Highlights from the 25th Annual Bank Capital Management Conference in London
Last week, I was invited to attend the 25th Annual Bank Capital Management in Banking Institutions conference in London and to lead the pre-conference workshop about “vulnerabilities revealed by the Archegos disaster”.
At the workshop, I could discuss with capital and risk specialists from international banks the reasons and lessons learned from this complex case. As highlighted by recent events in the UK gilts market and the energy sector, counterparty credit risk on derivatives remains a vulnerable area with lurking tail risks.
The finalization of the Basel III reform package (Basel IV) within the European Union by 2025 remains a key topic which was covered by various speakers from banks, consulting firms and the European Central Bank. The most pressing challenges are:
- Introduction of 72.5% Output floor on RWA (phase-in from 2025 to 2030) with the aim to reduce the variability of RWA. Banks which currently use internal models have to deploy additional resources for the calculation of RWA under the standardized approach. For most banks, it is yet discussed how output floors will affect deal pricing and performance measurement. Some speakers fear that the output floor will foster securitization transactions and/or shift loans into the shadow banking sector
- A quantitative impact study performed by the EBA shows that the minimum capital requirements for 99 EU banking groups could rise by 13.1%
- Non-Modellable Risk factors (NMRF) can trigger capital surcharges under FRTB rules if risk factors used in market risk models lack sufficient price observations
It was also interesting to hear how capital buffers were utilized during the Covid crisis. As opposed to the design of the framework, banks face in reality significant challenges (distribution restrictions, stigma, regulatory pressures) if they would operate below the Maximum Distributable Amount (MDA). A few speakers also stressed the problem that the mandatory stop of AT1 instrument payments below the MDA trigger creates a hurdle for utilizing capital buffers. In addition, it remains unclear over what period of time banks would need to rebuild capital buffers.
Stress testing continues to be seen as an important tool in risk management, as it provides management a good picture of what potentially could happen in a crisis situation. It can though not replace good decision making and the application of judgment in a real crisis. In market risk, some banks start to consider the liquidation horizon of trading portfolios at desk level to ensure that derivatives and hedging instruments are treated equally, which is currently often neglected.
Speakers and participants agreed that it is difficult and perhaps premature to include climate risk scenarios into capital stress tests. A main challenge is that climate changes occur slowly and over a time horizon that is much longer that the time horizon over which meaningful financial and capital forecasts can be made.
It was great that this industry-leading conference could again take place physically. Especially in challenging times, networking and exchange of ideas is more important than ever. Many thanks to Marcus Evans for inviting Orbit36 also this year.