Westpac and the new financial regulations Do we think that Basel’s faulty?
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Transcript of Westpac and the new financial regulations Do we think that Basel’s faulty?
Westpac’s Basel II experienceSlide 2
Contents
• A brief biography – how did I end up running the Basel program?
• A brief description of Westpac – how does it compare to global peers?
• Westpac and Basel II
Westpac’s Basel II experienceSlide 3
My resume
• Law school dropout
• Honours in Pure Maths and Statistics
• UNSW graduate
• 8 years experience in Australian banking industry
• Manage Westpac’s sponsorship of Co-op program
• Responsible for Basel II and Active Portfolio Management
Westpac’s Basel II experienceSlide 4
Why would a quant be interested in Basel II?
• New global financial regulations from 2007
• 3 Pillars
- Regulation, Supervision, Disclosure
• The regulations favour banks with sophisticated credit and operational risk management data, processes and analysis
- ie, all Australian major banks
- APRA requires the Australian majors to be compliant with the most sophisticated approaches for both credit and operational risk
Westpac’s Basel II experienceSlide 5
Economic Capital has been an area of intensive research for the last 8 years
• Current banking regulations are not risk-sensitive
• Basel II permits different methods for measuring credit and operational risk
• If sophisticated methods are used, there is greater alignment between
the capital needed in order to operate
and
the capital needed in order to be allowed to operate
Westpac’s Basel II experienceSlide 7
Westpac at a glance
• Established 1817
• Top 100 bank globally1
• Core markets of Australia, New Zealand and near Pacific
• 7.5 million customers
• Aa3/AA- rating
• Leader in sustainability
March 2003
4 year EPS CAGR 11%
Return on equity2 21%
Dividend yield3 4.6%
Total assets A$206bn
Market cap3 A$30bn
1 Euromoney June 20032 Cash earnings basis3 As at 30 June 2003
Westpac’s Basel II experienceSlide 8
Westpac at a glance
Over a period of 5 years total return for Westpac has been in excess of 59%
Westpac operates a full range of traditional banking services with operations focused across Australia, New Zealand and Pacific Region
NPAT by business segment
Net profit after tax Share price performance
Global locations
993
1,0511,018
979
924897
818
755
701
181
500
600
700
800
900
1,000
1,100
1,200
NPAT Significant items
A$m
993
1,0511,018
979
924897
818
755
701
181
500
600
700
800
900
1,000
1,100
1,200
NPAT Significant items
A$m
$6
$8
$10
$12
$14
$16
$18
31/0
3/98
30/0
9/98
31/0
3/99
30/0
9/99
31/0
3/00
30/0
9/00
31/0
3/01
30/0
9/01
31/0
3/02
30/0
9/02
31/0
3/03
All business segments contributed to the 1H03 result with Business & Consumer Banking providing the largest contribution
Westpac has 24 hour global coverage, with offices in Australia, New Zealand, New York and London
New YorkLondon
Sydney
Wellington
Business & Consumer Banking
56%Institutional
Bank20%
NZ Retail16%
Wealth8%
Westpac’s Basel II experienceSlide 9
Consistent shareholder return
100
150
200
250
300
Com
mon
wea
lth B
ank
of A
ustr
alia
Uni
Cre
dito
Ital
iano
Wes
tpac
Ban
king
Cor
pora
tion
The
Dex
ia G
roup
Dan
ske
Ban
k
BN
P P
arib
as
Am
erci
an In
tern
atio
nal G
roup
Citi
grou
p
Fift
h T
hird
Ban
corp
Sw
iss
Rei
nsur
ance
Com
pany
Nor
ther
n T
rust
Cor
p
Aus
tral
ian
and
New
Zea
land
Ban
king
Gro
up L
imite
d
Mar
sh a
nd M
cLen
nan
Com
pani
es In
c
The
Roy
al B
ank
of S
cotla
nd
Cap
ital O
ne F
inan
cial
Cor
pora
tion
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Oliver, Wyman & Company global Shareholder Performance Index1 (SPITM) - 2002
1 Shareholder Performance Index – annual benchmark for volatility-adjusted shareholder value performance amongst the largest financial institutions in the world.
Westpac’s Basel II experienceSlide 10
Leader in sustainability – gaining recognition
2003 Social Impact Report1 Reporting on Westpac’s corporate responsibility policies, practices and performance
1 Available at www.westpac.com.au under ‘Westpac Info’, then ‘Social accountability’
• Ranked number one in the global banking sector by the Dow JonesSustainabilityIndex
• Ranked third globally in the banking sector by oekom Corporate Responsibility Rating
• United Nations Association of Australia Triple Bottom Line Award 2002
Westpac’s Basel II experienceSlide 13
Number 2… Basel II is very good news
• Good for APRA
• Good for Australian banks
• Good for investors and those who analyse Australian banks
• Despite the challenges…
• Basel II is good for Westpac
Westpac’s Basel II experienceSlide 14
Basel II is good for APRA
• Provides deeper insight into bank risk management
• Gives greater comfort in the robustness of risk management practices in Australia
• Compliance simplifies operational risk management practices
• APRA has provided significant input to the Accord
Westpac’s Basel II experienceSlide 15
Basel II shows Australian banks to be safe
• APRA expects the 4 Australian majors to comply with the most sophisticated models
• International peer analysis shows Australian bank risk-adjusted assets to decrease by more than any other jurisdiction
- APRA expects “moderate” capital relief for the 4 majors and “modest” relief for regional banks
• Differences are attributable to:
- balance sheet structure
- different risk profiles
Westpac’s Basel II experienceSlide 16
Eq
uit
y in
vest
ors
/an
alys
ts
Basel II is good for bank stakeholders
Consistent disclosure
More finely honed modelling assessing relative risk
between issuers
Global comparability
Greater rigour of balance sheet analysis
Better understanding ofrisk / reward
Fundamental value
Deb
t investo
rs&
R
ating
Ag
encies
Westpac’s Basel II experienceSlide 17
Increased transparency
Reduced ‘Black Box’
Today Pillar 3
Ris
ks
Basel II reduces the perceived ‘black box’ component of a bank’s business
Disclosed risks
Undisclosed risks
Disclosed risks
Undisclosed risks
Westpac’s Basel II experienceSlide 19
….which is starting to pay dividends
• Equity investors:
- Preliminary results support relative improvement in P/E’s of Australian Banks
- Tangible evidence of lower risk profile of Westpac
- Equity investors starting to engage on Basel II
• Debt investors:
- Australian issuers already starting to see price differential in offshore capital markets
- Greater data granularity will lead to refinement of pricing decisions (measured in bps)
Westpac’s Basel II experienceSlide 20
Basel II compliance hurdles can be overcome
• Making credit data accessible is time consuming
• Discretion needed to avoid disrupting the Australian Securitisation Industry
• Proposing an objective way to make LGD’s conservative
• Suggestions that a significant pro-cyclicality capital buffer be required – not supported by Westpac stress testing
Westpac’s Basel II experienceSlide 21
Conservative LGDs – part of pillar 1
“… it is important that banks utilise default-weighted averages… in computing loss severity estimates. Moreover, for exposures for which LGD estimates are volatile over the economic cycle, the bank must use LGD estimates that are appropriate for an economic downturn if those are more conservative than the long-run average” – Para 430
• US and UK regulators have not provided clear guidance on what this means
Westpac’s Basel II experienceSlide 22
Westpac’s LGDs are both conservative and compliant
LGD by year of default
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Mea
n L
GD
Benchmark LGDs Definition of Default
Basel II
WBC QIS3
Raw LGDNo costs1
No discounting 28 41
LGD with costs1
Cost estimates includesNo discounting 36 51
LGD with costs1 and discountingCost estimates includedDiscounting at cost of equity 64
100 (benchmark)
WBC submission in QIS 3 study WBC actual LGD
1Costs include legal fees and other workout costs
Westpac’s Basel II experienceSlide 23
Why not discount at the cost of equity?
• Basel II implementation should not get any more complicated
• US and UK proposals for conservative LGDs introduce subjectivity where none need exist
• The 4 major Australian banks report very similar costs of equity so LGDs will be readily comparable between peers
Westpac’s Basel II experienceSlide 24
Credit stress tests are becoming an increasingly important part of the Accord
“…the bank must perform a credit risk stress test to assess the effect of certain specific conditions on its IRB regulatory capital requirements. …. The bank’s stress test in this context should, however, consider at least the effect of mild recession scenarios. In this case, one example might be to use two consecutive quarters of zero growth to assess the effect on the bank’s PDs, LGDs, and EAD, taking account – on a conservative basis – of the bank’s international diversification” - Para 397
“… the bank must include a consideration of….. the ratings migration of at least some of its exposures” - Para 398
Westpac’s Basel II experienceSlide 25
Basel II is good for Westpac
• Westpac has been working on Basel compliance for three years
• Early results support the hypothesis that we were “safer” than previously perceived
• Deeper analysis with each iteration of the Accord - yet to find evidence to contradict this assertion
• Feedback from stakeholders has been positive