Providing software solutions since 1976
Providing software solutions since 1976
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Moving in Tandem June 18, 2003 Undoubtedly, the impact of the Basel II Accord is being felt at all internationally active banks. Since the Basel Committee published the first draft of the Basel II Accord more than two years ago, we have seen significant developments in the way banks are approaching their Basel II programs. It is now generally accepted that Basel II will happen and that the implementation date of ‘06 is unlikely to change again. It is also clear that the majority of banks, regardless of size, are aiming for Internal Ratings Based (IRB) accreditation approach that is sensitive to banks’ internal methodologies and provides incentives for better risk management, versus a ‘broad brush - one size fits all’ approach that focussed on a single measure of risk. Meanwhile, of foremost importance is the need to recognise that the Basel II Accord is not a once-only requirement but an evolutionary program of risk improvement. This is because requirements of regulators, business managers, risk managers and finance professionals will evolve. To meet this challenge, it is vital to maintain coordination between business and IT – without this, Basel II implementation will surely fail. But what is happening currently? In the rush to meet these deceptively close deadlines, many banks appear to have forgotten who will be building and maintaining this solution. Surprising, as it may seem, we are likely to witness a significant disconnect between business/ risk managers and IT across the majority of Basel II programs. To enable IT to deliver this policy-driven technical solution, clear requirements are a must-have, as are robust communication and coordination plans. In keeping with this, where does India stand vis-à-vis banks in the developed countries? Most banks in developed countries have completed the program analysis phase, and the data analysis phase is well under way. The emphasis is now moving to the implementation of a tactical solution and identifying the target-operating model for achieving compliance. Meanwhile, in India, in line with Basel II, RBI has stipulated that all Indian banks be Basel II complaint by year ‘06. Further, in the recent credit and monetary policy for year ‘03-’04, RBI has asked banks to move towards a graded system of assigning risk weights depending on the quality of their assets. This will make the capital charges more responsive to the banks actual credit risk exposure. Further, banks will also be required to make capital requirements for operational risk. The regime that is envisaged will give incentives to banks to reduce their regulatory capital by improving credit, market and risk management practices thereby, resulting in savings. For instance, based on their internal ratings, banks may be required to assign 20% risk capital to a best-rated borrower and 100-200% on a sticky asset.
But are Indian
banks ready to meet the RBI stipulations? There are 105 banks in the country
with 55,000 branches – a majority of the public sector banks lack data due to
late computerisation. At the outset then, this means huge scale IT investments
are being made to have the one critical element to implement Basel II
successfully: Clean and reliable data – data that is accountable. At this point, it is important to note that as per the Accord, even though the use of pooled data and mapping of internal rating grades to external data sources are explicitly allowed by the Accord, it is also stated that internal data must always be used, at least to complement these techniques. This is because a rating model that is built on internal data using internal resources is likely to be the superior choice for an internal rating system in most circumstances. It would optimally support banks in generation of disclosure reports, aggregation and decomposition of risk measures, generation of migration matrices, conducting vintage analysis for tracking realised default rates, quality control, rating system monitoring and assessing the model validity. More importantly, it establishes a solid foundation for a path towards Risk Adjusted Performance Management from a strategy perspective. Thus, on an immediate basis, banks need to collect and store a minimum of 3-5 years worth of historical data, ensure data integrity and timeliness of figures, effectively integrate different risk types and guarantee accurate calculation of risk measures. This is where risk intelligence, a key component of the Business Intelligence suite, comes in. It gives banks the power to access, integrate, analyse data to provide timely risk intelligence across credit, market and operations risk. Undoubtedly, Risk Intelligence is the vanguard to meet the deadline of ‘06 effectively. Banks in India cannot afford to risk the possibility of not having one. However, before selecting the symbiotic Business:IT approach, there are three main strategic considerations that need to be borne in mind: The accord will continue to evolve, most likely as smaller, iterative modifications rather than the wholesale accord changes witnessed so far. The banks will need to build enough flexibility into its technical architecture to incorporate these changes as well as risk managers’ recommendations. Banks will also need to consider the integration of its Basel II solution with its existing technical infrastructure and any other major systems implementations that are already planned. Finally, as the Basel II program matures into the strategic implementation phase, banks need to ensure that the solution chosen is able to deliver the enhanced benefits that should be derived from Basel II, such as reducing capital requirements and enhancing shareholder value. Thus, questions that need to be comprehensively answered by banks today are the following: Has our logical data model been validated back to the Basel II Accord?; Do our reporting tools give us insight into capital calculation as well as perform the required regulatory reports?; Do we have robust data capture, cleansing and management practices in place? In conclusion, the Basel II Accord is not a
once-only requirement but an evolutionary program of risk improvement. The
relevance of the technical solution adopted will be gauged against its ability
to keep pace with these changes. Requirements of the regulators, business
managers, risk managers and finance professionals will evolve. To meet this
challenge, it is vital to maintain coordination between business and IT. The
course you set today will determine your ability to meet the challenges yet to
come. |
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