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Basel III doesn’t have to be a big pain for community banks
By Tara Heusé Skinner, SAS Risk Research & Quantitative Solutions
To comply with US Basel III using the Standardized Approach, community banks need to implement repeatable processes. For example, regarding reporting capital and other requirements, banks must be able to make all the calculations up‐front and routinely repeat these processes going forward. So if the calculations are made with tools designed specifically for them, banks save on capital expenditures and staffing in the long‐run.
At a high level, several capabilities are required for successful Basel III compliance:
- Data structure and validation: Community banks need assurance that the position data and exposure data necessary for capital calculations is cleansed and transformed at the required level and accurately reflects the current book of business.
- Risk and financial reconciliation: Banks need assurance that the risk data they use has been reconciled with finance data (in their general ledger) before it is reported to regulators for capital adequacy.
- Capital calculation updates: When capital calculation rules change, the right rules and the latest rules must be applied consistently and as intended.
- Risk reporting: Banks need assurance that all necessary reports and schedules are updated and submitted appropriately.
- Auditability: Demonstrating transparency down to the source data level is key to Basel III compliance. Community banks must be able to document all capital classification and computation rules to a sufficient degree to meet regulatory requirements during the auditing and review process.
Basel III isn’t going away. An investment now in a tool that gives you repeatable processes – and that updates automatically when the rules change – will be well worth the time and effort.
Overcoming the challenges
In our research into the misconceptions that community banks have around Basel III compliance, SAS found that most banks under the $15 billion asset mark don’t have sufficient infrastructure and data management capabilities to address Basel III. They also use external core banking systems for transactional or operational processing and, consequently, they have limited analytical and modeling processes.
Looking at your bank, do these conditions sound familiar?
If so, regulatory data mapping and data transformation issues alone can be challenging for your company, to say nothing of the issues related to computing exposures, applying the correct RWA ratios, and aggregating the appropriate capital levels. Data and analytic process issues that can be especially challenging for less sophisticated institutions include:
- Limited data availability: The collection and availability of data at the right level of granularity is crucial and is a key component for any regulatory capital implementation. If data is not available, the resulting rules may severely penalize a bank in terms of the capital that must be held.
- Data gaps: Initial and ongoing efforts to identify the critical data needed to generate the appropriate exposure calculations, attribute the applicable risk weights, and transform these metrics into the correct categories within the regulatory reporting taxonomy require a thorough understanding of both the source position data as well as the target reporting framework. The reporting framework, however, has yet to be completely identified and published. Differences in individual banking systems and operational processes can require substantial efforts in determining data gaps and evaluating appropriate reconciliation procedures to address these gaps.
- Model risk and model breakdowns: The financial crisis underscored the fact that models that work well under steady-state conditions may break down rapidly under certain stress scenarios. A case in point is the pre‐payment models used by banks—with most models assuming an inverse correlation between interest rates and pre‐payment speeds. No amount of historical modeling of the variables will capture the effects of markets when the performance is outside of historical levels. Hence, apart from continually testing variables and recalibrating models, banks should have a mechanism to incorporate such correlation breakdowns to make the regulatory capital process meaningful. This particular challenge exists for larger banks as well.
- Firmwide view: Basel III, like other regulatory requirements for capital, requires the application of calculations at varying levels of granularity across multiple lines of business. This could be challenging due to an inability to aggregate information across banking divisions using technology and automation rather than via manual extracts from business units using manual interventions. Manual extractions are also problematic because they have the potential to introduce error in the computations and aggregations.
- Process reusability: Smaller firms may not be able to capitalize on the ability to leverage the time and money invested in developing a regulatory process and apply this investment to areas such as economic capital modeling, capital allocation, scenario analysis and stress testing, or management decision making. Experience has shown that banks having a fragmented stream of solutions to handle one or more parts of Basel II face considerable difficulties in synchronizing the data and computations. The consequence of this is that future iterations of the regulatory capital process can be out of sequence or process steps can be missed, causing inaccurate capital calculations.
Yes, Basel III does apply
Basel III isn’t going away. An investment now, rather than later, in a tool that gives you repeatable processes – and that updates automatically when the rules change – will be well worth the time and effort. It will not only help you address the complexities of mandatory Basel III compliance, but also reduce staffing expenses in the future.
Read the entire white paper, “Does Basel III Apply to the Community Bank?” to learn how this regulation applies to your organization and what you can do to ensure compliance.
Read the entire Point of View paper, “Does Basel III Apply to the Community Bank?” to learn how this regulation applies to your organization and what you can do to ensure compliance.