The Basel Iii Compliance Conundrum

David Sherriff, CEO of Microgen

Around the globe banks have only a short time left before Basel III is implemented across international financial markets. As banks struggle to align financial, risk and regulatory reporting and link this to operational decisions impacting profitability, the underlying data issues are becoming increasingly apparent. Designed to strengthen the global capital and liquidity of financial institutions, this regulation will cause a significant change in the reporting mechanisms and control frameworks around liquidity management, through implementing the “liquidity coverage ratio”. Furthermore, it will create increased pressure for consistent data to validate and respond to any queries that may be raised by the regulators.

The new higher levels of capital and liquidity for the industry pose considerable challenges to the bank’s future business models. While many banks are already hurriedly shedding risk-weighted assets and withdrawing from some capital intensive investment, others are indicating that they will not be ready to meet the regulatory demands in time.

What will Basel III mean for financial institutions?
The clock is ticking and financial institutions need to focus efforts on demonstrating capital and liquidity resilience as soon as possible. This will be some feat – according to the latest data published by the Basel committee in September, the largest global banks would have needed an extra 374.1 billion Euros ($482.4 billion) in their core reserves to meet Basel III had the standard been enforced at the end of 2011. While full compliance is not required until the start of 2019, 2013 will offer a strong indication as to how prepared each bank is to meet regulatory stress tests.

The implementation of Basel III has been hotly debated recently, particularly as some nations have suggested they will miss the 2013 deadline to commence implementation of the reforms. Similarly other debates persist as to the effectiveness of the regulation on preventing a repeat of the 2008 financial crisis. Basel III will see a significant increase in the required minimum capital levels with different countries setting varied requirements.

Alongside proposals for increased regulation in the areas of capital and liquidity, there will also be increased supervision of banking practices. While some argue that Basel III is too complex and should instead be replaced by a simple leverage ratio, this seems unlikely to happen. In attempting to improve the risk sensitivity of the banks, a certain amount of complexity is inevitable. Those financial institutions that do not position themselves to cope with greater global and regional regulatory surveillance and tough economic conditions could find it increasingly difficult to raise much needed capital. As a result they may find themselves being crowded out by more strategically positioned banks.

The challenge
Getting the business model right to comply with Basel III, and numerous other global and regional financial regulations, will not be a straightforward task. Many banks hope to demonstrate to investors that they are financially stable by assessing the performance of existing methodologies in internal ratings based credit risk approaches. However, a number of critical data management issues will likely continue to impede the successful development of this. A significant amount of opacity continues to plague the banking system, created by many years of global financial innovation which yielded a vast number of exotic new financial products that has formed a tangled web of debt.

As has already been reported by the media, a number of financial institutions are already finding they lack the data management architecture to easily meet liquidity reporting requirements in a timely manner. There is no one-size fits all approach available – in order to determine the level of adjustments that need to be made to comply on a local and global scale, banks will need to assess their infrastructure in each individual market they operate in.

Resolving data management issues remains at the top of many financial institutions regulatory to-do lists before they can begin to claim that they are regulation ready. This is even more vital now that banks operate in an increasingly competitive environment- those failing to keep pace with the changes may find themselves losing ground to more agile rivals. Increased capital requirements will likely result in higher pressure on margins and operating capacity and the higher ratios will simply amplify inefficiencies that already exist.

What needs to be done?
The ability to understand the minimum level of reserve required to protect a business against liquidity events and aligning this with reported financials and other regulatory reporting requires a clear data strategy. Some existing difficulties that many financial institutions currently face are technology and data silos and a lack of granularity in reporting processes within the company. These issues can be easily addressed, however, through the creation of a shared, consistent and aligned environment where information is seen as an organisational asset. By adopting the right IT infrastructure that aligns data silos and presents an up to date view of liquidity, balance sheet, profitability through analytics and automated data management, banks could not only become compliant more easily but also reduce their operational costs. Adopting a solution that combines a single, enterprise-wide view of stakeholder approved, granular information with business controlled workflows and an integrated risk and finance framework can provide the visibility and accuracy that is required in today’s markets for optimum performance.

With considerable regulatory and liquidity challenges being presented to financial institutions operating in the aftermath of the 2008 crash, banks must engage with new compliance requirements sooner rather than later to ensure they are optimally positioned to compete in this post-crisis landscape and sustain both cash flow and profitability.