Basel III makes its mark

Modifications to the latest series of capital adequacy regulations issued by the Basel Committee on Banking Supervision (BCBS) in recent years have been so widespread that the market has now adopted the progressive moniker of “Basel IV”, instead of Basel III.

The regulations have introduced higher overall capital requirements; new standards for liquidity, leverage ratios and over-the-counter (OTC) derivatives – such as those related to bank exposures to central counterparties and a new standardised approach for measuring counterparty credit risk.

Also, the BCBS announced a new market risk framework known as the Fundamental Review of the Trading Book (FRTB) and other changes such as those relating to operational risk.

The business impact of these revisions is already a reality for regulated financial institutions as they transition their processes, standards and calculations to comply with multiple global and local implementation deadlines; international and local regulations; and local interpretations and restrictions. The overall impact has called into question banks’ business priorities and operating models, as well as their customer service standards and relationships.

Raising bank capital requirements has in turn increased their cost of doing business; reflected, for example, in a higher cost of credit or lower deposit rates for certain customers. Their time to market has also been impacted by higher mandated levels of due diligence, which have required the construction of sophisticated business intelligence systems pre- and post- the point of sale (PoS).

This has left doors open for financial technology (fintech) disruptors who are, in part, compensating for lower creativity within banks and breathing a fresh air of innovation, without the constraints of stringent regulations. The regulatory evolution of fintech remains a concern, needless to say.

Mitigating the effects

Certain bank client segments have been significantly impacted by this new paradigm. They include corporate treasuries, hedge funds, correspondent accounts and the wider universe of firms consuming working capital solutions related, for example, to trade finance.

Clients of banks can, in turn, adopt smart funding and cash management strategies that take into account the value of their business vis-à-vis a specific bank’s strategy and operating model, under higher regulatory constraints. In other words, bank clients should ‘know their seller’ better in order to mitigate the effects of regulation.

In addition to increasing the cost of doing business, so much change in regulation has led to a large increase in the amount, frequency and complexity of the necessary data, calculation and reporting. Banks have therefore taken a hard look at their supporting technology infrastructure and placed the onus on senior management to drive strategic cross-jurisdiction and cross-purpose regulatory solutions.

Since much of the variations in reporting can be achieved from the same underlying data, why not source once and use many times without the need for reconciliation? If you look at many financial institutions today, however, you will see a fragmented landscape of risk and regulatory solutions catering to various local, regional and global regulations. On the other hand, banks can reap efficiencies and synergies, while tightening up on data governance by ensuring consistency between the data used to run different risk calculations.

Regulation has therefore propelled the various bank teams – finance, treasury, IT, risk and operations – to come together in a concerted effort to understand data, monitor it and jointly respond to regulatory requirements. Banks typically do not have a “regulatory team” per se, looking solely into reporting, but instead are incorporating best practices. These include creating a cross-functional data dictionary, regulatory attestation and process endorsement.

Extending the collaboration theme, regulations also require banks to engage the services of consulting firms and financial technology providers further to manage their regulatory implementations and project rollouts.

Completing the regulatory-driven transformation, certain banks have responded very efficiently in tackling today’s increasingly complex and demanding global regulatory environment and internal reporting needs. These institutions have adopted a single strategic regulatory platform globally to transparently manage and automate such complexities and to concentrate their control and monitoring processes.

This drive towards automation, away from manual processes, is fully aligned with BCBS 239’s Principles for Effective Risk Data Aggregation and Risk Reporting, which postulates that automation needs to be implemented and sufficiently flexible to permit manual intervention under exceptional circumstances. Such a transformation cannot coexist with inaccurate, insufficient, or (worse) even missing data.

Conclusion

Financial institutions have spent many years trying to comply with the Basel requirements. With the increased “Basel IV” regulations coming into play, the end is not in sight. They need to think strategically about a global integrated regulatory platform. In doing so they will smoothly and efficiently adapt to the new regime and retain sufficient flexibility, to accompany the constantly advancing demands of regulators and the pressures of internal reporting.

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