Implementing Basel III
FRSGlobal
Implementing Basel III Are you ready?
frsglobal.com/solutions
Are you ready? This paper gives an overview of the imminent regulations pertaining to becoming Basel III compliant, particularly those centered on reporting. It aims to provide a current snapshot of how global adoption is progressing to date. It will be especially relevant to those tasked with compliance, risk and regulatory reporting within banks.
FRSGlobal
Implementing Basel III – Are you ready?
The perfect regulatory storm
The new regulatory regime of Basel III goes live on 1 January 2013, for both reporting and the new minimum capital requirements. Indeed from as early as this summer, banks are expected to capture and report on key aspects of the new ratios, despite the fact the new EU directive and regulation have yet to be finalised in readiness for the 2013 live date.
Banks will have to meet the following minimum capital requirements expressed in risk-weighted assets: 3.5% share capital, 4.5% Tier 1 capital and 8% total capital. Preparation for the new reporting and stress testing requirements must be largely complete by the end of 2012. Other measures to be implemented by the beginning of 2013 include new regulations for counterparty credit risk and minimum core Tier 1 ratios, and new treatment of banks’ short-term liquidity. With deadlines looming, taking a ‘wait and see’ approach is no longer an option. Despite this, much is still to be finalized. The banking industry is awaiting the publication of: The first stage of the Single European Handbook A revised sanctions regime A revised definition of capital Harmonization of pillar 1 measures l
l l l
Implementation on the fly Although institutions that have implemented Basel II are likely to fare better than those further behind the curve there is still much added complexity arising from the stricter data quality, more frequent reporting and greater aggregation of risk IT and operations, as required by Basel III. Furthermore the timelines for Basel III are much tighter. However, important parts of the framework, such as the capitalisation levels of bank central counterparty default fund exposures, have still not been finalised or, like the rules on systematically important financial institutions, have only been recently been published, with little time to respond to the changes before going live. The long transition period outlined for Basel III – with the last of the ratio changes not being imposed until 2019 – is a bit of a misnomer as many jurisdictions, particularly in Asia, aim to
go fully live years before this and banks hope to have the systems that are compliant with the new regime built by the end of 2013. Banks have the European Banking Authority (EBA) Quantitative Impact Study (EU-QIS) as a guide, but changes are still being made to the final reporting templates and it is not clear what the final mandatory requirements will look like. As a result, banks are having to make some tactical, rather than longer term strategic decisions to meet deadlines, perhaps resulting in temporary, but not completely satisfactory, solutions. This time it’s serious The current expectation of the European Commission is that the legislative negotiation process will have concluded by summer 2012 and the proposed date for the Capital Requirements Directive (CRD) and the Capital Requirements Regulation (CRR) legislation to become binding on banks, building societies and credit institutions is 1 January 2013. CRD IV, which is in fact a combination of the CRD and the CRR, and how Basel III will be implemented, will actually go beyond Basel III and bring in proposals on noncompliance sanctions, corporate governance and remuneration. What is clear here is that, regardless of the penalties for non-compliance, which will come, there has been a sea change in the attitude of Basel III regulators. Past regulations needed to be transposed into national law, whereas the regulations coming out of Brussels now, do not. They are direct and immediate, with very little room for national discretions. What is different this time is that the EU is set upon achieving uniform implementation and National Supervisory Authorities are losing much of their discretionary power under the Single Rule Book.
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Basel III reporting
Of the upcoming regulations much is centered on regulatory reporting and the implementation the EU standardized Common Reporting format (COREP) for credit, market and operational risk, which now extends to all three pillars of Basel III, and the development of a uniform standard for financial reporting (FINREP) despite the diversity of accounting rules worldwide.
A poll carried out by Risk magazine, in a recent audio seminar, revealed that 49% of its telephone audience believed that their biggest investment would be on reporting, followed by 24% saying that their biggest investment would be on databases and data warehousing. And yet, reporting is thought to be the one area where there is little competitive advantage to be gained from building systems in-house. The sheer complexity of the reporting templates – estimates are that nine times as many data points will be required – added to the analysis needed of the incoming specifications and additional data elements, on such tight timeframes, is causing many banks to consider external help to meet these requirements. Additionally, there is a wide ranging response to the implementation of reporting, despite the hard line being taken by the regulators on harmonization. For example, where Belgium has more or less fully adopted both COREP and FINREP, Germany has adopted most of COREP but not FINREP, and the UK has only partially adopted COREP but not FINREP. Common Reporting (COREP) The first milestone for reporting is imminent. The European Banking Authority (EBA) is expected to submit the final draft of COREP/ FINREP technical standards to the European Commission in June this year. First submissions under the reporting regime are expected in May 2013. It is highly likely that firms will be expected to switch over immediately, without a parallel run.
The first milestone for reporting is imminent. The European Banking Authority (EBA) is expected to submit the final draft of COREP/FINREP technical standards to the European Commission in June this year. First submissions under the reporting regime are expected in May 2013. It is highly likely that firms will be expected to switch over immediately, without a parallel run. 4
From 2013 COREP (revision 04) is expected to cover: Future CRD/Basel III changes to capital definitions Liquidity and leverage ratios Mortgage exposures Large exposures Disclosures by national supervisors l
l l l l
Some data items will be replaced by COREP while others will continue to leverage existing BIPRU reporting. Those items that are likely to follow COREP include reports on capital adequacy, credit, market and operational risk, large exposures and securitization. While COREP will improve compliance reporting and make it more effective, a critical issue is that it requires more granular information, prompting the need for a major overhaul of data collected for reporting purposes and identifying the additional data needed and changing the reporting model is proving a challenge under the tight deadlines. Financial Reporting (FINREP) FINREP is still a live issue in Europe. While Article 95 of the draft CRR states that the adoption of some form of financial reporting alongside COREP is expected from 1st Jan 2013, the EBA still need to specify these requirements. These are expected to be published in June 2012, but there is a likelihood of a delay of up to six months until standards for industry-wide financial reporting are drawn up. Until EBA publishes its final guidance, national regulators cannot
Implementing Basel III – Are you ready?
respond on where national discretions are allowed. Uncertainty so close to the go-live date is causing a lot of frustration and some countries are calling either for a delay in mandatory requirements or proposing that implementation by left to the discretion of national supervisors. There is a stark choice of wasting precious development time under the expectation that FINREP will go live or risking falling foul of the new reporting requirements if the EBA rules do go live. XRBL Another addition to the ‘to do’ list is the implementation of XBRL. The FSA is planning to introduce XBRL as a data collection channel and is assessing the impact of removing the current facility which allows users to enter data. EBA has ‘strongly recommended’ XBRL and is expected to mandate this in the Binding
Technical Standards, which are due to be published shortly. The EBA will be providing templates and taxonomies in XBRL. What’s yet to come? During the transitional period from 1 January 2013 up to and including 2019, the minimum capital ratios will gradually be stepped up to 4.5% share capital, 6% Tier 1 capital and 8% total capital. The conservation buffer will be build up along gradual lines to a percentage of 2.5% from 1 January 2016 through 1 January 2019. Thus, banks will ultimately have to hold 10.5% of their total capital expressed in risk-weighted assets. National supervisors will gradually introduce additional allowable deductions from bank capital such as deferred tax assets and investments in financial institutions from 1 January 2014 through 1 January 2018.
Transitional Arrangements for Basel III implementation 12% Minimum common equity capital ratio
10%
Capital conservation buffer
8%
Minimum common equity plus capital conservation buffer Minimum tier 1 capital
6%
Minimum total capital Minimum total capital plus conservation buffer
4%
2%
0 2012
Leverage ratio Liquidity coverage ratio Net stable funding ratio
2013
Supervisory monitoring
1014
2015
2016
Parallel Run 1 Jan 2013 - 5 Jan 2017 Disclosure starts 1 Jan 2015
2017
2018
2019
Migration to Pillar 1
Introduce minimum standard
Observation period begins Observation period begins
Introduce minimum standard
5
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The new Basel III liquidity rules mark the first time that specific global quantitative minimum standards for liquidity have been introduced. Monitoring of the new standards commenced at the end of year-end 2010. The liquidity coverage ratio (LCR) will have to be met from January 2015, with any revisions to its calibration, to address unintended consequences, issued by mid-2013. The period from 1 January 2013 through 1 January 2017 will be a parallel run period. During this period, the development of the leverage ratio will be monitored. The intention is to migrate the leverage ratio into the Pillar 1 requirements as from 1 January 2018. The net stable funding ratio (NSFR) will undergo a longer observation period and will not be introduced until January 2018. Revisions can be made to the NSFR no later than mid-2016. Speaking at a seminar on ‘Long term growth: organising the stability and attractiveness of the European financial markets’ held in Berlin in January 2012, Mr. Jaime Caruana, General Manager of the Bank of International Settlement, said it is unlikely that framework’s approach would be fundamentally altered. Since the Basel III liquidity rules are minimum standards, national differences will occur, particularly for reporting formats, assumptions for deposit runoff rates, contingent funding obligations and market valuation changes on derivatives. This means that global banks
“It is unlikely that framework’s approach would be fundamentally altered. Since the Basel III liquidity rules are minimum standards, national differences will occur, particularly for reporting formats, assumptions for deposit runoff rates, contingent funding obligations and market valuation changes on derivatives. “ Mr. Jaime Caruana, General Manager of the Bank of International Settlement
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will need to monitor parameters set by the local supervisors in the countries where they take deposits and to develop the flexibility to incorporate these differences in their risk analyses. The LCR will need to be reported at least monthly, with the operational capacity to increase the frequency to weekly or even daily in stressed scenarios at the discretion of the supervisor. The net stable fund ratio (NSFR) should be calculated and reported at least quarterly. Once the LCR has been implemented, its 100% threshold will be a minimum requirement in normal times. But during a period of stress, banks would be expected to use their pool of liquid assets, thereby temporarily falling below the minimum requirement. The Basel Committee has been asked to provide further elaboration on this principle by clarifying the LCR rules text to state explicitly that liquid assets accumulated in normal times are intended to be used in times of stress, and provide additional guidance on the circumstances that would justify the use of the pool. The Basel Committee will also examine how central banks interact with banks during periods of stress, with a view to ensuring that the workings of the LCR do not hinder or conflict with central bank policies.
Implementing Basel III – Are you ready?
Uptake so far
Monitoring the uptake The Group of Governors and Heads of Supervision (GHOS), the oversight body of the Basel Committee on Banking Supervision, met on 8 January 2012 to discuss its strategy for assessing implementation of the Basel regulatory framework. The Committee will monitor, on an on-going basis, the status of member countries’ adoption of the globally-agreed Basel rules. It will review the compliance of members’ domestic rules or regulations with the international minimum standards in order to identify differences that could raise prudential or level playing field concerns. The Committee will also review the measurement of risk-weighted assets to ensure consistency in practice across banks and jurisdictions. The Committee has already begun monitoring the uptake across the territories and the exercise will be repeated semi-annually with end-December and end-June reporting dates. Where banks have not yet have implemented some of the models and processes required for the calculations, they may provide quantitative data on a ‘best-efforts’ basis. A total of 158 banks submitted data for the EBA’s first published report in April 2012 on the results of the Basel III monitoring exercise, as a follow-up to the comprehensive European quantitative impact study (EU-QIS) conducted to analyze the impact of the new requirements. Banks were asked to apply Basel III rules to data taken from 30 June 2011 to get an indication of how they would fare. These results showed that on average, banks in Europe fell short – specifically they didn’t meet capital or liquidity requirements.
This level of reporting on implementation progress is unprecedented in the banking industry and does imply a level of ‘naming and shaming’ the laggard countries, to ensure true global adoption. Geographic uptake In terms of drafting and implementation of Basel III final rules by national regulators, progress has been made. However, to date, Saudi Arabia, which already has more stringent banking regulations than most, is the only country to have issued final Basel III rules to its regulated firms, and Gulf banks are likely to adopt the rules this year, ahead of the deadlines set. While Basel 2.5 rules were adopted by EU Member States at the end of 2011, the Basel III proposals will be implemented into EU law through CRD IV. This will be a key instrument through which the Commission intends to introduce substantive parts of the new European supervisory architecture, including the development of the Single Rule Book for financial services. These changes are due to be implemented from 1 January 2013, although there will be transitional arrangements for some elements. There are some concerns about the US, where Basel 2.5 and Basel III rules must be coordinated with work on implementation of the Dodd-Frank regulatory reform legislation, in particular with regard to the use of credit ratings. Despite the fact the US didn’t implement Basel II, the US Federal Reserve announced in December 2011 that it would implement substantially all of the Basel III rules and made clear they would apply not
A total of 158 banks submitted data for the EBA’s first published report in April 2012 on the results of the Basel III monitoring exercise, as a follow-up to the comprehensive European quantitative impact study (EU-QIS) conducted to analyze the impact of the new requirements.
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only to banks but to all institutions with more than US$50 billion in assets. Already, fifteen of the US’s largest 19 bank holding companies were shown to have adequate capital under what is understood to be the Fed’s most stringent stress test scenario to date.
In China, the broad concept of Basel III is supported as it indirectly endorses the conservative regulatory approach the Chinese have always adopted and banks are regarded as generally wellpositioned to meet the higher standards and measures required.
Some national authorities are actually setting out to apply the minimum capital requirements ahead of the mandated deadlines. They include the Australian Prudential Regulation Authority, which is proposing that banks meet the revised minimum capital ratios in full from January 2013, and to be fully compliant with the capital conservation buffer form January 2016, ahead of Basel III deadlines of January 2015 and January 2019, respectively. The Reserve Bank of New Zealand (RBNZ) has also already stated that banks will have to meet the minimum capital ratios in full from 2013 and is now proposing to implement the capital conservation and counter-cyclical buffers of the Basel III framework in full from
January 1, 2014 – two years ahead of the timetable set down by the Basel Committee. And similarly, the Reserve Bank of India has told domestic banks they must start reporting on aspects of Basel III liquidity strength measures from as early as June this year, ahead of the reporting timetable laid out by the Basel Committee. Furthermore, it has stipulated that banks go above and beyond Basel III requirements and provide a statement outlining their bond spread movements compared to their share price in a bid to better monitor early signs of systemic risk. In China, the broad concept of Basel III is supported as it indirectly endorses the conservative regulatory approach the Chinese have always adopted and banks are regarded as generally well-positioned to meet the higher standards and measures required. In Hong Kong too, despite escaping the global financial crisis relatively unscathed, regulators intend to implement the Basel III reform package, despite concerns about some of the unintended consequences, particularly the impact of the liquidity rules on the relatively immature corporate debt markets in Asia. Likewise, while Singapore officials support Basel III it has been made clear that rules should be adapted to local circumstances to reflect the different stages of economic growth, banking and regulatory approaches in Asia. The Monetary Authority of Singapore (MAS) is requiring that Singapore banks both meet Basel III capital standards earlier and to exceed Basel III’s common equity requirements by 2%. This is primarily due to the fact the four locally incorporated banks are systemically important domestically. Similarly, the Central Bank of the Philippines is insisting on full implementation of all of Basel III’s regulations by the end of 2014 – well ahead of schedule.
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Implementing Basel III – Are you ready?
It’s not a matter of if but when
The onslaught of the Eurozone debt crisis, coupled with the sheer scale and complexity of Basel III – CRD IV runs to more than 1,000 pages, with at least 200 references to points that need fleshing out and formalized by the EBA – has prompted some to speculate whether the implementation timelines are realistic, but there seems little likelihood that there will be much leeway now that the legally binding framework is in place and the wheels are in motion for the technical standards coming from the EBA. Furthermore, we are witnessing a wave of banks rushing to become compliant before deadline. Some banks already hold more highquality capital than Basel III will require and Checklist for 2012 Even without having complete knowledge of the full suite and extent of the upcoming wave of regulations and discretional national interpretations, much can be done now to ensure best practice rollout in coming months and the minimum disruption to the business of banking. • Are you managing the data challenge as well as you could be? Arguably, the biggest challenge banks face is getting timely and accurate data out of a myriad of systems in order to get a single view of the enterprise and better manage the firm’s position. Many banks are introducing more automated and robust reconciliation procedures, and centralizing information systems in order to gain the essential transparency demanded by Basel III. • Have you realigned your business models in accordance with your firm’s risk appetite? Banks need to de-risk lending activities, ensure they have high quality capital (and more of it), as well as attaining greater short and long term liquidity to fund and better withstand stress events in the market – these should all be in line with the firm’s risk appetite. • Have you standardized reporting and information across all branches? This is an essential part of the process to to ensure consistent, firm-wide reporting – it needs close attention if it has not already been addressed. • Have you established realistic but challenging scenarios for stress testing and reverse stress testing? Stress tests and reverse stress tests need to adequately reflect business lines, with the emphasis on identifying the appropriate stresses, their impact and relevant management actions. Not only essential internally, but regulators will want to see the results. • Are you truly up-to-date with latest regulatory developments? The analysis of regulatory information as it is published is essential to the keeping current with Basel III changes and mitigation of this process as far as possible reduces the risk of incorrectly anticipating the regulation.
many are already disclosing figures in a bid show investors that they can comply with the new regime sooner rather than later. Indeed, Barclays, for one, as far back as its 2010 annual results indicated an LCR of 80 per cent and a 94 per cent ratio for the NSFR. The products, risks and returns expected from banking are all changing as a direct impact of Basel III, and many banks have been aggressively reviewing their business models, because the sooner they can tackle compliance and ensure the minimum of capital is invested in it, the sooner they can get back to the main business of banking and finding better returns on equity. But with a sluggish economy, for others it is not so clear, as banks try to find the balance of de-risking banking activities and ensuring funds are available for risk-taking, balancing between stability and growth. As one banker put it: “There is a trade-off between de-risking banking activities and ensuring funds are available for risk-taking in the economy, balancing between stability and growth.” “Somehow we need to find a balance between financial stability and the reality that financial services are needed to support the real economy. It’s all about calibrating the rules in such a way that the trade-off between de-risking of activities and ensuring funds are available for risk-taking is balanced. This will take time and will need constructive cooperation between the banking industry and the regulators, and will also require the regulators globally to work together to ensure a level playing field.” Basel III represents a wholly new era in banking regulation. Non-compliance is not an option, only how quickly and accurately compliance can be achieved. Unlike Basel II, the implementation of Basel III is being monitored at every step of the way and with the findings set to become public, the implication is that no further regulation will swiftly follow until the new risk paradigm is reached.
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About Wolters Kluwer Financial Services | FRSGlobal Whether complying with regulatory requirements, addressing a single key risk, or working towards a holistic risk management strategy, more than 15,000 customers worldwide count on Wolters Kluwer Financial Services for a comprehensive and dynamic view of risk management and compliance. Wolters Kluwer Financial Services provides audit, risk and compliance solutions that help financial organizations improve efficiency and effectiveness across their enterprise. With more than 30 offices in over 20 countries, the company’s prominent brands include: FRSGlobal, ARC Logics for Financial Services, Bankers Systems,VMP® Mortgage Solutions, AppOne®, GainsKeeper®, Capital Changes, NILS, AuthenticWeb™ and Uniform Forms™. Wolters Kluwer Financial Services is part of Wolters Kluwer, a leading global information services and publishing company with annual revenues of (2011) €3.4 billion ($4.7 billion) and approximately 19,000 employees worldwide. We were voted the best regulatory reporting provider by Risk Tech 100 in 2011 and by Financial-i in 2009, 2010 and 2011.
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FRSGlobal
Implementing Basel III Are you ready?
frsglobal.com/solutions
Are you ready? This paper gives an overview of the imminent regulations pertaining to becoming Basel III compliant, particularly those centered on reporting. It aims to provide a current snapshot of how global adoption is progressing to date. It will be especially relevant to those tasked with compliance, risk and regulatory reporting within banks.
FRSGlobal
Implementing Basel III – Are you ready?
The perfect regulatory storm
The new regulatory regime of Basel III goes live on 1 January 2013, for both reporting and the new minimum capital requirements. Indeed from as early as this summer, banks are expected to capture and report on key aspects of the new ratios, despite the fact the new EU directive and regulation have yet to be finalised in readiness for the 2013 live date.
Banks will have to meet the following minimum capital requirements expressed in risk-weighted assets: 3.5% share capital, 4.5% Tier 1 capital and 8% total capital. Preparation for the new reporting and stress testing requirements must be largely complete by the end of 2012. Other measures to be implemented by the beginning of 2013 include new regulations for counterparty credit risk and minimum core Tier 1 ratios, and new treatment of banks’ short-term liquidity. With deadlines looming, taking a ‘wait and see’ approach is no longer an option. Despite this, much is still to be finalized. The banking industry is awaiting the publication of: The first stage of the Single European Handbook A revised sanctions regime A revised definition of capital Harmonization of pillar 1 measures l
l l l
Implementation on the fly Although institutions that have implemented Basel II are likely to fare better than those further behind the curve there is still much added complexity arising from the stricter data quality, more frequent reporting and greater aggregation of risk IT and operations, as required by Basel III. Furthermore the timelines for Basel III are much tighter. However, important parts of the framework, such as the capitalisation levels of bank central counterparty default fund exposures, have still not been finalised or, like the rules on systematically important financial institutions, have only been recently been published, with little time to respond to the changes before going live. The long transition period outlined for Basel III – with the last of the ratio changes not being imposed until 2019 – is a bit of a misnomer as many jurisdictions, particularly in Asia, aim to
go fully live years before this and banks hope to have the systems that are compliant with the new regime built by the end of 2013. Banks have the European Banking Authority (EBA) Quantitative Impact Study (EU-QIS) as a guide, but changes are still being made to the final reporting templates and it is not clear what the final mandatory requirements will look like. As a result, banks are having to make some tactical, rather than longer term strategic decisions to meet deadlines, perhaps resulting in temporary, but not completely satisfactory, solutions. This time it’s serious The current expectation of the European Commission is that the legislative negotiation process will have concluded by summer 2012 and the proposed date for the Capital Requirements Directive (CRD) and the Capital Requirements Regulation (CRR) legislation to become binding on banks, building societies and credit institutions is 1 January 2013. CRD IV, which is in fact a combination of the CRD and the CRR, and how Basel III will be implemented, will actually go beyond Basel III and bring in proposals on noncompliance sanctions, corporate governance and remuneration. What is clear here is that, regardless of the penalties for non-compliance, which will come, there has been a sea change in the attitude of Basel III regulators. Past regulations needed to be transposed into national law, whereas the regulations coming out of Brussels now, do not. They are direct and immediate, with very little room for national discretions. What is different this time is that the EU is set upon achieving uniform implementation and National Supervisory Authorities are losing much of their discretionary power under the Single Rule Book.
3
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Basel III reporting
Of the upcoming regulations much is centered on regulatory reporting and the implementation the EU standardized Common Reporting format (COREP) for credit, market and operational risk, which now extends to all three pillars of Basel III, and the development of a uniform standard for financial reporting (FINREP) despite the diversity of accounting rules worldwide.
A poll carried out by Risk magazine, in a recent audio seminar, revealed that 49% of its telephone audience believed that their biggest investment would be on reporting, followed by 24% saying that their biggest investment would be on databases and data warehousing. And yet, reporting is thought to be the one area where there is little competitive advantage to be gained from building systems in-house. The sheer complexity of the reporting templates – estimates are that nine times as many data points will be required – added to the analysis needed of the incoming specifications and additional data elements, on such tight timeframes, is causing many banks to consider external help to meet these requirements. Additionally, there is a wide ranging response to the implementation of reporting, despite the hard line being taken by the regulators on harmonization. For example, where Belgium has more or less fully adopted both COREP and FINREP, Germany has adopted most of COREP but not FINREP, and the UK has only partially adopted COREP but not FINREP. Common Reporting (COREP) The first milestone for reporting is imminent. The European Banking Authority (EBA) is expected to submit the final draft of COREP/ FINREP technical standards to the European Commission in June this year. First submissions under the reporting regime are expected in May 2013. It is highly likely that firms will be expected to switch over immediately, without a parallel run.
The first milestone for reporting is imminent. The European Banking Authority (EBA) is expected to submit the final draft of COREP/FINREP technical standards to the European Commission in June this year. First submissions under the reporting regime are expected in May 2013. It is highly likely that firms will be expected to switch over immediately, without a parallel run. 4
From 2013 COREP (revision 04) is expected to cover: Future CRD/Basel III changes to capital definitions Liquidity and leverage ratios Mortgage exposures Large exposures Disclosures by national supervisors l
l l l l
Some data items will be replaced by COREP while others will continue to leverage existing BIPRU reporting. Those items that are likely to follow COREP include reports on capital adequacy, credit, market and operational risk, large exposures and securitization. While COREP will improve compliance reporting and make it more effective, a critical issue is that it requires more granular information, prompting the need for a major overhaul of data collected for reporting purposes and identifying the additional data needed and changing the reporting model is proving a challenge under the tight deadlines. Financial Reporting (FINREP) FINREP is still a live issue in Europe. While Article 95 of the draft CRR states that the adoption of some form of financial reporting alongside COREP is expected from 1st Jan 2013, the EBA still need to specify these requirements. These are expected to be published in June 2012, but there is a likelihood of a delay of up to six months until standards for industry-wide financial reporting are drawn up. Until EBA publishes its final guidance, national regulators cannot
Implementing Basel III – Are you ready?
respond on where national discretions are allowed. Uncertainty so close to the go-live date is causing a lot of frustration and some countries are calling either for a delay in mandatory requirements or proposing that implementation by left to the discretion of national supervisors. There is a stark choice of wasting precious development time under the expectation that FINREP will go live or risking falling foul of the new reporting requirements if the EBA rules do go live. XRBL Another addition to the ‘to do’ list is the implementation of XBRL. The FSA is planning to introduce XBRL as a data collection channel and is assessing the impact of removing the current facility which allows users to enter data. EBA has ‘strongly recommended’ XBRL and is expected to mandate this in the Binding
Technical Standards, which are due to be published shortly. The EBA will be providing templates and taxonomies in XBRL. What’s yet to come? During the transitional period from 1 January 2013 up to and including 2019, the minimum capital ratios will gradually be stepped up to 4.5% share capital, 6% Tier 1 capital and 8% total capital. The conservation buffer will be build up along gradual lines to a percentage of 2.5% from 1 January 2016 through 1 January 2019. Thus, banks will ultimately have to hold 10.5% of their total capital expressed in risk-weighted assets. National supervisors will gradually introduce additional allowable deductions from bank capital such as deferred tax assets and investments in financial institutions from 1 January 2014 through 1 January 2018.
Transitional Arrangements for Basel III implementation 12% Minimum common equity capital ratio
10%
Capital conservation buffer
8%
Minimum common equity plus capital conservation buffer Minimum tier 1 capital
6%
Minimum total capital Minimum total capital plus conservation buffer
4%
2%
0 2012
Leverage ratio Liquidity coverage ratio Net stable funding ratio
2013
Supervisory monitoring
1014
2015
2016
Parallel Run 1 Jan 2013 - 5 Jan 2017 Disclosure starts 1 Jan 2015
2017
2018
2019
Migration to Pillar 1
Introduce minimum standard
Observation period begins Observation period begins
Introduce minimum standard
5
frsglobal.com/solutions
The new Basel III liquidity rules mark the first time that specific global quantitative minimum standards for liquidity have been introduced. Monitoring of the new standards commenced at the end of year-end 2010. The liquidity coverage ratio (LCR) will have to be met from January 2015, with any revisions to its calibration, to address unintended consequences, issued by mid-2013. The period from 1 January 2013 through 1 January 2017 will be a parallel run period. During this period, the development of the leverage ratio will be monitored. The intention is to migrate the leverage ratio into the Pillar 1 requirements as from 1 January 2018. The net stable funding ratio (NSFR) will undergo a longer observation period and will not be introduced until January 2018. Revisions can be made to the NSFR no later than mid-2016. Speaking at a seminar on ‘Long term growth: organising the stability and attractiveness of the European financial markets’ held in Berlin in January 2012, Mr. Jaime Caruana, General Manager of the Bank of International Settlement, said it is unlikely that framework’s approach would be fundamentally altered. Since the Basel III liquidity rules are minimum standards, national differences will occur, particularly for reporting formats, assumptions for deposit runoff rates, contingent funding obligations and market valuation changes on derivatives. This means that global banks
“It is unlikely that framework’s approach would be fundamentally altered. Since the Basel III liquidity rules are minimum standards, national differences will occur, particularly for reporting formats, assumptions for deposit runoff rates, contingent funding obligations and market valuation changes on derivatives. “ Mr. Jaime Caruana, General Manager of the Bank of International Settlement
6
will need to monitor parameters set by the local supervisors in the countries where they take deposits and to develop the flexibility to incorporate these differences in their risk analyses. The LCR will need to be reported at least monthly, with the operational capacity to increase the frequency to weekly or even daily in stressed scenarios at the discretion of the supervisor. The net stable fund ratio (NSFR) should be calculated and reported at least quarterly. Once the LCR has been implemented, its 100% threshold will be a minimum requirement in normal times. But during a period of stress, banks would be expected to use their pool of liquid assets, thereby temporarily falling below the minimum requirement. The Basel Committee has been asked to provide further elaboration on this principle by clarifying the LCR rules text to state explicitly that liquid assets accumulated in normal times are intended to be used in times of stress, and provide additional guidance on the circumstances that would justify the use of the pool. The Basel Committee will also examine how central banks interact with banks during periods of stress, with a view to ensuring that the workings of the LCR do not hinder or conflict with central bank policies.
Implementing Basel III – Are you ready?
Uptake so far
Monitoring the uptake The Group of Governors and Heads of Supervision (GHOS), the oversight body of the Basel Committee on Banking Supervision, met on 8 January 2012 to discuss its strategy for assessing implementation of the Basel regulatory framework. The Committee will monitor, on an on-going basis, the status of member countries’ adoption of the globally-agreed Basel rules. It will review the compliance of members’ domestic rules or regulations with the international minimum standards in order to identify differences that could raise prudential or level playing field concerns. The Committee will also review the measurement of risk-weighted assets to ensure consistency in practice across banks and jurisdictions. The Committee has already begun monitoring the uptake across the territories and the exercise will be repeated semi-annually with end-December and end-June reporting dates. Where banks have not yet have implemented some of the models and processes required for the calculations, they may provide quantitative data on a ‘best-efforts’ basis. A total of 158 banks submitted data for the EBA’s first published report in April 2012 on the results of the Basel III monitoring exercise, as a follow-up to the comprehensive European quantitative impact study (EU-QIS) conducted to analyze the impact of the new requirements. Banks were asked to apply Basel III rules to data taken from 30 June 2011 to get an indication of how they would fare. These results showed that on average, banks in Europe fell short – specifically they didn’t meet capital or liquidity requirements.
This level of reporting on implementation progress is unprecedented in the banking industry and does imply a level of ‘naming and shaming’ the laggard countries, to ensure true global adoption. Geographic uptake In terms of drafting and implementation of Basel III final rules by national regulators, progress has been made. However, to date, Saudi Arabia, which already has more stringent banking regulations than most, is the only country to have issued final Basel III rules to its regulated firms, and Gulf banks are likely to adopt the rules this year, ahead of the deadlines set. While Basel 2.5 rules were adopted by EU Member States at the end of 2011, the Basel III proposals will be implemented into EU law through CRD IV. This will be a key instrument through which the Commission intends to introduce substantive parts of the new European supervisory architecture, including the development of the Single Rule Book for financial services. These changes are due to be implemented from 1 January 2013, although there will be transitional arrangements for some elements. There are some concerns about the US, where Basel 2.5 and Basel III rules must be coordinated with work on implementation of the Dodd-Frank regulatory reform legislation, in particular with regard to the use of credit ratings. Despite the fact the US didn’t implement Basel II, the US Federal Reserve announced in December 2011 that it would implement substantially all of the Basel III rules and made clear they would apply not
A total of 158 banks submitted data for the EBA’s first published report in April 2012 on the results of the Basel III monitoring exercise, as a follow-up to the comprehensive European quantitative impact study (EU-QIS) conducted to analyze the impact of the new requirements.
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only to banks but to all institutions with more than US$50 billion in assets. Already, fifteen of the US’s largest 19 bank holding companies were shown to have adequate capital under what is understood to be the Fed’s most stringent stress test scenario to date.
In China, the broad concept of Basel III is supported as it indirectly endorses the conservative regulatory approach the Chinese have always adopted and banks are regarded as generally wellpositioned to meet the higher standards and measures required.
Some national authorities are actually setting out to apply the minimum capital requirements ahead of the mandated deadlines. They include the Australian Prudential Regulation Authority, which is proposing that banks meet the revised minimum capital ratios in full from January 2013, and to be fully compliant with the capital conservation buffer form January 2016, ahead of Basel III deadlines of January 2015 and January 2019, respectively. The Reserve Bank of New Zealand (RBNZ) has also already stated that banks will have to meet the minimum capital ratios in full from 2013 and is now proposing to implement the capital conservation and counter-cyclical buffers of the Basel III framework in full from
January 1, 2014 – two years ahead of the timetable set down by the Basel Committee. And similarly, the Reserve Bank of India has told domestic banks they must start reporting on aspects of Basel III liquidity strength measures from as early as June this year, ahead of the reporting timetable laid out by the Basel Committee. Furthermore, it has stipulated that banks go above and beyond Basel III requirements and provide a statement outlining their bond spread movements compared to their share price in a bid to better monitor early signs of systemic risk. In China, the broad concept of Basel III is supported as it indirectly endorses the conservative regulatory approach the Chinese have always adopted and banks are regarded as generally well-positioned to meet the higher standards and measures required. In Hong Kong too, despite escaping the global financial crisis relatively unscathed, regulators intend to implement the Basel III reform package, despite concerns about some of the unintended consequences, particularly the impact of the liquidity rules on the relatively immature corporate debt markets in Asia. Likewise, while Singapore officials support Basel III it has been made clear that rules should be adapted to local circumstances to reflect the different stages of economic growth, banking and regulatory approaches in Asia. The Monetary Authority of Singapore (MAS) is requiring that Singapore banks both meet Basel III capital standards earlier and to exceed Basel III’s common equity requirements by 2%. This is primarily due to the fact the four locally incorporated banks are systemically important domestically. Similarly, the Central Bank of the Philippines is insisting on full implementation of all of Basel III’s regulations by the end of 2014 – well ahead of schedule.
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Implementing Basel III – Are you ready?
It’s not a matter of if but when
The onslaught of the Eurozone debt crisis, coupled with the sheer scale and complexity of Basel III – CRD IV runs to more than 1,000 pages, with at least 200 references to points that need fleshing out and formalized by the EBA – has prompted some to speculate whether the implementation timelines are realistic, but there seems little likelihood that there will be much leeway now that the legally binding framework is in place and the wheels are in motion for the technical standards coming from the EBA. Furthermore, we are witnessing a wave of banks rushing to become compliant before deadline. Some banks already hold more highquality capital than Basel III will require and Checklist for 2012 Even without having complete knowledge of the full suite and extent of the upcoming wave of regulations and discretional national interpretations, much can be done now to ensure best practice rollout in coming months and the minimum disruption to the business of banking. • Are you managing the data challenge as well as you could be? Arguably, the biggest challenge banks face is getting timely and accurate data out of a myriad of systems in order to get a single view of the enterprise and better manage the firm’s position. Many banks are introducing more automated and robust reconciliation procedures, and centralizing information systems in order to gain the essential transparency demanded by Basel III. • Have you realigned your business models in accordance with your firm’s risk appetite? Banks need to de-risk lending activities, ensure they have high quality capital (and more of it), as well as attaining greater short and long term liquidity to fund and better withstand stress events in the market – these should all be in line with the firm’s risk appetite. • Have you standardized reporting and information across all branches? This is an essential part of the process to to ensure consistent, firm-wide reporting – it needs close attention if it has not already been addressed. • Have you established realistic but challenging scenarios for stress testing and reverse stress testing? Stress tests and reverse stress tests need to adequately reflect business lines, with the emphasis on identifying the appropriate stresses, their impact and relevant management actions. Not only essential internally, but regulators will want to see the results. • Are you truly up-to-date with latest regulatory developments? The analysis of regulatory information as it is published is essential to the keeping current with Basel III changes and mitigation of this process as far as possible reduces the risk of incorrectly anticipating the regulation.
many are already disclosing figures in a bid show investors that they can comply with the new regime sooner rather than later. Indeed, Barclays, for one, as far back as its 2010 annual results indicated an LCR of 80 per cent and a 94 per cent ratio for the NSFR. The products, risks and returns expected from banking are all changing as a direct impact of Basel III, and many banks have been aggressively reviewing their business models, because the sooner they can tackle compliance and ensure the minimum of capital is invested in it, the sooner they can get back to the main business of banking and finding better returns on equity. But with a sluggish economy, for others it is not so clear, as banks try to find the balance of de-risking banking activities and ensuring funds are available for risk-taking, balancing between stability and growth. As one banker put it: “There is a trade-off between de-risking banking activities and ensuring funds are available for risk-taking in the economy, balancing between stability and growth.” “Somehow we need to find a balance between financial stability and the reality that financial services are needed to support the real economy. It’s all about calibrating the rules in such a way that the trade-off between de-risking of activities and ensuring funds are available for risk-taking is balanced. This will take time and will need constructive cooperation between the banking industry and the regulators, and will also require the regulators globally to work together to ensure a level playing field.” Basel III represents a wholly new era in banking regulation. Non-compliance is not an option, only how quickly and accurately compliance can be achieved. Unlike Basel II, the implementation of Basel III is being monitored at every step of the way and with the findings set to become public, the implication is that no further regulation will swiftly follow until the new risk paradigm is reached.
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