BASEL III for dummies

July 23rd, 2014 by Stephen Jones Leave a reply »

The Basel Committee on Banking Supervision (BCBS) is a group tasked with providing thought-leadership to the global banking industry (http://www.bis.org/bcbs). The BCBS has released volumes of guidance over the last decade to promote stability within the financial sector. The Basel Committee thus influences financial regulations globally.

In June 2011, the BCBS released “Basel III: A global regulatory framework for more resilient banks and banking systems.” This new set of regulations includes enhancements to previous rules and will have both short and long term impacts on the banking industry.

BNP Paribas Fortis presents this 10 minutes animation on Basel III for non-specialists. This Video “Basel III for dummies” is based on life presentations by Lars Machenil (CFO BNP Paribas) and Walter Rosenhek (Basel 3 Program Manager BNP Paribas Fortis.

The liquidity and capital consequences of these changes cannot be ignored. A new report produced by KPMG’s Global Financial Services Risk and Regulatory Centre of Excellence crystallises many of these issues. The report “Liquidity bigger challenge than capital ” highlights that:

Banks face high adjustment costs to satisfy the new liquidity ratios. Additional costs will emerge from the assembling and reporting of the necessary data, running stress and scenario tests and formulating recovery plans

In many instances, satisfying liquidity requirements will hurt profitability, particularly from the need to hold more high quality but low yielding liquid assets on the balance sheet.

Problems will be compounded because many banks will be making similar adjustments at the same time. Changes to business models and organisational structures will be the inevitable consequence in many cases.

For some banks the requirement to report unrealised fair value gains separately from losses could challenge existing systems. It is also clear that the recognition of these gains/losses within Common Equity Tier 1 capital under the Basel III framework will mean increased regulatory focus on the fair value policies and procedures of banks

Key features of Basel III include:
• A stronger capital base – More stringent capital standards and higher capital requirements

• Additional risk coverage:
o Enhanced quantification of counterparty credit risk
o Credit valuation adjustments
o Wrong way risk
o Asset Value Correlation Multiplier for large financial institutions
• Liquidity management and monitoring
o Introduction of liquidity ratios
o Introduction of leverage ratios

• Introduction of capital buffers

• Even more rigorous data requirements

Banking executives must consider:
• How will Basel III play into their Risk Appetite?
• How will they create project plans for Basel III when they haven’t yet finished implementing Basel II?
• How will new regulations impact capital distributions to shareholders? (Will new lead to diminished profitability and implementation problems.

Implementation challenges include:
Data availability, data quality/integrity, data lineage, dat retention data Models and Compliance in prescribed formats.

Manual approaches to regulatory reporting are already too cumbersome and automation and sue of metadata tools is now the norm. A strong, scalable architecture with work flow tools, logs and audit trails demonstrate data integrity. Manual touch points have to be minimized. o Data relevance/coverage – Data must be relevant to all portfolios and storage devices must allow for sufficient data retention.

Coverage of both on and off balance sheet exposures is critical. Model development – Requires highly trained resources with both quantitative and subject matter expertise. All Basel models need to be validated. This requires additional resources with skills that may not be readily available. All models should be properly documented.

Its important to ensure that the data and processes related to Risk assessment and management and financial reporting are integrated. For Basel compliance the Allowance for Loan and Lease Losses (ALLL) is calculated by Finance, yet the Expected Loss (EL) is calculated by Risk Management – and they need to give the same answer.This is not trivial to achieve.

A Compliance Challenges is that some Basel III requirements leave room for interpretation. Business lines are challenged by the competing priorities which arise from regulatory compliance and business as usual work. To provide internal and external auditors with robust evidence Banking executives complain that regulations will have a detrimental affect on business. The introduction of new regulations will no doubt hinder short-term profitability. The regulator view seems to be that by requiring banks to focus on premium growth, there is more potential for sustainable long-term profitability. The argument is that a stable banking system will increase consumer confidence which in turn will supports banking activity .

The regulations also aim to ensure that adequate funding is available for individuals and companies i.e stability brings profitability to banks. Therefore, it is important that every banking institution takes the steps necessary to properly manage, monitor and disclose its risks and this warrants the assistance and oversight of an independent regulatory authority.

Whether that noble view will endear itself to banks struggling to avoid fins and to get reports out on time remains to be seen. Its too late to debate Instead with regulators over the implementation of new requirements, the key task at hand is to implement systems that embrace these regulations with minimum pain and to fund ways to use the information and analysis to be more competitive.

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