February 17, 2016 – By Nicola Hortin, Head of Regulatory Analysis Team, EMEA, AxiomSL
As part of its overhaul of the Basel capital adequacy framework, the Bank for International Settlements (BIS) has developed a new methodology for calculating how much capital banks need in order to mitigate their exposure to credit risk. Banks are eager to understand how they will be impacted by the new Standardized Approach for Measuring Counterparty Credit Risk Exposures (SA-CCR) – which will be mandatory for all over-the-counter (OTC) derivatives, exchange-traded derivatives (ETDs) and long-settlement transactions not treated under an internal model approach. However, in order to do so and to implement the new requirements optimally, banks must overcome a number of challenges.
SA-CCR uses a lot of the same terminology as the existing credit risk calculations. However, despite the superficial similarities, the new calculations are completely different from what has gone before. They are significantly more complex and include different calculations for individual asset classes and rules regarding the treatment of particular product sets. As a result, rather than tweaking what they already have, banks need to implement a totally new set of calculations.
The SA-CCR calculations bring with them new data requirements. While there is an overlap with the data used in the incumbent credit risk calculations, banks will also need to source many new attributes. For example, they will need information about margin agreements with counterparties, including threshold amounts and minimum transfer amounts, and the ability to link this information to their trade and collateral data.
Banks are likely to have most of the required data somewhere within their infrastructure. However, due to the complicated system structures that exist at most large banks, sourcing the data will be one of the most challenging aspects of implementing SA-CCR. In many cases it will involve changing not only the systems that directly feed the regulatory capital calculation platform, but also other upstream systems. To expedite the data sourcing process, many banks are likely to work with a third party who has already identified which additional data attributes are required.
All of these changes will inevitably alter banks’ capital requirements. Historically, some banks have relied on spreadsheets to manually calculate how they will be impacted by new capital adequacy rules. However, this is a very cumbersome approach. It means that when the requirements come into force, in order to automate the calculations, banks need to spend months reconfiguring their capital calculation engines based on the changes they have worked out on paper.
Banks can avoid this situation by doing their impact analysis work within their regulatory calculation tool, 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.
It is important to note that at present banks are working from the SA-CCR rules that have been defined by the BIS. These rules will inevitably be tweaked and changed when they are incorporated into European Union (EU) law. Banks will be able to implement these changes more easily and quickly if they do their impact analysis work within their regulatory calculation platform.
When preparing for SA-CCR, it is also important that banks consider the wider context in which the requirements are being introduced. SA-CCR is just one element in a package of new capital adequacy requirements, which are being introduced as part of what some are referring to as ‘Basel IV’. Other new calculations include the Fundamental Review of the Trading Book (FRTB), which replaces the current standardized market risk calculations, and the potential introduction of a new capital requirement to cover Interest Rate Risk in the Banking Book (IRRBB).
There is a significant overlap between the data that banks will need in order to run all of the different calculations and many of the calculations are also interdependent. Therefore, rather than using separate systems to run each of the calculations, banks can achieve greater efficiency and higher levels of accuracy and consistency by managing SA-CCR on the same regulatory calculation platform as all of the other ‘Basel IV’ requirements.
SA-CCR is a major change to the way banks calculate their credit risk capital requirements. By planning carefully, focusing on the data sourcing challenges and doing parallel running of the new calculations, banks can assess how they will be impacted by SA-CCR and ensure they are prepared when the requirements come into force.
This article was originally published by Futures and Options World (FOW).