In the banking domain, the Basel Accords provide recommendations to banks globally on banking regulations, specifically concerning capital, credit, market and operational risk. Set by the Basel Committee on Banking Supervision (BCBS), the Accords (Basel I, II and III) ensure that financial institutions have enough capital on account to absorb unexpected losses. Recently, implementation of Basel III has been extended to account for the additional Basel IV requirements which have been added to the Accord, making the expected date of implementation completion January 2023. This gives financial institutions just over two years to ensure the requirements are implemented, and that their risk calculations consider these new requirements.
Basel Accord deconstructed
The BCBS was founded in 1974 as a forum for co-operation between its member countries on banking supervisory matters. The BCBS’ original aim was the “enhancement of financial stability by improving supervisory knowhow and the quality of banking supervision worldwide”, explains Sam Terreblanche, credit risk expert at BBD. “Later, this was expanded to include monitoring and ensuring the capital adequacy of banks and the banking system.”
The Basel Accords were developed over several years beginning in the 1980s. The latest Accord, being Basel III, was initially agreed on in November 2010 after the economic crisis of 2008, requires banks to have a minimum amount of common equity and a minimum liquidity ratio.
Basel IV: The revised credit risk framework
“Given that credit risk, or the risk that a bank’s customers or debtors will not honour their obligations, is the main driver of most banks’ risk weighted assets (RWAs), changes to the Basel III credit risk framework represents the biggest challenge for the global banking sector. Basel III allows banks to use either the Standardised Approach (SA) or the Internal Rating Based Approach (IRB) to calculate their credit risk capital requirements. This ‘choice’ has resulted in risk weights being incomparable across banks.” Under Basel IV, IRB banks have to calculate the equivalent SA RWA to facilitate a prescribed RWA floor.
To address this as part of the Basel IV reform package, the BCBS overhauled the credit risk SA approach, ultimately improving its granularity and risk sensitivity. It also revised all exposure classes to reduce excessive variability in RWAs and improve the comparability of banks’ risk-based capital ratios. “The final SA to credit risk allows banks to use external ratings such as Moody’s or S&P, where available and permitted by national supervisors, for exposures to banks and corporates. It also allows the use of loan-to-value ratios to determine risk weights for retail and commercial real estate exposures.”
Basel IV compliance to the power of BBD
Adopting this revised framework takes considerable effort on the part of a bank, as compliance means accounting for the SA to credit risk over and above any IRB approaches, meaning the expenditure of resources in addition to those already allocated to credit risk calculation.
To accelerate an implementation that addresses the revised calculations required to comply with Basel IV, we have created a toolkit that enables seamless implementation into existing banking systems, while providing:
- World-renowned expert knowledge of all Basel guidelines and risk regulations which extends to the identification of new and additional data requirements
- Standardised frameworks for data input requirements
- A Basel IV standardised credit calculation engine capable of:
- Performing the calculations required for all asset class RWAs
- Identifying data elements to facilitate all regulatory and management reporting requirements
- Being fully auditable by internal / external teams
- System integration and implementation into existing frameworks within a bank
- The acquisition of a software solution to address the regulatory requirement means that internal teams can focus resources on other areas of the regulatory project requirement, whilst being confident that the required data flows and calculation aspects have been addressed
- The Basel IV calculator can be integrated into any operating system and with any mainstream programming language (Python, Java, C# etc.)
BBD’s Basel IV calculator is available to clients on a licensed usage basis, which includes upgrades and modification. We can also assist with the integration of the calculator into existing or new processes. Our expertise in credit risk and the Basel Accords overall position us as solution providers and consultants of choice to financial institutions, making Basel compliance fast, efficient and cost-effective.
Read more on our Basel toolkit here