Relief for documentary credits under Basel III Leverage Ratio

by Reed Smith
Contact

The Basel III Leverage Ratio has been amended following the Basel Committee on Banking Supervision’s recent publication of its paper, “Basel III Leverage Ratio Framework and Disclosure Requirements”.

The changes to the measure of banks’ exposure under traditional letters of credit for the sale of goods are a welcome revision to their treatment as originally envisaged by the Basel Committee in December 2010.

As a result of the changes, trade finance has successfully been distinguished from other forms of finance. In particular, the credit conversion factor (CCF) for short-term self-liquidating trade letters of credit arising from the movement of goods (e.g., documentary credits collateralised by the underlying shipment) is 20 percent and no longer 100 percent. This CCF will be applied to both issuing and confirming banks. The reduction of this CCF demonstrates recognition by the Basel Committee of the generally low-risk nature of these types of payment instruments for banks involved in trade finance. The differentiation of documentary credits from other off-balance sheet items under the Leverage Ratio makes sense. Such trade finance instruments are usually backed by a flow of physical goods and are usually short-term exposures for banks. Coupled with their self-liquidating nature, the reduced CCF better reflects that documentary credits in trade transactions do not generally pose high leverage risks.

This relaxation in treatment of documentary credits has to be a positive change for traders and banks. Traders can continue to trade using documentary credits without incurring greater costs for such payment instruments. Banks in this business can continue to engage in these off-balance sheet transactions.

What is the Leverage Ratio?

In addition to further refining the capital adequacy regulations under Basel II and making other adjustments, Basel III introduced some new requirements. One of these was the Basel III Leverage Ratio which acts as a control on the amount of banks’ indebtedness. In the Basel Committee’s recent paper, it stated that this “non-risk based ’backstop‘ measure” is “intended to restrict the build-up of leverage in the banking sector to avoid destabilising deleveraging processes that can damage the broader financial system and the economy”.

The Leverage Ratio is calculated by taking a bank’s “capital measure” and dividing this by its “exposure measure”. It is measured as a percentage and the minimum requirement is 3 percent from 1 January 2013 to
1 January 2017.

The “capital measure” is the Tier 1 capital as that definition has been reinforced under Basel III.

The “exposure measure” consists of the total of: (i) on-balance sheet exposures; (ii) derivative exposures; (iii) securities financing transaction exposures; and (iv) off-balance sheet items.

Off-balance sheet items are as defined under Basel II and include short-term self-liquidating trade letters of credit arising from the movement of goods now with a CCF of 20 percent. Before this change, a CCF of 100 percent applied to all off-balance sheet items. The recent changes, however, under the Basel Committee’s paper have brought the levels of CCFs back to the same as those applicable under the standardised basis of assessment for credit risk under Basel II.*

What is a Credit Conversion Factor?

A CCF is a percentage that is applied to the value of the relevant instrument or transaction which results in a “credit exposure equivalent”. Such percentage reflects how likely the instrument may become an exposure on the bank’s balance sheet. The CCF effectively therefore gives a value for the amount that the bank is exposed to on its balance sheet in respect of such instrument or transaction.

Implementation

The Leverage Ratio will be implemented on 1 January 2018. Prior to that banks are required to report their Leverage Ratio and underlying calculation during a parallel run period between 1 January 2013 and 1 January 2017, and the Basel Committee will monitor the same. Banks will also be required to publicly disclose their Leverage Ratio on a consolidated basis from 1 January 2015. The Basel Committee’s paper states that the definition and calibration of the Basel III Leverage Ratio may be finally adjusted by 2017 further to the results of the parallel period.

Following the issue of the Basel Committee’s paper, “Basel III Leverage Ratio Framework and Disclosure Requirements”, the change to the exposure measure of the Leverage Ratio is a good result for banks in the business of issuing or confirming short-term documentary letters of credit for its customers. Banks and, indirectly, customers should no longer face the risk of increased costs due to excessive capital costs with respect to these payment instruments. In addition, banks should be able to continue supporting global trade by remaining active within this classic area of trade finance.


* The CCF referred to in this alert is the CCF to be used in calculating the exposure measure for the purpose of determining the Leverage Ratio under Basel III. This is different to the CCFs applicable under the standardised approach under Basel II for assessing credit risk and the amounts of regulatory capital required. When calculating exposure values to determine its regulatory capital, a firm applies risk weightings to its exposures by applying CCFs in respect of certain risk categories.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Reed Smith | Attorney Advertising

Written by:

Reed Smith
Contact
more
less

Reed Smith on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.