Download Basel III: The Changing World of Banking

Basel III: The Changing World of Banking Regulation
James Babicz, SAS - 08 Feb 2011
Banks need to start addressing their Basel III requirements this year. This article examines the
challenges these requirements pose, and how they can best be tackled.
It is no secret that banks are now facing a regulatory landscape that is rapidly changing in new and
unanticipated ways. The Basel III banking reform package, for example, represents a step change in the way
national banking regulators interact and has been described as the first concrete example of 'macroprudential'
regulation that seeks to moderate the economic cycle.1 As a result, banks have little prior experience to help
them plan for or react to new rules as they are introduced.
Clearly in the past, banks have not had to concern themselves with macroprudential regulation and the impact
this would have on their business and, consequently, the need to provide a robust firm-wide management
framework to adopt and adapt to such changes was not a priority. However, going forward, it is imperative that
such a firm-wide framework be put in place, in order to ensure minimal disruption to the business, and to
capitalise on business opportunities that will inevitably arise from such changes.
The Requirements
Burying your head in the sand is not an option. Starting this year, banks need to begin addressing the
requirements of Basel III with the measurement and reporting of the liquidity coverage ratio (LCR) and leverage
ratio, followed by the net stable funding ratio (NSFR) in 2012. Following varying observation periods, these
ratios may be adopted into Pillar 1 requirements, possibly after some degree of recalibration.
Basel III has also introduced changes to the trading book and treatment of securitisations, and there is a
commitment to a further review of the trading book in 2011. Specifically, new guidelines have been drafted to
address credit risk and wrong way risk with the introduction of the incremental credit risk charge (IRC), credit
valuation adjustment (CVA) and counterparty credit risk (CCR) rules.
In terms of capital, starting in 2013 changes to the quantity and quality of capital, as well as the ratio of core
Tier 1, Tier 1 and Tier 2 capital, will be phased in gradually until 2019. The net effect by 2019 will be a sevenfold increase in core Tier 1 capital, and a rise of total capital from a minimum of 8% to 10.5%, assuming the full
2.5% conservation buffer is included, and possibly 13%, if the countercyclical buffer is fully in effect.
The Challenges
Under the Basel III regulations, banks will be required to provide more accurate and up-to-date information on
their capital position at any given time. However, there are numerous obstacles that prevent banks from gaining
an accurate picture of their organisation’s risk and capital position as a result of inconsistencies and gaps in
data.
First, one bank may well operate across a number of global locations, which not only means that its exposure
to risk across the business could vary considerably, but may also lead to inconsistencies in the implementation
of the agreed G20 standards. At a micro-level, even what seems like a small detail such as different methods of
accounting can affect the overall quality of data used to get a view of the whole organisation. Even what seem
like relatively small gaps or inaccuracies can in fact have a noticeable and detrimental effect on the bigger
picture. This problem is further compounded when banks have grown by acquisition. In this scenario, there is
likely to be a lack of consistency in the format and type of data, which can result in a difficult and time
consuming process to firstly understand the data from various sources and then combine it in a single uniform
manner which is useable for the organisation.
Second, each bank’s individual business model will have an impact on the way that it calculates risk. For
example, a global universal bank will take a completely different approach to that of a small retail bank with a
business model based on savings and mortgages. Each institution will subsequently have individual capital and
liquidity needs, making it difficult to apply regulatory standards to all banks in the same way. In particular,
where banks operate multiple business lines across multiple locations, information is often stored in silos
making it difficult to bring together all the information that is needed from across the organisation to create an
accurate picture of risk exposure.
Most banks still have a long way to go in order to be able to provide the timely data that is the appropriate
quality required under Basel III. The different approaches taken, even within a single institution as well as
across the industry, lead at best to confusion, and at worst to misleading information being circulated.
The Solutions
In order to address all these complexities, banks must first look internally. One approach is to appoint a chief
data officer (CDO) who is responsible for ensuring that accurate and reliable data can be gathered from all
parts of the business, and stored in a constructive format that allows senior executives to make business
critical decisions. Of course, gathering the vast amount of data necessary to consolidate the balance sheet of a
global institution is no easy task, therefore some banks have also tasked their CDO with constructing a
centralised data model to support an overall enterprise risk management strategy.
In many cases, far from needing a complete overhaul, Basel III builds on similar principles to its predecessor.
The next steps are to make a few strategic changes in order to aggregate existing data in a more streamlined,
consistent and quality-focused manner. Through this approach, Basel III can ultimately help bring about some
tangible business benefits as well. Implementing strategically, powerful, flexible and scalable architectures can
provide the firm-wide view capability. At a tactical level, best of breed business-focused applications will
provide firms with the agility they need in order to adapt and adopt changes as they occur. Typically in financial
institutions, strategy and tactics have not necessarily gone hand in hand as banks’ systems have often been
specially built using a bottom-up approach. For banks that are looking beyond mere compliance to achieve
significant business benefits, the key is to ensure that tactical systems are seamlessly integrated with the
broader enterprise framework for data management. This will enable the bank to ensure that data quality is
consistent, from a top-down approach, which will in turn deliver rapid, meaningful and actionable information
throughout the organisation.