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Safeguarding stability - ppt download
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Safeguarding stabilitySection 3: Safeguarding stability
Chart 3.1 Asset prices and credit growth in the United Kingdom(a)(b)(c)Sources: Bank of England, Global Financial Data Inc., Halifax, Nationwide, ONS, Thomson Datastream and Bank calculations. (a) The chart shows ratios of real asset prices, household credit and private non-financial corporate credit to GDP, relative to their ten-year moving averages. (b) The dashed lines show start dates for banking crises. The chart shows the secondary banking crisis, small banks crisis and the current crisis. (c) Asset price index is a weighted average of real equity prices, real house prices and real commercial property prices, weighted according to national accounts data for holdings of assets.
Chart 3.2 Network of large exposures between UK banks(a)(b)(c)Source: FSA returns. A large exposure is one that exceeds 10% of a lending bank’s eligible capital at the end of a period. Eligible capital is defined as Tier 1 plus Tier 2 capital, minus regulatory deductions. (b)	Each node represents a bank in the United Kingdom. The size of each node is scaled in proportion to the sum of (1) the total value of exposures to a bank, and (2) the total value of exposures of the bank to others in the network. The thickness of the line is proportional to the value of a single bilateral exposure. (c)	Based on 2009 Q2 data.
Chart 3.3 Difference between senior and subordinated CDS spreads for major banks(a)(b)Sources: Bankscope published by Bureau van Dijk Publishing, UBS Delta (Markit Partners) and Bank calculations. (a) Sample includes 28 of the world’s 100 largest banks by total assets, due to data availability. (b) Data from end-2006 are used here to illustrate the pre-crisis relationship.
Regulation could be strengthened through:Higher minimum capital requirements, comprising instruments that can absorb losses such as equity, or contingent capital that coverts to equity automatically in a pre-defined way. Appropriately defined mandatory maximum leverage ratios to complement risk-weighted capital requirements. Requiring banks to hold large buffers of reliably liquid assets, and complementary measures to reduce banks’ dependence on short-term wholesale borrowing to fund illiquid assets. Reducing over-reliance on external credit ratings, potentially through regulatory incentives. Better disclosure, for example with regard to liquidity positions and exposures between financial institutions. The use of macroprudential tools to combat the build-up of risk over the credit cycle and across firms, as outlined in a recent Bank Discussion Paper.
Table 3.A BCBS workstreams on reform of prudential standardsRaise the quality, consistency and transparency of the Tier 1 capital base. Introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework. Introduce a framework for countercyclical capital buffers above the minimum requirement. Assess the need for a capital surcharge to mitigate the risk of systemic banks. Review minimum levels of capital. Review the treatment of counterparty credit risk in Basel II. Introduce a minimum global standard for funding liquidity that includes a stressed liquidity coverage ratio requirement, underpinned by a longer-term structural liquidity ratio. Source: BIS and G20
Chart 3.4 Composition of the major UK banks’ Tier 1 capital(a)(b)(c)(d)Sources: Dealogic, published accounts and Bank calculations. (a) data refer to end-H1. (b) Includes Abbey National, Alliance and Leicester and Bradford and Bingley instead of Banco Santander. (c) Due to data availability, Nationwide is included after 2000 and The Co-operative Bank after Abbey National and Alliance and Leicester are not included in 2009 H1. (d) Northern Rock and Bradford and Bingley are excluded in 2008 and 2009 H1.
Chart 3.5 Stylised diagram of contingent capital with a core Tier 1 triggerSource: Bank of England.
Chart 3.6 Long-run capital ratios for UK and US banksSources: United States: Berger, A, Herring, R and Szegö, G (1995), ‘The role of capital in financial institutions’, Journal of Banking and Finance, Vol. 19(3–4), pages 393–430. United Kingdom: Sheppard, D (1971), The growth and role of UK financial institutions 1880–1962, Methuen, London; Billings, M and Capie, F (2007), ‘Capital in British banking, 1920–1970’, Business History, Vol. 49(2), pages 139–62; British Bankers’ Association, published accounts and Bank calculations. (a) US data show equity as a percentage of assets (ratio of aggregate dollar value of bank book equity to aggregate dollar value of bank book assets). (b) UK data on the capital ratio show equity and reserves over total assets on a time-varying sample of banks, representing the majority of the UK banking system, in terms of assets. Prior to 1970 published accounts understated the true level of banks’ capital because they did not include hidden reserves. The solid line adjusts for this observation is from H1. (c) Change in UK accounting standards. (d) International Financial Reporting Standards (IFRS) were adopted for the end-2005 accounts. The end-2004 accounts were also restated on an IFRS basis The switch from UK GAAP to IFRS reduced the capital ratio of the UK banks in the sample by approximately 1 percentage point in 2004.
Chart A LCFIs’ ratios of total assets to Tier 1 capital and trading assets to total assets(a)(b)Sources: Published accounts and Bank calculations. Assets adjusted for cash and cash items in the course of collection from banks and deferred tax assets. Assets adjusted on best-efforts basis to ensure comparability between institutions reporting under US GAAP and IFRS. Derivatives are netted in line with US GAAP rules. Off balance sheet vehicles are included in line with IFRS rules (excluding mortgages sold to US government-sponsored entities). (b)	Data as at end-2007.
Table 1 Summary of regulatory leverage ratio limitsUnited States	Tier 1 capital must be ≥3% of on balance sheet assets for ‘strong’ bank holding companies (BHCs) and ≥4% for all other BHCs. Canada	Tier 1 and Tier 2 capital must be ≥5% of on balance sheet plus qualifying off balance sheet assets for BHCs. Switzerland	Tier 1 capital must be ≥3% of on balance sheet assets less Swiss domestic lending for BHCs and ≥4% for individual institutions. This is applicable only to Credit Suisse and UBS. Source: IMF.
Chart B LCFIs’ ratios of total assets to Tier 1 capital and risk-weighted assets to total assets(a)Sources: Published accounts and Bank calculations. (a) See Chart A, footnote (a). (b) Excludes the US securities houses. (c) US leverage ratio limit proxied by a ratio of Tier 1 capital to total assets of 4%. The inclusion of qualifying off balance sheet assets places some US LCFIs above the leverage ratio limit.
Chart 3.7 Trading book capital requirements and write-downs across UK and European LCFIs(a)(b)(c)Sources: Published accounts and Bank calculations. (a) Includes six UK and European LCFIs that reported trading book risk-weighted assets at end-2006. (b) Cumulative write-downs due to mark-to-market adjustments where disclosed by firms. (c) Not all assets accounted for on a fair-value basis will be part of the regulatory trading book. So the chart is likely to overstate write-downs originating in the regulatory trading book.
Chart 3.8 Impact of taxes and expected bankruptcy costs on banks’ cost of capital(a)Source: Bank of England. ‘High support’ refers to high expectations of government support and ‘low support’ refers to low expectations of government support.
Chart 3.9 Central banks’ balance sheets as a percentage of GDP(a)Sources: Bank of England, Bank of Japan, Federal Reserve, Thomson Datastream, and Bank calculations. Bank of England balance sheet data: end-February 1914–66, end-year 1967– UK GDP: annual data (nominal). Federal Reserve balance sheet data: end-year 1914–81, end-July 1982–95, end-year 1996– US GDP: annual data (nominal). Bank of Japan balance sheet data: end-year. Japan GDP: annual data (nominal). Between 1914–51 National Income is used as a proxy for Japan’s GDP. The National Income data point for 1945 is unavailable and estimated by the average of the 1944 and 1946 data points.
Chart 3.10 Annual growth in interbank liabilities of UK-resident banks(a)Source: Bank of England. Interbank liabilities are defined as sight and time deposits from, and liabilities under repo to, other UK banks and building societies.
Chart 3.11 Risk weights for securitisations in the Basel II frameworkSource: BIS. (a) Base risk weights for securitisation exposures that are externally rated.
Table 3.B Areas for improved disclosureValuation	Explanation of fair-value techniques, particularly when there are no direct market observables. Quantitative information on inputs used for key assumptions, including sensitivity analysis. Liquidity risk	More granular information on the maturity structure and liquidity risk profile of firms’ balance sheets and on firms’ holdings of liquid assets. Group structures	Detailed information on balance sheets and profitability of key group affiliates, particularly in the case of large and complex financial groups. Financial Granular information on assets and liabilities to different types of financial institutions, split by the nature of the exposure. Intraperiod Period averages and highs/lows to present a window on the information	risks that institutions run during reporting periods. Frequency	More quantitative balance sheet information on a quarterly basis.
Chart Disclosure practices in selected areas of financial reports for large US and UK banks(a)(b)(c) Sources: Published accounts and Bank calculations. (a) The sample uses five of the largest US and five of the largest UK commercial banks by total assets. (b) This chart summarises an assessment of quantitative information disclosed on fair-value methodologies (Valuation), liquidity risk profiles (Liquidity risk), legal structure and risk positions of key group affiliates (Group structures), exposures between financial institutions (Financial interconnections), period averages, highs and lows (Intraperiod information) and frequency of comprehensive reports (Frequency). (c) 2008 and 2009 interim reports (SEC quarterly filings in United States, Interim Management Statements and semi-annual reports in United Kingdom) were used to assess Frequency annual reports were used for all other areas.
Chart 3.13 Stylised representation of a macroprudential regime based on capital surchargesSource: Bank of England. (a) Cyclical surcharge on sector that becomes increasingly exuberant through periods 4–8. (b) Surcharge based on the contribution of each bank to systemic risk. Bank 1’s contribution is assumed to be large and slowly rising through periods 1–10. Bank 2’s contribution is assumed to be smaller throughout.
Chart 3.14 Global cross-border capital flows (percentage of world GDP)(a)Sources: IMF World Economic Outlook and Bank calculations. (a) Sum of purchases of foreign assets by domestic residents
Structural changes to support stability could include:Extension of central counterparty (CCP) clearing for financial contracts, backed up by robust CCP risk management. Development of capital markets to reduce economic dependency on credit intermediated by the banking system. Insulation of core financial services – such as payments and credit provision – from disruption stemming from other activities, and removal of the expectation of government support for wholesale creditors.
Chart Ratio of bank assets to private debt securities and concentration of domestically owned banking sectors Sources: The Banker, Bankscope published by Bureau van Dijk Electronic Publishing, IMF and Bank calculations. (a) Bank assets defined as total assets of commercial banks, including subsidiaries. Data are for 2008. (b) Concentration defined as the three largest domestically owned banks’ share of total domestically owned banking sector assets. This includes assets of domestic banks held abroad. (c) UK data are from Bankscope as at end-2008 and include all banks and building societies. Data for all other countries are from The Banker’s ranking of the world’s largest 1,000 banks as at end This measure will underestimate the size of banking systems that have a large proportion of banking sector assets outside of the list.
Chart 3.16 Credit conditions for UK households and businesses during the financial crisis(a)Source: Bank of England Credit Conditions Survey, 2009 Q3. (a) Net percentage balances are calculated by weighing together the responses of those lenders who answered the survey questions on the change in the availability of credit. A simple average has been taken across household secured, household unsecured and corporate lending. (b) A positive balance indicates that more credit is available.
Table 1 Examples of regulatory tools used in different industries(a)Sector (regulator)	Ring-fencing Financial Special resilience administration measures	arrangements Water and sewerage	Financial Minimum credit Priority is (Ofwat) ratings transfer Energy networks Activities Minimum credit Explicitly allows (Ofgem) (b) financial ratings for ‘rescue’ Banking (FSA) Limited Capital against Special Resolution risk exposures Regime Sources: Bank of England, Energy Act (2004), FSA, Ofgem, Ofwat and Water Industry Act (1991). (a) This table shows examples and is not an exhaustive list. (b) Examples shown for electricity distribution and transmission, and gas transportation.
Table 3.C Stylised example of modularity in financial systemsA comparison of two alternative configurations of the financial system can usefully illustrate the relationship between diversification and systemic risk. In the first panel below, a single diversifed bank invests in two assets (A and B), while in the second panel two banks invest only in asset A or asset B. In both cases banks hold 10% equity. An idiosyncratic shock that results in a 20% drop in the value of asset A causes the diversified bank to fail. In the modular system, by contrast, only one bank is affected and the other can continue to provide financial services to the wider economy. Intuitively, the effect of diversification is to expose the equity backing asset B to shocks affecting asset A and vice versa.(a) The benefits of modularity are greatest where the likelihood of a common shock affecting returns on the two assets A and B is relatively low. This example is a numerical illustration of the general result that a portfolio of options is always at least as valuable as an option on the portfolio established by Merton, R (1973), ‘Theory of rational option pricing’, The Bell Journal of Economics and Management Science, Vol. 4(1), pages 141–83.
Chart Size of US money market mutual funds’ (MMMFs) total net assets relative to US commercial bank deposits,1974–2008 Sources: Federal Reserve, Investment Company Institute and Bank calculations.
Better crisis resolution arrangements should include:Pre-funded and risk-based deposit insurance to limit subsidies to riskier banks. The use of recovery and resolution plans (RRPs) to identify and reduce barriers to orderly resolution of financial institutions and to ensure losses can fall on unsecured wholesale creditors. Consideration of stronger arrangements to cater for the resolution of non-deposit taking institutions whose failure could undermine financial stability in some circumstances. Clear principles for public provision of capital support that ensure banks’ shareholders and unsecured wholesale creditors bear losses.
Chart 3.18 Number of deposit insurance schemes worldwideSources: World Bank and Bank calculations.
Table 3.D Comparison of selected deposit insurance schemesPre-funded?	Risk-based premia? Canada	√	√ Germany	√ √ Italy	x	√ Japan	√ x Sweden	√ √ United Kingdom	x	x United States	√ √ Sources: Canada Deposit Insurance Corporation, Deposit Insurance Corporation of Japan, European Commission and Financial Services Compensation Scheme.
Chart A Spread of six-month deposit rates from Official Cash Rate in New Zealand(a) Sources: New Zealand Treasury, Reserve Bank of New Zealand, and Bank calculations. (a) Figures are for deposit accounts with minimum balance requirements of NZ$5,000, other terms may vary. (b) Spreads of commercial institutions’ six-month term retail deposit rates from Official Cash Rate are for the first week of each month.
Table 3.E Recommendations of the BCBS Cross-border Bank Resolution Group (CBRG)In September 2009, the BCBS CBRG published a report as part of an ongoing project stocktaking the legal and policy frameworks for cross-border crisis resolution. It makes ten recommendations: Effective national resolution powers — National authorities should have tools to ensure orderly resolution of all types of financial institutions. (ii)	Frameworks for a co-ordinated resolution of financial groups — Each jurisdiction to co-ordinate resolution of financial groups and conglomerates within its jurisdiction. (iii)	Convergence of national resolution measures — Authorities to facilitate the co-ordinated resolution of cross-border financial institutions. (iv)	Cross-border effects of national resolution measures — Authorities should consider procedures to facilitate mutual recognition of crisis resolution measures. (v)	Reduction of complexity and interconnectedness of group structures and operations — Authorities to consider encouraging simplification where necessary for effective resolution. (vi)	Planning in advance for orderly resolution — Systemic cross-border financial firms to promote resilience of key functions, and plan for recovery and rapid resolution. (vii)	Cross-border co-operation and information sharing — Key authorities to agree arrangements for information sharing, for contingency planning and crisis management. (viii)	Strengthening risk mitigation mechanisms — Authorities to promote the use of risk mitigation techniques that reduce systemic risk and enhance resilience during crisis or resolution. (ix)	Transfer of contractual relationships — Allow resolution authorities to temporarily delay contractual termination clauses to complete a transfer in resolution. (x)	Exit strategies and market discipline — Authorities to have clear options or principles for exit from public intervention. Source: BIS.
Table 3.F Resolution funds in selected European countriesFeature	Spain	Sweden Current size (% of GDP) €9 billion (0.8) €3.21 billion (1.0) Flexibility (% of GDP) Can be expande d	Set to reach €7.7 billion (2.5) to €90 billion (8.3) Resolution powers	Capital injection, merger	Capital injection (Tier 1) into or total/partial transfer	ailing or sound institutions of business units Funding Public (75%) and Public (45.5%) and private (25%) private (54.5%) Sources: Banco de España, IMF, Regeringskansliet and Bank calculations.
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