Methodology for the identification of systemically important entities at the local level

The final declaration of the Group of 20 Leaders’ Summit in Cannes, France, in 2011 called on the Financial Stability Board (FSB), with the advice of the Basel Committee on Banking Supervision (BCBS), to extend the framework designed for Global Systemically Important Banks (Global Systemically Important Banks). G-SIBs) to Domestic Systemically Important Banks (D-SIBs).

To comply with this requirement, the BCBS disseminated, in October 2012, the set of principles that banking supervision must follow when establishing the scheme to be applied to financial institutions considered to be systemically important at the level of each jurisdiction.

In accordance with the deadlines stipulated to implement the requirements corresponding to the G-SIBs, the national authorities agreed to disseminate the regulatory framework to be applied to the D-SIBs of each jurisdiction before January 2014, and to introduce the additional capital requirements, gradually, between January 2016 and January 2019.

The adoption of the framework for G-SIBs is intended to mitigate the effects that the insolvency of these types of institutions may have on international financial stability and also to mitigate the risks and competitive distortions generated by entities that the public expects that, if necessary and due to their large size, they will be assisted or rescued by governments. The standards agreed upon by the BCBS, and subsequently shaped by the G20 Leaders, establish a universal methodology for identifying which banks are covered and how much additional capital they should have based on their overall systemic importance (1). The methodology identifies globally systemic banks based on 5 indicators that reflect their size, interconnectedness, lack of substitutes or alternative financial infrastructure for the services they provide, the scope of their interjurisdictional activity, and their complexity. On the basis of these indicators, none of the financial institutions incorporated in our country is globally systemic. However, the BCRA and supervisory authorities in other countries are mandated to periodically review the order of systemic importance of all banks with a global reach.

The framework to be applied to D-SIBs is complementary to the regime designed for G-SIBs, since this type of entity also generates negative externalities at the local level and, although they are not significant from an international point of view, they can compromise the financial system and the economy of their country and even generate effects that transcend neighboring countries. In the case of D-SIBs, it is a matter of assessing the impact that the insolvency or bankruptcy of an entity can have on a particular economy. Therefore, unlike the agreed universal standard for G-SIBs, the assessment of D-SIBs is the responsibility of the authorities in each country who, it is understood, are better equipped to estimate the effects of a stress situation on the local economy.
While the assessment of the systemic importance of institutions and the application of appropriate supervisory tools has a greater margin of discretion for national authorities than in the case of G-SIBs, the need to contain unintended consequences at regional level means that the decision of each jurisdiction must be framed within the set of principles agreed in the BCBS (2). The principles allow the structural characteristics of each country’s financial system to be considered but, like the standards for G-SIBs, they are applied on a consolidated basis; that is, at the level of the economic group within each jurisdiction, including branches of foreign entities; and they are based primarily on the establishment of a greater capacity to absorb losses, i.e. on a greater capital requirement.

Within the framework of the request of the G20 Leaders and within the commitments agreed within the BCBS, the BCRA has developed a methodology to identify financial institutions of systemic importance for Argentina, the main aspects of which are described below. Further details and a numerical example are provided in the annex below.

Within the framework of Principle 5 of the scheme developed by the BCBS, the process to define the degree of systemic importance of the financial institutions authorized to operate in our market begins with an individual evaluation of particular aspects related to size, interconnection, substitutability – both in terms of alternative infrastructures and concentration in the financial system – and complexity. In addition, in accordance with the recommendations of the BCBS, in order to classify an entity as D-SIB and define a possible requirement for additional capital, the structural characteristics of the aggregate financial system in Argentina are weighed, in particular, in terms of depth, concentration and degree of substitution in its role of intermediation and provision of financing. For its part, a significant degree of regional concentration in the provision of financial services can still be observed in our country, and a certain inequality in terms of the population’s access to these services, pending issues in which public policies will play a fundamental role in the coming years.

It should be considered that the entities that make up our system show a comparatively small size. The largest entity in terms of assets/GDP is significantly smaller than the main entities in most countries in the region. The flip side is a moderate degree of market concentration, a situation that allows us to estimate that the diversification evidenced in our financial system will make it possible to temper the possible systemic impact of stress situations, both on the group of institutions and for any particular entity.

The safety net and resolution mechanism provided for in the Law on the Bank Deposit Guarantee Insurance System and the Law on Financial Institutions, both of which were proven effective during the crisis of 2001 and 2002, are factors that, like diversification, make it possible to cushion the contagion of individual insolvency situations.

Based on these considerations, it was considered appropriate to evaluate the following components for each indicator:

(a) size: volume of assets (excluding liquid assets), number of branches and ATMs;

b) interconnection: intra-system assets and liabilities, excluding operations with the BCRA, and volume of wholesale funding;

(c) substitutability: provision of the service of custody of securities, participation in the payment system, and origination and administration of financial trusts; and

d) complexity: trading in OTC derivatives and holding of securities valued at the market, excluding those issued by the BCRA.

In the evaluation, the indicators and their components are weighted as follows: volume of assets, 20%; number of branches, 15%; number of ATMs, 15%; interconnection, 20%; substitutability, 20%, and complexity, 10%. The composite indicator can adopt values between 1 and 0.
In the coming months, the BCRA will carry out an order of the entities based on data of the aforementioned components at the end of 2013 and will announce the additional capital requirement that must be met by the entities that are included, as well as the opportunity and form of compliance. As required by Principle 12 of the document issued by the BCBS with respect to D-SIBs, this higher requirement must be integrated exclusively with Common Equity Tier One (COn1) capital. Within the framework of the agreement in the BCBS, in addition to the requirement of additional capital, entities classified as D-SIBs must be subject to greater attention from the supervisor and, in certain circumstances, may be subject to more demanding regulation. Such is the case of corporate governance requirements and other related provisions, mainly aimed at group A entities. On the other hand, the SEFyC will continue with its supervision plan based on risk and the importance and complexity of financial institutions.

ANNEX

Explanatory note on the construction of the internal regulations of financial institutions

The following describes the main aspects related to the definition of a score that allows the entities operating in the Argentine financial system to be internally ordered, in order to be used later in the process of defining the degree of systemic importance of each of them.

In line with the methodology proposed by the BCBS, the score assigned to each financial institution that operates locally takes into account the following individual aspects: a) size; b) interconnection between financial institutions; (c) degree of substitutability of activities; and d) complexity of the business. Below is the detail of the particular quantitative variables (components) that are used in the calculation of the score as well as their respective weightings:

A. Size

i. Volume of total assets. Weighting: 20%;

ii. Number of branches. Weighting: 15%;

iii. Number of ATMs. Weighting: 15%;

B. Interconnection between financial institutions

i. Inter-financial assets. Weighting: 6.66%;

ii. Inter-financial liabilities. Weighting: 6.66%;

iii. Wholesale funding. Weighting: 6.66%;

C. Degree of substitutability of activities

i. Provision of securities custody services. Weighting: 6.66%;

ii. Provision of payment system services. Weighting: 6.66%;

iii. Origination and administration of financial trusts. Weighting: 6.66%;

D. Business complexity

i. Derivatives trading. Weighting: 5%;

ii. Holding of securities valued at the market. Weighting: 5%.

The values of the aforementioned quantitative variables are obtained from the information from the different Information Regimes available to the BCRA, and have the following additional specifications:

A. Size

i. Volume of total assets. Balance of total bank assets, net of liquid assets in the broad sense. The latter include cash in banks, deposits of financial institutions with the BCRA, active passes for banks with the BCRA through LEBACs and NOBACs, and the own holdings of LEBACs and NOBACs.

ii. Number of branches. All types of bank offices are included.

iii. Number of ATMs. All types of ATMs that banks make available to the public, including self-service terminals, are considered.

B. Interconnection between financial institutions

i. Inter-financial assets. The balances of loans to other financial institutions and of active passes are considered when the counterparty is another financial institution.

ii. Inter-financial liabilities. The balances of deposits received from other financial institutions and of passive passes when the counterparty is another financial institution are incorporated.

iii. Wholesale funding. The balance of financial loans received is considered.

C. Degree of substitutability of activities

i. Provision of securities custody services. Includes the balance of the custody activity of securities and other securities carried out by each entity.

ii. Provision of payment system services. Both the debits (issuance) and credits (receipt) of cheques by each financial institution are taken into account.

iii. Origination and administration of financial trusts. It includes the activity of each entity in terms of its participation both as a trustor as well as a trustee of financial trusts whose underlying asset is bank loans.

D. Business complexity

i. Derivatives trading. Notional amounts traded for forwards and swaps operations in the field of the MAE and OTC operations.

ii. Holding of securities valued at the market. Public securities that are registered at fair value are considered, excluding the holdings of LEBACs and NOBACs.

The process to obtain the score value for each entity follows the steps detailed below. For expositional purposes, a table with a simple numerical example is included at the end of the text illustrating the application of this methodology for the case of a hypothetical financial system.
First, for each of the variables mentioned above (taking into account their respective scale and unit; see the first column for each variable in the table) the relative participation of each entity in the total financial system is calculated (second column of each variable). Subsequently, the relative participation for each variable is multiplied by the weighting coefficient established for each of them (third column for each variable).
A particular consideration should be made about the variable “Wholesale funding”. Following the BIS methodology, the indicator for each bank is taken in its calculation and then normalized using the sum of the indicators obtained by all financial institutions. Then the respective weighter is incorporated as previously mentioned.

The final value of the score of each entity – used to establish the internal ordering – is obtained by adding their corresponding weighted values obtained for each variable incorporated in the analysis (see the last column of the table). The sum of the score obtained by all financial institutions gives a value of “1”.

(1) http://www.bis.org/publ/bcbs255_es.pdf
(2) http://www.bis.org/publ/bcbs233.pdf