Gearing Up For Basel III
Stringent data reporting and risk management requirements will compel banks to significantly overhaul their IT infrastructure to not only comply with sweeping regulatory change but also to power new operational efficiencies and create market differentiation.
In its depth and scope, Basel III is unlike anything the banking business has seen. A combination of micro- and macro-prudential norms, the global regulatory mandate (which rolls out this year through 2018) 1 requires banks to increase their quality of capital by focusing on liquidity and common equity; improve supervision of firm-wide risk management; and provide detailed report ing on regulatory capital and the calculation of capital ratios. It mandates adherence to ratios such as liquidity coverage and net stable funding, which are aimed at strengthening banks’ short and long-term liquidity. Most prominently, Basel III is transforming risk management into a function that fortifies banks’ sound functioning.
These changes will necessitate a fundamental review of each bank’s operating model. Many banks will need to decide which businesses and geographies to focus on and which to exit.
Almost all banks will need to invest in technology capabilities to meet Basel III’s stringent data reporting and risk management requirements.
While these investments will strain bank bal ance sheets, they will also create opportunities to extract additional efficiencies from day-to-day
cognizant reports | march 2013
operations. Given the pressure on margins, we believe that banks need to go beyond the standard applications of the new technologies.
By building strong capabilities in the areas that are the focus of these regulations, banks can differentiate themselves from their competitors.
Key imperatives for banks as they prepare for
Basel III include:
• Undertake a fundamental analysis of individ-
ual businesses to identify growth drivers.
• Strengthen data management practices to create a single source of truth for all functions.
• Embed key functions such as liquidity and risk management into related processes across the organization. • Invest in technologies that can free up resources to focus on core activities.
• Improve project management capabilities to realize greater benefits from IT investments.
The impact of Basel III on banks is manifold, ranging from capital (see Figure 1, next page) and liquidity requirements to technology and strategy implications. The new key capital ratio is set at 4.5%, more than double the current
2%. In addition, there is a new buffer of 2.5%;
banks with capital within the buffer zone will face restrictions on dividend payments and discretionary bonuses. According to an estimate by
McKinsey & Co., the capital requirements under
Basel III could reduce return on equity (RoE) for banks by about 4% in Europe and 3% in the U.S.2
Basel III’s liquidity ratios constitute a “first of its kind” attempt at regulating bank liquidity. Its liquidity coverage ratio (LCR) will require banks to maintain cash-like assets in the short term; the net stable funding ratio (NSFR) will determine a one-year-horizon liquidity buffer. For banks that are unaccustomed to holding high-quality capital in the short term, adjusting to these requirements will entail significant costs, which may be further inflated by the increased market demand for such capital. Basel III will also create technological challenges.
For one, the proposed rules require banks to report their liquidity metrics on a daily basis.
Banks will, therefore, need to begin collecting data points, which could run into several thousands, across the organization. The mandated enhancements to banks’ risk management infrastructures will also pressure their technology infrastructure.
Basel III also includes a credit value adjustment
(CVA) charge that must be calculated over and above the default counterparty risk charge that