One of the remarkable issues which came to light during the 2008 financial crisis was the inability of financial regulators and supervisors to get up-to-date and accurate reports on the amount and quality of capital held by a financial institution (FI). This caused a considerable amount of uncertainty and damage to both the financial sector and the wider economy. The Basel Committee on Banking Supervision’s (BCBS) June 2012 paper, entitled ‘Composition of capital disclosure requirements’, was part of the Basel III capital adequacy regime and represents a concerted response to this issue. The paper lists a series of detailed capital resource reports to be completed by regulated FIs and published under Basel Pillar 3.
One of the stated aims of Basel III is to ensure that banks back their risk exposures with high quality capital and a raised level of consistency in measuring capital across the banking sector. Basel III also intended that market participants would be able to compare the capital adequacy of banks across jurisdictions; thus an improvement in disclosure standards was needed.
The BCBS set a deadline of 30 June 2013 for firms to start to adhere to a new regulatory standard. These rules will be incorporated into national reporting requirements and so each jurisdiction will individually set their implementation date.
The BCBS requests that financial firms provide the following reports and information at least half yearly:
- The common template listing details of items making up a firms common equity tier-1, tier-2 capital including national minimal amounts below threshold deductions and caps on tier-2. This report includes additional capital and capital adjustments.
- A three-step reconciliation report, reconciling a firm’s own funds as reported in their financial accounts with the regulatory capital as reported in the common template. This reconciliation includes details of the regulatory capital deductions and adjustments.
- A main feature template that discloses details of the financial instruments that make up a firm’s regulatory capital. Details include identification (for example Committee on Uniform Securities Identification Procedures (CUSIP) numbers and International Securities Identification Numbers (ISINs)), regulatory treatment, coupon/dividend details, maturity, write-down feature etc.
- A disclosure template for the transition phase of Basel III.
- Firms will also have to accompany any ratios that use regulatory capital items in their calculation with a full explanation of how these ratios are calculated.
This information will need to be provided for the regulated consolidated group. Where the legal entities of the financial reporting and the regulatory reporting groups are not the same reconciliation details must also be provided.
FIs will now have to reveal their capital in much greater detail than before, making them easier to compare against one another. As a result financial firms will have renewed pressure on them to ensure that capital is both adequate and appropriate. This pressure is balanced by the need of the firm’s owners to see a return on their investment. The management of FIs will need to be prepared for this increased scrutiny.
An Additional Task
The detailed reconciliation of regulatory capital to the accounting values will be new to many firms. As such they will need to ensure that their workflows, processes and information infrastructures are capable of producing the reconciliation in a timely and accurate way. More issues may, however, arise for senior management as a result of publishing the reconciliation. The true role played by the various financial instruments in supporting the prudential health of a firm will become clearer and firms may wish to alter capital composition, or be ready with detailed explanations and analysis at the time of first publication.
However the result of these reports does not only have an impact on firms but also the rule setters in each jurisdiction. Space has been given in the reports for firms to disclose where a regulator is more conservative than the Basel III approach. Where – and if – a regulator allows the inclusion of capital items not commonly followed by other jurisdictions, comparing these reports will bring these differences to light. These reports can be seen as part of the effort to encourage regulators to implement the full Basel III accord or to supersede it.
National supervisors have varied from the details in the BCBS paper, but mostly in terms of timing. For example, the Reserve Bank of India (RBI) and the Australian Prudential Regulation Authority (APRA) have implemented these reporting requirements from June 2013. APRA has also insisted that the relevant Australian firms also report qualitatively about their capital as well as quantitatively. Meanwhile the Canadian regulator, the Office of the Superintendent of Financial Institutions (OSFI), has implemented this reporting from the end of July 2013.
This compares with the European Banking Authority (EBA), which will be implementing this as part of their CRD IV package which takes effect as of January 2014. The EBA is also insisting that the reports are produced annually, a lesser frequency than that of the BCBS paper. The EBA has also elected not to include the three-step reconciliation schedule included in the ‘Composition of capital disclosure requirements’ paper, however the requirements to perform and provide reconciliation is included.
Some supervisors have used the introduction of this new reporting to request further details. For example, the RBI has requested additional information regarding counterparty credit risk and reporting regarding the legal entities included in the regulatory consolidation. Meanwhile APRA has also included more reporting around remuneration.
These changes have and will continue to present many FIs with challenges. There is the challenge related to the potential changes in the way firms are perceived. Management has to consider the impact of the increased disclosure on investors and other parties. Many can expect an increase in the number of queries.
FIs also have to consider the effect the reporting will have on their workflow and information processes. Therefore, reporting has to be consistent with risk, liquidity and credit functions. With the reconciliation to the financial reporting at its core, regulatory reporting must also be consistent with accounting. For some firms this change may represent a significant challenge, particularly where the legal entities included in financial and regulatory reporting are not the same.
Lastly firms should always be looking to use this extra investment into their reporting process to gain business advantage. These changes offer an opportunity to address previous inefficiencies. It is also true that the regulatory area may be the only area where such a wide range of risks and reporting are regularly addressed. This new Pillar 3 reporting is a significant global development and the effects will be widely felt.
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