Far from representing a threat, the new Basel II Accord - designed to make banks more accountable for ensuring provision of capital to cover default and risk - offers banks an unprecedented opportunity to increase profits.
That`s the view of Kerry Evans, sales manager: financial services at SAS Institute, the market leader in business intelligence.
"There are three main types of risk: market, credit and operational. Most banks have historically treated these as risk `silos`, handled by different departments, with little or no assessment of the bank`s overall risk exposure. That is changing - partly because of the Basel Accords, which look for an understanding of the impact of one type of risk on the other," says Evans.
The Basel II Accord requires banks to provide an internal credit rating for their customers and, furthermore, to aggregate the credit risk for their customer base. The Accord also calls on banks to calculate their exposure to operational risk (which can range from the impact of fraud to the impact of employee attrition) and to calculate the required capital provision based on internal measurement.
Basel II enables banks to choose from three variants of the internal rating-based (IRB) approach - standard, foundation and advanced. However, the Accord rewards banks that satisfy the more stringent conditions of the advanced approach by allowing a lower capital provision to be put aside to cover potential bad debt.
Few banks are currently in a position to comply with the foundation or advanced measurement approach, and most are currently overhauling their IT infrastructure to ensure compliance.
In addition, SA banks have to implement measures to meet the requirements of the so-called "Anti-Money Laundering Act" (Financial Intelligence Centre Act of 2001). By June this year, local banks must have systems in place which will enable them to detect and report on suspicious financial transactions. Failure to comply opens the financial institution to a potential fine of up to R1 billion.
"So, while SA banks address the requirements for the Anti-Money Laundering Act - which is the most urgent - they should also take cognisance of the requirement for Basel II," says Evans.
The IT challenges are many. To comply with Basel II, banks must focus on data, modelling, scorecarding, reporting and information delivery as well as enterprise risk management.
Data: Analysts such as Datamonitor believe that data collection and management represent the single greatest Basel II challenge. Most urgent is that banks gather data from various internal and external sources and store it in a suitable format, for example a risk data warehouse.
Modelling: The foundation and advanced IRB measurement approach requires most banks to develop more diverse risk models - and aggregate the risk of their credit portfolio - than they currently use.
Scorecarding: It is not enough to be able to calculate risk accurately. To satisfy the advanced measurement approach, banks must be able to prove that they are actively managing risk. Banks need to document processes and show how risk is handled within the organisation (for example, how bad debt warnings are escalated up the management chain). One of the best tools to manage risk is the balanced scorecard. Banks can set key risk indicators and then the software automatically flags a transaction or a trend that falls outside these.
Reporting and information delivery: A vital part of risk management is the provision of reports, to the Basel II regulators, and internally to demonstrate that risk management processes are being followed.
"The impact of the Basel II requirements on IT will be an increasing focus on holistic, or end-to-end risk systems, where a common risk data warehouse serves models for each type of risk," says Evans. "Consolidated analysis and reporting will be needed to provide information to management on corporate risk exposure, and an enterprise risk scorecard should monitor the impact of the different types of risk on each other, and on corporate performance as a whole."
SAS Risk Management for Banking, a complete suite of solutions for enterprise-wide risk management, is currently available. It provides one environment for establishing minimum capital requirements by accurately calculating and aggregating a bank`s credit, market and operational risk measures.
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SAS Risk Management for Banking is the only complete suite of solutions for enterprise-wide risk management available on the market. The solution provides one environment for establishing minimum capital requirements by accurately calculating and aggregating credit, market and operational risk measures. The solution is targeted at banks that are required to comply with the New Basel Capital Accord as well as banks looking to improve their risk/return profile -and ultimately their shareholder value - by gaining and acting upon a complete view of corporate risk.
Risk Types
SAS Risk Management for Banking helps banks estimate potential financial losses due to three types of risk:
* Credit - customers defaulting on payments
* Market - losses to market factors such as exchange rate shifts
* Operational losses due to natural or man-made accidents or disasters
The New Basel Accord (Basel II)
The new "Basel Capital Accord" or "Basel II" is an update of "The 1988 Accord" which was adopted by more than 100 countries worldwide. The New Accord is a set of broad policy guidelines proposed by the Basel Committee on Banking Supervision (BCBS), under the wings of the Bank for International Settlements (BIS). The new framework of Basel II Accord is intended to improve the safety and soundness of the financial system by aligning capital adequacy assessment more closely with the underlying risks in the banking industry, providing a thorough supervisory review process, and enhancing market discipline. It further seeks to maintain the current overall level of capital in the system and enhance competitive equality. Basel II, when finalised and adopted, will establish the basic capital frameworks for Committee member countries as well as non-member countries that have adopted the New Accord and will help guarantee that banks have a sound risk management strategy.
Basel II regulations specify methodologies by which financial institutions can measure their risk. The risk measures in turn form the basis of the calculation of the amount of capital an institution must set aside in reserves to cover potential losses. The monies in a reserve fund are blocked and can therefore not be used in the revenue generation process. The regulations apply to all internationally active banks and their subsidiaries within the accord membership. This will affect virtually every bank in the world. Compliance with Basel II will be enforced by national authorities (normally the Central Banks) and must be achieved by the end of 2006.
Basel II regulations allow banks to use their own methods (the internal ratings-based approach) for calculating their risk - as long as they can demonstrate these methods are in use and reliable using real data covering last two years. This means banks must start preparing and testing their implementations this year. The advantage for a larger bank to use its own approach for calculating risk rather than the standardised way is that a custom risk calculation provides a more accurate reflection of that institution`s risk. A better risk calculation can translate into lower reserve requirements - by up to 3% - and thus more working capital available.
SAS
SAS is the market leader in providing a new generation of business intelligence software and services that create true enterprise intelligence. SAS solutions are used at more than 39 000 sites -- including 90% of the Fortune 500 -- to develop more profitable relationships with customers and suppliers; to enable better, more accurate and informed decisions; and to drive organisations forward. SAS is the only vendor that completely integrates leading data warehousing, analytics and traditional BI applications to create intelligence from massive amounts of data. For more than 25 years, SAS has been giving customers around the world The Power to Know. For more information, visit http://www.sas.com/sa.
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