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8/3/2019 GT CZ BIII Survey Results vJKI2

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A snapshot of the preparations of Czech Banks for compliance withBASEL III

BASEL III – Readiness Survey 2011



Basel III – Readiness Survey 2011 | 2

The details of the BASEL IIIregulation are beginning to takeshape, indeed the first changes incategorization of the quality of assets will already come into force

in less than 18 months.

The new regulations will mean that Banks willhave to hold more capital reserves in terms of not only quality but also quality In addition,there will be new leverage, liquidity and netstable funding ratios to implement.

In short, BIII brings BII onto a higher levelnot only in terms of banks’ capital andliquidity obligations but also in terms of internal measures and processes needed to

ensure compliance in accordance with thedefined timeframe.

In an effort to take a snapshot of banks’readiness, we at Grant Thornton Advisory Czech Republic (formerly Facility s.r.o.) havecarried out a research survey with ourcolleagues and partners across the banking industry in the Czech Republic and throughour international member firms.

The survey mapped current preparations,

planned project structure and timeline andpotential impacts on banks operating models via 10 simple questions.

The respondents were asked to share theirapproached and to describe the measuresboth in place today and also planned in thefuture. We surveyed over staff from all main banksoperating in the Czech Republic via an on-

line survey completed by respondents during August 2011.

The following pages provide data andcommentary on the results received.

We would like to express our thanks to themany respondents for their time andinformation.

Jan Kincl | PartnerGrant Thornton Advisory s.r.o.Žatecká 14 | Praha 1 | 11000Czech Republic

T (office) +420 224 813 299 T (mobile) +420 736 772 341E [email protected] | W www.grantthornton.cz




1. At what stage is the Basel III project at your Bank?

The first question asked in our survey looked to understand at what stage in thecompliance process are BIII activities. The third chapter of the BASELregulation has been under discussion fora number of years as a follow-on fromBASEL II (BII) implementation in

January 2007 (or 2008 for advancedcalculation method) however the globalfinancial crisis which started in late 2008and resulting in numerous governmentbail-outs of banks bought urgency and apolitical angle on the regulation. The G20( as sponsors of the Financial Stability Board) decided to use the BASELframework to on one side protect thetaxpayer from paying for failing banks,but on the other hand providing requirements which will also allow large

banks to fail should they not beadequately prepared or financed.

The requirements for capital reserves haveonly been crystallized since the ratificationof the Basel Committee Annex of September 2010 at the G20 meeting inSeoul in December 2010. In the CzechRepublic the majority of banks already fulfil the requirements to hold 4.5% of

common equity (up from 2% in Basel II)and 6% of Tier I capital (up from 4% inBasel II) of risk-weighted assets (RWA) which form the first step of BIIimplementation.

For this reason, as our survey shows themajority of Czech Banks are monitoring developments and analysis the impacts ontheir credit and business models. Less than10% have started formal planning of theimplementation reflecting the long phased-

in implementation period.




2. Who do you see as the main stakeholders in the Basel III work?

As Basel II required banks to have anautomated and centralised internal creditevaluation system meaning that IT playeda significant role on the design of systemsand reporting applications howeveralmost 60% of our survey respondentsbelieve that IT will be no involvement in

the BIII project. However, 20% have ITas the Project Sponsor.It is likely that IT will be required tomaintain the systems and application on which the calculation and reporting programmes run but even thought thedata and parameters may be changed

during the course of the project, CzechBanks do not anticipate such a large rolefor IT as seen in BII projects. The results of our survey showed that BIIcontinues to be an agenda for Board-levelsponsorship; however BII implementation would be led by Risk Management as

stated by over 90% of respondents. Theonly other stated Project InternalCompliance functions typically come tothe fore when the regulation becomes“live” but 9% of respondents identifiedCompliance has having a key role in theproject team at this early stage.




3. At what level is responsibility for the project within the Group

driven?

All of the major banks in the CzechRepublic operate as part of a widerEuropean groups where the mothercompany is ultimately responsible foroverall BII compliance, local managementin the Czech Republic must ensure

compliance at entity level. The purpose of this question was to assess to what degreeis BIII devolved to the Czech operations. The answers showed that there is a spreadof approaches from Banks where BIIIcompliance is part of a wider intra-Group

project where there is a common approachand sharing of compliance methodologiesand the project is typically driven by aBoard member at the Group level.In Banks which operate a number of entities in the Czech Republic there are

also differing approaches. The majority of such organizations devolved BIIIresponsibility to the lowest entity level while 28% of Czech banks run the projectat a National level supporting their localentities.




4. Which of the following requirements of the Basel III do you

already fulfil?

Czech banks have emerged quicker thanexpected from the economic downturnand are “in a good position” to meet thestricter BIII regulatory requirements , asacknowledged by Standard and Poor’sratings agency and demonstrated by the

responses gained from our survey.

Indications are that in terms of Tier 1Core Capital, the majority of Czech bankshold between 8% and 9% of Risk Weighed Assets (RWA) which according to the implementation timetable wouldmeet requirements until the end of 2014.

Looking at the Liquidity Coverage ratio which LCR requires banks to maintain astock of "high-quality liquid assets" that is

sufficient to cover net cash outflows for a30-day period under a stress scenario, over60% of respondents replied that theirrespective banks are already complaint with the ratio requirements due to beintroduced in 2015.

The Net Stable Funding Ratio, a new requirement included in BIII whichmeasures the amount of longer-term,stable sources of funding employed by aninstitution relative to the liquidity profilesof the assets funded will be introduced in

2018. Our survey show that nearly half of the institutions surveyed already are ableto demonstrate the required stable funding of banks’ balance sheets, off -balance sheetexposures and capital markets activities. The final measure surveyed is the Liquidity Coverage Ratio which requires Banks tomaintain a stock of high-quality and liquidassets that would be sufficient to covercash outflows over a 30-day stress period.Our survey shows that only 36% of CzechBanks meet this measure today, however it

is likely that this relatively low value is dueto a lack of measurement currently (LCR will be introduced in 2015) rather than acurrent actual lack of high-quality andliquid assets.




5. How challenging do you view the B III implementation

timetable?

Banks and regulators agree that while thesharp increase in capital requirement andthe introduction of new ratios is steepand challenging for banks, the eightyears phased period for fullimplementation allows the banks time in

terms of preparation and for recovery as

the economy returns to pre-downturngrowth. The Basel Committee asadvised by national governments wantedto take into account the slow globalrecovery and move to the higherstandards in a gradual way.

However for some banks the five yearsto boost common equity reserves to4.5% of assets will still be challenging, as

will the deadline of 2019 to collect theadditional 2.5% reserve buffer.

While countries like Germany pushedfor a longer implementation period (upto ten years to meet the new standards),nations that have already tightenedbanking regulations, such as theUK, pushed for a five-year time line.

On the basis of our survey results, it would appear that the Basel Committeeseem to have struck an acceptable

balance between having BIII as apriority and on the radar of Bank Boardsand the risk of stifling economic growthif banks would be forced to hoardcapital too quickly instead of making itavailable in the form of credit to the

wider economy.




6. Where will B III impact on the internal workings of the Banks?

Moving between BII and BIII capitalrequirements will likely have asubstantial impact on bank’s profitability

with estimates of the effect on Returnon Equity /(ROE) of anything up to 4percentage points. Banks must carefully map and manage the impact of the

regulation on strategy and all areas of operations. As seen in the responses toQuestion 1, banks are currently monitoring developments and are

carrying out the type of impact analysisthat will allow them to plan and managesmoothly changes that will result in theareas of capital management, cutting costs, adjusting prices, through to capitalmanagement measures aimed atrestructuring the balance-sheet in a way

to improve the quality of capital andreduce additional capital needs arising from Basel III.

Bank management will also need toreview their business models going forward create capital and liquidity-efficient business models and productsand may even need to revisit the scopeof specific business lines.

A theme which was seen in previousquestions shows that the only impactdesignated as “Large” however is in thearea of commercial lending where the

volumes will be looked at in a new lightin terms of leverage, liquidity and the

funding for that lending as the new regulation is phased in.Our respondents anticipate the largestimpact to be felt in significant strategicareas such as overall business modeland capital management.Czech banks do not anticipate animpact on headcount and only aminimally in the area of processes andIT where existing models from BIIcompliance will be modified andsupplemented with BIII parameters.




7. How will BIII projects be resourced?

A characteristic of the BASEL I and IIaccords has been the decision by Banks toimplement the requirements using internalresources. The project stakeholders comefrom a wide range of functions in theBank such as IT, Risk, Business, andFinance making the implementation by an

external organization complex anddemanding. We have seen that Czech Banks havesought know-how in terms of technicaladvisory and training from consultancies,or the services of an external projectmanager to coordinate the activitieshowever where possible as much of the work has been kept in-house, a signperhaps of the longer-term nature of the

project and the fact that banks have“learnt” BASEL regulation over the past 2years from BI and BII regulation. The results of our survey show that thistrend is expected to continue for BIII withBanks looking to buy-in specialist resourceor know-how only for benchmarking or

quality assurance purposes where anobjective and independent opinion canonly be provided by a third-party partner.In other areas such as projectmanagement, readiness audit and capitalmanagement-related activities, banks willcontinue to rely and resource BIIIactivities from their own internal resourcesand knowledge base.




8. How do you perceive the role of the Czech National Bank?

The Czech National Bank (ČNB) in itspublications makes it clear that it’s broadsupport for BIII especially for the removalof Tier 3 capital that was part of BII andthe reduced influence of rating agencies inbanking regulation. The ČNB however hasreservations about the Liquidity Ratio and

its timing and views the counter-cyclicalbuffer that will come into effect in 2019 aspotentially problematic and generally callsfor the careful analysis of the impact of the regulation in the banking industry.

The ČNB also supports a “single-rulebook” to reduce the discretionary powersthat other European national banks may be able to bring to play in the applicationsto suit the local banking climate.

As with all regulation, the ČNB offers asupervisory but supporting role in the

application of the BIII regulations.Our question was focused on the side of the Banks, asking them how they perceived the role of the ČNB. The resultsare shown below:

It is important to note that survey respondents were able to click more thanone answer. The above chart shows that over two-thirds value the ČNB as a valuable source of BIII information and one third view theČNB as a partner for compliance.

The ČNB in its role as the supervisor of the Czech financial market and auditormust maintain its independence and over40% of Banks stated that it is in this rolethat they primarily see the ČNB.




9. What do you expect to be the impact on customer lending and

the cost of credit as a result of the higher capital requirements?

The combined effect of all of the capital andliquidity requirements, those that are at thefront of the implementation timetable andthose that are still under discussion will have wide-reaching implications for banks butalso for the credit markets and for bank

customers generally.

There will also be an impact on the inter-bank lending. Stricter capital requirementsmay lead to cost pressures for lenders andtherefore for also for customers whoborrow for retail and corporate purposes.

Indeed the wider banking landscape may beforced to change, as Czech Banks may berequired to slim down in some areas and toinvest in others, to meet changing capitaland liquidity requirements. A study carried out by the OECD in 2010

states that impact of Basel IIIimplementation on GDP growth is in therange of −0.05 to −0.15 percentage pointper annum and that banks may be requiredto increase their lending spreads on averageby about 15 basis points to fund the highercapital requirements.




In the Czech Republic, most banksanticipate a small impact on the level of bank lending due to the higher capitalrequirements, reflecting the increased cost

of funding that some banks will have toincur. Increases in the cost of capital willbe passed onto the customer. Our resultsalso make it clear that neither a significantimpact on customer lending or a

significant increase for customer credit isneither expected nor desired nor thatcompetition between the banks willcontinue to drive efficiencies and force

banks to find the most effective way toensure compliance with the minimumpossible customer impact (funding models,processes, reorganization etc).




10. Please indicate when you intend to start with the following

phases

The BIII regulations will come into forcein less than 18 months time and bank must start to prepare now. The ČNBrecommends that banks do notunderestimate the complexity of theregulations and especially the new

liquidity, leverage and funding requirements. The timing of theimplementation project activities seemedto be quite conform across our responses with impact analysis work being carriedout this year. The readiness audit will beplanned for the period before the initialcapital requirement step comes into forcein January 2013.

In general, our responses show that Czechbanks plan to be prepared before and inthe first phases of BIII implementation.It is likely that Banks will plan anintegrated response to each requirement of BIII but will test and then implement the

individual requirements separately.Many banks in the Czech Republic will be“internally compliant” well before theimplementation dates as they will parallelrun their capital, liquidity and leveragemodels according to BII and also to BIIIstandards.




Summary

Basel III represents the mostcomplex regulatory challenge thatthe Czech Banking industry hasseen in decades.

Despite the long and phases

implementation timetable, Czech banksseem to have understood the challengesahead of them and have started to prepareand plan for the strategic and technicalcompliance with the new rules and ratios,and also to plan how to re-calibrate theirbanks in the light of potential changes tocapital management and business models.In fact, a number of Czech banks have tobegin monitoring certain ratios well beforethe first date of mandatory complianceand indications from the ČNB and the

Czech national banks show that the CzechBanking sector is placed in a healthy position to meet the higher capitalrequirements today. Although the survey results show patternsand trends in the Czech Banking sectors views, approaches and timing forimplementation, there are differences ineach banks’ governance, risk strategy,management, IT, processes, andmanagementinformation systems that will mean that

each approach is different.

However, successful approaches will havea number of factors in common: aclear goal and scope, the achievement of compliance at minimum cost, early impactanalysis and planning and the leverage of in-house existing BASEL framework knowledge gained from BI and BII.

All of these factors must be defined andmanaged by strong project managementand strong senior-managementsupervision, and a sufficient budget. As seen, getting ready for Basel III willinvolve many parts of the bank from IT toRisk to Operations, Internal Audit.

The Czech Banking sector remains vibrant, dynamic and creative andsupported by a solid National Bank.

We at Grant Thornton Advisory Czech Republic remain committed toproviding advice and supportthroughout the implementation periodand look forward to a fruitfulcooperation.

Yours sincerely,

Jan Kincl,

Partner




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© 2011 Grant Thonrnton Advisory s.r.o. All rights reservedGrant Thornton Advisory s.r.o. is a member firm of Grant Thornton International Ltd. Grant Thornton International Ltd(Grant Thornton International) and the member firms are not a worldwide partnership. Services are deliveredindependently by the member firms. This publication has been prepared only as a guide. No responsibility can beaccepted by us for loss occasioned to any person acting or referring from acting as a result of any material in thispublication.

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