The Basel culture takes root in Korea

Kookmin Bank is Korea's first to comply with the Basel II Accord – and is already feeling the benefits

With a customer base that includes approximately half of South Korea's adult population, Kookmin Bank (KB) has a dominant position in the country's banking sector, the third largest in Asia. Created from a merger between the Kookmin Bank and the H&CB Bank in 2001, KB achieved annual revenues of KRW 20.88 trillion in 2004 (US$20.78 billion) and a turnaround of its net income to KRW 555.3 billion (US$553 million). Moreover, in 2005 it nearly quadrupled its net profit in the first half from a year earlier to KRW 890 billion (US$860.7 million).

The company has improved its financial performance by enhancing its operational effectiveness in the face of intense competition from domestic and international rivals, and is now poised for renewed asset expansion as the Korean economy picks up again. In particular, Kookmin has improved its credit risk management and bolstered internal control systems and procedures. To expand its customer base, Kookmin is concentrating on high value customers through cross-selling based on integrated customer relationship management. In retail banking it is seeking to build up relationships with existing customers rather than acquiring new ones, while in the corporate banking sector the bank has actively secured large corporate customers with high credit ratings. Two interlinked strategies have been critical to Kookmin's pursuit of these goals. One is to diversify its revenue sources, and the second, to improve its risk management.

Risk management
KB chose SAS software to integrate its credit risk management procedures, which had previously been separated from the business lines. KB separated the credit risk management function from the marketing operation to efficiently manage complicated credit risks. "Integrated credit risk management, which controls the bank-wide credit policy, has enabled KB to cope with potential risks much better, and to limit the spread of risk," says Woo-Yeul Lee, Deputy General Manager of the Risk Capital Team. "This has helped Kookmin to secure stable profitability and growth momentum through optimal portfolio management," he adds. The SAS implementation was achieved remarkably rapidly, commencing in January 2005. "In July 2005 KB received approval from Korea's Financial Supervisory Service (FSS) to use its internal model for market risk. It was the first Korean bank to receive this distinction. Previously the only two banks to have received such approval were Australian owned," says Lee.

It is an achievement for which KB feels rightly proud. "Basel II compliance will have to be achieved by 2007 in Korea. The FSS is giving requirements and objectives to all Korean banks to establish a Basel II framework and system. We feel we are well ahead of schedule and establishing a true Basel II culture at KB," says Donald H. MacKenzie, Chief Risk Officer and Senior VP of Kookmin Bank.

KB's risk team has 85 employees. "Basel II has a high priority so we have a large dedicated team and full backing from senior management. The FSS is very pleased that KB is leading the way for compliance efforts in Korea," says MacKenzie.

Huge data volumes
The Basel II framework is based on the three pillars of minimum capital requirements, supervisory review and market discipline. As of mid-January KB had achieved Pillar I (Mininum Capital Requirements) including the system for exposure at default (EAD), loss given default (LGD) and risk weighted assets (RWA) calculations. It currently takes 24 hours to perform the EAD, LGD and RWA calculations (eight hours each). "This is already very fast considering we have 18 million accounts, and we are confident that we can reduce the turnaround to five hours," says Lee. Those 18 million accounts add up to 14 terabytes of data, with a further 240 gigabytes added every month.

Data volume was a key reason for choosing SAS, according to Lee. "KB needed a platform that was capable of handling the ever-expanding data. The advantage of SAS is that everything can be done within a single platform, which speeds up the process and makes it easier to manage. Data integration, metadata management, user authority management and credit risk management reporting are all integrated within the SAS®9 architecture."

Outperforming SAP
A second key factor in the selection of SAS was the flexibility to customize the solution. In benchmark testing against the other short-listed contender, SAP, KB's IT department found SAS to be much easier to handle and more efficient. Data quality, a SAS strength, was key to getting the correct RWA calculations. Moreover the RWA calculations could be customized to fit KB's own methodologies, making the calculation much more transparent than with a black box solution.

The Basel Accord is applied differently in each country according to the decisions and the supplementary requirements of the supervisory agency (in this case Korea's FSS). On top of this, each individual bank has its own peculiarities such as its data structure and its internal reporting requirements. "SAS is powerful and can be implemented quickly, yet it is also uniquely flexible. That is a big advantage," says Lee.

A team effort
IBM provided the consultancy service to analyse KB's Basel II and customer credit scoring requirements. Lee says that the three team players, KB, SAS and IBM complemented each other perfectly and the partnership was key to a successful project. KB was particularly delighted with the training and technical support from SAS. "We have worked with many other consulting companies from around the world but we feel the employees of SAS Korea offer commitment, ability and knowledge that exceeds the global standard," says Lee.

KB is now confident that Pillar II will be easily achieved on the basis of the work already done, but operational risk compliance will require further concentrated effort.

Saving regulatory capital
The benefits of Basel II do not stop with regulatory compliance. In fact, KB's leadership say that Basel II is a welcome external stimulus that is helping to change company culture, making the bank more disciplined in its whole approach to business. "With this project, the bank is conducting intensive reviews of its internal controls and correcting all deficiencies," says Donald H. MacKenzie.

Moreover Basel II compliance means more independence of action for the bank, not less. By earning the right to use its own internal models to manage risk, KB is improving its capital allocation by saving on regulatory capital, say Lee and MacKenzie. A review by the FSS in 2006 will give KB an objective external assessment of the bottom-line impact of the project. Meanwhile, risk management is also giving KB a better knowledge of its customer portfolio, which it can now manage more proactively and more profitably.

Establishing a risk culture at a company as large as KB is a major challenge and MacKenzie is looking forward to constant infrastructure improvements through 2006 before final completion of the project. Meanwhile, "Satisfaction with SAS is 100 percent," concludes MacKenzie. "With the Basel II implementation we have enforced greater discipline across the company. We can measure a lot more, with a lot more accuracy, and we can now manage with greater effectiveness."

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