 1 Risk-Based Capital
Requirements. [Online] https://www.federalreserve.gov/aboutthefed/boardmeetings/ltd-chart-20151030.pdf[Accessed 27 May 2016]
Federal Reserve System (2015b). Total Loss-Absorbing Capacity, Long-Term Debt, and Clean Holding Company
Requirements for Systemically Important US Bank Holding Companies and Intermediate Holding Companies of
Systemically Important Foreign Banking Organizations; Regulatory Capital Deduction for Investments in Certain
Unsecured Debt of Systemically Important US Bank Holding Companies; Proposed Rule. [Online]
https://www.regulations.gov/#!documentDetail;D=FRS-2015-0390-0001 [Accessed 27 May 2016]
Fender, I. and Lewrick, U. (2015a). ‘Calibrating the leverage ratio’, BIS Quarterly Review.
Fender, I. and Lewrick, U. (2015b). ‘Shifting tides – market liquidity and market-making in fixed income
instruments’, BIS Quarterly Review.
Fernandez-Villaverde, J. (2009). ‘The Econometrics of DSGE Models’, NBER Working Paper, (14677).
Feroli, M., Kashyap, A.K, Shoenholtz, K., Shin, H. (2014). ‘Market Tantrums and Monetary Policy’, Chicago BoothThe Initiative on Global Markets Working Paper, (101).
Financial Services Roundtable (2016). Rules in Focus: Fed Proposes G-SIB Surcharge. [online] Available at:
http://fsroundtable.org/rules-focus-fed-proposes-g-sib-surcharge/# [Accessed 16 May 2016].
Fitch (2012). Complete Sovereign Rating History - Fitch Ratings. [Online]
https://www.fitchratings.com/web_content/ratings/sovereign_ratings_history.xls [Accessed 27 May 2016].
Flood, M.D., Liechty, J.C., and Piontek, T. (2015). ‘Systemwide Commonalities in Market Liquidity’, Office ofFinancial Research Working Paper, (15-11).
Foglia, A., Piersante, F. and Santoro, R. (2010). ‘The importance of the bank balance sheet channel in thetransmission of shocks to the real economy’.
Foran, B., Moszkowski, G., and Elliott, G. (2016). ‘US Banks, An Investor’s Guide to Banks’, Autonomous.
Forbes (2014). ‘Credit Suisse Announces Strong Q3 Results, Plans To Shrink Investment Bank Further’Forbes (2015). Q2 2015 US Banking Review: Common Equity Tier 1 Capital Ratios.
Fraisse, H., Le, M., and Thesmar, D. (2015). ‘The real effects of bank capital requirements’, Banque de France Debats
economiques et financiers, (8).
Francis, W. and Osborne, M. (2009a). ‘Bank Regulation, Capital and Credit Supply: Measuring the Impact ofPrudential Standards’, UK Financial Services Authority Occasional Paper, (36).
Francis, W. and Osborne, M. (2009b). ‘On the behavior and determinants of risk-based capital ratios: revisiting theevidence from UK banking institutions’, Financial Services Authority Occasional Paper Series, (31).
Francis, W. and Osborne, M. (2012). ‘Capital requirements and bank behaviour in the UK: are there lessons forinternational capital standards? ’ Journal of Banking & Finance, 36(3), pp 803–816.
Franklin, J., Rostom, M., and Thwaites, G. (2015). ‘The Banks That Said No: Banking Relationships, Credit Supply
and Productivity in the United Kingdom’, Bank of England Staff Working Paper, (557)
Freixas, X., Laeven, L. and Peydro, J. (2015). ‘Systemic Risk, Crises, and Macroprudential Regulation’, MIT Press.

140© Oliver Wyman

Post Crisis Basel Reforms

Appendix D

Frenkel, M. and Rudolf, M. (2010). The Implications of Introducing an Additional Regulatory Constraint on Banks’Business Activities in the Form of a Leverage Ratio.
FSB (2015). Principles on Loss-absorbing and Recapitalisation Capacity of G-SIBs in Resolution and Total Loss-absorbing
Capacity (TLAC) Term Sheet.
FSB and BCBS (2015). Summary of Findings from the TLAC Impact Assessment Studies Overview Report.
Furceri, D. and Mourougane, A. (2009). ‘The effect of financial crises on potential output: new empirical evidence
from OECD countries’, OECD Economics Department Working Papers, (699).
Furfine, C., Groeneveld, H., Hancock, D., Jones, D., Perraudin, W., Radecki, L. and Yoneyama, M. (1999). ‘Capitalrequirements and bank behaviour: the impact of the Basel Accord’, Basel Committee on Banking Supervision Working
Papers, 1.
G20 Leaders (2009). Leader’s Statement The Pittsburgh Summit.
Gabrielsen, A., Marzo, M. and Zagaglia, P. (2011). Measuring market liquidity: An introductory survey.
Galiay, A. and Maurin, L. (2015). ‘Drivers of banks’ cost of debt and long-term benefits of regulation – An empiricalanalysis based on EU banks’, ECB Working Paper Series, (1849).
Gallardo, G.G., Schuermann, T., and Duane, M. (2015). Stress Testing Convergence.
Galles, C. and Vallas, A. (2014). ‘Eurozone: Corporate Financing via Market: An Uneven Development Within theEurozone’, Societé Générale EcoNote, (24).
Galper, J. (2015). ‘Securities Lending, Market Liquidity and Retirement Savings: The Real World Impact’, Finadium.
Gambacorta, L. (2011). ‘Do Bank Capital and Liquidity Affect Real Economic Activity in the Long Run? A VECM
Analysis for the US’, Economic Notes, 40(3), pp.75-91.
Gambacorta, L. and Mistrulli, P. (2004). ‘Does bank capital affect lending behavior?’ Journal of Financial
Intermediation, 13(4), pp.436-457.
Gambacorta, L. and Shin, H. S. (2016). ‘Why bank capital matters for monetary policy’. BIS Working Papers, (558).
Gambacorta, L. and van Rixtel, A. (2013). ‘Structural bank regulation initiatives: approaches and implications’, BIS
Working Papers, (412).
Gauthier, C., Lehar, A. and Souissi, M. (2010). ‘Macroprudential Regulation and Systemic Capital Requirements’,Bank of Canada Working Paper, (2010-4).
George, R. and Mohan, T. (2015) ‘Liquidity Coverage Ratio Requirement Increases Cost of Securitization for US
Banks’, The Journal of Structured Finance, 20(4), pp. 13-21
GFMA and IIF to the Federal Reserve System (2016). GFMA and IIF Submit Comments to the FRB Governors Regarding
Market Liquidity.
GFMA and The Clearing House (2013a). Responding to the revised Basel III leverage framework (Extrapolation).
GFMA and The Clearing House (2013b). Responding to the revised Basel III leverage framework (Survey Results).
GFMA to BCBS (2016). Re: Comments in response to Consultative Document: Haircut floors for non-centrally cleared
securities financing transactions.
GFMA, ABA, FSR, IIB, IIF, and ISDA to BCBS (2013). Re: Comments in Response to the Consultative Document on the
Revised Basel III Leverage Ratio Framework and Disclosure Requirements.
GFMA, CRE Finance Council, Commercial Real Estate Financial Council Europe, IIF, IACPM, ISDA, SFIG, and SFJ to
the BCBS (2014). Joint Associations' response to the second Consultative Document on Revisions to the Baselsecuritisation framework.
GFMA, CRE Finance Council, Commercial Real Estate Financial Council Europe, IIF, IACPM, ISDA, SFIG, and SFJ to
the BCBS (2014). Further data and analysis relating to the proposed Revisions to the Basel securitization framework.
GFMA, IIF, and PwC (2015). Global financial markets liquidity study.
GFMA, ISDA and IIF (2015). Joint Associations’ NSFR Derivatives Study. Unpublished report, cited with permission© Oliver Wyman

141

Appendix D

Post Crisis Basel Reforms

Giordana, G. and Schumacher, I. (2012). ‘An empirical study on the impact of Basel III standards on banks’ default
risk: the case of Luxembourg’, Central Bank of Luxembourg BLC Working Paper, (79).
Glasserman, P. and Loudis, B. (2015). ‘A Comparison of US and International Global Systemically Important Banks’,
Office of Financial Research Brief Series, (15-07).
GlobalCollateral, DTCC, Euroclear, and Finadium (2015). Taking action on Collateral.
Glover, J. (2016). ‘Basel Should Stick to Leverage Ratio as Risk Backstop, ING Says’, Bloomberg.
Gobat, J., Yanase, M. and Maloney. J. (2014). ‘The Net Stable Funding Ratio: Impact and Issues for Consideration’,
IMF Working Paper, (14/106).
Goldman Sachs (2014). Four Trends Shaping Markets and Economies: Annual Report 2014
Goldman Sachs (2015). ‘United States Banks: TLAC rule financially manageable, operationally challenging.’ Equity
Research
Goodhart, C.A.E., Kashyap, A.K., Tsomocos, D.P., and Vardoulakis, A.P. (2012). ‘Financial Regulation in General
Equilibrium’, NBER Working Paper Series, (17909).
Gorton, G., Lewellen, S. and Metrick, M. (2011). The cost of bank capital: thinking beyond Modigliani and Miller.
Graham, S., Li, L., and Kruse, J. (2016). European Banks: Basel 4: Playing out.
Greenlaw, D., Kashyap, A.K., Shoenholtz, K., Shin, H.S. (2012). ‘Stressed Out: Macroprudential Principles for Stress
Testing’, Chicago Booth The Initiative on Global Markets Working Paper, (71).
Haber, S. and Calomiris, C. (2014). Fragile by Design: The Political Origins of Banking Crises and Scarce Credit.
Princeton, NJ: Princeton University Press.
Hale, Thomas and McCrum, Dan. (2016) “Why Coco Bonds Are Worrying Investors”. Financial Times. [Online]. 31
May 2016.
Hamaide, S. and Johnson, C. (2011). ‘Credit Agricole Quits Commodity Trade as Crisis Bites’, Reuters
Hancock, D. and Wilcox, J. (1994). ‘Bank Capital and the Credit Crunch: The Roles of Risk-Weighted andUnweighted Capital Regulations’, Real Estate Economics, 22, pp.59-91.
Hancock, D., Laing, A. J., Wilcox, J. A. (1995). ‘Bank Capital Shocks: Dynamic Effects on Securities, Loans andCapital’, Journal of Banking and Finance, 19, pp. 661-677
Hanson, S. G., Kashyap, A. K., and Stein, J. C. (2011). ‘A Macroprudential Approach to Financial Regulation. Journalof Economic Perspective, 25(1), pp. 3-28.
Hanson, S. G., Scharfstein, D. S. and Sunderam, A. (2014). ‘An Evaluation of Money Market Fund Reform Proposals.
IMF Economic Review, 63(4), pp. 984–1023.
Harris, R.E. (2015). ‘Sovereign Debt Exposure – Opportunities for Regulatory Improvements’, George Washington
University.
Haselkorn, D., Pedersen, C., Kaya, U., and Tan, R. (2011). ‘Basel III Liquidity Metrics: In Need of Refinement’, Oliver
Wyman.
Hirtle, B. (2011). ‘Using Crisis Losses to Calibrate a Regulatory Capital Buffer’, Federal Reserve Bank of New York
Liberty Street Economics.
HM Treasury (2013). ‘Impact Assessment of the Financial Services (Banking Reform) Bill’.
ICC to BCBS (2015). Subject: Revisions to the Standardised Approach to credit risk.
ICMA (2012). Shadow banking and repo.
ICMA (2016). European Repo Market Survey.
IIF (2011). The Cumulative Impact on the Global Economy of Changes in the Financial Regulatory Framework.
IIF (2014). Risk-Sensitivity: The Important Roles of Internal Models.
IIF (2015). Market Liquidity in Emerging Markets.

142© Oliver Wyman

Post Crisis Basel Reforms

Appendix D

IIF (2016). Basel Capital Reforms, Key Data Points on Potential Impacts.
IIF to Mr. William Coen (2016). Re: Consultative Document, Reducing variation in credit risk-weighted assets –constraints on the use of internal model approaches.
IIF, GFMA, ICMA, TCH, and ISDA to BCBS (2014). Joint Associations’ Submission re.: Consultative Document: Basel III,
the Net Stable Funding Ratio.
IIF, GFMA, ISDA, and IACPM to BCBS (2016). Re: Comments on the second consultative document on revisions to thestandardized approach for credit risk.
IIF, IBF, GFMA, ISDA to TFIR (2014) Re: Industry comments on the proposed IRRBB/CSRBB QIS templates.
IMF (2014). Global Financial Stability Report Risk Taking, Liquidity, and Shadow Banking: Curbing Excess While
Promoting Growth.
IMF (2015a). Global Financial Stability Report Navigating Monetary Policy Challenges and Managing Risks. World
Economic and Financial Survey.
IMF (2015b). Global Financial Stability Report Vulnerabilities, Legacies, and Policy Challenges Risks Rotating toEmerging Markets. World Economic and Financial Survey.
IMF (2015c). International Banking After the Crisis: Increasingly Local and Safer? Global Financial Stability Report.
pp.55-91.
IMF (2016). Global Financial Stability Report Potent Policies for a Successful Normalization. World Economic andFinancial Survey.
ISDA and Atrevida Partners LLC (2010). Interest Rate Swap Liquidity Test: A report sponsored by the International
Swaps and Derivatives Association.
ISDA, GFMA, and IIF (2015). Industry FRTB QIS Analysis.
ISDA, GFMA, and IIF to BCBS. (2015). Re: Industry Response to the BCBS Consultative Paper on the Review of the Credit
Valuation Adjustment Risk Framework – BCBS 325, published in July 2015.
Ivashina, V., Scharfstein, D.S., and Stein, J.C. (2015). ‘Dollar Funding and the Lending Behavior of Global Banks’,
Quarterly Journal of Economics, 130(3), pp. 1241–1281.
J.P. Morgan (2010). ‘European Banks Regulatory fears now over-discounted’. Europe Equity Research.
J.P. Morgan (2014). Leveraging the Leverage Ratio.
J.P. Morgan (2015). A defining moment, New regulations and their impact on the definition of cash deposits.
J.P. Morgan (2016). Final FRTB Ruling Raises Capital for ABS, CMBS and Non-agency MBS.
J.P. Morgan Cazenove (2010). ‘Global Investment Banks Dodd/Lincoln Bill Analysis: implications for the future
structure of the IB industry.’ Europe Equity Research.
J.P. Morgan Cazenove (2011). European Banks: All eyes on funding: LCR, the next undiscounted regulatory headwind.
J.P. Morgan Cazenove (2012). ‘Global Investment Bank IB landscape changes across the globe – the path to an
acceptable ROE for Tier I and II players.’ Global Equity Research.
J.P. Morgan Cazenove (2015). ‘European Banks: Harmonizing bank capital ratios to drive stock
J.P. Morgan Cazenove (2016). ‘European Banks: Top picks and Investment themes for 2016.’ Europe Equity
Research.
J.P. Morgan Chase & Co. (2013). Annual Report 2013.
J.P. Morgan Chase & Co. (2014). Annual Report 2014.
J.P. Morgan Chase & Co. (2015). 2015 Annual Report – Letter to shareholders.
Jakovljevic, S., Degryse, H. and Ongena, S. (2015). ‘A review of empirical research on the design and impact ofregulation in the banking sector’, The Annual Review of Financial Economics, 7, pp 423–443.

© Oliver Wyman

143

Appendix D

Post Crisis Basel Reforms

Jeffery, Erica and Verma, Sid. (2016) ‘AT1 capital/CoCo bonds: what you should know’. Euromoney. [Online]. 31
May 2016.
Jenkins, P. (2016). ‘Sovereign risk system needs reforming’, Financial Times.
Jimenez, G., Ongena, S., Peydró, J. L. and Saurina, J. (2014). Macroprudential policy, countercyclical bank capital
buffers and credit supply: Evidence from the Spanish dynamic provisioning experiments.
Johnson, D.C. (2015). ‘Private Fund Data Shed Light on Liquidity Funds’, Office of Financial Research Brief Series.
Jones, H. (2015). ‘UPDATE 1-Global bank watchdog to review rule on zero-risk weighting for sovereign debt’,
Reuters.
Jones, H. (2016). ‘Japanese regulator says banks should keep role in determining lending risks’, Reuters.
Kang, W., Rouwenhorst, K. G. and Tang, K. (2014). ‘The Role of Hedgers and Speculators in Liquidity Provision to
Commodity Futures Markets’, Yale International Center for Finance Working Paper, (14-24).
Kapan, T. and Minoiu, C. (2013). ‘Balance sheet strength and bank lending during the global financial crisis’, IMF
Working Paper, (13/102).
Kapinos, P., Mitnik, O. and Martin, C. (2015). ‘Stress Testing Banks: Whence and Whither?’, Federal Deposit
Insurance Corporation and Center for Financial Research Working Paper Series, (7).
Kasekende, L., Bagyenda, J., and Brownbridge, M. (2011). ‘Basel III and the global reform of financial regulation:
how should Africa respond? A bank regulators perspective’, New Rules for Global Finance, Washington, DC.
Kashyap, A., Stein, J. and Hanson, S. (2010). ‘An Analysis of the Impact of “Substantially Heightened” Capital
Requirements on Large Financial Institutions’, Harvard Business School.
Kashyap, A.K. and Stein, J.C. (2000). ‘What Do a Million Observations on Banks Say About the Transmission of
Monetary Policy?’, American Economic Review, 90(3), pp. 407-428
Kashyap, A.K., Tsomocos, D.P., and Vardoulakis, A.P. (2014a). How does macroprudential regulation change bankcredit supply?
Kashyap, A.K., Tsomocos, D.P., and Vardoulakis, A.P. (2014b). ‘Principles for macroprudential regulation’, Banquede France Financial Stability Review, (18).
Kato, R., Kobayashi, S. and Saita, Y. (2010). ‘Calibrating the Level of Capital: The Way We See It’, Bank of Japan
Working Paper Series, (10-E-6).
Keenan, O. and Spick, M. (2015). ‘F.I.T.T. for investors Basel 4 - Truth and Advertising’, Deutsche Bank Market
Research.
Kiema, I. and Jokivuolle, E. (2014). ‘Does a leverage ratio requirement increase Bank stability?’, European Central
Bank Working Paper Series, (1676)
Killian, T.W. (2016). ‘Total Loss Absorbing Capacity (TLAC): Material Repercussions and Disruptions for US Banksand Investors’, Sandler O'Neill Partners.
King, M.R. (2010). ‘Mapping Capital and Liquidity Requirements to Bank Lending Spreads.’ BIS Working Papers,(324).
King, M.R. (2013). ‘The Basel III Net Stable Funding Ratio and Bank Net Interest Margins’, Journal of Banking &Finance, 37(11), pp. 4144-4156.
Kisin, R. and Manela, A. (2015). ‘The Shadow Cost of Bank Capital Requirements’, Washington University in St. Louis.
Kolesnikova, M. (2014). ‘Barclays Plans to Exit Most Commodities Activities’, Bloomberg
Kowalik, M. (2011). ‘Countercyclical Capital Regulation: Should Bank Regulators Use Rules or Discretion?’,Economic Review, (QII).
KPMG (2015). Basel 4 Revisited.
Krouse, S. and Vaishampayan, S. (2015). ‘Exiting automated US options market-making activities’, The Wall Street
Journal144© Oliver Wyman

Post Crisis Basel Reforms

Appendix D

Kupeic, P.H. (2016). ‘Fixing Prompt Corrective Action’, American Enterprise Institute Economics Working Paper,(2016-03).
Kutler, J. (2010). US in the Background on Basel Regulatory Debate.
Le Lesle, V. (2012). ‘Bank debt in Europe: are Funding models broken?’, IMF Working Paper, (12/99).
Lea, M. (2010). ‘International Comparison of Mortgage Product Offerings’. Research Institute of Housing America
and Mortgage Bankers Association.
Liu, Y. and Morley, B. (2013). ‘Sovereign Credit Ratings, the Macroeconomy and Credit Default Swap Spreads’,
Brussels Economic Review, 56(3-4), pp. 335-348.
Lowes, J. and Nenova, T. (2013). ‘The foreign exchange and OTC interest rate derivatives market in the UK’, Bank ofEngland Quarterly Bulletin, (2013 Q4).
Ludwig, E. (2016). ‘Call to Action: It's Time for a 21st-Century Look at Regulation’, The Clearing House Quarterly
Journal, 4(1), pp. 47-51.
Luttrell, D., Rosenblum, H., and Thies, J. (2012). ‘Understanding the Risks Inherent in Shadow Banking: A Primer
and Practical Lessons Learned’, Dallas FED Staff Papers, (18).
Macquarie Equities Research (2016). ASEAN and multinational banks – Basel IV is coming.
MAG (2010a). Final Report Assessing the Macro-Economic Impact of the Transition to Stronger Capital and Liquidity
Requirements. BIS.
MAG (2010b). Interim Report Assessing the Macroeconomic Impact of the Transition to Stronger Capital and Liquidity
Requirements. BIS. (also referred to as MAG – Interim)
Malesova, J. (2015). ‘The impact of Basel III on trade finance’, Charles University in Prague, Faculty of Social Sciences,
Institute of Economic Studies.
Managed Funds Association (2015). Too Big to Default: Policy and Legal Perspectives on Current Bank Regulator
Initiatives to Restrict End-Users’ Default Rights Against Big Banks.
Mariathasan, M. and Merrouche, O. (2013). ‘The manipulation of Basel risk-weights’, CEPR Discussion Papers,(9494).
Martynova, N. (2015). ‘Effect of bank capital requirements on economic growth: a survey’, DNB Working Paper,(467).
McDonnell, B. (2013). ‘Designing Countercyclical Capital Buffers’, 18 North Carolina Banking Institute Journal, (123).
McKinsey (2015). McKinsey Capital Management Survey 2015.
Meeks, R. (2014). ‘Capital regulation and macroeconomic activity: Empirical evidence and macroprudential policy’,(Final Publication: 2015).
Meeks, R., Nelson, B.D., and Alessandri, P. (2014). ‘Shadow banks and macroeconomic instability’, Bank of EnglandWorking Paper, (487).
Memmel, C. and Raupach, P. (2007). ‘How Do Banks Adjust Their Capital Ratios? Evidence from Germany’,
Deutsche Bundesbank Research Centre Discussion Paper Series 2: Banking and Financial Studies, (2007:06).
Mendicino, C., Nikolov, K., Suarez, J. and Supera, D. (2015). Welfare analysis of implementable macroprudential
policy rules: heterogeneity and trade-offs.
Mesonnier, J. and Monks, A. (2015). ‘Did the EBA capital exercise cause a credit crunch in the euro area?
International Journal of Central Banking.
Meyer, G. and Hume, N. (2015). ‘Morgan Stanley oil business sold for $1bn’, Financial Times
Miles, D., Yang, J. and Marcheggiano, G. (2012). ‘Optimal Bank Capital’, The Economic Journal, 123(567), pp.1-37.
Miller, M.H. (1988). ‘The Modigliani-Miller Propositions After Thirty Years’, The Journal of Economic Perspectives,
2(4), pp. 99-120.
Miller, M.H. (1995). ‘Do the M&M propositions apply to banks? ’ Journal of Banking and Finance, 19, pp. 483-489.

© Oliver Wyman

145

Appendix D

Post Crisis Basel Reforms

Mizrach, B. (2015). ‘Analysis of Corporate Bond Liquidity’, FINRA Office of the Chief Economist.
Modigliani, F. and Miller, M. H. (1958). ‘The Cost of Capital, Corporation Finance and the Theory of Investment’,
The American Economic Review, 48(3), pp.261-297.
Monaghan, A. (2014). ‘Shadow banking system a growing risk to financial stability – IMF’, The Guardian.
Moore, M. and Dexheimer, E. (2015). ‘JPMorgan to Cut $100 Billion of Deposits to Limit Capital’, Bloomberg
Morgan Stanley (2015). ‘Large Cap Banks: Fed TLAC Proposal: Tough Rule, But Better Than Feared.’ Morgan
Stanley Research
Morgan Stanley (2015). 1Q15 Fixed Income Investor Call
Morgan Stanley (2015). 1Q16 Fixed Income Investor Call
Morrison & Foerster LLP (2015). Structured Thoughts Master Class: TLAC, Bail-in, BRRD, and other Regulatory Capital
Issues Affecting Structured Products Issuance.
Munyan, B. (2015). ‘Regulatory Arbitrage in Repo Markets’, Office of Financial Research Working Paper.
Nguyen, T.T. (2014). ‘Bank capital requirements: a quantitative analysis’, Fisher College of Business Working Paper,(2015-03-14).
Nier, E. and Zicchino, L. (2005). ‘Bank Weakness and Loan Supply’, Bank of England Financial Stability Review,
pp.85-93.
NIESR (2016). The Economics Underlying NiGEM Model Overview Introduction. [online] Available at:https://nimodel.niesr.ac.uk/nigem-intro/nigemintro.php [Accessed 1 Apr. 2016].
Noss, J. and Toffano, P. (2014). ‘Estimating the impact of changes in aggregate bank capital requirements during
an upswing’, Bank of England Working Paper, (494).
OFR (2013). Asset Management and Financial Stability.
OFR (2015). Financial Stability Report.
Oliver Wyman (2012). The Volcker Rule Restrictions on Proprietary Trading.
Oliver Wyman and Morgan Stanley (2011). ‘Wholesale & Investment Banking Outlook: Reshaping the Model.’ Blue
Paper.
Oliver Wyman and Morgan Stanley (2015). ‘Wholesale & Investment Banking Outlook. Liquidity Conundrum:
Shifting risks, what it means.’ Blue Paper.
Oliver Wyman and Morgan Stanley (2016). ‘Wholesale Banks & Asset Managers Learning to Live with Less
Liquidity.’ Blue Paper.
Ordonez, G. (2015). Sustainable Shadow Banking.
ORX Association (2016). Capital impact of the SMA: ORX benchmark of the proposed Standardised Measurement
Approach.
Osborne, M., Straughan, M., Iscenko, Z. and de Ramon, S. (2010). ‘Revisiting the macroeconomic costs andbenefits of prudential standards: additions to the FSA/NIESR impact assessment framework’, Financial Services
Authority.
OSFI (2014). Liquidity Adequacy Requirements (LAR): Chapter 2 – Liquidity Coverage Ratio.
Parker, G., and Masters, B. (2011). ‘Osborne to set out bank reform plans.’ Financial Times.
Perotti, E. and Suarez, J. (2011). ‘A Pigovian approach to liquidity regulation’, International Journal of Central
Banking.
Perotti, E., Ratnovski, L. and Vlahu, R. (2011). ‘Capital Regulation and Tail Risk’, IMF Working Paper, (11/188).
Pessarossi, P. and Vinas, F. (2014). ‘Banks’ supply of long term credit after a liquidity shock: Evidence from 20072009’, Banque de France ACPR Debat economiques et financiers, (16).
Pfinsgraff, M. (2016). ‘The Resilient Bank of the Future’, The Clearing House Quarterly Journal, 4(1), pp. 25-29.

146© Oliver Wyman

Post Crisis Basel Reforms

Appendix D

PIMCO (2016). US Real Estate: A Storm is Brewing.
Pozsar, Z. (2014). ‘Shadow Banking: the Money View’, Office of Financial Research Working Paper.
Puhr, C. and Schmitz, S.W. (2014) ‘A view from the top: The interaction between solvency and liquidity stress.
Journal of Risk Management in Financial Institutions, 7(1).
Ramcharan, R., Verani, S. and Van den Heuvel, S. (2013). ‘From Wall Street to Main Street: The Impact of the
Financial Crisis on Consumer Credit Supply’, Finance and Economics Discussion Series, (2013-10).
Reinhart, C.M. and Rogoff, K.S. (2009a). This Time is Different: Eight Centuries of Financial Folly. Princeton, NJ.:
Princeton University Press.
Reinhart, C.M. and Rogoff, K.S. (2009b). ‘The aftermath of financial crises. American Economic Review: Papers &Proceedings’, 99(2), pp. 466-472.
Rennison, J. (2015), ‘CFTC head calls for leverage ratio fix.’ Financial Times
Repullo, R. and Saurina, J. (2011). ‘The Countercyclical Capital Buffer of Basel III: A Critical Assessment’, CEMFIWorking Paper, (1102).
Repullo, R. and Suarez, J. (2012). ‘The Procyclical Effects of Bank Capital Regulation’, CEMFI Working Paper, (1202).
Rime, B. (2001). ‘Capital Requirements and Bank Behaviour: Empirical Evidence for Switzerland’, Journal of Banking& Finance, 25(4), pp. 789-805.
Risk Control (2014). Quantitative Impacts of BCBS 269 Securitisation Capital Approaches.
Risk Control (2016). Update on Capital Floors, the Revised SA and the Cost of Loans in Switzerland. [online] Available
at: http://www.riskcontrollimited.com/insights/update-on-capital-floors-revised-sa/ [Accessed 1 May 2016].
Roche, G.G. and Lermyte, J. (2016). ‘Securitization and regulatory arbitrage within the ABCT framework’, The
Review of Austrian Economics, 29(1), pp. 67-84.
Rochet, J.C. (2014). ‘The extra cost of Swiss banking regulation’, Swiss Finance Institute White Paper.
Roger, S. and Vitek, F. (2012). ‘The Global Macroeconomic Costs of Raising Bank Capital Adequacy Requirements’,
IMF Working Paper, (WP/12/44).
Roger, S. and Vlcek, J. (2011). ‘Macroeconomic costs of higher capital and liquidity requirements’, IMF Working
Paper, (WP/11/103).
Sabunwala, Z. Z. (2012). ‘Impact of Basel III Norms on Banking Sector in Emerging Markets.’ IBMRD's Journal ofManagement & Research [Online], 1.1: pp. 34-40.
Santos, A. O. and Elliott, D. (2012). ‘Estimating the Costs of Financial Regulation’, IMF Staff Discussion Note.
Santos, J.A.C. (2000). ‘Bank Capital Regulation in Contemporary Banking Theory: A Review of the Literature’, BIS
Working Papers, (90).
Sarr, A. and Lybek, T. (2002). ‘Measuring Liquidity in Financial Markets’, IMF Working Paper.
Sbordone, A., Tambalotti, A., Rao, K. and Walsh, K. (2010). ‘Policy Analysis Using DSGE Models: An Introduction.
FRBNY Economic Policy Review.
Schanz, J., Aikman, D., Collazos, P., Farag, M., Gregory, D. and Kapadia, S. (2011). ‘The long-term economic impactof higher capital levels’, BIS Papers, (60), pp.73-81.
Schwartzkopff, F. (2015). ‘Capital Backstop Needed to Halt Risk Creep, Danish FSA Says’, Bloomberg.
Segoviano Basurto, M., Jones, B., Lindner, P. and Blankenheim, J. (2013). ‘Securitization: Lessons Learned and theRoad Ahead’, IMF Working Papers, 13(255).
Sharma, A. (2014). ‘Royal Bank of Scotland to exit US mortgage business’, Reuters.
Sheng, A. (2013). ‘Asian Banking: Moving Beyond Basel III’, Fung Global Institute.
Shin, H.S. (2010). ‘Financial Intermediation and the Post-crisis Financial System’, BIS Working Papers, (304).

© Oliver Wyman

147

Appendix D

Post Crisis Basel Reforms

SIFMA (2014). Supplemental Comments to Federal Banking Agencies on Basel III LCR Rule.
SIFMA (2015a). Industry Supports Total Loss Absorbency Requirement to Help Ensure G-SIBs Can Be Resolved in an
Orderly Manner without Taxpayer Assistance.
SIFMA (2015b). US Securitization Year In Review.
SIFMA (2016). US Repo and Reverse Repo Data. [online] Available at:https://www.sifma.org/uploadedfiles/research/statistics/statisticsfiles/funding-us-repo-sifma.xls [Accessed 1
April 2016].
SIFMA and AMG to US SEC (2015). Re: Potential Market and Regulatory Changes to Strengthen Liquidity in the Fixed
Income Markets.
SIFMA to BCBS (2014). Re: Comment on the Net Stable Funding Ratio consultative document: Additional Comment on
the Treatment of Equities, Repos, and Corporates.
SIFMA, AMG, and IAA to FSOC (2015). Re: Financial Stability Oversight Council Notice seeking comment on asset
management products and activities Docket No. FSOC-2014-0001.
Simply Statistics (2013). A general audience friendly explanation for why Lars Peter Hansen won the Nobel Prize.
Slater, S. (2015). ‘HSBC's investment bank to shed clients, assets in profitability push’, Reuters
Slovik, P. and Cournede, B. (2011). ‘Macroeconomic Impact of Basel III’, OECD Economics Department Working
Papers, (844).
Smyth, N. and Wetherilt, A. (2011). ‘Trading Models and Liquidity Provision in OTC Derivatives Markets’, Bank ofEngland Quarterly Bulletin, (2011 Q4).
Spencer, G. (2014). ‘Comments on the Basel liquidity standards and central bank operations’, Reserve Bank of New
Zealand.
Srivatsava, S., Bart, K., Miles, T. (2014). ‘Credit Suisse evaluates prime brokerage business as part of October cuts’,
Reuters
Stafford, P. (2014). “’Too big to fail’ worries reach clearing houses”. Financial Times.
Standard & Poors (2010). What Financial Reform Could Cost the Largest US Banks.
State Street to Robert de V. Frierson, Secretary Board of Governors of the Federal Reserve System (2013). Joint
Notice of Proposed Rulemaking - Enhanced Supplementary Leverage Ratio Standards for Certain Bank Holding
Companies and their Subsidiary Insured Depositary Institutions.
Stein, J.C. (1998). ‘An Adverse Selection Model of Bank Asset and Liability Management with Implications for theTransmission of Monetary Policy’, RAND Journal of Economics, 29(3), pp. 466-486.
Stein, J.C. (2012). ‘Monetary Policy as Financial-Stability Regulation’, Quarterly Journal of Economics, 127, pp. 57-95.
Sullivan and Cromwell (2015). Basel Capital Framework: Basel Committee Outlines Updated Policy Agenda, Including
Plans to Finalize Outstanding Revisions to Its Regulatory Reform Framework by the End of 2016.
Sutorova, B. and Teply, P. (2013). ‘The impact of Basel III on lending rates of EU banks’, Czech Journal of Economics
and Finance, 63(3).
Tarullo, D. (2008). ‘Banking on Basel: The Future of International Financial Regulation.’ Peterson Institute forInternational Economics.
Tarullo, D. (2011). Remarks by Daniel K. Tarullo, Member, Board of Governors of the Federal Reserve System to theAmerican Bar Association Banking Law Committee Fall Meeting.
Tarullo, D. to Board of Governors (2015). Draft final rule – Risk-based Capital Surcharges for Systematically Important
US Bank Holding Companies.
Thakor, A.V. (1996). ‘Capital Requirements, Monetary Policy, and Aggregate Bank Lending: Theory and Empirical
Evidence’, The Journal of Finance, 51(1), pp. 279-324.

148© Oliver Wyman

Post Crisis Basel Reforms

Appendix D

Thakor, A.V. (2014). ‘Bank capital and financial stability: An economic tradeoff or a Faustian bargain?’ Annual
Review of Financial Economics.
The Association of German Public Banks (2016). Relationship between regulation and profitability: A quantitative
impact study, covering the top 17 German banks.
The Clearing House (2013). The Basel Committee’s Large Exposure Proposal: The 2013 Industry Study.
The Clearing House (2014a). Estimating the Regulatory Costs for US GSIBs.
The Clearing House (2014b). Quantifying the impact of Macroprudential Regulation on the Largest US Banks. Working
Paper, (4).
The Clearing House (2016). TCH Research Study: Empirical Analysis of BCBS-Proposed Revisions to the Standardized
Approach For Credit Risk.
The Clearing House to BCBS (2015a). Re: Comments in Response to Consultative Documents–Revisions to theStandardised Approach for Credit Risk and Capital Floors: The Design of a Framework Based on Standardised
Approaches.
The Clearing House to BCBS (2015b). Re: Identification and Measurement of Step-in Risk – Consultative Document,
dated December 2015.
The Clearing House, American Bankers Association, SIFMA, IIB, IACPM, SFIG, and FSR to Office of the Comptrollerof the Currency (2014). Re: Liquidity Coverage Ratio: Liquidity Risk Measurement, Standards, and Monitoring.
The Clearing House, SIFMA, American Bankers Association, Financial Services Roundtable, and Financial Services
Forum to Robert deV Frierson (2016). Comment Letter on the Notice of Proposed Rulemaking on External TLAC, LongTerm Debt, Clean Holding Company, and Other Requirements Applicable to US G-SIBS.
The Clearing House, SIFMA, and FSR to BIS (2016). Re: Comments in Response to Consultative Document – Revisions
to the Standardised Approach for Credit Risk.
The Economist (2015). Whose model is it anyway? Regulators are taking a firmer stand on how banks gauge risk.
Tolo, E., Jokivuolle, E. and Viren, M. (2015). ‘Are Too-Big-To-Fail Banks History in Europe? Evidence from overnightinterbank loans’, Bank of Finland Research Discussion Paper, 29.
Tracy, R. (2014). ‘Banks Retreat From Market That Keeps Cash Flowing’, The Wall Street Journal
Trebbi, F. and Xiao, K. (2015). ‘Regulation and Market Liquidity’, NBER Working Paper, (21739).
Tressel, T. and Zhang, Y.S. (2016). ‘Effectiveness and Channels of Macroprudential Instruments: Lessons from theEuro Area’, IMF Working Paper, (16/4).
Tsomocos, D.P. (2001). ‘Equilibrium Analysis, Banking and Financial Instability’, Bank of England and International
Financial Stability Programme.
Turner, M. (2012). ‘European banks face RWA headache’, Financial News.
Turner, S. (2011). ‘EU agrees debt deal; 50% Greek debt haircut’, MarketWatch.
US Department of Treasury, Board of Governors of the Federal Reserve, Federal Reserve Bank of New York, US SEC,
and CFTC (2015). Joint Staff Report: The US Treasury Market on October 15, 2014.
UBS (2011). Investor Day Presentation 2011
UK Debt Management Office (2016). Gilts Market Turnover Annual Turnover Report. [online] Available at:
http://www.dmo.gov.uk/index.aspx?page=Gilts/Turnover [Accessed 1 April 2016].
Van den Heuvel, S. (2002). ‘Does Bank Capital Matter for Monetary Transmission?’, FRBNY Economic Policy Review,
pp.259-265.
Van den Heuvel, S.J. (2008). ‘The welfare costs of bank capital requirements’, Journal of Monetary Economics, 55, pp.
298–320.
Van Hoose, D. (2007). ‘Theories of Bank Behavior Under Capital Regulation’, Journal of Banking and Finance, 31(12),pp. 3680-3697.

© Oliver Wyman

149

Appendix D

Post Crisis Basel Reforms

Visco, I. (2016). ‘Banks’ sovereign exposures and the feedback loop between banks and their sovereigns’, BIS
central bankers’ speeches.
Walsh, P. (2016). ‘IOSCO predicts boom in use of collateral transformation’, The Trade.
Western Asset (2016). What’s Happening in the Commercial Real Estate and CMBS Market?
World Council of Credit Unions to BCBS (2015). Re: Consultative Document: Revisions to the Standardised Approachfor credit risk (bcbs 307).
Yan, M., Hall, M. J. B. and Turner, P. (2012). ‘A cost-benefit analysis of Basel III: some evidence from the UK’,
International Review of Financial Analysis, 25, pp. 73–82.
Yanase, M. (2013). ‘Basel III Liquidity Rules’, IMF.
Zsohar, P. (2012). ‘Short Introduction to the Generalized Method of Moments’, Hungarian Statistical Review,(Special number 16).

150

© Oliver Wyman