Basel II - the wait is over, it's time to implement! Time to get weaving Although the Basel II Accord will not be firing on all cylinders until early 2007, global banks and software vendors are trying to get ahead of the game and benefit from the changes they will need to make as soon as possible. Some are very well advanced down this road, others woefully under-prepared. Considering the fact that institutions will be required to report three years of historical data on operational losses, Basel II should really be at the top of the agenda by now. Remind me - what's Basel all about? It's a global standard for capital adequacy - the amount of money an institution needs to keep in reserve in case of losses. By the time this article goes to press, the current consultation period will be over, and banks, brokers and insurers the world over will soon know the final fine print of the requirements. The new Accord is based on three pillars: (I) The Minimum Capital Requirement (measuring potential losses in terms of credit risk and market risk as before, but with the addition of operational risk); (II) A Supervisory Review Process, ensuring sound internal processes to assess capital adequacy; and (III) Market Discipline Standards, to ensure proper disclosure. The choices and the payoff - what options do I have? The main options are based around how you wish to calculate each type of risk, for Pillar I. The basic rule is: the more sophisticated the method that you adopt, the less regulatory capital you need to tie up. Most bankers understand that reducing risk can directly boost earnings - yet few have actually implemented comprehensive risk platforms! Adopting a sophisticated method of calculating risk involves sophisticated procedures and systems, which can be a complex and expensive undertaking. Basel is basically saying - increase your capital reserves or demonstrate that you can systematically control your credit and operational risk! By exhibiting the appropriate risk diligence, banks are rewarded by not having to keep such high reserves - therefore this money can be used to fund other business. Business Intelligence is the answer The traditional approach of data capture, data analysis and reporting applies here more than ever before. The better an institution is at identifying, analysing, managing and documenting the risk data, the more it will benefit from Basel. Heads of risk functions will require sophisticated metrics to assess their risk positions and allow them to monitor these according to the scenarios they choose. What are the technology demands? The law will make banks continuously monitor their operational risk exposures using KPIs, scorecards, event alerts and predictive measures. IT departments will need to consider all of the following: - Budgeting, planning and forecasting systems - Data warehousing and data mining techniques - Enterprise risk consolidation (integrating market, credit and operational risk data in one place) - Predictive forecasting applications (to calculate potential loss) - Scorecards (combining operational and credit risk for products/services) - Event alerting (software to notify personnel when risk indicators are exceeded) - Fraud detection (to bolster existing operational risk measures) Sounds like an awful lot! But it all needs doing if you want to reduce your overall reserves and make the capital work for you. Good PR too Advanced reporting and market disclosure will also give market analysts a better impression of the bank. More transparent and granular reporting will enhance the market's confidence in the management of the institution and therefore enable it to raise capital in the markets at better rates. Investors will be able to scrutinise a firm's behaviour very closely. Clearly, the winners will be the larger banks who can implement sophisticated solutions, and those smaller banks who only adopt the standardised approach will pay a significant 'Basel tax' and could become takeover targets as a result. So what's the plan? - Estimate the cost of doing this - have an implementation plan, and understand the complex dependencies that are out there (e.g. IAS) - Analyse in detail how you intend to realise the benefits to justify this massive investment! - Align business and IT thinking as soon as possible! - Align the bank's existing risk strategy with Basel II as soon as possible! - Set the scope for the project - bite-sized chunks if possible! From 'meet the regs' to 'beat the regs' - Ensure all stakeholders and essential resources are tied in NOW - Link Basel to other change programmes - place it at the centre - Start to implement a 'risk culture' (behaviours, compensation, etc) - Engage the regulator, if you haven't already - Have a communications plan within the organisation - Identify and minimise duplication of data - Leverage your current infrastructure wherever possible Moving from 'comply' to 'compete' Basel II compliance is only the first step. The goal that the more advanced institutions are shooting for is 'intelligent risk'. This is where the real benefits lie, since better risk metrics bring a better view of the customer, enabling tailored offerings. For example, in loan origination banks could better assess economic value of the lending portfolio with a more sophisticated risk dashboard. Putting the right tools in place for Basel compliance can leave you head and shoulders above the rest if you go the extra mile. Bluerock is a strategic partner of Conchango (www.conchango.com), and together they are currently working with financial institutions on Basel II. Bluerock's knowledge of the market, combined with Conchango's renowned Business Intelligence expertise is helping senior management to select and implement the appropriate Basel II solutions