Bank of Montreal 2014 Annual Report Download - page 54

MD&A
In March 2013, OSFI issued guidance designating the six largest
Canadian banks, including BMO, as domestic systemically important
banks (D-SIBs). The D-SIBs are subject to continued enhanced super-
vision and disclosure. Commencing on January 1, 2016, the D-SIBs will
be required to hold an additional 1% Common Equity Surcharge in addi-
tion to the 2.5% Capital Conservation Buffer. No Canadian banks are
currently considered to be globally systemically important.
The fully implemented Basel III requirements and the OSFI “all-in”
Basel III requirements are summarized in the following table.
Regulatory Capital Requirements (% of Risk-Weighted Assets)
Common
Equity
Tier 1
Ratio (1)
Tier 1
Capital
Ratio
Total
Capital
Ratio
Leverage
Ratio (3)
Basel III – Stated 2019 minimum
requirements 4.5 6.0 8.0 3.0
Plus: Capital Conservation Buffer (2)
(effective January 1, 2013) 2.5 2.5 2.5 na
Plus: D-SIB Common Equity Surcharge
(effective January 1, 2016) 1.0 1.0 1.0 na
OSFI Basel III effective requirements (4) 8.0 9.5 11.5 3.0
(1) The minimum 4.5% CET1 Ratio requirement is augmented by the 2.5% Capital Conservation
Buffer that can absorb losses during periods of stress. The Capital Conservation Buffer for
BMO will be augmented in 2016 with the addition of the 1% Common Equity Surcharge for
D-SIBs. If a bank’s capital ratios fall within the range of this combined buffer, restrictions on
discretionary distributions of earnings (such as dividends, equity repurchases and
discretionary compensation) would ensue, with the degree of such restrictions varying
according to the position of the bank’s ratios within the buffer range.
(2) The Capital Conservation Buffer does not include the counter-cyclical capital buffer of up to
2.5% of CET1, which may be required on a national basis by supervisors if they perceive
credit growth resulting in systemic risk. If imposed, this additional buffer would be
effectively combined with the Capital Conservation Buffer.
(3) A 3% minimum Leverage Ratio has been established by the BCBS. It will be subject to
monitoring and analysis during a four-year parallel run test period, which began on
January 1, 2013. Depending upon the results of the parallel run testing, there could be
subsequent adjustments, which are targeted to be finalized in 2017, with the final Leverage
Ratio requirement effective January 1, 2018. In October 2014, OFSI announced that, in the
first quarter of fiscal 2015, its current leverage measure, the Assets-to-Capital Multiple
(ACM), will be discontinued and replaced by the Leverage Ratio, and has established a 3%
minimum Basel III Leverage Ratio requirement.
(4) OSFI’s Basel III “effective requirements” are the capital requirements systemically important
Canadian banks must meet in 2016 to avoid being subject to restrictions on discretionary
distributions of earnings.
na – not applicable
OSFI’s Basel III capital rules also require the implementation of
BCBS guidance on non-viability contingent capital (NVCC). The guidance
stipulates that in order to qualify as regulatory capital, non-common
share capital instruments must be automatically convertible into
common equity in the event that OSFI announces that a bank is
non-viable, that conversion is necessary to protect the interests of the
bank’s depositors and creditors and that conversion is reasonably likely
to restore the bank to viability. All non-common instruments issued
after December 31, 2012, are required to meet these NVCC requirements
to qualify as regulatory capital.
Under OSFI’s Basel III rules, non-common share capital instruments
that do not meet Basel III requirements, including NVCC requirements, are
subject to grandfathering provisions requiring that they be phased out
over a nine-year period that began on January 1, 2013, at which point
their recognition as regulatory capital was capped at 90% of their total
value as at that date. This cap reduces by a further 10% each subsequent
year until 2022. BMO’s preferred shares, innovative Tier 1 capital (BMO
Capital Trust Securities and BMO Tier 1 Notes) and Tier 2 subordinated
debt instruments outstanding on January 1, 2013, will not ultimately
qualify as regulatory capital under Basel III and are accordingly being
phased out. OSFI’s guidance also outlines the requirements for
redemption of these regulatory capital instruments due to a regulatory
capital event. BMO currently does not expect to redeem any outstanding
regulatory capital instruments due to a regulatory capital event.
Under Basel III, banks may select from alternative approaches to
determine their minimum regulatory capital requirements to support the
credit, market and operational risks they undertake. We primarily use
the Advanced Internal Ratings Based (AIRB) Approach to determine
credit risk-weighted assets (RWA) in our portfolio. Credit RWA arising
from certain U.S. portfolios are determined using the Standardized
Approach. The AIRB Approach is the most advanced of the approaches
for determining credit risk capital requirements. It utilizes sophisticated
techniques to measure RWA at the exposure level based on sound risk
management principles, including consideration of estimates of the
probability of default, the likely loss given default and exposure at
default, term to maturity and the type of Basel Asset Class exposure.
These risk parameters are determined using historical portfolio data
supplemented by benchmarking, and are updated periodically. Vali-
dation procedures related to these parameters are in place and are
enhanced periodically in order to appropriately quantify and differ-
entiate risks so they reflect changes in economic and credit conditions.
BMO’s market risk RWA are primarily determined using the Internal
Models Approach, but the Standardized Approach is used for some
exposures.
Commencing in the third quarter of 2014, operational risk capital
requirements have been determined using the Advanced Measurement
Approach and are based on our internal operational risk measurement
system, using quantitative and qualitative criteria. Prior to the third
quarter of 2014, BMO’s operational risk RWA were determined using the
Standardized Approach and were based on the size and type of our lines
of business.
In August 2013, OSFI advised banks that it would begin phasing in
the Credit Valuation Adjustment (CVA) risk capital charge for Canadian
banks in the first quarter of 2014. The CVA risk capital charge applicable
to CET1 was 57% of the fully implemented charge during 2014, and will
increase to 64% in 2015. This will increase each year until it reaches
100% by 2019.
In January 2014, BCBS released its Basel III Leverage Ratio frame-
work and reporting requirements. In October 2014, OSFI issued its final
Leverage Requirements Guideline and announced that, in the first
quarter of fiscal 2015, its current leverage measure, the Assets-to-
Capital Multiple (ACM), will be discontinued and replaced by the
Leverage Ratio, and has established a 3% minimum Basel III Leverage
Ratio requirement.
A number of other potential regulatory changes are still under
discussion with regulators. OSFI may implement a stand-alone or “solo”
capital framework that would assess a bank’s stand-alone capital
adequacy by reducing such bank’s capital by the portion of its invest-
ments in subsidiaries that are not considered available to protect the
parent bank depositors and senior creditors under exceptional circum-
stances. These changes could affect the amount of capital that we hold
or are required to hold, or the attractiveness of certain investments in
subsidiaries.
In an effort to increase the comparability of capital requirements,
the BCBS is considering various alternatives, in particular including
measures to improve the risk sensitivity of standardized approaches and
to reduce excessive variability in advanced approaches. The BCBS is also
expected to propose revised capital floors based on standardized
approaches. If such changes were implemented, they could have the
effect of increasing the capital that we are required to hold.
In August 2014, Canada’s Department of Finance issued a Con-
sultation Paper outlining a Canadian bail-in regime, which includes a
proposal for a Higher Loss Absorbency (HLA) requirement applicable to
D-SIBs, to be met through a combination of regulatory capital and long-
term senior debt.
In November 2014, the Financial Stability Board (FSB) issued a
Consultation Paper to enhance the loss-absorbing capacity of global
systemically important banks (G-SIBs) in resolution. Under the FSB
proposal, G-SIBs would be required to maintain minimum amounts of
BMO Financial Group 197th Annual Report 2014 65