Monday, January 28, 2008

Implications on Banks of Basel II Capital Standards

RBC Capital Markets, 28 January 2008

The process that determines Canadian banks' regulatory capital will change beginning Q1/08.

• Regulators are introducing new capital standards that should better reflect individual banks' risk profiles and the banking world of today, than do the existing capital guidelines, which were initially established in 1988.

• We expect that the banks will hold less regulatory capital for credit risk, similar capital for market risk and more capital for operational risk. We do not expect overall regulatory capital to change materially for the industry in general.

• Large global banks' capital could decline by about 5%, which is made up of a 11% decline in capital allocated to credit risk and a 6% increase in capital coming from the introduction of capital requirements for operational risk.

• Regulatory capital requirements will be lower for retail exposures than for wholesale exposures, all else being equal. The lower capital requirements for retail exposures reflect lower and less volatile loan losses historically.

• Areas that will have higher capital charges include low rated corporate lending, bank and sovereign exposures, undrawn commitments and equity holdings.

• Banks will likely disclose significantly more details about their risk exposures than today. We expect enhanced disclosure on loan book composition, credit migration, and counterparty risk.

• The variability of capital ratios will increase under Basel II, with expected increases in risk weightings in tougher times and the opposite in good environments.

• The calculations of regulatory capital will incorporate some changes, with the most significant impact expected to be around general reserves and, for TD, its investment in TD Ameritrade.