ComplianceFinanceJuly 05, 2021

How to comply with Basel IV: Implementation strategies for Basel IV vary from one jurisdiction to another

Under the timetable set by the Basel Committee on Banking Supervision (BCBS), a five-year implementation period for Basel IV is due to begin on 1 January 2023. How banks and supervisory authorities are using the two-plus years until then varies from one jurisdiction to another.

The establishment of regulatory frameworks across the European Union is relatively advanced, while regulators in Asia-Pacific and the Americas have only finalized a handful of elements.

CRD V and the latest Capital Requirements Regulation (CRR II) in Europe came into force on 27 June 2019 and provide a solid text on which implementation can be based. Succeeding drafts, CRR III and CRD VI, were anticipated in the second half of 2020 but have been delayed by the COVID-19 pandemic.

Moving on to North America, Canadian regulators have finalized most of the Basel IV building blocks, with still a number awaiting public proposal. Bart Everaert, Product Management Director, Americas at Wolters Kluwer, says, “The United States has experienced a regulatory slowdown during the Trump administration and only seen the Federal Reserve issue a handful of updates that comply with the 19 BCBS Basel IV components.”

This presents an opportunity for banks to determine how implementation challenges can be resolved to give them their best chance of meeting the deadline, as well as to research the issues they are likely to face after implementation. It is a chance to review everything within each bank’s “Basel chain,” to investigate whether these components are ready for the future. This means reviewing credit risk, market risk, operational risk, liquidity, leverage ratios and all the reporting systems and system data that align with those elements.

In terms of risk infrastructure, much has changed. But that does not necessarily mean that organizations must replace their entire systems architecture. Banks are advised to review their systems step by step and then make a call.

Suitability assessment

Firms need to identify whether they would prefer a patchwork replacement for elements of their current solutions or whether it makes more sense to embark on a full-scale overhaul. They should evaluate this by considering levels of satisfaction with existing elements, but also whether any upgrades will be fit for purpose beyond the next several years.

Xavier Dubois, Product Management Director, EMEA at Wolters Kluwer, says: “We believe it is far more prudent to consider whether their selected architecture will fulfill regulatory obligations and meet audit and business requirements in the coming years and well into the future. Assessments should be conducted at a global level and across the entire Basel framework, not limited to credit or market level.”

One criticism of the Basel framework currently in force is that there is an imbalance in the regulatory expectations for smaller regional banks, compared to global giants with more significant investment. Organizations have been expected to follow all the rules, regardless of the degree of complexity or risk in their business models.

Under Basel IV, a proportionality principle has been introduced to put requirements on banks based on their size and risk level. Small, simpler banks do not have to deal with complex calculation methods and requirements. Banks in general will face standards as demanding as their size, complexity and risk levels warrant.

The proportionality principle is being put into practice somewhat differently in Europe. Risk assessment standards and calculation methods there will vary for several types of risk – such as market risk or CCR, or for determining the credit valuation adjustment (CVA) – depending on a bank’s size and the complexity of its operations.

Basel IV/CRD V: A total overhaul

In the United States, the Federal Reserve has defined categories of banks based on risk-based indicators, similar to the criteria used to define global systemically important banks: size, cross-jurisdictional activity, non-bank assets, short-term wholesale funding and off-balance-sheet exposure. This categorization of banks will drive the complexity of the approaches that a bank must take to calculate its various risk exposures.

When we look at Asia-Pacific, the initiatives are relatively mature due to proactive interventions by the Australian Prudential Regulation Authority and the Monetary Authority of Singapore. Many of the largest banks have already looked at options around the current Basel framework extensively, with some having implemented core calculations on market and credit risk.

There is still a long way to go on the journey to Basel IV, especially concerning the alignment of data, processes, and systems, as well as the deployment of Basel metrics for business, not just for compliance. “The full regulatory scope of proportionality needs to be covered,” Dubois says.

Firms often have preferred suppliers but, as Dubois notes, the decision to employ separate vendors for different parts of the Basel IV risk assessment, notably CCR, CVA risk, large exposure and leverage ratio calculations, can lead to difficulties later.

Basel – BCBS 17th Progress Report – Country ranking

Progress against the current 19 BCBS Basel IV components

For example, the rules for CCR are reused in assessing CVA risk, large exposure and leverage ratio calculations. If a bank uses a variety of vendor software, there is no guarantee that each vendor will employ the same aggregation methods. This could lead to inconsistencies, not only in results, but in subsequent reporting, perhaps leading to questions from regulators.

Some organizations are likely to prefer a fully integrated solution for that reason. It guarantees consistency and enables easier reconciliation comparisons, reducing the need to employ further resources to match datasets and verify accuracy.

Generating consistency is vital. That is why Wolters Kluwer looks at the full scope of risk, whereas some specialist vendors confine their assessment to limited, discrete elements of it. Banks that use multiple specialists therefore increase the likelihood of inconsistencies in their regulatory submissions.

Being compliant at all times

Basel IV’s mandate that institutions be compliant at all times is designed to ensure that organizations large and small are continuously aware of their risk exposures. Regulators will expect larger banks to provide a comprehensive risk assessment within a few hours. Smaller firms, such as local savings banks, will have a few days or weeks. That reflects an understanding that smaller firms are much less engaged in risk-based market activities.

Larger banks that have not reviewed their systems for several years will need to do so with some urgency. The timeliness requirement underscores the need to explore whether their existing technology allows quick, intraday calculations, a capability that many legacy solutions lack. Examining your system to assess its viability over the long haul should be a priority in the run-up to the Basel IV deadline. It will ensure that your bank makes the best use of those crucial months and help to keep costs down after that.

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