Ernst & Young approach - EY

1 Timeline and requirements Basel III. Ernst & Young approach Minimum capital requirements New capital buffers Leverage ratio Strategic forecasting Capital optimization Capital Strategy Countercyclical buffer The minimum level for total capital will remain at 8% A capital conservation buffer, of of CET1, A leverage ratio will be introduced as a supplementary measure to the Basel II. of risk-weighted assets (RWA) but the proportion will be added to the minimum CET1 level of , risk-based framework. Setting strategy poses particular challenges in accounted for by Tier 1 is being increased. By 2015, bringing total CET1 to 7%. It will be built up in good Optimum business strategy Optimal balance sheet Optimal risk governance Optimum legal entity Business processes and practices The ratio will require a minimum percentage of Tier 1 to gross on- and off-balance-sheet the new regulatory environment given the the minimum level for common equity Tier 1 (CET1) times and can be drawn upon in bad times.

2 Assets. Data will also be collected during the observation period using total capital and CET1. substantial increases in required capital and management structure 0% will increase to of RWA and Tier 1 to 6% of RWA. Capital distribution constraints will be imposed on Basel II treatment of counterparty credit risk for OTC derivatives and cross-product netting liquidity buffers: Core portfolios Growth Controls Capital/liquidity In addition, there is a new tighter definition of Tier 1 any bank not fully meeting the capital conservation arrangements will apply in the calculation of the exposure measure. Core geographies Assets MI Tax I dentifying areas of business which are and a focus on CET1. buffer. Allowable capital Tier 1 + Tier 2 . Optimize The minimum Tier 1 leverage ratio is set at 3% for the observation phase.

3 No longer profitable Core products Liabilities Risk transparency Supervisory intensity Non-allowable capital The country-specific countercyclical buffer will be Capital conservation Capital Risk-based remuneration shortfall and other deductions applied to overheating markets. This buffer will vary Optimizing strategy across three Tier 3 capital (available to cover market risk) is being buffer stops profit Additional Leverage between 0% and of CET1. dimensions: capital, liquidity and leverage eliminated. Innovative hybrid capital instruments requirement Capital ratio Client issue being distributed Strategic forecasting Risk appetite Legal entity optimization with an incentive to redeem will be phased out. The Market and counterparty credit risk for Improving finance models to assess the Indicative phaseout period is 2013 21.

4 Requirements 2012 2013 2014 2015 2016 2017 2018 2019 systemically benefits of different strategies Capital optimization Stress testing Recovery and resolution A new stricter approach to the inclusion of minority 7% important planning RWAs Market risk N. ot all banks will be subject to the same Liquidity Counterparty credit risk interests within consolidated capital is being New stressed VaR, incremental risk capital charge, firms to be pressures the new business model will not be introduced. comprehensive risk capital charge for certain correlation decided the same for all. Regulatory capital adjustments trading portfolios, and additional securitization requirements Countercyclical buffer 0% 0% 0% 0% Systems and operating models need to be fit for purpose to deal with all these areas Deductions for CET1 calculation Models Data quality Capital calculation Examples include goodwill, deferred tax assets (DTAs).

5 Counterparty credit risk Effective expected positive exposure (EEPE) with Capital conservation buffer Legal entity optimization (other than from temporary differences), intangibles, stressed parameters Given pressures on capital, banks must make sure usage is optimum. certain holdings in other unconsolidated financial To ensure the optimum legal entity structure Comply/minimize institutions, shortfall of the stock of provisions to New credit valuation adjustment (CVA) charge 8% 8% 8% 8% 8% to avoid trapped liquidity and capital as well Capital calculations Counterparty risk Liquidity calculations Leverage calculations Internal reporting Changing strategy where needed expected losses, defined benefit pension fund assets New explicit Pillar 1 capital charge for wrong way risk as manage impact of IFRS changes 8% 8% Legal entity rationalization and investments in own shares.

6 (WWR). 8% 6% 6% 6% 6% 6% Minimal capital (CET1) To minimize regulatory pressure A limit of 15% of CET1 capital has been set on the Higher asset value correlation multiplier for large Total Ensuring the capital requirement calculations are efficient: combined capital contribution from DTAs from To make recovery and resolution Regulatory reporting Bank levy calculations ICAAP Stress testing Remuneration policies financial institutions capital Recognizing collateral temporary differences, significant investments in New standards for the capitalization of exposures to planning easier the common shares of unconsolidated financial Other data issues are dealt with central counterparties (CCPs) institutions and mortgage servicing rights. Boom Recession Boom Calculations are risk sensitive Higher quantitative and qualitative requirements for collateralized transactions Ernst & Young has extensive experience in helping banks in this area and has been 4% Higher operational requirements (backtesting, stress Tier 1 instrumental in finding multibillion-dollar capital savings for individual firms.)

7 4%. testing and model validation) capital CET 1. 2%. capital LCR: liquidity coverage ratio NSFR: net stable funding ratio Ernst & Young liquidity risk management approach Ernst & Young tools and accelerators Liquidity Liquidity risk management There is a common set of liquidity monitoring metrics that capture specific Stock of high-quality liquid assets 100%. Available amount of stable funding >100%. information related to a bank's cash flows, balance sheet structure, available Tool Description Total net cash outflows over the next 30 calendar days Required amount of stable funding unencumbered collateral and certain market indicators. Liquidity diagnostic tool Gap analysis Governance asting The liquidity coverage ratio (LCR) will prescribe the The net stable funding ratio (NSFR) is designed to Contractual maturity mismatch Concentration of funding Liquidity Operating Leverage diagnostic model Stress testing quantity of high-quality liquid assets a bank must have provide incentives for banks to seek more stable forms Identifies the potential gaps between the Analyzes concentrations of wholesale funding Business and regulatory stress test design n at any given time.

8 Of funding. Best practice Policies design Liquidity target operating model tio Bu contractual inflows and outflows of liquidity for provided by significant counterparties, instruments Stress test production ic forec benchmarking Enhanced ALCO. iza It aims to ensure that each institution maintains 100% of illiquid assets need to be backed with stable ffe defined time periods and currencies Quantitative stress factor development an adequate level of unencumbered, high-quality funding, but this is 65% for qualifying residential n tim Ca Stress assumption validation rs assets that can be converted into cash to meet its mortgages. , overnight, 7 days, 14 days, 1, 2, 3, 6 and 9 Useful in assessing funding liquidity risk, if one or pi atio ILAA production and review op ta iz Liquidity conceptual framework Strateg liquidity needs for 30 days under a specified acute months; 1, 2, 3, 5 and 5+ years more of the sources are withdrawn, and potential l im Liquidity risk systems and data program tity liquidity stress.

9 Useful in indicating how much liquidity a bank exposure to currency exchange risk pt Support end-to-end liquidity risk systems and The net cash outflow is the cumulative expected cash lo data enhancement programs: l en would potentially need to raise if all cash outflows No prescribed concentration limits; however, Liqu ti a nt eme outflow minus cumulative expected cash inflow over PMO office Regulatory reporting and assurance occurred at the earliest possible date reporting expectations by time horizon idit ap g Detailed business requirements ga a 30-designated-day period (using specified stresses). y C an a Target operating model Reporting build support ty m Le No behavioral adjustments Business requirements definition Tactical reporting tools id i Available unencumbered assets Market-related monitoring tools Liqu Vendor assessment and selection Data management road map Reporting UAT support Reporting assurance process and control Bank reporting to LCR minimum NSFR minimum LCR.

10 Measures the amount of unencumbered assets Provides early-warning indicators in monitoring Risk systems/data Implementation planning reviews, GL reconciliation Vendor selection regulators starts standard standard a bank has which could potentially be used as potential liquidity concerns Reg Implementation support collateral for secured funding ula Business benefit measurement Useful in assessing overall health of the market, tor y r Post-implementation review Basel III liquidity timeline LCR observation period Introduce LCR minimum standard Useful in comparing ability to raise additional funds industry or specific institution R e Co epo Development of common data warehouses Contractual cash flow reporting tools No prescribed liquidity haircuts; however, No specific metrics are specified or required; NSF anc un te rtin g FTP and liquidity buffer costs rn FTP benchmarking monetization value is expected to be reported net however, guidance prescribes that accurate rp NSFR observation period Introduce NSFR.