Basel III and the rest

Basel III and the rest Finance of Entrepreneurship Schumpeter 2011 Conference Stefan Bruckbauer, Chief Economist Bank Austria Vienna, 28th October 2011

Why do we need new regulation? Also Basel Com. is not fully sure how expensive banking crises are Expected long-term gains from higher capital and liquidity ratios (as % of yearly output, GDP) Expected net effect of higher capital and liquidity ratios (% of yearly output, GDP) % of GDP 7 6,65 % of GDP 7 6 5 4 3 3,5 5,26 High lont-term costs of banking crises 6) Moderate long-term costs 4) No long-term costs 5) 2,65 6 5 4 3 3,33 4,91 5,85 High long-term costs of banking crises 6) Moderate long-term costs 4) No long-term costs 5) 2 1,4 2,1 2 1,23 1,75 1,85 1 0 0,63 0,80 7 8 9 10 11 12 13 14 15 capital ratio 1 0 0,28 0,00 7 8 9 10 11 12 13 14 15 capital ratio 4) Moderate long-term costs of 63% of GDP 5) No long-term costs, only 19% of GDP 6) High long-term costs of 158% of GDP S: BIS, Assessing the macroeconomic impact ot the Transition to stronger capital and liquidity requirements, Dec. 2010

But was shortage of capital really the driver of the crises? T1 of banks which did not need help was only 1 pp higher than the T1 of banks in troubles Was T1 of 2006 too low for the crisis? T1 in 2009 20 without help from outside 15 10 T1of 2006 too low for the crisis? (T1 of 2006) 7,9 8,9 5 6% 0-5 -10-15 -20-25 5 7 9 11 13 15 T1 (2006) fallen below 6% not fallen below 6% T1 in 2009 without help S: Company reports, 90 large banks Europe and US.

It is hard to calculate costs of banking rescue But it is only a small share of the total increase in debt Components of the increase of government debt since 1998 (Euro area, from 1998 ot end of 2010, EUR bn. and as % of GDP) 37% 26% 2% 3% 5% 3329 2344 197 295 493 53 Increase debt Cycl. adjusted business cycle other bank rescue gross bank rescue net S: Eurostat, OECD, EU, Bank Austria Economics & Market Analysis Austria

Especially if you calculate net costs Max 6% of GDP, net about 1.2% of GDP Costs of banking rescue in the euro area? (until end of 2010, EUR bn and % of GDP) 5.5% 493 4.9% 0.6% 0.8% 0.2% 0.6% 440 Increase debt Increase assets 53 77 22 55 Net Costs Revenues Net Source: Eurostat, OECD, EU, Bank Austria Economics & Market Analysis Austria

And if you look where it happened There is more idiosyncratic than one might think Increase of government debt due to banking rescue (EUR bn until 2010 and as % of GDP) 23,3% 13,4% 493 335 0,0% 0,3% 2,4% 1 4 26 8,9% 53 5,9% 3,6% 2,1% 1,6% 0,0% 21 6 4 0 6 36 6,0% 5,5% 3 DE FR IT ES NL BG OE GR FN PT IR LX EU12 S:Eurostat, OECD, EU, Datastream, Bank Austria Economics & Market Analysis Austria Net cost of banking rescue to date (as % of GDP total and thereof for new capital) 23,2% 23,1% 0,7% -0,1% 0,0% -0,1% 0,6% -0,1% 0,5% 1,3% 0,0% 0,0% 0,0% 0,5% 0,0% 0,7% -0,2% 0,0% 0,0% 0,0% 0,0% 0,1% 0,0% 0,7% 0,6% 0,0% DE FR IT ES NL BG OE GR FN PT IR LX EU12 S:Eurostat, OECD, EU, Datastream, Bank Austria Economics & Market Analysis Austria

T1 Ratio according new regulations. Excluding new definitions of T1 and CT1, from 4% to..% T1 change due to Basel III (in %) 4,5 5,5 6 8,75 1 0,5 0,625 0,625 10 1 0,5 1,25 1,25 11,25 1 0,5 1,875 1,875 12,5 1 0,5 2,5 2,5 SIFI max? *** SIFI min? *** Counter Cyclical national Buffer? Capital Conservation Buffer (CT1) 4,5 5,5 6 6 6 6 6 Minimum T1 (of which 4,5%-p CT1) 2013 2014 2015 2016 2017 2018 2019 Source: OeNB, Company reports, Bank Austria Economics & Market Analysis Austria, CT1=Core T1 capital *** Only for Systemic Important Financial Institutions, could be higher than 1.5%.

Some leverage more, others less Leverage ratio (assets/t1 capital, 2010) Deutsche; 45 CA; 40 UBS; 37 SoGen; 32 BNP; 29 Barclays; 28 CS; 27 Commerz; 24 UniCredit; 22 Santander; 20 HSBC; 18 Erste; 17 BBVA; 17 BA; 15 Source: Company reports, Bank Austria Economics & Market Analysis Austria

So Basel Com. targeted large banks, but only small correlation Many similar small banks together are as risky as one large bank Too big? T1 2009 without help 20 from outside* 15 10 No help necessary 6% 5 0-5 Help necessary -10-15 -20-25 0 500 1000 1500 2000 Total assets (2009), EUR bn * Theoretical T1 of 2009, calculated as T1 (2007) minus RoE of 2007, 2008 or 2009 if negative. Company reports, 90 banks Europe and US.

But there are large differences in the business models of banks Trading results* as % of revenues (2010) 60% 50% Goldman, ML, MS; 51% 40% 30% 20% 10% 0% CS; 30% CA; 27% Barclays; 27% UBS; 24% SoGen; 19% Commerz; 16% HSBC; 13% Deutsche; 13% BNP; 12% BoA, Citi, JPM Ch.; 9% * Not all trading profits are included in the trading results and not all trading profits come from proprietary trading (hedging) Source: ECB, Bank Austria Economics & Market Analysis Austria BBVA; 9% Santander; 6% Erste; 6% BA; 5% UniCredit; 4%

Strong increase in capital requirements for trading (400%) Much less for lending business? Capital requirement in %** through Basel III Austria 403% 403% Min. Max. 112% 185% 128% 197% Market risk* Lending business Total * Market risk and CCR, illustrativ, estimates basis 2009 ** as % of capital requirement in Basel II for this risk (without extra capital due to new capital definition) Source: OeNB, Bank Austria Economics & Market Analysis Austria

BUT: in absolut terms, lending business is hurt much more, 80% of new capital requirements for lending business Capital requirement in %** through Basel III Austria Capital requirement in EUR bn through Basel III Austria Min. Max. Min. Max. 175% 197% 44 50 128% 32 106% * 27 22% 22% 6 6 Market risk* Lending business Total * Market risk and CCR, by way of illustration, estimates basis of 2009 ** as % of total capital requirement in Basel II (without extra capital due to new capital definition) Source: OeNB, Bank Austria Economics & Market Analysis Austria Market risk* Lending business * Market risk and CCR, by way of illustration, estimates basis on 2009 ** Without extra capital due to new capital definition Source: OeNB, Bank Austria Economics & Market Analysis Austria Total

This applies also to Europe as a whole (though to a lesser extent than in Austria due to large investment banks) About 75% of new capital requirements for lending business Higher capital requirements as %* through Basel III in adv. economies (QIS) Large banks 161% 155% Small banks Total 113% 113% 113% 121% 49% 43% 9% Market risk** Higher T1*** Total * Higher capital due to higher min. ratio and market risk, not due to def. ** CCR, SecBB, svar, E SMM, IRC and Sec TB, *** T1 incr. from 4% to 6% plus 2.5% conservation buffer=8.5% Source: QIS of BCBS, Bank Austria Economics & Market Analysis Austria

Trading profits as % of revenues only 7% (2009, strong year) in A, D, F and about 3% to 4% in E and I; about 20% in the UK, 27% in CH Basel III hits normal lending business in continental Europe Trading result* as % of revenues (2009) 27,0% 18,1% 6,8% 6,6% 2,7% 6,1% 3,9% 9,1% A D E F I UK EU CH** * not all trading activities are included in the trading profit, not every trading profit is due to proprietary trading (hedging) ** CH 2010, CS and UBS only Source: ECB, Bank Austria Economics & Market Analysis Austria

Concerning the pricing of a SME loan Capital costs are not that important Pricing components of a typical SME loan (illustrative, in bp p.a. of the loan volume) 1.59 1.23 1.23 0.32 0.55 0.47 Basel II Basel III min. before 2007 Summer 2011 today in one year*** Capital costs* Liquidity costs (5 y)** 3 m. Euribor * illustrative SMEw ith average risk (about 50% of SMEhave at least medium risk) ** CDS for banks, senior unsecured w ith a above average rating *** forw ard Source: BIS, Bank Austria Economics & Market Analysis Austria

What does this mean for Austrian banks at a glance? New capital requirements of EUR 35 bn up to 53 bn on the one side and excess capital (minus market buffer of EUR 8 bn) of EUR 35 bn on the other side. 60 50 40 30 20 10 Capital needs from Basel III (EUR bn) 19 new extra capital requirements min. new extra capital requirements max. Excess capital today (end 2010) Excess capital today (2010) minus "market buffer" 35 35 53 Max. extra capital needs 4 22 0 2007 2013 2014 2015 2016 2017 2018 2019 Source: OeNB, Company reports, Bank Austria Economics & Market Analysis Austria Austrian banking groups (consolidated) as of end of 2010. Assumptions: No increase in RWA, no extra capital through retained earnings.

Impact on P&L of Austrian banks at a glance! Not sustainable? Impact on the P&L of Austrian banks (EUR bn per year) 8,3 1,1 0,3 Higher funding costs 8) Financial Activities Tax (FAT) 7) 5,4 0,6 0,1 0,5 0,4 3,7 0,5 0,4 5,6 Financial Transaction Tax (FTT) 6) Bank levy in Hungary 5) Bank levy in Austria Prepaid Deposits Guarantee Schemes 4) Basel III Minimum Q: Bank Austria Economics and Market Analysis Austria Possible For FN see page 21

Net profit and RoE of Austrian banks the last 5 years On average EUR 5.8 bn, new strains of about EUR 5 bn are not sustainable. Profit p.a. and RoE of banking groups in Austria (after tax) 7,5 6,8 Profit (after tax), EUR bn RoE (on T1 in %) 4,6 4,6 4,3 21% 13% 15% 1,5 0,6 7% 9,9% 1% 3% 2005 2006 2007 2008 2009 2010 Average S: OeNB, Company reports, Bank Austria Economics & Market Analysis Austria

Banks will loos their role as financier of the economy We will change to the US capital market model! External financing of corporates* (in %) 7% 25% 53% 64% Bank loans 68% 10% 37% 16% 19% US Euro area A S: OeNB, EZB, Fed, Economics and Market Analyses Austria Bank Austria, * non-financial corporations without other loans and other equities, 2010 Bonds Equities 0

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FN for chart 17 4) 0.15% of retail deposits have to be paid into DGS. Austria with EUR 250 bn deposits, i.e. 0.15% is about EUR 400 m p.a. 5) Market share of Austrian banks in Hungary about 25%, levy EUR 450 mio announced. 6) According to estimates of Wifo, EUR 287 bn for EU27, i.e. Austria has 2.6% of EU27 assets, 1/3 will be paid by banks (EUR 2.5 bn), but estimated EUR 287 bn much too high.the Austrian government estimates EUR 500 mio to EUR 1.1 bn for Austria, we take 1/3 of 1.1 bn (about 350 mio) as max and a "Börseumsatzsteuer" of 0.15% for banks with about EUR 100 mio as min. 7) IMF favoures the FAT vis-à-vis a FTT because a FTT reduces turnover (liquidity). FAT is like a VAT for banks and the tax base is the value added (profit+wages) in total or a defined share of it (only a part of wages, like bonus or wages over a certain amount). The value added of Austrian banks is about EUR 8.5 bn. A tax of 1% is EUR 100 mio, a tax of 3% would be EUR 250 mio. 8) CDS for Austrian banks increased from 16bp to 153bp until end of 2009 compared to 2007, if 1/3 of this remains, about EUR 250 bn own issues with higher costs of EUR 1.1 bn. In our conservative scenario only 1/2 of these costs is assumed.