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WHITE PAPER
Evolution of Regulatory Capital Planning, Measurement and Management Deriving Business Benefits from Risk-Based Capital Adequacy Regulations
SAS White Paper
Table of Contents
Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Background and Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Changing Regulatory Expectations on Capital Adequacy . . . . . . . . . 2
Basel 2.5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Basel III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
US Version of Basel III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Regulatory Capital Planning Under Stress Scenarios . . . . . . . . . . . . . 6
Large Bank Stress Testing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Comparison of Regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Types of Risks Covered . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Applicability of Regulations in the US . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Regulatory Requirements – US versus the EU . . . . . . . . . . . . . . . . . . . 9
Impact on Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Additional Capital Requirement Under Basel III . . . . . . . . . . . . . . . . . . 10
Impact on Profitability Due to Basel III . . . . . . . . . . . . . . . . . . . . . . . . . 10
Strategy for Addressing Capital Planning Regulations . . . . . . . . . . . . 11
Implementing a Capital Adequacy or Capital Planning Project . . . . 11
Governance Structure and Steering Committee . . . . . . . . . . . . . . . . . 12
Defining the Anticipated Steady-State Process . . . . . . . . . . . . . . . . . . 12
Defining the End-State Architecture . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Data and Reporting Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
The content provider for this paper was Ravi Varadachari, Senior Risk Specialist in the Americas
Risk Practice at SAS.
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Evolution of Regulatory Capital Planning, Measurement and Management
Executive SummaryBanks and financial institutions have faced a spate of regulations centered on capital adequacy since the financial crisis started in 2008 . The Basel Committee on Banking Supervision (BCBS) initiated a series of reforms to strengthen risk, capital and liquidity rules across banks . Among the important changes recommended are new rules for calculating Tier I and Tier II capital and the inclusion of additional risk measurement components for market risk, liquidity risk and counterparty risk . Despite these changes, a key drawback of the Basel framework is its focus on historical capital adequacy . While being useful, it does not help assess the impact of stress events on banks from an ex-ante basis . Hence regulatory agencies in several jurisdictions have mandated banks to define a forward-looking capital plan that incorporates stress scenarios . While there are a lot of commonalities between the Basel capital adequacy rules and the forward-looking capital planning rules in terms of risk modeling and data infrastructure, there are substantial differences in the goals of these regulations, types of risks covered and specific nuances of each jurisdiction . Further, these new regulations can have a substantial impact on the growth and profitability of banks .
Most banks may have to redesign their risk modeling, data infrastructure and technology components in order to comply with these new regulations . Additionally, these regulations necessitate the tighter integration of risk and finance departments within a bank . This could pose a challenge, as most banks hitherto have managed risk and finance separately .
Compliance with these risk-based capital adequacy regulations can be a daunting task, and banks need an appropriate system to manage this process . However, this is also an opportunity for banks to bolster their risk management systems to derive business benefits from these regulations .
Background and OverviewThe global financial crisis of 2008 was unprecedented in terms of scale (quantity of losses) and spread (number of countries and financial markets affected) . Many banks and financial institutions failed – or very nearly did . The financial crisis also underscored the contagious nature of markets – where a problem in one jurisdiction quickly spreads to others . The primary reasons for the financial crisis were high reliance on liquidity in the marketplace; banks chasing lower quality assets; incentive structures that led to risky behavior; and so-called “black swan” events . However, it is widely accepted that better governance structures, robust risk management practices and better measures for capital adequacy might have substantially softened the impact of the global financial crisis .
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Changing Regulatory Expectations on Capital AdequacyIn response to the global financial crisis, the BCBS initiated a series of reforms to strengthen risk, capital and liquidity rules across banks . The objective of these reforms was to improve the ability of the banking sector to absorb financial and economic stress, thereby reducing the risk of spillover into the larger economy .
The current prescriptive formula1 for computing capital, risk-weighted assets (RWA) and capital adequacy ratio (CAR) is outlined in the document Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework, published in November 2005 . As per the rule, banks need to maintain a CAR of 8 percent, of which at least 4 percent has to be from Tier I capital . Further, under the Tier I capital, equity has to be at least 2 percent . As per the Basel II rules, the CAR could be defined as follows:
Capital Adequacy Ratio =
Total Capital (Tier I + Tier 2 + Tier 3)
----------------------------------------------------------------------------------------
RWA (credit risk) + RWA (market risk) + RWA (operational risk)
RegulatoryChange
MarketEvents
Basel I -InternationallyActive Banks
Introduction of Market Risk
Amendment and Operational Risk
Introduction of Basel III and
Capital Planning Under Stress
Scenarios
Introduction of Basel II and Basel 2.5
1980s 1990s 2000s 2010s
Failure of Bank Herstatt
Trading Losses Due to Inadequate
GovernanceExample: Barings
Continued Financial Crisis
andEuro-Zone Crisis
Technology Crisisin Early 2000
andFinancial Crisis
of 2008
Figure 1: Market events leading to change in regulations.
1 Regulators in a few countries have not mandated some or all of their banks to comply with Basel II guidelines; in such a scenario, banks compute CAR based on Basel I.
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Evolution of Regulatory Capital Planning, Measurement and Management
Basel 2.5In July 2009, BCBS published its first set of amendments to Basel II after the financial crisis . Titled Revisions to the Basel II market risk framework, the amendments are popularly known as Basel 2 .5 . This set of additional rules focused on supplementing the RWA calculation for market risk and has four key elements:
1 . An incremental risk charge to account for default and credit migration risk in the trading book .
2 . A stressed value-at-risk (SVaR) model in addition to the VaR-based capital requirements for the trading book under Basel II . SVaR is intended to capture the potential consequences of more volatile market conditions than those encountered historically .
3 . An additional charge (using a standardized approach) for securitization and re-securitization positions .
4 . A comprehensive risk capital charge for correlation between trading positions .
The deadline recommended by the BCBS for Basel 2 .5 implementation was Dec . 31, 2010 . However, many countries are still in the process of adopting these guidelines .
In the US, the Agencies2 introduced an amendment similar to Basel 2 .5 through a Notice for Proposed Rulemaking (NPR) in the document Regulatory Capital Rules: Advanced Approaches Risk-based Capital Rule; Market Risk Capital Rule in June 2012 . The rules will apply to US banks that have aggregated trading assets and liabilities of at least $1 billion, or 10 percent of total assets .
Basel IIIIn June 2011, BCBS finalized its second set of amendments to Basel II in Basel III: A global regulatory framework for more resilient banks and banking systems . The key changes outlined under Basel III can be classified under four broad categories:
1. Raising the quality, consistency and transparency of the capital base. Some of the measures included are:
•RaisingtherequirementforTierIcapitalratiofrom4percentto5.5percentas of Jan . 1, 2014, and 6 percent from Jan . 1, 2015 .
•RaisingtherequirementfortheTierIcommonequityrequirementfrom2percentto 3 .5 percent as of Jan . 1, 2014, and 4 percent from Jan . 1, 2015 .
•EliminationofTierIIIcapitalwhilecalculatingcapitaladequacy.
•Acapitalconservationbufferandacountercyclicalbufferaspartofthecapitalrequirements that increase in a phased manner . These additional buffers are a fundamental and important shift in the way capital adequacy is viewed . This buffer can be used by banks during periods of stress, thereby allowing them to maintain a lower CAR during such periods . Further, regulators may restrict dividend payouts if the above mentioned buffers fall below a defined threshold .
2 The Office of the Comptroller of the Currency, Treasury (OCC); the Board of Governors of the Federal Reserve System (Fed); and the Federal Deposit Insurance Corporation (FDIC) are collectively referred to as the Agencies.
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2. Additional charges for counterparty risk assessment. Basel III introduces an additional charge for counterparty credit exposures arising from banks’ derivatives, repo and securities financing activities . The capital charge for counterparty risk should include a credit value adjustment charge to factor any deterioration in counterparty asset quality and an estimate of wrong-way risk to account for correlations among financial institutions . In addition, there are recommended measures for an integrated management of market and counterparty credit risk and increased incentives for moving to qualified central counterparties in the form of lower capital charge .
3. Supplementing the risk-based capital requirement with a leverage ratio. Under the Basel II rules, the capital adequacy of a bank was measured purely in terms of a capital adequacy ratio, defined as total capital/RWA . However, under Basel III rules, the capital adequacy would also be measured using an additional ratio, namely the leverage ratio . The leverage ratio is defined as Tier I capital/exposure, where the exposure would comprise balance-sheet items and loan equivalent measures for off-balance sheet items . The leverage ratio would be a disclosure requirement as part of the Pillar 2 process until January 2017 . Subsequently, from January 2018, this ratio would be suitably included to compute the capital adequacy of a bank under the Pillar 1 process .
4. Funding liquidity risk assessment. Apart from changes to the calculation of CAR, Basel III has also introduced two liquidity risk ratios . The first ratio, liquidity coverage ratio, checks whether a bank has sufficient high-quality liquid assets to survive a significant stress scenario that lasts 30 calendar days . The second measure, net stable funding ratio, checks the stability of funding sources from a one-year perspective . The liquidity ratios are very important as this was a key reason for failure of many banks .
The BCBS allows banks to comply with Basel III rules in a phased manner, starting in January 2013, with full compliance by January 2019 .
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Evolution of Regulatory Capital Planning, Measurement and Management
Minimum standard for net stable funding ratio
Migration of leverage ratio to Pillar 1
Exclusion of non-qualifying capital instruments in equity Tier 1 and Tier 2
Dec 2010 Jan 1, 2013 Jan 1, 2015 Jan 1, 2016 Jan 1, 2018 Jan 1, 2019 Jan 1, 2022
Basel IIIrules issued
Capital conservation buffer of 1.5%
Capital conservation buffer of 2.5%
Phase 1
Parallel run for leverage ratio
Exclusion of non-qualifying capital instruments in common equity
Minimum liquidity coverage ratio
Leverage ratio
Minimum common equity requirement of 4.5%
Figure 2: Timelines for Basel III implementation.
Basel IIIFramework
Pillar IIIMarket Discipline
(Reporting)
Liquidity Ratios (LCR & NSFR)
CounterpartyRisk
Leverage Ratio
Capital
Standardized
Credit
Standard
VaR
IMA
IRB F
IRB A
Tier 1
Tier 2
Operational
BIA
Standard
AMA
RWA
Market
Stressed VaR
IRC
Pillar IISupervisory
Review Process
Pillar ICapital Ratios
Figure 3: Additional requirements under Basel 2.5 and Basel III – highlighted in blue.
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US Version of Basel IIIIn the US, the Agencies introduced an amendment similar to Basel III through an NPR in the document Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, and Transition Provisions in June 2012 . The proposals in this NPR would apply to state member banks, bank holding companies, and savings and loan holding companies (SLHCs), albeit using a relatively simplified approach (called the Standardized Approach) .
Further, in the notice Regulatory Capital Rules: Advanced Approaches Risk-based Capital Rule, the Agencies are revising the capital rules for advanced approaches consistent with Basel III . The rules will apply to a group of US banks (called mandatory banks) that have consolidated assets of at least $250 billion or foreign exposures of at least $10 billion . Apart from the mandatory banks, select banks (called opt-in banks) have also decided to comply with the rules . The US rules follow the principles laid down under Basel III except for nonallowance of use of external credit ratings, as required by the Dodd-Frank Act, and a different set of floors for capital adequacy called the Collins Amendment .
Regulatory Capital Planning Under Stress ScenariosOne of the key drawbacks of the Basel framework is that it computes the CAR on a historical basis . Thus the CAR of a bank as of Dec . 31, 2012, is known to the regulators after a period of a month or two . Further, the internal capital adequacy assessment process (ICAAP) and the stress tests under the Basel framework (which are part of the Pillar 2 process) are useful for understanding the risk profiles of banks from a historical perspective, but provide limited information regarding the impact on banks from an ex-ante basis . Hence regulatory agencies in several jurisdictions began to conduct forward-lookingstresstests.Forexample,theEuropeanBankingAuthorityconductedaforward-lookingstresstestforbanksintheEUinJuly2011.TheregulatorsintheUS conducted a forward-looking stress test called the supervisory capital assessment program (SCAP) in 2009 for the 19 largest banks .
Subsequently, the Dodd‐Frank Wall Street Reform and Consumer Protection Act (Dodd‐Frank) was signed into law in July 2010 . As per Section 165 of the act, the federal Agencies are responsible for conducting stress tests annually to determine whether banks have the capital needed to absorb losses in baseline, adverse and severely adverse economic conditions . In accordance with the act, the Agencies have published two forward-looking stress testing guidelines based on the requirements of Section 165 of the Dodd-Frank Act:
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Evolution of Regulatory Capital Planning, Measurement and Management
1. Comprehensive Capital Analysis and Review (CCAR). The Federal Reserve issued a final rule on Nov . 22, 2011, called the Comprehensive Capital Analysis and Review (CCAR), which expanded the scope of SCAP . The CCAR is applicable to all banks and bank holding companies (BHCs) with assets greater than $50 billion . The CCAR requires banks to outline their capital plans over a nine-quarter horizon under three scenarios: (1) base case as per the bank; (2) adverse macroeconomic scenario as per the bank; and (3) a severely adverse macroeconomic scenario . The objective here is to demonstrate that the institutions have sufficient capital to continue operations throughout times of economic and financial market stress . Apart from the bank stress test, the Federal Reserve (the Fed) will also conduct an independent stress test (based on a base case and an adverse scenario) for these banks, as they are considered to be systemically important financial institutions . Some of the additional aspects of CCAR are:
•BanksneedtomaintainaTierICARof5percentormoreundertheFed-supplied adverse macroeconomic scenario to pass the stress test .
•Thecapitalplanningexercisehastoaccountfortheriskimpact(theimpact of stress scenarios on credit risk, market risk and operational risk) and balance sheet impact (profitability, dividend payout and Tier I capital) .
•TheFedmayrestrictanyactivitiesthatcanaffectcapital(suchasdividendpayout or acquisitions) if a bank fails the test .
•Apartfromtheannualsubmissionofacapitalplan,mandatedbankshave to submit portfolio-level data on a monthly basis .
2. Annual Stress Tests. The Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) issued the Annual Stress Test NPR in January 2012 . This rule is applicable to banks with a consolidated asset size of more than $10 billion . The FDIC/OCC will provide a minimum of three economic scenarios, reflecting baseline, adverse and severely adverse conditions .
Large Bank Stress TestingApart from the capital planning exercise, the Agencies have also issued guidance to banks with assets of $10 billion or more to conduct a portfolio-level stress test . The Agencies issued Large Bank Stress Testing Guidance on May 14, 2012 . This stress test is at a portfolio level and also involves conducting a reverse stress test, wherein a bank has to identify conditions under which it could face a capital or liquidity challenge .
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SAS White Paper
Comparison of RegulationsThe additional requirements under Basel III and the capital planning exercise are complex due to the additional elements introduced and the enterprisewide nature of the impact . There are quite a few commonalities and differences between these regulations from three perspectives, namely: types of risks covered, applicability (based on bank size)andjurisdiction(USversusEurope).
Types of Risks Covered
Figure 4 compares the regulations from the perspective of types of risks covered . A key area where the capital planning regulations differ is noninclusion of liquidity risk measurement . Under Basel III, banks have to assess the funding liquidity risk from a short-term as well as a long-term perspective . Additionally, the Basel requirements are on a historical basis, while the capital planning requirements are on a forward-looking basis .
Applicability of Regulations in the US
Figure 5 provides the details of the applicability of the various regulations in the US . The Agencies have segregated banks based on their size and complexity of operations . For example, banks with an asset size greater than $250 billion are required to comply using the advanced approaches under Basel III . However, banks with assets less than $250 billion but more than $500 million are required to comply using a relatively simplified approach called the standardized approach under Basel III .
Banks with assets greater than $50 billion (which are considered as systemically important financial institutions or SIFIs) are required to comply with the relatively complex CCAR rules . Banks in the $10 billion to $50 billion range are required to comply with a lighter form of stress testing (called the annual stress test) .
CVA/Wrong Way Risk
StressedVaR
LiquidityRisk
StressTesting
HistoricalBasis
HistoricalBasis
ForwardLooking
ForwardLooking
OperationalRisk
MarketRisk
CreditRisk
Speci�cRiskDescription
Basel I and1996 Amendment
Basel II
Basel 2.5 andBasel III
Capital Planning
Figure 4: Comparison of regulations from a risk perspective.
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Evolution of Regulatory Capital Planning, Measurement and Management
Description Applicable to Regulator
Basel II: Advanced Approaches
Banks above $250 billion or foreign exposures above $10 billion
Compliance by
Parallel run by January 2011
Proposed January 2013
2013 to 2019
Proposed January 2015
January 2012
Proposed January 2014
January 2013
Agencies
Agencies
Agencies
Agencies
Fed
Agencies
Agencies
Trading assets & liabilities of above $1 billion or 10% of total assets
Banks above $250 billion or foreign exposures above $10 billion
Banks above $500 million but below $250 billion
Banks above $10 billion but below $50 billion
Banks above $50 billion
Banks above $10 billion
Basel 2.5: Market Risk Rule
Basel III: Advanced Approaches
Basel III: Standardized Approach
Capital Planning:CCAR
Capital Planning:Annual Stress Test
Large BankStress Testing
Figure 5: Regulations for a US bank based on its size and complexity of operations.
Regulatory Requirements – US versus the EU
Figure6highlightsthedifferencesbetweentheUSandEUcapitaladequacyregulations.The Agencies require a stress test based on 26 macroeconomic variables comprising 14domesticvariablesand12internationalvariables.TheEUrules,ontheotherhand,useonlyfourmacroeconomicvariables.Further,theEUrulesalsoconsidersovereignrisk due to the presence of multiple jurisdictions with the potential of default by some sovereign states .
Description US Rules
Types of Scenarios
EU Rules
Benchmark ScenarioAdverse Scenario
4 Variables
Credit, Market and Sovereign Risk
No
Yes
Yes
Base CaseAdverse ScenarioSeverely Adverse Scenario
26 Variables
Credit, Market and Operational Risk
Yes
Not Yet
No
Macroeconomic Factors
Risk Types Stress Tested
Independent Stress Tests by Regulator
Use of Ratings for Determining Capital Under Basel III
Additional Capital Surcharge for SIFIs Under Basel III
Figure 6: Comparison of regulations across the US and the EU.
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Impact on Banks
All things being equal, the Basel III framework will decrease the capital adequacy ratio of banks due to decrease in eligible capital and increase in the RWA . Further, the regulators in most jurisdictions are demanding that banks maintain a higher minimum capital .
CapitalAdequacy Ratio
Eligible Capital
Risk Weigthed Assets
Minimum Capital Adequacy Ratio Required
Figure 7: Impact on capital adequacy ratio.
Additional Capital Requirement Under Basel III
As per a McKinsey study in November 2010,3 the top 25 banks in the US would require upwards of $600 billion in additional capital by 2019 to comply with Basel III . Increased capitalwouldresultinlowerprofitabilityandlowerRoEfortheshareholder.Further,manyjurisdictions are restricting activities that can affect future CAR, such as dividend payout .
Impact on Profitability Due to Basel III
The report How much capital is enough?4estimatedthattheRoEofbankswouldfallby2 .9 percent after the Basel III recommendations are implemented, assuming that there is no increase in lending spreads . Further, if an additional capital surcharge of 2 .5 percent forSIFIsisimplemented,theRoEoftheselargebankswouldfurtherdropby2percent.
3 Basel III: Now the hard part for European banks.4 Clearing House Association, Sept. 22, 2011.
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Evolution of Regulatory Capital Planning, Measurement and Management
Historical USAverage RoE 12.1%
9.2%
7.2%
2.9%
2.0%
Average RoE AfterBasel III Rules
Impact ofBasel III on RoE
Impact of 2.5% SIFI Surcharge
Average RoE After Basel III Rules and 2.5% Surcharge
Figure 8: Impact of Basel III on the profitability of US banks.5
Strategy for Addressing Capital Planning Regulations
The new capital adequacy regulations can be very daunting for any bank or financial institution . While all the new regulations are related to capital adequacy, there are substantial differences in each of these regulations . One potential approach would be to use a divide-and-conquer strategy to meet the new guidelines by organizing the projects into four separate work streams:
1 . Basel III – Pillar 1 risk measurement and changes to capital definition .
2 . Basel III – liquidity risk assessment .
3 . Annual capital planning exercise (such as CCAR) .
4 . Data submission – monthly and quarterly .
Implementing a Capital Adequacy or Capital Planning ProjectThe new regulations are complex and affect all lines of business in a bank . This calls for a well-orchestrated and centrally coordinated implementation program . Some of the key factors to consider during project implementation are:
• Governancestructureandsteeringcommittee.
• Definingtheanticipatedsteady-stateprocess.
• Definingtheend-statearchitecture.
• Dataandreportinginfrastructure.
5 Source: The Clearing House Association LLC. How much capital is enough? Sept. 22, 2011.
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Governance Structure and Steering Committee
Banks embarking on a capital adequacy or capital planning program should first set up a governance structure and a steering committee that can ensure that activities conform to the set goals . The steering committee should have senior representatives from each line of business, treasury, group risk, finance, operations and information technology . Based on the complexity and preparedness of the bank, the steering committee can design the end state and define the implementation program .
The governance framework should address the following:
• Initiatingawarenessandtrainingprograms.
• Establishingacommunicationchannelwithregulatorstokeepthemabreastofthedevelopments and challenges .
• Communicatingobjectivesandstrategiestoallthekeystakeholders.
• Determiningifanexternalconsultingoradvisoryfirmisnecessaryinsome areas to supplement the existing team .
Defining the Anticipated Steady-State Process
Giventhecomplexityofcomplianceandinvolvementofmultiplebusinessunits,definingthe steady-state process will prove useful . An example steady-state process for capital planning is highlighted in Figure 9 . Outlining this process helps identify the connections between various business lines, stating the business specifications and functional specifications, identifying data gaps, and designing an appropriate technology architecture .
Basel I or Basel III
NIM from the ALM System
Chief Economist/External Providers
Provide macroeconomic scenarios
Normalize scenarios to suit speci�c lines of business
Strategy
• What-if analysis
• Acquisitions
• Divestments
• Dividend policy
Line of Business
Project growth, loan loss forecast and PPNR
Group Risk
Provide inputs for RWA calculation such as CCF
Provide portfolio-level view and capital calculations
Group Finance
Aggregate P&L, balance sheet, RWA, capital and PPNR
Initiate the Cycle
Work�ow
Data Infrastructure
Generate Various Views
FR Y 14 A reports
Forecasted P&L and
balance sheet
Management reports
Portfolio metrics,RWA, ECL
Work�ow
Data Infrastructure
Figure 9: Process for forward-looking capital planning.
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Evolution of Regulatory Capital Planning, Measurement and Management
Defining the End-State Architecture
The next step would be to define the end-state architecture in such a way that it meets the current regulatory needs and is also flexible enough to meet additional requirements that may come due to additional legislation . The design of the end state will also help protect existing investments and analyze the key additional modules required to complete the system . Figure 10 illustrates an end-state architecture with core components highlighted in light blue .
CreditRisk
CounterpartyRisk
MarketRisk
ALM/Liquidity
OperationalRisk
FinanceSystems
Risk and Finance Integration
Stress Testing
Basel II/Basel III
Data Integration/Data Infrastructure
Operational Data Sources
Risk Engines/Risk Analytics/Finance Systems
General LedgerDepositsTreasuryConsumerCommercial
Management and Regulatory Reporting
WO
RK
FLO
W AU
DIT
Business Intelligence Reporting Analytics
Figure 10: Example end-state architecture.
Data and Reporting Infrastructure
The data and reporting infrastructure may prove to be the most tedious, depending on the number of existing risk and finance systems and the current state of data management . Apart from the checks on the risk models, the regulators have substantial focus on data quality . Further, the capital adequacy regulations demand data at a level of granularity that is often not readily available in the data management systems of banks . This necessitates going back to the source systems, where data may not necessarily be available in the required format .
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ConclusionMost of the larger banks (assets greater than $50 billion) have launched implementation programs for Basel III and capital planning . The implementation road map varies from bank to bank depending on size, complexity and specific situation . However, most banks may have to redesign their risk modeling, finance systems, data infrastructure and technology infrastructure to meet these regulations . Two areas that merit attention are the requirement of a tighter integration between the risk and finance departments within a bank and data management . A cross-functional team with members from risk, finance, treasury, lines of business and technology would be critical for the success of implementation .
The regulatory burden on banks is growing and banks will need to put in place solutions that meet the current regulatory requirements and are flexible enough to address future regulatory requirements . Compliance with the risk-based capital adequacy regulations is very challenging; however, this is also an opportunity for banks to bolster their risk management systems . Banks that demonstrate better ability to measure and manage risk can derive business benefits from these regulations and will emerge as winners .
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Evolution of Regulatory Capital Planning, Measurement and Management
References1 . “Basel II: International Convergence of Capital Measurement and Capital
Standards: A Revised Framework,” BCBS, November 2005 .
2 . “Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework,” BCBS, June 2006 .
3 . “Revisions to the Basel II market risk framework,” July 2009 .
4 . “Regulatory Capital Rules: Advanced Approaches Risk-based Capital Rule; Market Risk Capital Rule,” BCBS, June 2012 .
5 . “Basel III: A global regulatory framework for more resilient banks and banking systems,” BCBS, December 2010 (rev June 2011) .
6 . “Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, and Transition Provisions,” The Fed, June 2012 .
7 . “Regulatory Capital Rules: Standardized Approach for Risk-weighted Assets; Market Discipline and Disclosure Requirements,” The Fed, June 2012 .
8 . “Comprehensive Capital Analysis & Review .” The Fed, March 2011 .
9 . “Annual Stress Test .” OCC, January 24, 2012 .
10 . “Annual Stress Test .” FDIC, January 2012 .
11. “SupervisoryGuidanceonStressTestingforBankingOrganizationsWithMoreThan$10 Billion in Total Consolidated Assets,” The Fed, FDIC and OCC, May 2012 .
12 . “Day of reckoning? New regulation and its impact on capital-markets businesses,” McKinsey Quarterly, September 2011 .
13. “BaselIII:NowthehardpartforEuropeanbanks.”McKinseyQuarterly,November 2010 .
14 . “How much capital is enough?” The Clearing House Association LLC, Sept . 2011 .
15 . Reporting forms and instructions FR Y-14A, The Fed .
16 . Reporting forms and instructions FR Y-14M, The Fed .
17 . “Proposed Rulemakings for an Integrated Regulatory Capital Framework: Questions and Answers,” The Fed, June 2012 .
18 . 2011 EU-Wide Stress Test: Methodological Note,EuropeanBankingAuthority,March 2011 .
19 . Status of Basel II, Basel 2 .5 and Basel III adoption: links to domestic implementation documents, BCBS, bis.org/publ/bcbs/b3prog_dom_impl.htm
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