Preparing strategically for ‘Basel IV’

March 15, 2016 – By Nicola Hortin, Head of Regulatory Analysis Team, EMEA, AxiomSL

The Bank for International Settlements (BIS) has published new rules that will govern how much capital banks must maintain Nicola Hortin - Head of Regulatory Analysis Team, EMEA, AxiomSLin order to mitigate their exposures to credit and market risk. Banks are eager to understand how they will be impacted by the Standardized Approach for Measuring Counterparty Credit Risk Exposures (SA-CCR) and the Fundamental Review of the Trading Book (FRTB). However, they should not lose sight of the other new calculations that are being introduced as part of the overhaul of the Basel capital adequacy framework.
In addition to SA-CCR and the FRTB, changes are being made to the way banks calculate the capital needed to cover their exposures to central counterparties (CCPs), operational risk and credit risk due to securitizations. There will also be a new framework for measuring and controlling large exposures, and changes to the risk weights in the standardized approach to credit risk capital calculations. The changes are so numerous and so significant that, although they are part of Basel lll, some people are now referring to them as ‘Basel IV’.
There is a significant overlap between the data that will be needed to run all of these new calculations and many of the calculations are interdependent. For example, the same product data will be required for all of the calculations, and the outputs from SA-CCR will need to be fed into the large exposure and credit valuation adjustment (CVA) calculations. It is therefore important that banks plan strategically for the entire suite of new Basel capital rules rather than focusing on SA-CCR and the FRTB in isolation.

Overlapping requirements

Banks that do not think about all of the new Basel capital rules collectively may end up using a separate system to manage each of the calculations. Given the overlapping and interconnected nature of the requirements, it is clear this would be extremely inefficient and unnecessarily complex.
The most efficient way for banks to tackle the new Basel capital rules is by using a single platform to run all of the different calculations. By doing so, banks will avoid the need to load the same data onto many different systems; they will ensure consistency between the data used to run the different calculations; and it will be easier for them to feed the outputs of individual calculations into other related calculations.
When preparing for the new Basel capital rules, banks also need to think about how they will manage the staggered implementation timetable for the requirements, which will be phased in over a number of years. Many banks struggle to keep up with a quick succession of regulatory changes due the inflexibility of their technology. These banks often find they need a complete software update to accommodate each regulatory change. Installing and testing such an update is a long and complicated process, which eats into the time banks have to prepare for a regulatory change, increasing the risk of missing a deadline.

Calculation platform

To ensure they can keep pace with the implementation of the new Basel capital rules, banks should use a calculation platform that separates the regulatory functionality from the core platform functionality. This will mean that when the final version of one of the new calculations is published, a bank will be able to add it to the platform quickly without having to update the entire infrastructure, impacting other functionality and users in the process.
At the moment, the priority for banks is to understand whether their capital requirements will increase when the new Basel rules come into force and, if so, to ensure they will be adequately capitalized. Historically, many banks have relied on spreadsheets to work out manually how they will be impacted by new capital requirements. This is an extremely cumbersome approach, which increases the chances of errors. It is also highly inefficient because, when the requirements come into force and banks want to automate their calculations, they must repeat the work they have done in order to update their regulatory calculation system.
Banks can avoid this situation by doing their impact analysis work within their regulatory calculation system – for example, running the new SA-CCR calculations in parallel with their incumbent credit risk calculations. This approach makes it easier for banks to run the calculations over an extended period in order to get a more complete understanding of the impact. It also gives them more confidence in the accuracy of the results because they are based on production data. And when the requirements come into force, the banks will already have the calculations set up within their regulatory compliance infrastructure.
The new Basel rules will change significant parts of the existing capital adequacy framework. By thinking strategically about all of the changes that are to come, banks can ensure they will be able to adapt smoothly and efficiently to the new regime.
This article was originally published by Börsen-Zeitung.

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