Gearing up for the Basel Accord

Susan Andre Survival Strategy Column

The Basel Capital Accord is here, and here to stay, but many banks are not prepared for compliance and implementation in 2005.

In January 2001, the Basel Committee on Banking Supervision issued a proposal for a New Basel Capital Accord that replaced the current 1988 Capital Accord. The proposal is based on three mutually reinforcing pillars that allow banks and supervisors to evaluate the various risks that banks face.

Bank on it

"The impact and consequences of Basel II will be immense for financial institutions."

The New Basel Capital Accord focuses on minimum capital requirements, which seek to refine the measurement framework set out in the 1988 Accord, a supervisory review of an institution's capital adequacy and internal assessment process, and market discipline through effective disclosure to encourage safe and sound banking practices.

Recent instability in the world banking market has highlighted the implementation of the Basel Accord even further. To be ready for a 2005 implementation, banks should be starting the effort to build related infrastructure today, as addressing the Basel Accord is a major project requiring multiple working groups and various phases.

Major effort is required to gather and maintain data requirements for credit risk and operational risk as well as preparation for the significant changes in reporting and disclosure requirements and the associated interaction with all stakeholders.

Under the Accord, credit risk mitigation rules have been extended and require detailed data on collateral, guarantees, netting and credit derivatives. The business processes and data issues are enormously complex, requiring two, three, and/or five years of history and the external validation of credit processes.

With the huge amount of data gathering and manipulation requirements, many banks and financial institutions are looking at providers to provide solutions for software and services in their efforts towards Basel compliance.

Overall impact

The impact and consequences of Basel II will be immense for financial institutions. New processes and procedures will need to be implemented and there is a tremendous need for new data management requirements. The proposals are complex and financial institutions are only now starting to fully understand their overall impact, specifically with relation to data management.

While the implementation of the Accord is not until 2005, systems and process changes will need to be made much sooner as there is a requirement to analyse three or more years' worth of data in certain conditions. Some institutions are already working on this by setting up teams from all business areas affected by the new Accord. These include corporate planning, risk, finance, compliance and investor relations.

The Basel Accord implies a much greater focus on the use of risk ratings. This means improved data, improved methodologies, and better management processes. The use of internal ratings for limit setting, lending authorities, pricing and reserving, and implications for the front office has to be clearly documented. Each institution will therefore need to assess data warehousing capabilities and develop a strategy to deal with the substantial increase in data requirements.

Data integration and integrity therefore becomes critically important. Assessments of data ownership and data quality will have to meet standards of external verification, regulatory scrutiny, and transparency for disclosure purposes. But it is not simply the system or data warehouse that ensures the integrity of the data.

Financial institutions will need to invest in both technology and processes surrounding the acquisition, maintenance and distribution of the underlying data. It will be a challenge to organise the extensive data collection across the different geographies, divisions or business units of an institution.

Furthermore, early responsibility for the data gathering and storage needs to be established as risk responsibility deferral has been a common cause for poor risk management across banks with broad product and geographical coverage. In this regard, the value of the data warehouse and business intelligence initiatives can be expanded to accommodate the Basel II requirements. Certain vendors have identified this need and are well positioned to assist institutions with the challenge of compliance.

The greatest challenge of the demands set by Basel II lies in creating an environment permitting the collation and assimilation of heterogeneous loss data from across all business lines throughout the enterprise at a global level. Data quality and integrity is tantamount to attaining the required level of support to take advantage of the lower capital charges associated with the internal measurement approach to operational risk. This can only be achieved through standardising information at enterprise level.

Institutions can choose not to be compliant, although the loss of reputation of their business, including customer and stakeholder perceptions, market acceptability of their products and services and the need to have significantly increased capital requirements to guarantee risk will mean that most institutions will adopt some form of compliance route.