basel iii and its implications for the world banking system

7/31/2019 Basel III and Its Implications for the World Banking System

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Basel III and Its Implications for theWorld Banking System


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The Group of 20 Summit scheduledfor November in Seoul will provide a

forum for a wide range of economic andfiscal issues, ranging from World Bankgovernance to fossil fuel subsidies. Theworlds biggest economies cannot be saidto have a common economic strategy, butthey will be discussing action on a number

of common matters, including bankscapital structures, liquidity and exposureto risk.


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The stated purpose of the G20 SeoulSummit is to create a foundation forbalanced, sustainable growth in theglobal economy as the world emerges

from the recent financial crisis. Butwhat does this mean for the financialinstitutions that will ultimately haveto implement and follow a morecomprehensive set of regulatory rulesin the future?

As this paper is going to print, it is nowapparent that the G20 will defer finaldecisions on some of the key aspects ofBasel III until 2011 rather than duringthis meeting. While this is perhaps not asurprise given the political make-up of

the G20, debate will continue after thislatest summit on the specifics of capitalstructure and on other critical issuessuch as establishing a methodology foridentifying banks that are too big tofail and what additional regulatoryrequirements will apply to this elitegroup.

Since the London Summit in April2009, the Group of 20 leadingcountries (G20) has been workingto reform financial rules in light of

the ongoing global fiscal crisis. Inparallel, the world financial systemhas been facing challenges on nearlyevery level. While banks senior

managements have grappled withimportant strategic issues, regulatoryauthorities worldwide are mindful ofwhat happened, or nearly happened, tothe banks within their purview. Theseregulators have, in many cases, beengranted expanded powers and newenforcement teeth.

More than ever, regulators are seekingto act in concert, cooperating todevelop frameworks that extend acrossgeographies. While the regulators

position is logicalsystemic problemsin one bank, or within one country,can clearly have a significant if notdrastic impact on banks aroundthe worldit has proven extremelydifficult to define and agree, let aloneimpose a common standard on banksthat have different starting points,that are accustomed to operatingwithin different prudential guidelines,and have different expectations asto acceptable margins, compensationstructures and disclosure requirements.

Given this complexity, and theoutcomes of the previous three G20forums, our expectation is that theclarity desired by many in the industry

will still be lacking at the conclusionof the Seoul meetings. It thereforeraises some interesting questions: IsBasel III a destination, or the nextpoint along a longer journey? Willthere be a level playing field acrossthe banking sector, and, if so, when?And, by extension, until the rules areclear, is it advantageous for bankingleaders to keep things as they are, orto put in place key components of theanticipated reforms before they arerequired?

From where we sit today, there aresimply too many complexities andinter-relationships across the disparategeographies and economies whichmake up the G20 to believe thatthe timelines and/or requirementsof the recently structured Basel IIIwill accelerate or result in higherrequirements for capital. However,we fully expect that additionalrequirements and modificationswill emerge as banking institutions,


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economic leaders and politicalleaders work together to implementa solution that provides the stabilitydesired without overly affecting the

still nascent financial and economicrecovery cycle.

Following the Seoul G20 Summit webelieve that a number of countrieswill not wait any longer and will pushforward independently with specificrequirements for the institutionsoperating in their geographies.Obviously, the US has passedsignificant measures with the recentDodd-Frank regulation. In Switzerland,the authorities have defined additional

capital requirements above thebase of Basel III, the Swiss Finish.These acts are likely to become lessisolated in the coming months as othergeographies also follow this trend tobuild their local priorities alongsidethe continuing Basel III development,but with increasing attention to theirlocal agendas and less to the globalconstruct.

In considering whether it isadvantageous for banks to push aheadwith their own regulatory agendasagainst this evolving structure, it is

easy to forget that, in many cases,banks and regulators best interestsare not mutually exclusive and may,in fact, run along parallel paths. Thechallenge for banks is to chart acourse that rewards both shareholdersand customers while avoiding notonly unacceptable levels of risk butbusiness practices that perpetuatethe kind of boom-and-bust cycle seenall too often in recent years. Banksand regulators, after all, share a vitalcommon interest in protecting the

worlds financial system.

It is our view, therefore, that it isadvantageous for banks to progressthe main elements of Basel III directlynowinstead of waiting for the inkto dry on the final reforms sometimein the future. The direction has beenset and those institutions which canmove ahead rapidly will be in a better

position to devote the necessarymanagement resources needed tofocus on customers, competitors andprofitability as opposed to internally

focused regulatory metrics and ratios.

We also believe that by taking thesepro-active steps these leaders can helpto set the direction for the industryand make the issues and debatesregarding the consequences (intendedand unintended) more tangible forboth the industry and the regulators.


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The Basel III LandscapeWhile many banks are still in theprocess of compliance with the BaselII regulatory standards, the newguidelines proposed under Basel III willbe an important topic during the G20discussions in Seoul.

In the broadest strokes, a globalconsensus is building among G20leaders that will lead to the followingchanges:

1. Capital ratios will increase. BaselIII calls for banks common equity toincrease from 2 percent to 4.5 percent,to be phased in by January 1, 2015.

2. Tier 1 capital requirements, whichinclude common equity and other

qualifying financial instruments basedon stricter criteria, would increasefrom 4.5 percent in 2013 to 6 percentas of 2019. Certain types of capital,such as contingent convertible bonds,will no longer be classified as Tier 1.

3. In addition to the higher Tier 1requirements, a capital conservationbuffer of 2.5 percent may be requiredso banks can absorb losses duringperiods of financial and economicstress. Banks that draw down on the

buffer will face constraints on earningsdistributions such as discretionarybonuses and higher dividends.

4. Over and above the new Tier 1and capital conservation bufferrequirements, a countercyclicalbuffer remains a topic of discussion.

5. In addition to the capitalrequirements, a non-risk basedleverage ratio mandating that Tier 1capital be no less than 3 percent of the

banks total exposure is expected toreceive broad support.

6. Banks will be asked to takeresponsibility for defining andarticulating liquidity risk tolerancesthat are appropriate to their businessstrategy and for their role in thefinancial system, with sound processesfor identifying, measuring, monitoringand controlling liquidity risk.

7. Senior management will beexpected to establish a liquidity riskmanagement framework that is robustenough to ensure maintenance ofsufficient liquidity and to withstandboth institution-specific and market-wide stress events.

8. New liquidity standards will includea liquidity coverage ratio (LCR)dictating that high-quality liquidassets must equal net cash outflowsover a 30-day time period; in addition,a net stable funding ratio (NSFR) willrequire that the available amount ofstable funding match the requiredamount of stable funding.

9. Banks will operate with simplifiedlimits for large exposures and with anew limit for inter-bank exposures.Inter-bank exposures will be treatedlike other exposures, regardless of theirmaturity, and limited to 25 percent ofthe banks own funds.

10. Systematically importantfinancial institutions will be singledout for special treatment. Theywill receive regulatory scrutinyin the areas of capital adequacy,liquidity and transparency, and theircompensation structuresa topic offocus in countries such as the UKwillbe dramatically re-shaped, eithervoluntarily or by regulatory directive.

It should be noted that Basel III nowcalls for implementation of thesestandards over a transition period ofas long as eight years. Since mostbanks have already undertaken steps inthese directions, Basel IIIs capital andliquidity requirements do not appear

overly burdensome, but there will beimpacts. Capital is becoming moreexpensive and there will be an impacton credit availability and on overallbank margins, but estimates varywidely and there is broad agreementthat Basel III takes the industry in theright direction.


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Different Region, Different Experiences

The Seoul meeting will drawattention to contrasts andcomparisons among banking

institutions in the Americas,Europe and Asia-Pacificregions. When we examine thecurrent state of play amongmajor banks in these regions,we see more differencesthan similarities. A downturnthat affected these regionsunevenly has been followed bya recovery that is progressing

at different speeds in differentcountries. These differenceshave pressured some banksinto mergers and sent othersscrambling to raise capital.Others are deleveraging byselling off assets or otherwiseexiting non-core businesses.

In Europe, the large global banksand the better-capitalized banks inNorthern Europe have emerged fromthe downturn in better comparative

shape to the majority of institutions inSouthern Europe. The European centralbank put tremendous emphasis on theimportance of Tier 1 capital and mostinstitutions in this category adhered toa regimen of deleveraging while addingcapital, in many cases through publicofferings.

The smaller scale banks and mutualstructures in Europe such as thebuilding societies in the UK, theSparkassen (savings and loans)

and Landesbanken (state banks) inGermany and the cajas (regionalsavings banks) in Spain have beenpressed to raise capital without alwayshaving ready access to the capitalmarkets. European banks in this grouphave historically relied to a greaterextent than US banks on softerforms of capital such as preferredstock, and the balance sheets haveincluded investments in insurers and

minority investments in banks that willno longer be treated as Tier 1 capitalunder Basel III.

In recent weeks we have seen anumber of European banks turn to theequity markets to raise capital andbolster balance sheets for the periodahead. The reasons vary by institution,but are clearly a combination ofthe increasing regulatory pressures,higher volatility in the markets, andpreparation for some to make futurebusiness model changes through eithergeographic or product line expansion.

Global banks in Europe (as well as

in the United States) will no doubtre-examine their trading operations,due to new capital required to supporttrading. Similarly, new restrictionson securitization will make it harderfor large European (and US) banksto package and sell loans to avoidcapitalization requirements. A numberof investment banks will continue toexplore changing the focus of theirbusiness model to increase retail


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operations and secure other, lessvolatile, streams of revenue into thefuture.

In the Americas, there have beensignificant differences among theexperiences of banks in Canada, Braziland Mexico (mostly good) and banks inthe United States (mostly not as good)

in dealing with the downturn and therecovery. Major US banks have cutdividends, tightened lending standardsand engaged in ongoing consolidationwhile bolstering their own capitalstructures.

In an Accenture survey conductedafter the passage of the Dodd-Frank bill, 66 percent of US financialinstitutions surveyed said thatregulatory changes will require re-thinking of existing business models.

Among the initiatives that US bankssaid they need to undertake are:

1) Incorporating and integratingrisk management into performancemanagement metrics;

2) Doing a better job of automatingfinancial and regulatory reporting;

3) Building better, more accuratepricing and valuation models for eachcustomer offering;

4) Conducting deeper analysis ofcounterparty exposures to avoidthe domino effect that was sodestructive in 2008; and

5) Designing better products to reflectboth changing customer attitudestoward risk and new economic andregulatory realities.

In Asia, many major banks have alreadymet or exceeded proposed Basel IIIcapital requirements. Asian banks

experience with the financial crisis of1997 led many institutions to makerisk management a top managementpriority, and banks in this regiontended to avoid taking large positionsin structured products, which becamean issue for many banks in the West.Historically, the flow of best practiceinformation for this industry has beenfrom west to east. However, in thistopic area we now see much morebalance and increasingly a sharing of

perspectives in both directions. No oneregion has a monopoly on what is theright approach.

Many Asian banks, however, arefacing market saturation in their homemarkets and are reviewing growthstrategiesincluding entering newcountries or launching new products

that entail significant credit andoperating risks.

Asian banks confront other risks,as well. For instance, Asian bankshave been hampered in their growthstrategies by an overall scarcity oftalent. Major initiativessuch asexpansion into emerging economiesor the entry into capital marketactivitieshave been slowed whilebanks develop or recruit the talentneeded to undertake such efforts.

As talent is identified and developed,leading Asian banks can be expectedto explore growth capital markets andtransactional banking; in lending tosmall and medium-sized enterprises;and in wealth management.

Banks in larger, more economicallydeveloped Asian countries such asSouth Korea and Singapore confrontmajor operational challenges whenentering less developed markets. Manybanks in countries such as Indonesia

and Thailand are not yet Basel IIcompliant in terms of their capitalstructures. Outright acquisitionsrequire an injection of capital aswell as investment in operations andinformation technology.

Many Asian banks, especially in rapidlygrowing markets such as China, haveample capital and their relativelylow leverage creates pressure forgrowth. The major Chinese banks areresponding to this pressure, in part,

by expanding their presence in thecapital markets, both through alliancesand through internal development.Managing such growth, however, isdifficult without the necessary talentand corresponding operational controlsin place.

While many Asian banks have robustcapital structures and low leverage,there has been a consistent levelof under-investment in technology

leading to increased operational risk.Banks especially in the emergingcountries are still operating onold platforms and a multitude ofinterdependent systems that arechallenging to fully integrate. One keyarea that would require significantinvestment is in the area of globallimits and exposure management,

especially given their more regionalfootprint and increased marketexposure. Asian banks ambitiousgrowth plans depend on opening upnew markets, but doing so withoutnecessary investments in talent andtechnology will create unanticipatedoperational riskexemplified byrecent events which damaged banksreputations while inconveniencingcustomers.


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Seeking high performance under Basel III

How should banks seeking highperformance be looking at risk in lightof Basel III and the expected G20guidelines?

Generallyas was the case underBasel IIbanks will continue to useinternally developed risk modeling forboth lending and trading activities.The higher capital requirements willdecrease the absolute risk associatedwith these businesses, and the moresophisticated banks in all marketswill continue to improve their riskmodels. However, as history has shown,effective risk management is not onlyabout the models.

Accenture sees three major areas inwhich banks can begin to improve theiroverall risk management.

First, banks must accelerate theprocess of integrating the risk andfinance functions. The chief financialofficer and the chief risk officer mustwork from a single set of information,and must share an understanding ofthe inter-relationships among credit,market and operational risk. Enterprise

risk management must become areality rather than a stated objective.Risk must be seen as a growth andprofitability-enhancing capability, not

as a back-office or compliance-centricfunction.

Second, banks must improve theiroverall data management. Under BaselIII, banks will need to consolidatepositions from their trading desks, andmake their trading book match upmore seamlessly with their bankingbook. Banks have always applied arigorous approach to the P&L explainprocess. They have also been veryfocused on meeting the reporting and

output requirements for the regulators.To manage going forward, they willneed to apply a significantly increasedlevel of focus and rigor to the qualityand maintenance of data across thefull suite of activities from front officethrough to back office. Standard riskmodels will remain and it will be up tothe banks to ensure that their own dataand models are up to the task.

The rise of the chief data officeranew and senior level position at

many banksis a reflection of banksrecognition of this need.

Third, banks must prepare for whatwe call intelligent growth. In Asia,for instance, lending to small andmedium enterprises (SMEs) representsa major opportunity for banks inanchor economies such as SouthKorea, Singapore and Australia. Inentering these new markets, however,banks can mitigate both credit andoperating risk by using analytics andautomating credit scoring to make thelending process more efficient andless risk-prone. Financial reform isimportant for restoring the confidence

of shareholders and customers, andeveryone will have more faith in banksthat evidence both financial stabilityand sound risk management practices.Getting there, however, is easier saidthan done.

Because of these markedly differenteconomic and regulatory environments,there are no one size fits allrecommendations for institutionsexamining the course of the Basel IIIprocess and their next steps following


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the G20 meeting in Seoul. As per ourcomments at the beginning of thepaper, we do not expect the forum toagree to specific resolution on Basel

III or to be in a position to publishformal guidelines much beyond what isunderstood today.

Based on this our view remains that:Banks will be better off undertakingcomprehensive risk assessments ontheir own, rather than waiting forformal directives to be finalized. Bankscan expect more, rather than lessregulation in the future, and the natureof this regulation is changing rapidly.Rather than ticking off a regulatory

checklist, newly empowered regulatorsare using much broader judgment todetermine banks true condition. Theyare developing benchmarks based onglobal standards and international bestpractices and using such benchmarksaggressively. Compliance with thisnew regulatory environment placesburdens on banks leadership, butit also provides forward-lookinginstitutions with the opportunity to setthe standard and create value through

effective, flexible risk managementprocesses.

The G20 process is clearly importantas it provides a regular and high profileforum for global leaders to turn theirattention and the global spotlight onthe establishment of a more robust andmore uniform set of financial rules anda consistent timeline for adherence.The playing field will never be perfectlylevel, but Accenture believes thatthe banks which approach Basel IIIin a proactive and holistic mannerand incorporate the principles of theregulation throughout their operationsas opposed to viewing the requirements

as a separate set of complianceactivitieswill be in a better positionto compete effectively on a globalbasis and will be better positioned forsuccess over the longer term.


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Appendix: Basel III Guidelines

2013 2014 2015 2016 2017 2018 as of 2019

Min. Core Tier 1 CapitalRatio (% of RWA)

3.5% 4.0% 4.5% 4.5% 4.5% 4.5% 4.5%

Capital ConservationBuffer (% of RWA)

0.625% 1.25% 1.875% 2.5%

Min. Core Tier 1 plusCapital ConservationBuffer (% of RWA)

3.5% 4.0% 4.5% 5.125% 5.75% 6.375% 7.0%

Phase-in of deductionsfrom Core Tier 1

20% 40% 60% 80% 100% 100%

Min. Tier 1 Capital(% of RWA)

4.5% 5.5% 6.0% 6.0% 6.0% 6.0% 6.0%

Min. Total Capital(% of RWA)

8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0%

Min. Total Capital plusCapital ConservationBuffer (% of RWA)

8.0% 8.0% 8.0% 8.625% 9.125% 9.875% 10.5%

Countercyclical Buffer range between 0 2.5% (common equity or other fully loss absorbing capital)

Capital instruments thatno longer qualify as Non-Core Tier 1 Capital or Tier2 Capital

Phased out over 10 year horizon beginning 2013(reduction of 10% per year)


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About AccentureAccenture is a global managementconsulting, technology servicesand outsourcing company, withapproximately 204,000 people servingclients in more than 120 countries.Combining unparalleled experience,comprehensive capabilities across allindustries and business functions,and extensive research on the worldsmost successful companies, Accenturecollaborates with clients to help thembecome high-performance businessesand governments. The companygenerated net revenues of US$21.6billion for the fiscal year ended Aug.

31, 2010. Its home page iswww.accenture.com.

Copyright 2010 AccentureAll rights reserved.

Accenture, its logo, andHigh Performance Deliveredare trademarks of Accenture.

About Accenture RiskManagementAccenture Risk Management

works with clients to create andimplement an integrated riskmanagement capability designedto gain higher economic returns,improved shareholder value andincreased stakeholder confidencein an uncertain global economy.Our work helps companies cost-effectively align risk and reward tofuel growth and drive better businessperformance while also protectingthe interests of shareholders andother key stakeholders. Operating

globally across a wide variety ofindustries and functions, we provideclients with a unique combinationof resourcesstrategic consulting,systems integration and technologydelivery at scale, outsourcing andchange management servicestoembed risk management throughoutthe enterprise. Find out more atwww.accenture.com/riskmanagement.

About the authors

Steve Culp

Steve is the managing director Accenture Risk Management. Basedin London, Steve has 20 years ofexperience working with our globalclients to deliver programs across:strategy definition, risk management,

enterprise performance managementand large scale finance transformation.Prior to his current role, Steve was theglobal lead for Accentures Finance &Performance Management consultingservices for global banking, insuranceand capital markets institutions. Withhis extensive risk management andperformance management experienceand business acumen, Steve workswith our client executives and theirteams on the journey to becominghigh-performance businesses.

Kyo-Sik Bae

Kyo-Sik is executive director, RiskManagement. Based in Seoul, Kyo-Sik has nearly 15 years of experiencein the areas of CTSS (Core trading,settlement services), investmentbanking, credit lending processing and

risk management. His deep financialservices experience, broad knowledgeof market risk, credit risk and riskdata, and very strong technical skillsaround compliance matters helpsexecutives and their firms become highperformance businesses.

Christopher Loh

Christopher is director - RiskManagement, Singapore, responsiblefor Southeast Asia. Christopherhas over 13 years of industry andconsulting experience in financialservices and risk management

across Asia and the United Kingdomwhere he worked with regional andglobal corporations to transformtheir business and risk capabilities.His extensive experience in riskmanagement, risk and regulatorycompliance, operating model andstrategy, credit transformation,operational efficiency, bankingtransformation and capitalmanagement helps client executivesand their firms become highperformance businesses.

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basel iii and its implications for the world banking system

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