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DR. RANEE JAYAMAHA CHAIRPERSON HATTON NATIONAL BANK PLC 17 TH OCTOBER 2014 Slide 2 Global Financial System -Regulatory Rethinking Financial crises and adverse impacts on world economy imprudent banking and laxed supervision market rigging and scandals inadequate capital despite Basel I and II Regulatory responsibilities safeguard national and global financial systems encourage to work within the global regulatory framework safeguard interests of all stakeholders Tightening regulation is considered to be the solution Cost to banks, their growth and profitability are disregarded Slide 3 Global Financial System - Regulatory Rethinking Regulatory tower is rising - new floors are added Bailing in instead of Bailing out is considered Regulators view global and systemically important banks are too big to fail too big to save too big to fix too big to jail Slide 4 Assessment of Basel Capital Adequacy Framework Quantitative restrictions are like regulatory commandments Basel I thou shall not- simple and limited to credit risks Basel IIthou shall provide the internal model is correct too complicated - discretion with banks DIY nature- non compliance banks grew and made profits supportive elements are missing Due to simplicity, the Glass Stegall Act was far more effective Slide 5 Basel Capital Adequacy Framework Enhanced quantity and quality of capital under Basel III Source: Basel Committee - BIS Items of Capital Main Components Requirement as a percentage of risk weighted assets Basel III requirements with capital conversation Buffer of 2.5% Basel IIBasel III Common Equity Share capital, retained profits and disclosed reserves 2.0%4.5%7.0% Tier I Capital Common equity plus other capital instruments which are subject to strict eligibility criteria and which encompass a loss absorption mechanism 4.0%6.0%8.5% Counter Cyclical Buffer (Capital Conservation Buffer) Common Equity 2.5% Total Capital Tier I capital and capital instruments subordinated to depositors and general creditors of the bank subject to strict eligibility criteria 8.0% 10.5% Slide 6 Financial Regulatory Framework National regulatory systems USA - Basel plus Dodd-Frank regulation UK - Basel plus Financial Policy Committee Regulations Europe - Basel plus EU Directives Stress testing and restrictions on trading book /investment banking Profitability of banks is from: reduction of branches / employees selling /closing non profit earning units reduced operations of investment arms restructure overseas operations Slide 7 Sri Lankas Financial Regulatory Framework On Basel II, and moving on to Basel III Flexible and banks behave well. No criminalization of banking Regulatory framework is tolerable and allows banks to grow/profit Mandatory Corporate Governance has saved the banking industry Need to avoid adhoc regulatory tightening Inter-regulatory institutional coordination and internal consultation need streamlining Slide 8 Impact of Policy and Regulatory Changes by Advanced Countries USA: reversal of ultra - loose monetary policy free loanable funds from the Fed, ECB, BOE helped banks to grow and maintain profits Emerging markets benefited due to inflow of funds Tapering off of QE programmes (June/July 2013) had severe impacts on global financial markets Uncertainty and loss of business opportunities for banks in emerging countries Slide 9 Cost of Regulatory Reporting and Compliance Ever increasing regulatory costs (normal + cost of raising extra capital) Cost of providing data/ information data requests by multiple regulators /different units of a regulator not making use of such information for analysis; agony/frustration maintenance of an army of compliance officers Cost of compliance with FATF +, UN regulations, FATCA and others Criminalization of banking business - USA reprimanding /black listing of banks unprecedentedly high penalties and non transparent settlements Slide 10 Overall Impact on Growth and Profitability of Banks Growth has suffered; costs have escalated and profitability lowered Severe competition and industry wide impact M0vement of business to shadow and less regulated markets /institutions asset and property bubbles potential risks Restrictions on investment banking and trading book Shareholder/ investor frustration Restructure / merge and consolidate Slide 11 Managing Growth and Profitability Reduce other costs and conduct prudent banking business restructuring outsourcing of non-core functions leaner organizations and use of technology Share infrastructure and common platforms Diversify and increase fee incomes where possible Seek joint operations to minimize risks and leverage on expert knowledge Slide 12 Observations and Remarks Financial system stability is a prime regulatory objective. Banks are prime constituents of the financial system. Both should survive Balance between regulations and banking business is imperative regulatory objectives should be clear dangers of over-regulation should be understood Watch dogs failures should be accepted (2007-2009) Regulation should not be a wining game Catching/avoiding a crisis is difficult but complexity aggravates situation