Jan 27, 2015

Basel III has been developed as an outcome of the exposed deficiencies in financial regulation by the financial crisis. By reinforcing global capital and liquidity rules, the aim is to promote a more resilient banking sector; the ability for Financial Institutions to absorb financial and economic stress as previous Basel’s have failed to do. Holding core capital will obviously come at a cost but it is not the only cost.

1. Process and technology re-engineering costs

Basel III requires intra-day liquidity risk management and reporting by understanding funding requirements real time. Most Financial Institutions calculate funding requirements at the end of the day prior to settlement (S-1) based on expected cash, and then perform bank account reconciliations the day after settlement date (S+1). This increases liquidity risk and prevents firms from accurately reporting intra-day.

A number of institutions have already recognized this, launching large process and technology re-engineering programs transforming their settlements infrastructure to provide intra-day transparency on settled and unsettled cash. This not only allows them to better manage their liquidity risk by understanding their funding requirements intra-day but also provides more accurate and timely reporting to national supervisors.

2. Data management and analytics costs

Not only do processes need to become timelier but also transparency and access to large amounts of data is critical.  This is requiring greater focus on data standards, golden source reference data, as well as data management and analytics driven aggregation tools across the front to back infrastructure. Without these effective investment decision-making, compliance monitoring, and real/near time capital and liquidity calculations are difficult. Equally improved data management allows more accurate forecasting of future scenarios within set limits, making stress-testing scenarios under Basel III less onerous or surprising.

3. Policies, procedures and governance costs

Basel III requires contingency plans for Systematically Important Financial Institutions (SIFIs) beyond the existing “living-wills” recovery and resolutions plans (RRP’s), to ensure under severe stress scenarios Financial institutions can maintain capital and liquidity requirements, restoring businesses to stable and sustainable conditions.

Financial institutions will have to invest in enhancing their existing RRP’s on data structure, business activity and exposures to other banks and depositors. This will require testing, maintaining, evidencing and updating RRP’s on an ongoing basis. Already stretched compliance departments will become even more stretched.

Summary

Calculating capital ratios and liquidity requirements is reasonably scientific. Clearly these new requirements will come at a cost but they are measureable. The hidden costs of complying with Basel III are not so measureable but equally costly. Despite the history with Basel accords in the past, financial institutions should not underestimate the technology and resources costs of re-engineering, data management, analytics, documentation and planning. Is your compliance budget big enough?