FRSGlobal : Risk Analysis and Regulatory Reporting

Regulators in China

The supervisory and regulatory bodies for the financial industry in China are:

• The China Banking Regulatory Commission (CBRC)
• People’s Bank of China (PBOC)
• State Administration of Foreign Exchange (SAFE)

FRSGlobal in China

China's economy has changed considerably over the past 30 years. It has gone from a centrally planned system largely closed to international trade, to a more market-oriented economy with a rapidly growing private sector to become a major player in the global economy.

Since instigating reforms in the late 1970s, which included the gradual liberalisation of prices, fiscal decentralisation, and increased autonomy for state enterprises, China’s GDP has substantially increased making it, in 2009, stand as the second-largest economy in the world after the US.

This does not mean that China was exempt from the challenges faced by the global credit crunch, indeed, China suffered like most developed countries.

Regulatory requirements are being demanded by the three regulators which are largely based on the Basel Committees consultative papers i.e. Principles for sound stress testing practices and supervision, Revisions to the Basel II market risk framework, Guidelines for computing capital for incremental risk in the trading book, and Proposed enhancements to the Basel II framework.

It is likely that the Basel II implementation will greatly enhance the supervisory effectiveness and banks’ risk management capacity. This set of guidance finds a balance between complying with the Basel requirements and improving the risk management practices in local banks. During the next a couple of years, all commercial banks will need to fully understand the relations of the three pillars of the new accord and ensure the balanced implementation.

Regulatory Environment — China

Statutory

Balance sheet reporting
Balance sheet reporting provides information on the financial position of a bank and is required by the China Banking Regulatory Commission (CBRC). Under this type of reporting all banks in China are required to submit reports on assets and liabilities in China as well as Off Balance sheet reports.

Profit and loss reporting
The profits gained or losses incurred in a quarter need to be reported to the CBRC on a quarterly basis.

Prudential

Capital adequacy reporting
This type of reporting is mainly concerned with risk incurred by banks and is centred around risk reporting. The CBRC uses the Basel II framework to calculate the capital adequacy requirements. Capital adequacy reporting collects the information on market risk exposures, operational risk as well as the existing credit risk.

Liquidity reporting
The liquidity position of a bank, maturity profile and selected data for stress testing is needed for reporting to the CBRC on a monthly and quarterly basis to analyse the positions of the banks in the country.

Interest rate risk reporting
Banks need to report interest rate risk exposures as well as supplementary information on the weighted average interest costs of interest bearing liabilities of authorised institutions on a monthly basis to the CBRC.

Loans, advances and provisions reporting
Authorised Institutions (AIs) that provide loans and advances for use in China as well as the analysis of the performance of an institution’s selected assets (mainly loans and advances) and off balance sheet exposures are included in this report .

Large exposures reporting
Banks need to report to the CBRC information on large exposures to banks, non-banks and connected parties. ‘Exposure’ means all potential losses which might result if a counter party defaults. This reporting needs to be done on a quarterly basis.

Foreign currency position reporting
Banks that have transactions in foreign currency positions (including options) need to submit a report on all the open positions on a monthly basis to check the foreign exchange risk. Banks need to submit a report to the State Administration of Foreign Exchange (SAFE) on a monthly basis.

Statistical

Deposit reserve ratio
All commercial banks need to maintain a minimum reserve of customer’s deposits and the same needs to be reported to PBC on a monthly basis.

Monthly statistics of real estate related loans
Loan applications related specifically to real estate need to be reported to the People’s Bank of China (PBC) to analyze the credit growth in the country.

Housing loan statistics
All the applications for housing loans by the customer’s needs to be reported by the commercial bank to PBC

Corporate loan statistics
The different loan applications of the corporate are need to be reported for statistical analysis to the PBC.

Transactional

External position reporting
This type of reporting is mainly concerned with the international transactions. It covers detailed information on the financial position like external liabilities, claims and cross border claims which need to be reported to the SAFE.

Related party transaction reporting
All business transactions between major shareholders and corporations need to be reported to the SAFE.

Derivative transaction reporting
All transactions in derivative contracts along with the profits and losses need to be reported to the CBRC on a monthly basis.

Securities transaction reporting
All transactions in securities contracts along with the profits and losses need to be reported to the CBRC on a monthly basis.

What’s coming up: China

New Liquidity framework

With recent developments in global financial markets, the regulators across the globe are facing major challenges to monitor liquidity risk of commercial banks. As a member of the BCBS and the FSB, the China Banking Regulatory Commission (CBRC) has been actively participating in global banking regulatory reforms and has begun the process of revising regulations to implement BASEL III from 2012.

To strengthen the liquidity risk management and maintain safe banking system in China the CBRC published a draft on commercial bank liquidity risk management for public comments. This draft is based on the Basel Committee’s recommendations on liquidity risk and aims to guide commercial banks for further improvements in liquidity risk management and assist banking system to cope with liquidity pressure shocks.

The draft version requires that a bank’s Net Steady Finance Ratio (NSFR) and Liquidity Coverage Ratio (LCR) be no lower than 100%. Also banks will have to maintain maximum 75% of Loan to Deposit ratio and Current ratio of no lower than 25%.

The draft consultation is open for public opinion until November 12, 2011. Once the proposed regulation is finalised banks will have to meet these new liquidity requirements with LCR no later than year-end 2013 and NSFR requirement no later than end 2016.

Earlier in July, the CBRC unveiled stricter regulation rules for commercial banks, setting the minimum capital adequacy ratio for banks of systemic significance at 11.5 percent, while that for banks with non-systematic significance at 10.5 percent.

According to the CBRC, major banks will have to meet the new standards by the end of 2013, while others will have to meet them by the end of 2016.

Asset & Liability Management (ALM)

ALM is being embraced as more than just a tool to monitor and manage interest rate risk in banking books. It is a process for managing balance sheets against other risks that affect earnings and portfolio valuations of banks, shifts in customer behaviour, future balance sheet growth and impact of business strategies (pricing, hedging, growth and planning).

In light of the recent financial crisis, firms of all shapes and sizes are re-evaluating their ALM model. In order to earn an adequate return, the need to assess and mitigate the adverse value and income impact of changes in the market has become even more vital.

So how do different types of financial institutions manage their ALM requirements today?

Large, tier 1 firms typically develop their ALM systems in-house; a luxury few smaller firms can’t afford. These systems typically include sophisticated and finely tuned functionality for Value exposure, Value at risk, Dynamic simulation, Earnings at risk and Treasury view.

In the past, smaller firms have found solutions for meeting ALM requirements to be over-complicated, difficult to integrate with incumbent systems, resource-dependent and cost-prohibitive. For these reasons they have resorted to using alternative methods such as spreadsheets or independent consultants, neither of which is ideal.

Until now the sheer cost of developing and supporting an in-house ALM system has been prohibitive to smaller firms but the need to have accurate visibility into the future position of the firm is critical.

Our heritage and in-depth knowledge of market have enabled the configuration of our solution to be so flexible that it meets the needs of ALL firms; from those with highly complex derivatives to those with a vanilla approach.

Our ALM solution provides a comprehensive range of capabilities that cover the following areas:

• Value exposure / market risk (static)
  For a consistent and comprehensive assessment of the adverse value impact of changes in market risk factors based on common pricing models using gap analysis and analytical/numerical stress testing analysis
• Value at risk / market risk (static)
  To calculate the loss potential of a specific portfolio or the total balance sheet over a given time horizon and confidence level
• Dynamic simulation (“what if” NII analysis)
  To assess and manage income, using a dynamically modelled balance sheet and market environment
• Earnings at risk (interest rate models)
  To calculate the potential to lose income, and to value it in a dynamically modelled balance sheet and market environment
• Treasury view
  To assess the exposure and risk position of Treasury, using the risk management techniques applied by the firm

And for the smaller firm

Our rich ALM solution offers a functionally that require immediate return on investment by taking a ‘compact’ approach with risk management features that absorb complexity. Along with evaluating a mismatch between assets and liabilities, our ALM solution also manages risks arising due to liquidity and interest rate in banking books.

With our ALM solution firms can:

• Quantify the value impact of interest rate changes over the total balance sheet based on regulatory requirements
• Conduct stress testing / value impact of any risk factor change over the total balance sheet
• Benefit from robust processes with audit ability and traceability, reverse processing from results to initial input using modelling (strategies & scenarios)
• Meet processing times / frequency of analysis and reduce manual work
• View Balance Sheet value impacts from interest rate moves in terms of sensitivity, liquidity and margin
• Utilise a simple financial analysis framework
• Make use of a flexible reporting tool and standard export to standard formats (Excel, PDF, HTML, XML)

FRSGlobal 6-step process for ALM

Basel II

The China Banking Regulatory Commission (CBRC) asked commercial banks in China to maintain a minimum capital adequacy ratio (CAR) of 8 %. Besides the systematically important financial institutions (SIFIs) need to maintain additional surplus also. Thus large, small and medium sized banks need to maintain a CAR of 11.5 and 10% respectively.

Banks need to follow the below instructions by CBRC while calculating CAR:

• The Tier 1 capital must be 75% of the total capital in order to have a stronger capital base.
• To manage the systematic risk which is associated with the crossholding of subordinated debts, the banks need to deduct the same from issuer’s Tier 2 capital.

In 2010 CBRC completed the periodic assessment of large banks for the implementation of Basel II so that the banks get to know the importance of implementing an effective approach to optimize their capabilities of decision making, capital management and risk control.

As the global influence of banks has shifted away from North America and Europe, leading banks in China and developed markets in Southeast Asia are well into their preparation for adopting the internal model approach (IMA) to market risk, the advanced measurement approach (AMA) to operational risk, and the internal ratings based approach (IRB, AIRB).

Our solution provides a sophisticated Basel II module with the ability to calculate the capital charge for credit risk, market risk and operational risk. It can be used as an independent standalone solution or in combination with our other reporting and risk management solutions assisting banks to meet regulatory requirements and improve their performance over risk.

Adoption of the IFRS7 and IAS 32, 39

Employ dynamic ALM for better balance sheet management

The Ministry of Finance promoted new accounting standards referred to as IFRS which needs to be followed by all the listed organizations.

The China Banking Regulatory Commission (CBRC) issued a notice on banking financial institutions integral implementation of the accounting standards in September 2007. All the financial institutions including the policy banks, joint stock banks, city commercial banks, trust and investment companies, financial leasing companies, auto financing companies, money brokerage companies, foreign funded banks need to comply with the International Accounting Standards (IAS).

Our IFRS solution enables classification of financial instruments and calculation of valuations using appropriate fair values or amortised costs. It also supports several methods for testing and estimating impairment as required by IAS 39.

Read more about the FRSGlobal IFRS solution here.

Liquidity Risk Management

With lessons learnt from the recent liquidity crunch, banks are going beyond simple static financial ratios and gap reports as measures of liquidity risk management. Recent efforts by the European Banking Authority – EBA (formerly Committee of European Banking Supervisors- CEBS), the Basel Committee on Banking Supervision (BCBS) and the UK FSA, in terms of principles and recommendations have set greater emphasis on liquidity risk management.

Since the BCBS issued its final paper, ‘Principles for Sound Liquidity Risk Management and Supervision’, banks have been adopting liquidity stress testing scenarios to simulate bank-specific and system risks to their balance sheets.

By modelling their liquidity contingency plans against such scenarios, the measure of a bank’s cash-flow survival horizon can be derived, giving a statement of the effectiveness of its plan against such crisis.

The China Banking Regulatory Commission (CBRC) published a draft on commercial bank liquidity risk management to strengthen the liquidity risk management and maintain safe banking system in China.

The major banks in China will have to implement the liquidity standards by the end of 2013 and others need to implement the same by the end of 2016. With our solution and experts keeping eye on global regulatory change, banks need not worry about the changes in reporting requirements.