UK-based lender HSBC will pull capital from underperforming businesses in a bid to bolster the profitability of its retail banking and Asian segments.
The bank announced plans to redeploy $100 billion of risk-weighted assets (RWAs) by 2022. HSBC will cull around $58 billion of RWAs from its non-ring-fenced bank in Europe and the UK, with the trading division bearing the brunt – specifically the rates and G10 long-term derivatives units.
There will also be a reshuffle of RWAs within the US business, with the trading unit facing $5 billion of reductions. These savings will be ploughed back into the US commercial and retail banking operations. Additional redeployments of RWAs will take place across geographies, with the end-2022 goal being a 50% allocation to Asia, up from 42% today.
In 2019, HSBC cut RWAs by $21.9 billion net. A gross $22.8 billion was pulled from the global banking and markets division (-8%); $4.5 billion from commercial banking (-1%); and $2.8 billion from global private banking (-17%). In contrast, $1.1 billion was added to the corporate centre (+1%) and $7.1 billion to retail banking (+6%).
HSBC achieved a return on risk-weighted assets (RoRWA) – adjusted profit before tax divided by RWAs – of 2.6% in 2019, compared with 2.4% the year prior.
The retail banking division achieved the highest RoRWA, at 6.6%. The global banking and markets division achieved an RoRWA of 2.1%.
Who said what
“We intend to reduce RWAs by over $100 billion in areas generating low revenues to risk-weighted assets with very high cost/income ratios. And we intend to redeploy these risk-weighted assets in areas of higher revenue and lower cost/income ratios, particularly over the medium to longer term. The reduction and redeployment of RWAs and associated revenue impacts will be spread fairly evenly over the three years of our plan, and we do expect further benefits from the redeployment of RWAs to flow into 2023 and beyond” – Ewen Stevenson, chief financial officer at HSBC.
What is it?
RWAs are used to set minimum capital requirements for banks. Credit assets, such as loans, are assigned a risk-weighting to generate their RWA value. The riskier the loan, the higher the RWA. Market RWAs are set using value-at-risk measures and other gauges of trading risk. Operational RWAs are set using banks’ own models or regulator-set formulae.
Why it matters
HSBC’s profitability has been held back by the sclerotic performance of its trading divisions in both Europe and the US. Profits before tax were down -80% at the European and -24% at the US arms of the global banking and markets segment, respectively. The division as a whole contributed 24% to total adjusted profits, but consumed an outsized 31% of RWAs.
RWAs determine the amount of capital tied up by a business, and HSBC clearly believes it is not getting enough bang for each buck invested in its trading entities. In this, the bank is not alone. RBS also announced it would shrink its struggling markets unit, which contributed just 9% to total income while taking up 20% of RWAs.
European rates businesses in particular appear to be a drag on earnings at both banks. As one head of flow rates at a European dealer told Risk.netlast year, the business is not sustainable, thanks to competition and the stability of Europe’s low, steady rates. Perhaps both HSBC and RBS are waking up to this reality.
By Louie Woodall, Abdool Fawzee Bhollah | Data | 13 February 2020
Operational risk-weighted assets (RWAs) dipped below €20 billion ($21.7 billion) at Commerzbank for the first time in at least nine years in Q4, following updates to its advanced measurement approach (AMA) model.
Op RWAs at the German lender stood at €18.7 billion at end-2019, a decrease of €3.1 billion (-14%) from Q3 and -12% on a year prior. This translates to a capital requirement of €1.5 billion.
In Q1 2012, op RWAs hit a high of €27.7 billion, and averaged €22.3 billion over the next 30 quarters.
Total RWAs at Commerzbank stood at €182 billion at end-2019, and the Common Equity Tier 1 (CET1) capital ratio at 13.4%.
Who said what
“In operational risk, we reduced the RWA by around €2 billion [sic] through improvements in our risk model, which were approved by the regulator in Q4. A dropout of external loss events and the industry-wide database further contributed to the reduction. The moderate driven reduction should be maintained going forward” – Bettina Orlopp, head of legal and group compliance at Commerzbank.
What is it?
Basel II rules lay out three methods by which banks can calculate their capital requirements for operational risk: the basic indicator approach; the standardised approach; and the AMA. The first two use bank data inputs and regulator-set formulas to generate the required capital, while the AMA allows banks to use their own models to produce the outputs.
Why it matters
The AMA allows banks to refresh the loss data used as an input to their op risk models, meaning as large losses recede into the past, they hold less sway over present capital requirements. This makes AMA banks’ RWAs more volatile, however. Commerzbank’s have shifted by a range of €9 billion since Q4 2011.
The bank is also one of just a handful that still exclusively uses the AMA. Most EU lenders use a mix of approaches, or use the standardised approach in isolation, to calculate their requirements. Commerzbank, too, will need to switch to using the new standardised approach as Basel III reforms come into effect. This may result in its op risk requirements creeping upwards again.
In January’s largest operational risk loss, Russia’s VTB Bank lost $535 million in a fraud involving loans to state-owned companies in Mozambique. Between 2013 and 2016, three Mozambique companies borrowed over $2 billion to finance maritime projects, comprising $535 million from VTB, $622 million from Credit Suisse, and an $850 million eurobond arranged by VTB and Credit Suisse. The loans were guaranteed by Mozambique’s government.
In May 2016, Mozambique Asset Management, which borrowed the $535 million from VTB, defaulted on its loan after generating virtually no income. In January 2019, three former Credit Suisse employees pleaded guilty to conspiracy to commit money laundering and wire fraud in the scheme and were charged in the US. On January 6, 2020, VTB filed a lawsuit against Mozambique Asset Management and the Mozambique state to recover the $535 million.
The second-largest publicly reported loss is a 7.56 billion rupee ($106.4 million) loan fraud suffered by commercial lender Bank of India. Directors and guarantors of trading firm Frost International allegedly forged documents to obtain the loans and siphoned off the funds by giving unsecured loans and advances to non-business-related parties. According to India’s Central Bureau of Investigation, the company did not make any genuine business transactions. In total, 14 banks have lost 35.92 billion rupees in the fraud.
Third, the Central Bank of Suriname lost $100 million from its foreign currency reserves in a suspected fraud. In 2019, local banks were instructed to transfer 50% of foreign currency that was held in customer deposits to the central bank. Since then, government investigations have revealed irregularities within the central bank such as overcharging for the purchase of cars, backdating loans, and conflicts of interest between the private accounting firm of former central bank governor Robert van Trikt and the bank. Authorities have arrested van Trikt in connection with the missing funds.
In the fourth-largest loss, Citadel Securities reached a settlement of 670 million yuan ($97.7 million) with the China Securities Regulatory Commission for breaking account and asset management rules. In 2015, the CSRC launched a probe into algorithmic trading and spoofing. In August of that year, the Shanghai and Shenzhen stock exchanges suspended 28 trading accounts, including Citadel’s, on suspicions that algorithmic trading had distorted the market. After an investigation into “malicious” short-selling, the CSRC also reached settlements with four other firms totalling 15.2 million yuan and said Citadel had “taken necessary measures to strengthen internal controls”.
Finally, Wells Fargo preliminarily agreed to pay $79 million to settle a class action lawsuit after it excluded participating employees from a deferred compensation plan. The bank incorrectly used a forfeiture clause in the plan to deny payouts to departing employees. The plan provided participants with retirement incomes funded by a deferral of income during employment. To qualify for retirement, the plan participant had to meet several requirements, otherwise the deferred compensation was forfeited. The lawsuit alleged that this forfeiture clause was unenforceable because the plan constituted a “pension benefit plan” and was thus subject to US funding, vesting and non-forfeitability requirements.
Spotlight: Citi’s $18m flood insurance fine
Citi is facing a $18 million fine after it failed to buy flood insurance for borrowers who had loans secured by buildings and mobile homes located in areas at risk of flooding. The lapses had taken place from at least 2014. Though climate-related financial risks are a growing focus for many banks, the purchase of such cover has in fact been a requirement for lenders since the Flood Disaster Protection Act of 1973.
Under Citi’s Flood Act compliance programme, an unnamed third party was responsible for servicing the bank’s loans. The programme aimed to ensure that the collateral securing customer loans had appropriate flood insurance cover. Banks typically have 45 days after notifying borrowers of the required insurance to put a policy in place. However, Citi’s policies and procedures allowed its third-party servicer to delay buying insurance beyond this 45-day period, resulting in late purchases of flood insurance for borrowers who were at risk.
In focus: IT risk tops bank concerns
Information security is the top operational risk for financial institutions, according to a new survey by loss data provider ORX. IT-related risks dominate the survey, in common with Risk.net’s top 10 op risks survey.
Information security encompasses risks associated with IT and cyber security: for example, cyber attacks by malicious actors, cyber-related business disruption and cyber-related data breaches. Technology, the third-placed risk, means risks associated with IT infrastructure. Second in the list of emerging risks is digital disruption, which means risks associated with disruption from new technologies and market entrants.
Notably, regulatory compliance jumped up the rankings from eighth to fourth this year. Survey respondents reported worries about new rules around cyber and new technologies such as artificial intelligence. Other concerns include complicated and inconsistent regulations and rules addressing data handling, money laundering, sustainable finance and Brexit.
Fraud fell to eighth spot, after consistently taking the number three spot in previous years. This is likely due to risk professionals categorising sophisticated frauds, for example synthetic identity fraud, as information security.
The US-China trade war, this year’s upcoming US presidential election and a continuing lack of clarity on Brexit have driven geopolitical risk to the top of the emerging category. It polls ahead of digital disruption, which remains high thanks to new technologies and market entrants. Meanwhile, change risk has risen to the fourth spot in the emerging list, largely due to climate change. The Bank of England will include climate change in the scenarios for its 2021 stress test, with a focus on both physical and transition risks.
These last two categories are akin to some of the concerns aired in the organisational change category in Risk.net’s survey, which shot up four places last year.
Forty-nine ORX members participated in the Operational Risk Horizon 2020 study, comprising 40 banks and nine insurers.
Editing by Alex Krohn
All information included in this report and held in ORX News comes from public sources only. It does not include any information from other services run by ORX, and we have not confirmed any of the information shown with any member of ORX.
While ORX endeavours to provide accurate, complete and up-to-date information, ORX makes no representation as to the accuracy, reliability or completeness of this information.
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