Post the Financial Crisis of 2008, Banks Globally witnessed a barrage of Regulations on various topics which aimed at stricter rules for maintaining adequate liquidity and capital to meet its commitments in normal as well as stressed time. As the Regulatory Tsunami has started to abate, the regulatory bodies like BIS (bank for international settlement) have started to come up with a Regulatory agenda which now attempts to streamline and standardize the Risk and Compliance requirements from Banks. To quote a few examples this change can be seen in host of newer regulations like
- Standardized approach for Credit Risk (SA CR) which increases the risk sensitivity of the existing SA CR framework while reducing a dependence on external ratings
- Standardized approach on Operational risk (SA OR) which focusses on replacing the earlier 3 approaches with a single risk sensitive approach
- Revisions to IRB approaches by introduction of floor values for asset classes that are difficult to model
- Revision of Leverage Ratio (LR) standards which also includes buffer requirements for LR for GSIB’s (Global Systemically important Banks).
While most of the Regulations for management of various risk types are getting enhanced, the Pillar 3 Disclosure requirements are also undergoing an overhaul .It was observed by BCBS that during the financial crisis the existing Pillar 3 framework did not give adequate information to the investors to derive the required insights and conduct a fundamental analysis on the financial health of the Banks in comparison with its peers. Hence the BCBS launched a revised Pillar 3 framework with an objective to improve comparability and consistency of disclosures across Banks which will eventually enable market participants to assess a banks overall capital adequacy and compare it with its peers. Pillar 3 disclosures forms the third pillar of the Basel requirements which aims to ensure market discipline through disclosures in prescribed format, while Pillar1 focusses on Capital adequacy and Pillar 2 looks at the supervisory review process.
So what’s changing with Pillar 3Disclosures?
The BCBS committee released the revised disclosures in Jan 2015 which superseded the requirements published in 2004,so far there have been a couple of consultations or iterations to the Pillar 3 requirements between 2015 to 2018 with the final version released in Dec 2018 . Revised Pillar 3 framework is very data intensive in nature and aims to Integrate and consolidate disclosures across areas under the purview of the guidelines.
Some of the other key changes are mentioned below
- Establishes Guiding Principles – Provides five guiding principles in terms of Clarity, Comprehensiveness, significance, consistency and comparability .Banks are required to follow these principles which will enable them to achieve a strong foundation in maintaining transparent pillar 3 disclosures which will eventually benefit the Market participants to understand and compare the Banks Business and its Risk
- Regulatory submissions a mix of Fixed and Flexible format – Complementing the guiding principles defined, the committee has also defined the submission aspects and its structure. The disclosures consists a total of 40 Tables and Templates in Fixed and Flexible format. Banks are mandated to report as per the format detailed out in the guideline document. It also prescribes the frequency for regulatory capital and risk exposures. The below tables gives a high level view of the sections along with the reporting formats and their frequencies
- More focus on Qualitative Disclosures – Along with the Quantitative details provided in the above templates and tables Banks are also required to provide qualitative information explaining the significant changes in the reporting period . Additional narratives which the Banks feel may be of interest to Market participants can also be provided and are solely left to banks discretion.
- Linkages between financial and regulatory exposures – This schedule focusses on enhancing understanding of the linkages between regulatory disclosures and finance data. These are qualitative disclosures which highlights how the amounts reported in financial statements correspond to regulatory risk disclosures
- Establishes an effective control structure and Internal review process – Banks are expected to establish a formal board approved policy for pillar 3 and also set internal controls to review the information included in the Pillar submissions
Challenges observed in implementing the Revised Framework
The Revised standards integrate disclosures across areas ,There are close to 75 plus disclosures required with varied frequency and differing formats which will make this a challenging exercise for the Banks to adhere to the prescribed standards .Some of the Key challenges are listed below
- Disclosing Confidential information – Some of the disclosures require sharing proprietary information with in the disclosure which may be of strategic importance to the banks .For e.g disclosures around internal risk limits will provide a view on the Risk appetite statement of the Bank which determines the overall risk profile ,a topic which banks may not be very comfortable to disclose.
- Volume of Disclosures – The new standards see a huge increase in the volume of disclosures which will have a resultant effect on Data Procurement, Data Adjustments and Data Reconciliation. Also there need to be adequate controls on the qualitative commentary that needs to be provided with the required disclosures.
- Governance – Most of the Banks will need to set up a governance structure with adequate internal controls to manage the required data and also attest the data
- Data Management – Some Banks may not have Authorized Data sources like a Central repository where they can tap in to create disclosures, they may rely of source systems, End user applications and Spreadsheets for their disclosure needs. This creates a significant challenge with aspects around Data Governance, Data quality and Metadata Management.
How are Banks approaching this?
Since Pillar Three Disclosures have come in iterative mode many impacted Banks and financial institutions have created dedicated Pillar 3 team who look in to ensuring the compliance of the disclosures .The
- Dedicated Department to handle Pillar 3 disclosures– Most of the Banks earlier used to handle the Pillar 3 disclosures on a standalone basis, the current framework however is driving this in a more integrated manner. This change is warranting a need for a dedicated focus on Pillar 3 disclosures as a result of which many Banks are setting up a separate team to handle and manage all the pillar 3 disclosures.
- Understanding Cross Program impacts and integrating them to Pillar 3 disclosures Work stream–Integrated Pillar 3 disclosures touch upon a host of areas and Risk types which need to reported to the regulators in specified formats (either fixed or flexible) at varied frequencies, such disclosures require huge amount of data and information which requires the Banks to understand the cross program dependencies and integrate them in to Pillar 3 works stream. For e.g. Reports on Liquidity, Credit Risk, Operational Risk or RWA will require the data to be sourced from the teams that are handling such programs in the format as required by Pillar 3 work stream.
- Investing in Third Party tools– To streamline the disclosure reporting many banks are mostly investing in Third party tools that have these requirements built in .Most of the leading third party tools come with their own data layers to ingest the information in to the final templates. These data layers can tap in to any type of informational sources within the Bank and transform the same in to the format required as per the Pillar 3 guidelines.
- Digital intervention to fill in qualitative disclosures – With the Foray of Digital Technologies in Banking ,many Banks have also started looking at AI (Artificial Intelligence) based tools which can create the required commentaries for the qualitative disclosures required by Pillar 3.Such experiments are still in initial stages and many banks are looking at using such tools to reduce manual efforts and optimize their cost of compliance
The revised pillar 3 guidelines have a huge bearing on the Business Processes, Data management and the technology infrastructure of the Banks .Most of the Banks have already started investing in creating Strategic solutions to address these requirements as they will be quite frequent in nature and a robust infrastructure will result in better management and timely creation of the disclosures .In many cases Banks are also looking at Digital enablers like AI to help them in creating the qualitative commentary and addressing the volume issues.
About the Author
Ajay Katara is a Domain Consultant with the Risk Management practice of the Banking and Financial Services (BFS) business unit at Tata Consultancy Services (TCS). He currently heads the Solution and Strategy for Enterprise Risk and Compliance Regulations. He has extensive experience of more than 14 years in Consulting & Solution design space cutting across CCAR Consulting, AML, Basel II implementation and credit risk, and has worked with several financial enterprises across geographies. He has significantly contributed to the conceptualization of strategic offerings in the risk management space and has been instrumental in successfully driving various consulting engagements. He has also authored many editorials, details of which can be found in his linked in profile (https://www.linkedin.com/in/ajaykatara/)