Richard Ivey School of Business
The University of Western Onta.rio IVEY 910N29
BASEL 111: AN EVALUATION OF NEW BANKING REGULATIONS 1
David Blaylock wrote this case under the supe,vision of David Conklin solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation_ The afflhors may have disguised certain names and other identifying information to protect confidentiality
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Copyright© 2010, Richard Ivey School of Business Foundation Version: 2013-03-11
INTRODUCTION
The world’s biggest banks have a combined 1,730 (US$2,287 billion) gap in liquid investments that they must fill within four years, according to the Basel Committee on Banking Supervision, the intemational banking watchdog_
Under tl1e Basel III rule book, finalized by the c01mnitt.ee on Thursday, December 16, 2010, 91 of the world’s biggest banks – tested in an impact assessment – also have a 577 billion capital shortfall compared \Vith the ne,v 7 per cent headline number for equity tier one capital, a measure of financial strength_1
It was expected that the capital target could be achieved over tin1e from retained eamings_ For the 91 banks examined by the Basel conunittee, the combined ”tier one capital ratio” was 5_7 per cent This ratio was lower than previously calculated because the Basel III agreement disqualified certain non-equity capital from the numerator and changed the risk weightings of assets in the denominator_ Under the ne,,• rnles “any bank with less than a 7 per cent ratio will face significant restrictions on bonus and dividend pay-outs, making that the de facto minimum for most” This new 7 per cent ratio will be phased in over the period 2011-2019_ Meanwhile, some banks such as Credit Suisse, planned to issue ‘coco” bonds (contingent convertible bonds)_ These bonds would conveit into equity if the bank suffered losses that
reduced its capital below specified ratios_
The new rnles also required specific ratios of liquid investments, to be achieved by 2015_ Analysts pointed to these liquidity targets as being more difficult to achieve_ Many banks would have to rely often on the inter-bank markets to achieve the liquidity ratios_ Perhaps any freezing of inter-bank markets could result in even more financial chaos than the inter-bank mad:et freezing of 2008_ A new leverage ratio target would in.dude off-balance sheet assets_ Important questions remained, including national enforcement and
‘ This case has been written on the basis of published sources only_ Consequently, the inte,pretation and perspectives presented in this case are not necessarily those of the Basil Committee or any of its members.
Brooke Masters and Patrick Jenkins, “Basel reveals liquidity gap for world’s biggest banks,· Financial Times, December 17. 2010, p_6.
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ultimate impacts of the new Basel ill mies. Meanwhile, some nations were adding their own new regulation5, separate from Basel ill.
THE CHALLENGES IN DESIGNING INTERNATIONAL BANKING REGULATIONS
The 2007 /08 financial crisis and subsequent recession precipitated discussions on strengthening the stability of financial systems.3 Many national govemments have considered the enactment of stricter regulation of financial markets and bank liquidity. In the next few years, national and intemational ~11pervisors will implement regulatory adjustments through coordinated efforts as well as independently, causing significant changes in the banking industry.
An internationally con5istent regulatory fran1ework is desirable for the world’s banking ~ystem. Increased global interconnection means that bank failures in one country can negatively influence other national economies. Governn1ents and taxpayers may suffer because of the negative con5equences from other nations’ poor regulato1y practices. Internationally coordinated regulation also helps to mininlize competitive differences among national banking ~ystems. Uncoordinated policy iniplementation allows some nations a competitive advantage over those with a more restrictive regulatory framework.
Designing global bank regulation is a complex task. Negative shocks to the financial system repeatedly uncover new problem5 in the banking industry, which regulators tl1en work to correct. International regulation has therefore become increasingly coniplex and restrictive. A more coniplicated superviso1y framework is less able to acconuuodate countries’ financial differences. Predicting the effects of new regulation is difficult. Increased regulation u5ually reduces the ri5k profile of banks. However, the coinciding decrease in banks’ lending may be more detrimental to the economy than any bank failures avoided in the future. A more restrictive fran1ework reduces the willingness of banks and regulators to adopt the policies for fear of lost perfonuance and reduced economic growth. Banks will enjoy a more favorable regulato1y enviroruuent in those economies that choose to reject new intemationally coordinated regulation. Systemic risk may therefore move to tl1ose financial system5 tl1at reject a more restrictive proposal.
Regulators Ill many countries look to the Basel Committee on Banking Supervision at the Bank for International Settlements for a new regulatory framework.4 The Conunittee is a gathering of national ~11pervisors fom1ed to promote cooperation in global ba11king regulation. 5 Central Bank governors of the Group of Ten countries establi5hed the Conuuittee in 1974, with the goal of mininlizing differences in hank n~gnl~tion intP.m~tion~lly Sinc.P. 197.’i, thP. C’.ommittP.P. lrns pnhlishP.rl ~n<l <listrihntP.<l ~ sP.1iP.~ of documents related to supe1visory standard5. However, the Conuuittee has no supranational autl1ority to regulate the banks in member nations. The Conuuittee’s conclu5ions do not have legal force, and national regulators must independently choose to implement the Conuuittee’s reconuuendation5.
The Conuuittee has focused primarily on capital adequacy 6 Capital ratios appeared to be deteriorating at many international banks in tl1e early 1980s, while global risk seemed to be increasing. The Conuuittee proceeded to publish tl1e Basel Capital Accord in 1988, conuuonly refen-ed to as Basel I. A new capital framework replaced Basel I in 2004 and was nicknamed Basel II. The most recent update con5ist5 of two
3 For the remainder of the case, the 2007/08 financial crisis will be 1eferred to as “the financial crisis.• ‘For the remainder of the case, the Basel Committee on Banking Supervision will be referred to as ‘The Committee.• 5 Basel Committee on Banking Supervision, “History of the Basel Committee and Its Membership~ August 2009, available at http://www.bis.org/bcbslhistory.pdf, accessed July 29, 2010. • Capital adequacy is the measure of a bank’s capital base in relationship to the bank’s assets.
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documents: the lntemational Framework for Liquidity Risk Measurement, Standards and Monitoring and Strengthening the Resilience of the Banking Sector.1 The Committee published the doctunents in December 2009, in response to the financial crisis. TI1e combined doctunents have been nicknamed Basel ill. Ongoing discussions have sought to determine how the new mies should be iniplemented.
Banks have been critical of the Basel ill documents. Predicting the influence of the accords is difficult, and many disagree with the Committee’s dec.ision5. The financial crisis did not damage some cotu1tries as much as others, and some relatively undan1aged economies seek to maintain their current regulatory ~ystem. TI1ose who agree with the recommendatio11S often disagree with aspects of the technical methodology for calculating the various capital ratios. However, both ~11pporters and critics agree that the recommendations in Basel ill will drastically change tl1e global banking system. Tilis c.ase will outline the first two Basel Accords, evaluate the recommendation5 proposed by the Committee in the Basel ill con~1tltative documents and address the potential problems caused by financial institutions that are not regttlated tu1der the new proposals.
Some national regttlators are implementing additional regulations to coniplement the Comnlittee’s capital adequacy framework. TI1iscase will exanline both the Dodd-Frank Wall Street Reform and Con5mner Protection Act implemented in the United States and the principle-based approach used by Canadian financial regttlators. The case will conclude by pointing to possible foture additions to the Basel ill framework and reconunendations.
PAST BASEL ACCORDS
Basel I
The document titled International Convergence of Capital Measurement and Capital Standards was tl1e Conu11ittee’s first major publication on capital adequacy.8 Banks’ capital ratio is the ratio of banks’ capital to on-balance sheet risk-weighted assets. TI1e Co11u11ittee reconunended a nlininuun capital ratio of 8 per cent. Basel I focused primarily on credit risk and ~11ggested appropriate risk weights for different kinds of loans and asset5. For example, government debt and cash received a weight of zero. Loans secured by mortgages received a 50 per cent weighting, and private-sector loans received a 100 per cent weighting. Basel I applied a general definition of capital that was easily integrated into most national regulation5. All member cotmtries introduced the framework, as did ahnost all otl1er cotmtries that host international banks.
Basel II is a revised version of the 1988 doctunent.9 The updated doctunent seeks to in1prove risk cak.ulation in capital measurement by introducing three pillars. The first pillar expand5 on the nlininuun capital requirements proposed in Basel I by introducing a system that is based on external credit ratings. For example, government debt from a cotu1try with a single-A credit rating would receive a 20 per cent risk weight, whereas a triple-A rated government would maintain a zero weighting. High-risk assets could receive weightings of more than 100 per cent. Alternatively, banks that received superviso1y approval
7 Basel Committee on Banking SupeNision, ·consultative Document: Strengthening the Resilience of the Banking Sector,· December 2009, available at http:l/www.bis.org/publ/ bcbs164.pdf, accessed August 7, 2010. 8 Basel Committee on Banking SupeNision, “International Convergence of Capital Measurement and Capital Standards,• 1988, available at http://www.bis.org!publl bcbsc111.pdf, accessed August 10, 2010. • Basel Committee on Banking Supervision, ‘International Convergence of Capital Measurement and Capital Standards, A Revised Framework~ 2006, available at http://www.bis.org!publlbcbs128.htm, accessed August 7, 2010.
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could measure credit risk u5iilg an internal ratiilg framework outlined in Basel II. The first pillar also promotes the use of Value at Risk (VaR) to measure market, credit and operational risk.10 The second pillar recommends that supeivisors evaluate a bank’s capital level in relation to the bank’s risk profile to promote early regulator iiltervention. The third pillar encourages greater transparency of banks’ holdiilgs.
Some recommendations proposed in Basel II may have increased systemic risk. The Committee iilcreased unifomlity in risk aversion, relied heavily on credit rating agencies and encouraged procydical behavior. 11
Imposiilg standardized, risk-based capital reqtlirements limits financial i.n5titutions’ ability to iildependently define tl1eir risk aversion. Banks have greater difficulty selling tl1eir risky assets in a time of crisis when prices begiil to fall because other finm are unable to accept a higher level of risk.12 Minimtuu capital requirements c.an therefore decrease market liquidity and iilcrease systenlic risk.
Measuring tl1e minimum capital reqtlirements on the basis of evaluations by credit rating agencies and iiltemal rating systems may also exacerbate a crisis. 13 Credit rating agencies are unregulated, and ratiilgs can vaiy substantially between agencies. Directiilg ba!lks to monitoring their holdings on the basis of a rating agency’s assessments may cause banks to unknowingly increase tl1eir risk profile if agencies base their analysis on mistaken asstuuptions or metl1odologies. Banks’ iilternal risk models are complex and based on assumption5 tl1at proved untrue during the recent crisis.14 Dependence on iiltemal and external risk modeling also promotes procyc.lical behavior because ratings are procyc.lical.15 Ratiilgs strengthen iil stable period5 and lower dtu’ing period5 of crisis. Procyclical behavior iilcreases systenlic risk by increasing the probability of bank failure from tu1expected crises and discouraging lending dtu’ing downturn5.
BASEL Ill
Improving the Capital Base
Sununa,y
Basel m recommends raisiilg the quality, con5istency and transparency of banks’ capital base, while reducing the required capital ratio to 7 per cent. The prim~ adjustment is to dec.lare conuuon eqtlity and retained earnings as the predominant forn1 of Tier 1 capital. 6 Past capital regulation did not require banks to hold a defined level ofconuuon equity and it set Ii.nuts only on total Tier 1 capital and total capital. 17For
10 Value at Risk measures the worst expected loss over a period on the basis of a given probability and assuming normal market conditions. 11 Procyclical behavior is the tendency of banks to react predictably to business cycle fluctuations. Procyclical banks over/end or hold less capital during expansionary periods and attempt to under/end or hold more capital during recessionary periods. 12 Jon Danielsson et al., ‘An Academic Response to Basel II~ LSE Financial Markets Group Special Paper Series, Special Paper No. 130, May 31, 2001, available at htlpf/www.bis.org/ bcbslcalfmg.pdf, accessed August 24, 2010. 13 Robert C. Pozen, Too Big to Save?: How to Fix the U.S. Financial System, Wiley, Hoboken, NJ, 2010, p. 144. ” Sheila Bair, “Remarks by FDIC [Federal Deposit Insurance Corporation] Chair Sheila Bair to the Institute of International Bankers Annual Washington Conference, Washington, DC,• March 2, 2009, available at http://www.fdic.govlnewslnewslspeecheslarchives/2009/ spmar0209.html, accessed August 3, 2010. 15 Jon Danielsson et al., ‘An Academic Response to Basel II~ LSE Financial Markets Group Special Paper Series, Special Paper No. 130, May 31, 2001, p 15, available at http/lwww.bis.org/bcbslca/fmg.pdf, accessed August 24, 2010. 1 • Tier 1 capital is a bank’s core capital base. Basel II defines Tier 1 capital as equity capital and disclosed reseNes. Equity
capital includes common stock and non-cumulative preferred stock. Non-cumulative preferred stock dividends do not accumulate if left unpaid, whereas cumulative preferred stock dividends accumulate. Disclosed reseNes refer primarily to retained earnings. 17 Tier 2 capital is supplementary capital. Tier 2 capital consists of reseNes other than those included in Tier 1 capital that are accepted by a bank’s regulatory authority. Tier 2 capital may include hybrid (debt and equity combination) instruments and subordinated debt (debt that ranks lower than ordinary bank depositors).
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example, Bas,el II stated only that banks must maintain all 8 per cent minimum capital base composed of at least 50 per cent Tier 1 capital. Banks could have held as little as 2 per cent of assets ill common equity without breaking regulatory sta11dards.18 Banks could therefore maintain adequate capital ratios but hold the majority of capital in preferred stock or supplementary capital.
The highest quality capital component is common equity because it is subordinate to all other types of ftmdillg, in1mediately absorbs losses and has no maturity elate. Any assets included in Tier 1 capital that are not common equity must be able to absorb losses effectively.
Stremrths
Many banks failed to maintain a high-quality capital base prior to the crisis. Banks stmggled to rebuild their capital as the crisis worsened because investors, tULsure about the quality of banks’ assets, were hesita11t to hold bank equity. Heavy losses and writedowns incurred during the crisis reduced banks’ retained earnings component of Tier 1 capital. Many investors therefore distmsted reported measures of Tier 1 capital reserves because it was difficult to observe which banks held sufficient common stock to withstand the crisis. Attaining ~11fficie11t capital was difficult a11d required govemment ~11ppo1t. Increasing the a11101111t of common equity will improve banks’ ability to absorb losses during difficult periods. Banks with more Tier 1 capital and greater reliance on deposits received higher rettmis during the crisis.19 Greater common equity requirements will also encourage investors and other banks to trust a bank’s repo1ied capital ratios.
Weaknesses
The Committee’s proposals will increase a bank’s amotmt and cost of capital. Investors have a limited demand for banks’ common equity. Forcing banks to hold substantially more conuuon stock will require issuance at increasingly favorable temis to attract more investors. Global capital may be insufficient for banks to recapitalize according to the new rules, without incurring higher costs.20 Some a11alysts and regulators worry that the world has a limited amount of “safe assets,” particularly high-quality govenuuent and coiporate bonds. The increased cost of capital will increase borrowing costs for retail and commercial customers, since banks will attempt to recuperate increased operating costs by charging greater interest on their loruis. Banks must maintain a mininuuu ratio of !ugh-quality capital to total risk-weighted assets. Brulks may be forced to reduce total assets, including [oruis below the levels they could achieve in the absence of Basel ill. The Cruiadiru1 Brulkers Association wanis that requiring banks to hold too much capital may be as damaging to the world economy as allowing banks to operate with too little c.apital.21 The Institute of Intemational Finance predicts that Basel ill could decrease potential gross domestic product
18 Basel Committee on Banking Supervision, ‘Consultative Document: International Framework for Liquidity Risk Measurement, Standards and Monitoring,• December 2009, p. 4, available at http:l/www.bis.org!publlbcbs165.pdf, accessed August 8, 2010. 10 Andrea Beltratti and Rene M. Stutz, Why Did Some Banks Perform Better during the Credit Crisis? A Cross-Count,y Study of the Impact of Governance and Regulation,• Finance Working Paper No. 254/2009, European Corporate Governance Institute, 2009, p. 21, available at http://www.ecgi.orglwplwp_id.php?id=386, accessed August 26, 2010. 20 Canadian Bankers Association, ‘CBA Comments on the Basel Committee’s Consultative Document ‘Strengthening the Resilience of the Banking Sector,m April 16, 2010, p. 3, available at http:l/www.bis.org!publlbcbs1651cbac.pdf, accessed August 9, 2010. 21 Ibid., p. 1.
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(GDP) growth by 3 per cent and decrease the number of available jobs by 10 million in the United States, the European Union and Japan.22
Leverage Ratio
Su11una1y
The Committee recommends supplementing the risk-based capital requirements of Basel II with a leverage ratio.23 TI1e leverage ratio is based on a bank’s total exposure. It is expected to protect against model risks and measurement errors.24 TI1e munerator of the leverage ratio is composed of high-quality capital and the denominator includes both on-balance sheet and off-balance sheet assets.25 The goals of the leverage ratio are to limit banks’ leverage and discourage rapid deleveraging that may destabilize the overall economy.26
The proposal recommends that high-quality assets, total repurchase agreements and sec.uritizations be included in the calculation of exposure while disallowing nettinf!”27 In a July 26, 2010 statement the Committee proposed a minimum Tier 1 leverage ratio of 3 per cent. 8
Stremrths
The leverage ratio provides a 11011-risk-basedmeasure. As previou5ly mentioned, Basel II iniposes a mininuun capital requirement u5ing a ratio of high-quality capital to risk-weighted assets. Risk is
22 The Institute of lntemational Finance represents more than 400 of the world’s largest banks. David Keefe, ·usRegulator Says Basel Capital Rules Still Tight~ Global Risk Regulator, July 31, 2010. 23 Bank leverage is the use of funding borrowed from depositors or purchased on the market to finance interest-bearing assets, primarily loans. Banks seek a profit by investing depositor funds in loans at rates high enough fo cover capital costs and operating expenses. A leverage ratio compares a bank’s leverage to its capital level. 24 Current exposure is the Joss that would be incurred today if a counterparty tailed to honor its contract. Credit risk or credit exposure is the risk that a counterparty will fail to pay back the full amount that is owed at the scheduled time or anytime in the future. A counterparty is the opposing party in a financial transaction, such as a security trade or Joan. 25 On-balance sheet leverage is leverage incurred from financial transactions renected on the balance sheet according to accounting standards. Off-balance sheet transactions are financial transactions that are not observable on the balance sheet of the financial institution conducting the transaction. Financial derivatives such as futures contracts are included in off-balance sheet transactions. Off-balance sheet leverage is therefore leverage that is not renected on the balance sheet, usually because the leveraging is part of a financial derivative transaction. 26 The economy can be destabilized by a Joss spiral. A Joss spiral occurs when leveraged investors’ assetsdrop in value and their net worth declines very quickly because of leverage. For example, an investor may buy $100 million worth of assets on a 10 per cent margin. The investor therefore finances the investment with only $10 million of his or her own capital and borrows the remaining $90 million. The leverage ratio is 10 to 1 assetsto capital or 9 to 1 debt to capital. Consider the asset value dropping to $95 million. The investors original $10 million in capital has been reduced to $5 million. The investor is forced to reduce the position to $50 million to maintain the leverage ratio of 10, meaning that the investor must sell $45 million worth of assets at a tower price than when he or she originally bought the asset. The sale further decreases prices and induces more selling to create a spiral of declining asset value. 27 Repurchase agreements are contracts to sell and tater repurchase securities at a pre-specified date and price. Securitization involves compiling assetsinto new securities backed by the underlying assets and the assets’ cash flows. Netting is the offsetting of positions by trading partners to reduce a large number of individual positions into a smaller number of positions. Committee on Payment and SeWement Systems,A Glossary of Terms Used in Payments and Settlement Sysiems•,March 2003, available at http:llwww.bis.org/publlcpssOOb.pdf, accessed August 10, 2010. 28 The recommended leverage ratio is based on the Committee’s more limited definition of cap1al and more broad definition of assets,including off-balance sheet assets. The minimum Tier 1 leverage ratio of 3 per cent means that banks must hOfd at least 3 per cent of their total assets in Tier 1 capital, or a bank’s total assetsc<1nnot be more than 33 times its Tier 1 capital. Bcse/ Committee on Banking Supervision, “Annex•, July 26, 2010, available at http:// www.bis.org/press/p100726/annex.pdf, accessed August 9, 2010.
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quantified through financ.ial modeling and dependenc.e 011 credit rating agenc.ies. The leverage ratio inc.reases tra115parenc.y by supplementing the risk-based models with a broader model that does not distinguish between low-risk and high-risk asset5. The ratio can help to identify banks that are operating radic.ally different from their peers, particularly in regard to off-balance sheet activities.29
The primaiy strength of the leverage ratio is the monitoring of off-balance sheet leverage. Brulks heavily expru1ded both 011-balru1cesheet ru1d off-balru1ce sheet leverage prior to the fi11ru1cialcrisis. The bru1ki11g ~ystem maintained strong capital ratios while significantly inc.reasing leverage. Brulks were therefore able to expru1d their risk profile without exceeding regulat0ty limits. For exan1ple, Lehman Brothers boasted a Tier 1 capital ratio of 11 per cent just five days before the finn’s collapse. However, Lehman Brothers reported a leverage ratio of30.7 to 1 in the compru1y’s 2007 ruumal report.30
Weaknesses
Strict implementation of a leverage ratio may have tulintended co11Seque11ces. Assigning too much impo1iance to a leverage ratio could incent banks to focus more on higher-risk assets with !}feater potential retums than on low-risk assets with lower yield because all assets are equally weighted. 1 Allowing the ratio to be too broad may also cotmteract the significance of the ratio by overstating potential risks ru1d therefore making the identification of outliers more difficult.
Counter-Cyclical Capital Buffers
Summa1y
The Conunittee proposes the maintenance of capital buffers dtu111g stable periods to absorb losses dtu111g period5 of stress. A capital buffer is a range defined above the regulato1y mi.11i.11uu11 capital requirement to protect against losses. Cotu1ter-cyc.lical capital buffers reqtlire brulks to hold capital greater than the regulatory mi.ninuun dm111g periods of stability in order to ~1uvive dw111g a sudden industry downturn. Regulators would enact co115traints when capital levels fall within the range. For example, a bank could 111ai11tawa rnpital uuITer of 3 per ceut above the 11w.lll11um capital retttrireme11t of 7 per ceut during slaule period5. Regulators would interfere when a bank’s capital ratio fell below 10 per cent. A bank would then replenish capital by linliting dividend5, share buybacks ru1d bonuses tmtil the brulk’s capital ratios approach the nlinimtm1 regulatory reqtlirement.. The goal of the cotmter-cyclical capital buffers is to com1ter excessive leverage and tmwarranted lending dm111g expruisionruy periods. Supervisors cru1 also suspend the buffer requirement dm111g period5 of stress to inc.rease credit supply dll11llg econonlic downttuns. =·
2
29Richard Barnes et al., “Basel 3 for Global Banks: Third Time’s the Charm?,• Standard and Poor’s, Mach 4, 2010, available at http://www2.standardandpoors.comlspf/pdflfixedincomel Basel_/11.pdf, accessed August 10, 2010. 30 Lehman Brothers calculated the leverage ratio as total assets divided by total stockholders’ equity. 31 Sylvi9 Dalmaz 9/ al., “Th9 Bas9I /JI L9v9,ag9 Ratio Is a Raw M9asur9, But Could Supp/9m9n/ Risk-Bas9d Capital Metrics,• Standard and Poor’s, April 15, 2010. Available at http://www.bis.org/pubVbcbs165lsplr.pdf, accessed July 29, 2010. 32 Basel Committee on Banking Supervision, ·countercyclical Capital Buffer Proposar, July 2010, p. 9, available at htfp:/lwww.bis.org/pubVbcbs172.pdf, accessed August 10, 2010.
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Strem1ths
Markel pmticipauls leuc.l lu act in a pro-cyclical 111,muer. Mauy accept greater risk c.ltuiug favuraule p~riuc.ls and pum1e less risk dtu111g 1u15table periods. Periods of credit expa1l5ion often precede liquidity crises. 33
During the financial crisis, heavy losses destabilized the banking sec.tor following a period of excess lending. Some banks ftuiher weakened the system by continuing to pay dividends early in the crisis. Many banks quickly retumed to paying dividends and distributing bonuses following the crisis, although the ~ystem remained fragile. For example, in 2009, the investment bank Goldman Sad15 distributed annual bonu5es equal to the record payouts made in 2007.34 Ac.cess to cheap borrowing from the Federal Deposit l!mirance Corporation’s debt-guarantee program partially fuelled Goldman Sach5’s retum to profitability.35
Goldman Sachs could have added the excess earnings to a capital buffer to protect against future crises.
TI1e Committee proposed the capital buffer as an altemative to the creation of a govenunent capital buffer ftmded by a tax on banks. The l!!temational Monetary Ftmd proposed two global bank taxes in April 201360. The first was a flat-rate tax on all banks, i1l5urance companies and hedge ftmds. The second was a tax on profits and compensation. Such a bank tax would create a centralized capital buffer. Govemments would move ftmds gained from taxation into either an extemal ftmd or into general govenunent revenues perhaps with a11 explicit pledge to support failing banks in funlfe crises. The Canadian govemme11t opposed the in1plementation of a brulk tax. Jin1 Flal!erty, Canada’s Mini.5ter of Finance, stated that a brulk tax would reduce brulks’ ability to absorb losses and would increase moral haza37rd. The capital buffer requirement proposed by the Conunittee would serve a similar ptupose to a brulk tax but would avoid moral hazard and would not require responsible brulks to pay for the poor mruiagement of irresponsible banks.
Weaknesses
The capital buffer niay have negative co115equences similar to those caused by improving brulks’ capital base. High capital stupluses will increase capital costs, thus reducing brulks’ profitability 38 As a res1tlt, capital accumulation will be more diffic.ult dm111g expansionruy periods. Banks may therefore attempt to compensate for a large excess capital buffer by increasing their ri.5ks dtlfing upttum.
33 Graciela Kaminsky and Carmen M. Reinhart, “The Twin Crises: The Causes of Banking and Balance-of-Payments Problems,• The American Economic Review, June 1999, p. 19. ” Graham Bowley, ‘Bonuses Put Goldman in Public Relations Bind,• New York Times, October 15, 2009. 35 Susanne Craig, ‘Goldman Goes Gangbusters on Profit, Pay,• The Wall Street Journal {New York], October 16, 2009. 30Staff of the International Monetary Fund, A Fair and Substantial Contribution by the Financial Sector: Interim Report for the G-20, lntemauonal Monetary Fund, April 16, 2010, p. 3, available at http:llnews.bbc.co.uk/2/sharedlbsplhilpdfs/2010_04_20_imf_g20_ 37 Jim Flaherty, ‘Speech by the Honourable Jim Flaherty, Minister of Finance, to 7he Canada Forum’ Euromoney Conference~ speech, “The Canada Forum• Euromoney Conference, Toronto, Canada, April 21, 2010, Department of Finance. Canada. available at http://www.fin.gc.ca/n10/10-029_1-eng.asp. accessed August 25. 2010. 38 Canadian Bankers Association, ‘CBA Comments on the Basel Committee’s Consultative Document ‘Strengthening the Resilience of the Banking Sector”‘,April 16, 2010, available at http:f/www.bis.org/publlbcbs1651cbac.pdf, accessed July 29, 2010.
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Measures to Limit Counterparty Credit Risk
S Ullllllaty
CoUllterparty credit risk is the risk that the opposing party in a financial transaction will fail to honor an agreement. TI1e Committee believes that Basel II did not require banks to hold enough capital to limit counterparty credit risk. Basel III therefore imposes more consetvative measures for calculating counterparty credit risk. For example, banks calculate capital requirements for counterpru1y risk tL�ing historical data when estimating volatility and correlation assumptions in their intemal risk measurement models_ 39 Basel III requires banks to include a period of economic and market stress when making modelo assun1ptions_ The Committee also proposes that banks should apply a multiplier of 1-25 to historical obseivations when calculating the correlation betweet1 :financial fi11ns’ asset value and the economy_ Increasing banks’ correlation assumptions will require banks to hold more capital to protect against the negative effects of other financial institutions’ credit risk The Committee also proposes that banks’ exposure to counterparty risk receive a zero-risk weight if deals are processed through exchanges and deaii.ughouses_40 Applyiug a zero-11.’>k weigh! lo lrnm,adiom, settled through ceulrnlizeu deariugl10L1!>t:!!>
41encourages banks to shift over-the-counter derivative trading to exclianges.o
Stremrths
Previous capital frameworks did not account for the high interconnectedness of large financial iru,titutions_ Banks’ countetJJll11y exposure to other financial finns increased when markets dropped, and correlation beh.veen financial firms’ asset values increased_ Increasing the correlation assumptions ,vill increase the
irisk-adjusted weightng for banks’ funding from other financial institutions_ Banks will therefore seek to hold fewer assets from other financial institutions_ The Committee drafted the recommendation to decrease financial institutions’ dependence on one another_
Wealmes�es
Proposals to move the processing of over-the-counter derivative transactions outside of banks may have unintended consequences_ Hedging instruments, such as option�, futures ru1d swaps, will continue to be necessary for fan1S that seek to offset their risks_ TI1e oost of hedging the interest rate and currency risk through banks will increase, and these costs will be pa,;sed on to the end-tISer.42 Over-the-countero
,. Counterparty correlation assumptions are predictions of the relationship between a counterparty’s asset value and /he performance of the overall economy_ The performance of the economy is often estimated by metrics such as GDP, unemployment rates, interest rates and market indexes_ The assumptions are used lo predict banks’ exposure during an economic downturn. Attempting to predict correlation assumptions has a similar purpose lo stress-testing_ Stress tests such as those administered in the European Union in 2010 also seek to measure banks’ exposure to economic downturns and losses of market confidence. “Banks Find Exercise Relatively Pain,’ess,• Financial Times (London], July 24, 2010, p_ 9_
r
‘° Clearinghouses are cent al processing locations through which financial institutions exchange securities. Clearinghouses settle the exchange and deliver payments. Committee on Payment and Settlement Systems, A G/ossaf}’ of Terms Used in Payments and Settlement Systems,· March 2003, available al .’ltlpJlwww.bis.org!publlcpssOOb.pdf, accessed August 3, 2010. 41 Over-the-counter is a trading method that does not involve exchanges or clearinghouses. Participants trade directly by telephone or through computer links. Ibid_ 42 Thierry Grunspan et al., “Basel Ill Proposal lo Increase Capital Requirements for Counterparty Credit Risk May Significantly Affect Derivatives Trading,” Standard and Poor’s, April 15 2010, available at http.llwwwbis.orglpubl/bcbs165/spccr.pdf, accessed August 3, 2010.
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derivatives business may be tramferred to unregulated institutions, such as hedge funds, if costs become too high.
Liquidity Ratios
S ununa,y
The Conuuittee’s International Framework for Liquidity Risk Measurement, Standards and ll(onito1ing ~11pplementsthe Principles for Sound Liquidity Risk Management and Supervision., which was issued in September 2008. The liquidity framework aims to iinprove banks’ resilience to liquidity problems in the market. Films mu5t be able to with5tand periods of low market liquidity.43 TI1e Committee’s recommendations include l:\vo liquidity ratios intended to monitor both sho1t-tenn and longer-tenu scenanos.
The short-tem1 metric, entitled the Liquidity Coverage Ratio (LCR), is the ratio of high-quality assets to net cash outfl!ows over a 30-day period. The ratio value should be equal to or greater than 100 per cent, and quality assets mu5t be highly liquid. Banks should continuou5ly maintain an acceptable liquidity level. The Conuuittee advises supervisors to define a stress scemu’io and requires banks to demonstrate their ability to remain solvent for one month. The stress scenario illcludes a downgrade of the bank’s public credit rating, a partial loss of deposits, a loss of tlll5ecured wholesale funding and an increase in derivative collateral calls.
The Conuuittee nan1ed the medium- and long-tenn metric tl1e Net Stable Fundillg Ratio (NSFR). The NSFR is detemlined by tl1e ratio of available stable funding to tl1e amount of stable funding required to cover all illiquid assets and securities held. Stable funding is composed of equity and liabilities financing that are reliable somces of fundillg under stress scenarios. The ratio value should remain above 100 per cent.
Stremrths
Banks suffered from poor liquidity risk management precedillg the financial crisis. Liquidity problems caused Bear Steams’ near collapse ill March 2008. Bear Stearns heavily relied on short-tenn secured funding to finance long-tenu illiquid assets and struggled when secured funding disappeared. 44 TI1e LCR will ensure tluat banks maintaill a defined level of higl1-quality asset5 tliat can with5tand problems in short tem1 funding. Banks can convert tl1e assets into c.ash in tl1e case of liquidity problems. The ,eonunittee assumes that 30 days will provide bank management or the supervising regulatory body enougl1 ti.me to resolve a liquidity crisis. The LCR also works to counteract the interconnectedness of tl1e financial system because the definition of high-quality asset5 used to calculate the LCR excludes both bank debt and in~1irancefim1 debt. Liquidity problems at otl1er financial institutions will therefore have less influence on a bank’s ability to remain liquid .
.., Market liquidjfy is low when it becomes difficult to raise money by selling assets without significantly decreasing the sale price. Markus K. Brunnermeier, ‘Deciphering the Liquidity and Credit Crunch 2007-2008, • Journal of Economic Perspectives, -.<ol. 23, no. 1, 2009, p. 90. u Senior Supervisors Group. ‘Risk Management Lessons from the Global Banking Crisis of 2008,• 2009, available at hltp:/lwww.financialstabilityboard.org/publicationslr_0910a.pdf, accessed August 25, 2010.
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The availability oflow-cost funding as well as poor risk evaluation supported the build up ofleverage prior to the financial crisis.45 Leverage was often predominantly composed of sho1t-tenu wholesale ftmding. TI1e liquidity framework sets an intemational minimum standard and requires more detailed analysis of each bank.
Weaknesses
The liquidity framework will increase the cost and decrease the availability of credit. TI1e available supply of long-tem1 wholesale ftmding may not be sufficient for banks to confonu to the minimum regulato1y NSFR.46 Implementation of the LCR and NSFR may encourage all tmderfunded banks to increase their stable deposits sinmltaneously. If this were to happen, the m5h to obtain stable deposit5 could result in the mispricing of stable ftmding. The Conuuittee’s exdusion of bank debt from high-quality assets will ftuther reduce liquidity, and issuers of non-high quality assets will depend more on bank debt because of reduced demand for the issuers’ securities.
The high-quality assets u5ed to cak.ulate the LCR co115ist of cash, high-quality govenuuent debt and some high-quality corporate bond5. The conservative definition used in the LCR may create liquid asset sho1iages and a large concentration of risk because all banks will wish to hold similar assets. The definition is much more restrictive than the collateral definition tmder national regulators’ liquidity standards.47 TI1e calculation of cash inflows al5o assumes that banks cannot rely on lines of credit, liquidity facilities or other contingent ftu1ding facilities to reduce their dependence on wholesale ftmding. Tilis ass1m1ption could negatively affect the interbank lending market, wllich is currently a major source of ftmding for many banks.48
BASEL Ill EXCEPTIONS
5.1. Country Exclusion
The Conuuittee’s reconuuendatio115 are not legally binding. Member cotmtries must choose whether to iniplement the Conu11ittee’s ~11ggestions. Some countries could explicitly reject tl1e proposals or indefinitely delay implementation of t11e fran1ework. A co11U11oncriticism of Basel ill is that the increased restrictiveness and ~pecificity make the fran1ework more difficult to iniplement globally. Liu Mingkang, chainnan of the China Banking Regulatory Conllllission, stated tl1at tl1e Basel ill doctuuents consider tl1e banking practices only in Europe and the U11ited States while ignoring tl1e practices in emerging eco1101uies such as China.49 Major emerging eco1101uies could therefore refuse to fully enact tl1e Basel ill proposals. The brulking sectors i.11those economics could enjoy o competitive boost over their cow1tcrpruts in Europe
45 Stefan Best and Scott Sprinzen, “Basel /II Proposals Could Strengthen Banks’ Liquidity, But May Have Unintended Consequences,” Standard and Poor’s, April 15, 2010, available at h/tp:/Avww.bis.orglpubVbcbs165/spl.pdf, accessed August 7, 2010. 40 Canadian Bankers Association, ·cBA Comments on the Basel Committee’s Consultative Document ‘International Framework for Liquidity Risk Measurement, Standards, and Monitoring,m April 16, 2010, p. 6, available at http:/lwww.bis.org/pubVbcbs1651cbal.pdf, accessed August 8, 2010. 47 Stefan Best and Scott Sprinzen, “Basel /II Proposals Could Strengthen Banks’ Liquidity, But May Have Unintended Consequences,” Standard and Poor’s, April 15, 2010, available at http:/Avww.bis.orglpubVbcbs165/spl.pdf, accessed August 7, 2010. 48 The interbank lending market allows banks to make unsecured, short-term loans lo each other. Markus K. Brunnerrneier, •Deciphering the Liquidity and Credit Crunch 2007-2008, • Journal of Economic Perspectives, vol. 23, no. 1, 2009, p. 85. ” Liu Mingkang, “CBRC Feedback on the BCBS Documents,” China Banking Regulatory Commission, April 13, 2010, available at http:/lwww.bis.org/publlbcbs1651cbrc.pdf, accessed August 8, 2010.
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and the United States and subsequently receive a larger amount of global business. Systemic risk may merely shift from Westem brulking system5 to developing countries’ finru1cial imtitutions; thus, the new regulatio115would not significru1tly reduce tl1e risk of global financial crises.
Non-Bank Financial Institutions
The Basel ill frruuework may fail to reduce systemic ri5k because it may directly or indirectly shift ri5k to non-brulk institutio115. Brulks’ increased operating costs will be transferred to c.lients and so may shift business to hedge fund5 ru1d other non-regulated institutio115. Unregulated finru1c.ial institutio115 were a ftmdruuental prut of the finru1cial system £rior to the crisis, providing loruis, liquidity, insurance ru1d other se1vices traditionally offered by brulks. Placing greater regulation on brulks ru1d allowing 11011-brulk institutio115 to operate witl1out supervision may trru15fer more services to 11011-brulkill5titutio11S. Greater concentration of finru1cial services in unregulated imtitutio115 may increase rather tl1an decrease systemic risk.
NATIONAL REGULATIONS
6.1. United States of America: Dodd-Frank Wall Street Reform and Consumer Protection Act 51
The Dodd-Frrulk Wall Street Refonu ru1d Co11S\lmer Protection Act was signed into law on July 21, 2010, ru1d is the most significant national regulation enacted in response to tl1e financial crisis. The legislation seeks to refom1 tl1e brulking industiy by ending taxpayer bailouts, monitoring compensation practices, limiting proprietruy trading ru1d regulating non-brulk financial iiistitutions.52 Regulators can identify both brulks ru1d non-banks as ~ystemically iiuportant and subject to additional supervision. The legislation also seeks to protect iiivestors, co115umers and future homeowners by increasing oversigilt of lending ru1d financial service practices. U.S. ~f,!latory bodies accused some financial n15titutions of deceiving buyers of complex finru1c.ialn15tnunents., The bill created the Con~1m1ei· Protection Agency to prevent deceptive financial products ru1d practices. The “Vokker Rule” would ban proprietruy tradii1g by conm1ercial brulks, ru1d would prohibit a commercial bailk from ownii1g or ii1vestii1g iii a hedge ftmd or private equity fund. The Dodd-Frank Act does not include reconuuendatio115 on capital adequacy, ru1d Basel ill is expected to complement the act.
50 Andrew W. Lo, “Hedge Funds, Systemic Risk, and the Financial Crisis of 2007-2008: Written Testimony for the House Oversight Committee Hearing on Hedge Funds,• Committee on Oversight and Government Reform, November 13, 2008, p. 10, available at ht/pf/ papers.ssrn.cornlsol3/papers.cfm?abstract_id=1301217, accessed August 30, 2010. 5′ For the remainder of the case, the Dodd-Frank Wall Street Reform and Consumer Protection Act will be referred to as the Dodd-Frank Act. “Brief Summary of the Dodd-Frank Wall Street Reform and Consumer Protection Act,• Committee on Financial Services, US House of Representatives, June 29, 2010, available at httpflbanking.senate.govlpublicl_filesl 070110_ Dodd _Frank_ Wal(_ Street_ Reform_ comprehensive_ summary _Final.pd(, accessed August 10, 2010. 52 Proprietary trading is security or derivative trading for a firm’s own account rather than on clients’ behalf. Committee on Payment and Settlement Systems, A Glossary of Terms Used in Payments and Sell/ement Systems,• March 2003, available at http:/Avww.bis.orglpubV cpssOOb.pdf, accessed August 3, 2010. 53 For example, Goldman Sachs was forced to pay $550 million to U.S. regulators on July 16, 2010, for misleading investors. Christine Harper and Joshua Gallu, ‘Goldman Sachs Victory’ Ushers Change for Wall Street,• Bloomberg, July 16, 2010, available at http:// www.businessweek.com!news/2010-07-16/goldman-sachs-victory-ushers-change-for-wall-street.html, accessed August 10, 2010.
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Canada: Principle-Based Approach
Many Canadian supe1visors and banks ~11ppo1t a princ.iple-based regulato1y system rather than a rule-based regulatory system. A princ.iple-based approach uses general frameworks to guide brulks’ compliru1ce without establishing specific. rules. For exrunple, the Offic.e of the Superintendent of Financial Institutions’ (OSFI) liquidity guidelines allow bru!ks to decide whic.h ru1alytical tools should be used to monitor liquidity risk ru1d allow liquidity management tools to differ depending on the size of the brulk’s funding sources ru1d the diversity of the bank’s business.54 Tilis guideline differs from the Basel Comnlittee’s rule based approach to liquidity that defines both the metric ru1d the risk factors that banks should use to calculate liquidity risk. Rules-based regulation may encourage banks to c.irctunvent specific rules. Regulators confront a bank only when a rule is broke11. In contrast, Canada’s princ.iple-based regulation requires banks to embed risk mruiagement in their c01porate culture.55 Regulators require bru!ks to design their own monitoring system. OSFI focu5es on the quality of controls ru1d on identifying problems with individual institutio115 through stress testing before problems become crises.56 Cruiada’s bru!ks perfonned well compared to other countries’ banks during the financial crisis, prutly because of its principle-based regulatory system that makes brulks responsible for their own risk nianagement.
EU: A New International Regulatory Framework
A series of questions reniain to be addressed in regard to implementation of a new EU “brulking tulion.” Members of the EU euro area have debated the optinial regulatory frrunework that can prevent a recurrence of EU financial crises. EU members have also debated the tem15 ru1d conditions for providing EU assistru1ce to individual bru!ks when they encotmter severe difficulties. hlitially, it was proposed that an EU regulato1y authority supervise only the largest banks, but recent proposals would broaden this r~po115ibility to all bru!ks.
CONCLUSIONS
Universality
The Comnlittee should advocate proposals that better protect banks from finru1cial downtun15 without inc.reasing systemic risks in other areas in the financial system. Encouraging iniplementation by all members should be a priority, ru1d the extension of regulatio115 to non-brulk financial institutio115 should be addressed.
Improving the Capital Base
The Committee’s proposal to raise the quality of eac.h brulk’s capital base will allow brulks to better absorb shoe.ks during finru1c.ial c.ri.5es. However, the Conu11itt,ee should broaden the defolition of lligh-quality capital to allow for effective implementation in all member cotmtries. The new definition of high-quality
54 Office of the Superintendent of Financial Institutions Canada, Uquidity Guideline. December 1995, p. 2, available at http://www.gloriamundi.org/Library _Journal_ View.asp? Journal_id 55 Tara Perkins, ‘Nobody’s Saviour,· Globe and Mail. April 20. 2009. available at http:l/www.theglobeandmail.com/report-on businesslarticle1138040.ece. accessed August 10, 2010 . .., Stress testing is the process of estimating credit and liquidity exposures that a bank would experience during scenarios of extreme volatility. Committee on Payment and Settlement Systems, A Glossary of Terms Used in Payments and Settlement Systems,• March 2003, available at http://www.bis.org/pubVcpssOOb.pdf, accessed August 10. 2010.
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capital will allow for a lower minimum overall capital ratio than would have been required with previous classifications because Basel ill redefined capital to better absorb losses. Banks’ implementation period of the new capital standard should be sufficient to avoid banks rapidly increasing their couunon equity and to allow the market to adjust to the changes.
Ill many 11atio11s,regulators face tulique challenges. For example, in Australia the ballking sector represents a much greater proportiou of the equity markets thal1 in the US or Europe. The bal1king system is practically dominated by all oligopoly of four major ballks; there is a heavy relial1ce on off-shore debt fi.mding by these ballks. Past budget stupluses resulted in a relatively limited alllOtu1t of govemment bonds in circulation. That is, Au~tralia lacks sufficient depth of the govemment securities to folfill the liquidity coverage ratio tmder Basel ill. The central bank (Reserve Ballk of Au5tralia) imtead has created a liquidity facility to broaden the definition of acceptable securities for repos to also include securities issued by other financial institutio115 (with credit ratings BBB+ and better).
Leverage Ratio
A leverage ratio is a strong addition to the Basel frameworks. Caliadial1 regulators have effectively used leverage ratios to linlit banks’ holding too much leverage.57
Counter-cyclical Capital Buffers
The Conmlittee should avoid defining a specific level for cotmter-cyclical capital buffers. Capital buffers restrict pro-cyclical behavior but also define a capital level that investors alld depositors may co115ider the actual minimtun capital reqtlirement. A bank breaching the capital buffer may cau5e all tmwarranted prulic alllOllg investors and depositors.
Measures to Limit Countemarty Credit Risk
The Conmlittee’s reco11unendatio115to limit cotmterparty credit risk will decrease ballk interconnectedness. Increasing co1relatio11 and volatility asstunptio115 will help limit ballks’ dependence on one another.
Liquidity Ratios
Liquidity ratios will allow sufficient time to mitigate individual ballk’s liquidity crises alld decrease rehal1ce on sho1t-ten11 fundrng. The Conumttee should also promote eflic1e11t stress testmg procedures. Thorough stress testing will help ballks ensure that their liquidity levels accurately reflect the ctuTent environment.
57 OSFI imposes a maximum leverage limit. Banks must hold an asset-to-capital ratio of Jess than approximately 20 to 1. The use of a broad leverage rabo as a complement to a risk-adjusted capital requirement has been cited as a contributor to Canada’s relative success during the financial crisis. Carol Ann Northcott, “Lessons for Banking Reform: A Canadian Perspective,• Central Banking, vol. 19, no. 4, 2009, pp. 43-53.
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Possible Additions to the Basel Framework
A framework for continual stress testing is a possible addition to Basel ill. The Basel ill recommends stress testing as part of managing counteiparty credit risk and mention5 the in1portance of stress testing in the liquidity repo1t. However, the Committee does not include a fran1ework for conducting continual stress testing. An internationally coordinated stress testing framework would strengthen the global financial ~ystem and encourage the early detection of crisis scenarios.
The Committee of European Banking Supervisors (CEMS) stress tested large European banks.58 The objective of the stress test was to evaluate the resilience of the Emopean Union’s banking sector to financial system shocks. The CEMS stress test evaluated the capital adequacy of European banks. Banks should regularly conduct a similar exercise and stress test both their capital adequacy and liquidity risk management. OSFI requires Canadian banks to stress test for credit, liquidity, market, in5urance and operational risk in addition to testing other risk management areas.59 Proposing principle-based guidelines for stress testing that encompass a range of financial in5titutions’ risks would complement the ratios and metrics outlined in Basel ill.
How best to regulate the large international banks remains a dilenuua. Large banks may be better able to absorb the costs of new regulation5 than can small banks, and this may lead to greater market concentration. Large banks may be seen as “too big to fail,” cariying risks that their failure could damage the broad financial system. Some regulators believe that such banks should be required to create “living wills” that stipulate how each bank will cope with catastrophic losses that could prevent ongoing survival. Part of a “living will” may include provisions for a “top down bail in” where the authorities would take over and operate a failing bank and compel shareholders and bond holders to accept losses. This process could be facilitated by the bank issuing “coco bonds” which would automatically become shares in the event of ~pecified ratios being breached.
The Importance of Unintended Consequences
The financial crisis demon5trated that previous regulato1y efforts were in5ufficient to prevent systemic crashes. The Basel Conuuittee on Banking Supervision drafted the International Framework for Liquidity Risk Measurement, Standards and Monitoring and Strengthening the Resilience of the Banking Sector to address some of the major systemic problems observed dtumg the financial crisis. TI1e reconuuendations build on the Basel I and Basel II fran1eworks and provide a new fran1ework for national regulators. However, the unintended consequences from the Basel ill reconuuendation5 may increase rather than decrease the probability of financial crises. Any regulatory changes must decrease systemic risk and avoid merely distributing risk to other areas of the financial system. The next few years will see major regulato1y changes in the banking indu5try Banks should prepare themselves for operational and strategic shifts.
Committee of European Banking Supervisors, “Aggregate Outcome of the 2010 EU Wide Stress Test Exercise Coordinated by CEBS in Cooperation with the ECB,• July 23, 2010, available at http:llstress-test.c ebs.orgldocuments/Summaryreport.pdf, accessed August 10, 2010. “‘ Office of the Superintendent of Financial Institutions Canada, “Guideline: Stress Testing,• December 2009, p. 5, available at http://www.osfi-bsif.gc.calapplDocRepository/1/engl guidelineslsoundlguidelinesle18_e.pdf, accessed August 30, 2010.
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