1. Banking Control Commission Basel III A Comprehensive Regulatory Response (The Lebanese Road - map) Dr Amine Awad Executive Director, Lebanons Banking Control Commission Member of the Higher Banking Council Coordinator of Basel III Implementation Task Force Beirut February 10, 2011

2. Banking Control Commission Outline Reasons behind the International Financial Crisis Major Components of Basel III Lebanons Action Plan to fully implement Basel III 2

3. Basel I 1988 Banking Control Commission Capital / Risk weighted assets 8% One Type of Risk Credit Risk 4 categories of risk weights :0%,20%,50% & 100%. (One Size Fits All)Off balance sheet items converted to on an balance sheet amount with appropriate risk weight Date of Impl. : 1992 3

4. Banking Control Commission Market TrendIn the early 1990s,many banks did nothave the Capital to Equitysupport the creditrisks they weretaking on theirbalance sheets. Credit Risks 4

5. Banking Control Commission Consequences of Basel IThe Credit Crunch:Shifts observed from Commercial and Industrial Loans intoTreasury SecuritiesExample:Commercial loans were assigned a 100% risk weight which requireshigh capital, while Treasuries were assigned a 0% risk weight whichrequires no capital 5

6. Banking Control Commission Consequences of Basel ISecuritization:Regulatory capital standards may have played a role in theexpansion of Securitization.Example:Off-balance sheet guarantees were not subject to capitalrequirements, so shifting from loans to these guaranteesprovided a way to reduce effective regulatory capitalrequirements. 6

7. Banking Control Commission Illiquid Individual Financial Financial Assets Assets Special Vehicle S S E E .C .CLiquid & Tradable Liquid & Tradable Capital Market Capital Market Instruments Instruments7

8. Banking Control Commission (Mortgage-Backed Securities (MBS- In M.B.S. the Principal and Interest of the individual mortgage loan are paid to the new MBS holders.- The leading issuers of these securities were the US government-sponsored agencies:Freddie Mac *Fannie Mae *Ginnie Mae * 8

9. Banking Control Commission How the Market evolvesResidential mortgages fit the best the securitizationprocess, because: * Their long maturities (15-20 years or more) * Mortgage lendings are backed by charge over Real Estate. 9

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12. Structured Finance: Banking Control Commission The Complex Scheme of Securitization End borrowers Broker $I&P ($) Mortgages Servicer Originator $ Insurance I&P ($) Mortgages company Conduit/trust/ SPV/SPE/SIV $ MBS Investment bank (underwriter) $ MBS, I&P ($) Rating agency Institutional investor $ Financial returns ($) End lenders 12

13. During This Period Banking Control Commission Basel II was implementedGlobal Capital Adequacy Supervisory Review Market Discipline * Quantity of * ICAAP * Information on Risk Capital to Management Cover Risks * SREP (CR + MKT + * Timely quantitative & OP( qualitative information Capital 8% CR + MKT + OP Risks ( Weighted )

14. Banking Control CommissionMortgaged loans Crisis 14

15. Whats new in Basel III Banking Control Commission OLD NEW OLD NEW NEW OLD* Quantity of * Quality of * ICAAP * Leverage Ratio * Compensation * InformationCapital to Capital Policy Disclosure on RiskCover Risks * SREP * MIS as a Major Management(CR + MKT + * Capital Management * CorporateOP( Conservation Tool Governance Practices * Timely Buffer quantitative & * Stress Tests * Pressure to fully qualitative * Liquidity implement Pillar 3 + information Ratios (LCR + * Countercyclical IFRS7 NSFR( Capital Buffer * Capital Charge on OFF B/S...

16. Banking Control Commission Emergency MeasuresSeveral meetings of the G20 leaders that lead to adopt thefollowing Roadmap:1- Upgrade the F.S.F. to become the F.S.B. (with more enforcement power), asking the latter to issue a new set of regulations aiming at strengthening the International Financial Sector2- Work on finding new Accounting Standards and Financial Rules and Management Practices that avoid the pro -cyclicality in the markets.3- Find new Regulatory and Supervisory frameworks that avoid the reoccurrence of such crisis in the future (no more silos). 16

17. Banking Control Commission Major Elements of Basel IIIUnder Pillar I: The quality, consistency, and transparency of the capital base will be raised. The risk coverage of the capital framework will be strengthened. Build up of capital buffers in good times that can be drawn upon in periods of stress New Liquidity Risk Measurement 17

18. Banking Control Commission Major Elements of Basel IIIUnder Pillar 2: A Leverage Ratio as a supplementary measure to the Basel III risk-based framework New Risk Management Approach Stress Tests in F.I.s Concentration Risk Improvement of Corporate Governance practicesUnder Pillar 3: Full Implementation of Pillar 3(full Transparency & timely Disclosures) Full Implementation of IFRS 7 (Full reporting to all stakeholders) 18

19. Banking Control Commission New Definition of CapitalThe following key changes are proposed: The quality and consistency of the common equity element of Tier 1 capital will be significantly improved The required features for instruments to be included in Tier 1 capital outside of the common equity elements will be strengthened. 19

20. Banking Control Commission Tier 1 Other ElementsTo be included in Tier 1, instruments will need tobe sufficiently loss absorbent: - They need to be subordinated - Have full discretionary non cumulative dividends or coupons - Neither have a maturity date nor an incentive to redeem. 20

21. Banking Control Commission Tier 1 Other ElementsInnovative features such as step-ups, which over time have eroded the quality of Tier 1, will be phased out.The use of call options on Tier 1 capital will be subject to strict governance arrangements which ensure that the issuing bank is not expected to exercise a call on a capital instrument unless it is in its own economic interest to do so. 21

22. Banking Control Commission Tier 2Tier 2 capital will be simplified.There will be one set of Tier 2, removing subcategories ofTier 2.All Tier 2 capital will need to meet the minimum standardsof being: * Subordinated to depositors and general creditors * Have an original maturity of at least 5 years. 22

23. Banking Control Commission No More Tier 3Tier 3 capital will be abolished.This will ensure that capital used to meet marketrisk requirements will be of the same quality ascapital used to meet credit and operational riskrequirements. 23

24. Banking Control Commission Harmonized Structure of CapitalTotal regulatory capital will consist of the sum ofthe following elements:(Tier 1 Capital (going-concern capital a. Common Equity b. Additional Going-Concern Capital(Tier 2 Capital (gone-concern capital 24

25. Banking Control Commission Harmonized Structure of CapitalThere will be 3 components of the Capital AdequacyRatio: Conservation Gross CAR (+) Buffer (=) Total CARCommon Equity/RWA 4,5% 2,5% 7%Tier 1 Capital /RWA 6% 2,5% 8,5%Total Capital /RWA 8% 2,5% 10,5%P.S: In addition to a Countercyclical Buffer Range ( 0% to 2,5% ) 25

26. Banking Control CommissionMore Capital to Cover Additional RisksAdditional Capital to cover:1) Trading Book Portfolio2) Securitization Instruments3) Other off Balance sheet Items 26

27. Banking Control Commission New Leverage Ratio- A supplementary measure to the Basel III risk-based framework- The purpose is to avoid building excessive leverage in the banking system- Helps to address model risk and measurement errorIncludes: All Assets + Certain off Balance Sheet items at 100%Measured as per accounting Balance Sheet: Net of provisions andvaluation adjustments?)Capital Measure: Tier 1 Capital (or Core Tier 1 Capital??P.S. If adopted, Under Pillar I or Pillar II 27

28. New Liquidity Risk Banking Control CommissionAfter having limited its Capital Charge on Market Risk (i.e.mainly Interest Rate Risk) Basel III introduces a newLiquidity Ratio with 2 Components:1) Liquidity Coverage Ratio (L.C.R.) (2015) With a short term (30 days) horizon, based on Cash Flow: Stock of High Quality Liquid Assets 100% Net Cash Flow for the next 30 days2) Net Stable Funding Ratio (N.S.F.R.) (2018) With a longer term (1 year) horizon, based on Liquidity Transformation (or Mismatch): Amount of Stable Funding (Available( 100% Amount of Stable Funding (Required( 28

29. Banking Control Commission Under Pillar II1) Countercyclical Capital Buffer, above Regulatory Capital Including Dynamic Provisions (i.e. provisions in good years to cover losses of capital in bad years)2) New Risk Management Practices * Do not Rely on Rating Agencies only * Do not Rely on one Model only * Do not Rely on Mathematical Models only3) Stress Testing, a major tool of Risk Management4) Capital charge to cover: * Concentration Risk * Counterparty Risk5) Strong Management Information System (M.I.S.) that helps 29 Decision Taking.

30. Banking Control Commission Under Pillar III Improvement of Corporate Governance PracticesCompensation CommitteeBoard Audit CommitteeBoard Risk CommitteeIndependent and Expert Board MembersCriteria for the Appointment of DirectorsBusiness Continuity Planning Succession Plan 30

31. Banking Control Commission Lebanons Action Plan to Implement Basel III1)The B.C.C.L. has sent (in April 2010) its comments on the following C.P.s of the B.C.B.S.: * Strengthening the Resilience of the Banking Sector (Dec. 2009) * International Framework for Liquidity Risk Measurement (Dec. 2009) * Good Practice Principles on Supervisory Colleges (March 2010)2) B.C.C.L. issued a Memo (January 2010) asking Banks to have strong M.I.S.3)The B.D.L. will issue soon a new circular based on the new Principles for enhancing Corporate Governance issued by the Basel Committee (March 2010), that follows the Corporate Governance chart issued by ABL in January 2011. 31

32. Banking Control Commission Lebanons Action Plan to Implement .(Basel III (Cont4)The B.C.C.L. made a study (Q.I.S.) to measures the impact of the implementation of Basel III on Lebanese banks. (based on 30 June, 2010 figures); the results are discussed on a case - by - case basis with every bank.5)The B.C.C.L. issued ICAAP templates to banks, which will help performing its SREP missions in banks (October 2010 for submission in June 2011)6)The B.C.C.L. issued new regulations relating to the implementation, as of January 2011, of : * IFRS 9 * IFRS 7 (in preparation)7)B.D.L. & B.C.C.L. are in the process of issuing a new Liquidity methodology, based on the New Concept of L.C.R. and the Basel paper on Liquidity Risk Management 32

33. Banking Control Commission Lebanons Action Plan to Implement .(Basel III (cont8)B.C.C.L. performed in September 2010 a Stress Test on banks, to study the impact of a variation of the interest rates on their Profitability and Equity.9)B.C.C.L. is preparing a serie of Stress Tests on banks, with different scenarios (during 2011)10)B.D.L. is studying the implementation of a Dynamic Provisioning Process in banks. 33

34. Banking Control CommissionE Mail: amawad@bccl.gov.lb 34