Complications in Bank Valuations  755 bank consist of different layers that add up to a total of 8.0 to 10.5 percent of RWA: Basel III CET1 capital requirements % of risk-weighted assets Legal minimum 4.5 Capital conservation buffer 2.5 G-SIB countercyclical buffer 1.0–3.5 Total 8.0–10.5 The first 4.5 percent is the so-called legal minimum that applies to any bank in any given year. The second layer of 2.5 percent is the capital conservation buffer, which can be drawn down in years of losses and then rebuilt in profitable years. The third, or countercyclical, layer can be up to 3.5 percent of RWA but applies only to so-called global systemically important banks (G-SIBs). These banks are identified by the Financial Stability Board (FSB) as sources of systemic risk to the international financial system because of their size and complexity.18 In November of each year, the FSB publishes the additional capital charge for each G-SIB, which depends on the FSB’s assessment of the risk that the bank represents. Among these largest global banks, JPMorgan Chase faced a surcharge of 2.5 percent in 2018, with Citigroup, Deutsche Bank, and HSBC in the next-lower bucket of 2.0 percent. For the smaller G-SIBs, such as Santander, ING Bank, Agricultural Bank of China, and Morgan Stanley, the surcharge amounted to 1.0 percent. Many of the larger banks nowadays already target CET1 at around 13 percent of RWA or higher, reflecting not only stricter regulations but also in- creased investor requirements. According to the Bank for International Settle- ments (BIS), the worldwide average CET1 for large international banks was at 12.9 percent of RWA in 2018, well above the 2013 level of 9.5 percent.19 Using your RWA forecasts and the targeted CET1 ratio, you can estimate the required Tier 1 capital in each future year. From the projected CET1 capital requirements, you can estimate the implied shareholders’ equity requirements by applying an average historical ratio of CET1 capital to shareholders’ equity excluding goodwill and deferred-tax assets. Historical Tier 1 capital is reported separately in the notes to the bank’s financial statements and is typically close to straightforward shareholders’ equity excluding goodwill and deferred-tax assets. Value Drivers for Different Banking Activities Given that many banks have portfolios of different business activities, some- times as distinct as consumer credit card loans and proprietary trading, their 18 The FSB is an international body monitoring the stability of the international financial system and was established by the G20 Leaders’ Summit of April 2009. 19 Basel III Monitoring Report, Bank for International Settlements, March 2019, p. 2 (available at www .bis.org). 756  Banks businesses can have very distinct risks and returns, making the bank’s con- solidated financial results difficult to interpret, let alone forecast. The busi- nesses are best valued separately, as in the case of multibusiness companies, discussed in Chapter 19. Unfortunately, financial statements for multibusiness banks often lack separately reported income statements and balance sheets for different business activities. In that case, you have to construct separate state- ments following the guidelines described in Chapter 19. Interest-Generating Activities  Retail banking, credit card services, and wholesale lending generate interest income from large asset positions and risk capital. These interest-generating activities can be analyzed using the eco- nomic-spread approach and valued using the equity DCF model, as discussed for ABC Bank in the previous section. Trading Activities  Like a bank’s interest-generating activities, its trading ac- tivities also generate income from large asset positions and significant risk capital. However, trading incomes tend to be far more volatile than interest incomes. Although peak income can be very high, the average trading income across the cycle generally turns out to be limited. The key value drivers are shown in Exhibit 38.15, a simplified value driver tree for trading activities. EXHIBIT 38.15  Value Drivers: Trading Activities (Simplified) Value creation Growth Cost of equity Return on equity Operating expenses1 Equity Trading result VaR/net trading assets Return on VaR1 Trading liabilities Trading assets Cost/income 4 2 1 2 3 4 5 6 7 1 6 7 Capital ratio 3 Key value drivers Trading position: Net trading position (assets minus liabilities) Return on VaR: Relative trading result VaR/net trading assets: Relative trading risk Operating expenses: E.g., driven by number of traders relative to trading assets and bonuses paid out on trading profits Equity: Required equity levels Growth: Growth of trading volumes COE: Cost of equity 5 1 After taxes.