Basel III the Publication of the Basel III 2017 Reforms Was a Watershed Moment for Capital Regulation Globally

The calm before the reform Basel III The publication of the Basel III 2017 reforms was a watershed moment for capital regulation globally. In contrast to the fundamental changes which the reforms represent for firms of all sizes, what has come next has been a surprising lull and so far muted response across the industry, mainly driven by the seemingly long timeframe to implementation.

Based on our discussions with firms over the past six months, we believe this to be the calm before a relative storm of change given the comparability in scale of these reforms to what was required in the move from Basel I to Basel II (which took approximately seven years). In an effort to avoid the sometimes panicked and expensive last minute implementations prevalent in Basel II, institutions should be considering now how best to build a sustainable future business model, potentially through a “drive to simplicity“ in product set and markets served.

Given the efforts required against what is, on the surface, a reasonable implementation timeline, it is the firms who are most prepared who will be the most competitive in future.

A cautious approach to the Basel III reforms is being adopted by the industry given the timelines and the current degree of uncertainty.

BCBS Basel III implementation timeline

Jan 2022: Implementation of revised Dec 2017: BCBS agreement standardised approach for credit risk, on core components of the use of IRB approaches and for the Basel III reforms operational risk

Jan 2022 onwards: Implementation of revised standardised output ﬂoors (5 year phase in period running to 2027) Assess the impacts of the reforms and mobilise change programmes to implement the required changes

2025- 2018 2019 2020 2021 2022 2023 2024 2027

Since the publication of the reforms to Having said that, there is potential also the Basel framework in December 2017, for some jurisdictions to adopt the Experience in adopting firms have been cautiously weighing up the reforms ahead of the proposed BCBS previous revisions to fundamental changes to the calculation of implementation date. capital against the generous lead times for the Basel framework implementation. While few firms have openly communicated the potential size of the impact in terms dictates that there is While the BCBS has set 1 January 2022 of RWA, the industry in general is aware of good reason to act as the target implementation date for the challenges ahead and is beginning to most of the Basel reforms, there is a formulate a strategic response. Experience sooner rather than later. likelihood of delay and divergence in in adopting previous revisions to the Basel the implementation of these standards framework dictates that there is good between different jurisdictions. reason to act sooner rather than later.

This is particularly the case in the EU, given the need for a long and complex legislative process that raises the prospect of substantial changes being made to the content of the BCBS standards, and consequently, their impact on firms.

The industry is realising that the impact of the reforms will be firm-wide. Retail, wholesale and investment banking activities will all be affected.

Risk type illar approaches

Sophistication of approach

Banks and SA F-IRB A-IRB other FI

Sovereigns SA A-IRB*

Large SA F-IRB A-IRB corporates

Other Credit Risk SA F-IRB A-IRB corporates

Specialised SA Slotting F-IRB A-IRB lending

Retail SA A-IRB

Equity SA F-IRB A-IRB

Credit Valuation Basic Approach Standardised Standardised Advanced dustment (BA-CVA) Approach Approach (SA-CVA) Approach

Securitisation Standardised Approach Securitisation External Ratings-Based Securitisation Internal Ratings-Based Securitisation (SEC-SA) Approach (SEC-ERBA) Approach (SEC-IRBA)

Standardised Alternative Advanced Basic Indicator The Standardised Operational Risk Measurement Standardised Measurement Approach (BIA) Approach (TSA) Approach (SMA) Approach (ASA) Approach (AMA)

Counterparty Standardised Approach (SA-CCR) Credit Risk Internal Model Methodology (IMM)

Approach removed under ﬁnal reforms Calculations impacted by updated CRC risk weights and EAD calculations *Exemption from 0.05% PD ﬂoor

•• The requirement to calculate •• These changes will affect Wholesale •• Changes to the RWA calculation process Standardised RWAs for all risk types and Investment Banking businesses the for IRB exposures are not limited to the will be a challenge for most, if not all, most. These businesses have historically banking book. Banks with significant IRB banks. Given the importance of the been able to use modelled approaches counterparty credit risk exposures will Standardised RWA number in setting the for Financial Institutions and Large need to understand the effect of changes floor for capital calculations, banks will Corporate counterparties and would in calculation approaches in respect of want to ensure that it is as accurate as not have had to use a combination both the CCR charge and the potential possible. This will require considerable of Standardised (for the output floor impact of the Standardised Floor. work in respect of both data sourcing and calculations) and Foundation‑IRB (with calculation system upgrades. regulatory based LGDs and CCFs) for the Consequences modelled calculations to get to an RWA. •• Some of the most significant changes All of the above changes will come in how non‑retail asset classes (for •• The effect is twofold: both the calculation require updates to calculators example banks and large corporates) will of the exposure value and the calculation and data flows. It will also mean be treated, with the proposed loss of the of the risk weight for the counterparty a recalibration of model suites for credit Advanced‑IRB approach and a move to credit risk charge will be affected, and risk, and perhaps more substantial Foundation‑IRB. the overall impact on capital could be changes where an institution needs to significant. move to Foundation‑IRB.

Firms need to plot their Firms have an opportunity to look at the impact that reforms will have on roadmap for adopting their capital and adjust their strategy accordingly. the reforms in the most We believe that a competitive advantage can be gained, for example, through: strategic manner possible. •• Avoiding regrettable investments and sunk costs, e.g. through the pursuit of IRB approvals for specific portfolios where the perceived capital benefits will be Firms are beginning to respond to the ultimately constrained by the output floor, or where there is little benefit above the reforms with strategic engagement at Standardised Approach. senior levels, as well as some modelling •• Optimising capital and pricing strategies earlier to avoid or offset any potential of the potential impacts for their specific increases in the cost of capital. businesses. Over the course of the coming years, banks are expected to change •• Adopting a strategic approach to change portfolio prioritisation given the impact gears and begin the ramp up towards full the reforms will have on data, systems architecture, model landscape, reporting, implementation. etc., with a view to reducing the overall cost of compliance.

reas of focus in the lead up to implementation

months years years

uild senior uild functional commitment eliver, test and capability overnance and agree and embed new model for new engagement processes into A process ownership approach H H H

evelop Implementation of requirements Risk management risk management and agree T requirements and and controls frameworks T (e.g. limits, data) H H

etailed ngoing Tactical tooling Models and calculation calculator design to inform design and iteration and calculations on impacts implementation optimisation H H H

esign detailed pscale T Deﬁne high level architecture, capability against Systems and data design and data deliver key IT new process/ strategy components and policies H data “quick wins” H H

Agree requirements Implementation and develop of automated Reporting changes inc solution frequency, (templates and granularity H workﬂow) H

obilise cross divisional asel evelop detailed business and • Implementation of infrastructure governance and budget design requirements build data sourcing, calculator, Delivery focus • Deﬁne delivery model across etailed T design and control reporting T and Change functions framework • Parallel run of impacts Tactical tooling design • Commence implementation • Embed new processes and controls

Illustrative magnitude of work (budget and eﬀort)

The reforms will once again drive changes across the front-to-back operating model.

Capital management Risk management Models and calculations The dynamics underlying and controls New and amended models capital management Controls around new will be required to reflect will change for most data flows, calculations the updated approaches. businesses. and limits will be required. •• New standardised calculators will •• With the introduction of the output •• Risk appetite frameworks and need to be developed for credit and floor and the removal of Advanced policies will need to be refreshed, operational risk to reflect the new IRB and IRB approaches for some and management reporting methodologies and risk weights. portfolios altogether, the approach updated to inform risk decision •• There will be an overhaul of internal for managing capital across making and governance. models to implement new input portfolios will need to be revised. •• The controls framework relating to floors and account for greater This will drive a reassessment of new risk data flows and calculations specification of parameter the business banks operate in. will need to be refreshed to ensure estimation methods. •• Finance and/or Treasury functions robust management of data inputs •• The scope of model validation will need to factor in the new and outputs. activities will need to reflect the reforms in capital planning and •• Limit monitoring controls will need to new and updated models. consider the capital costs of be calibrated to reflect sensitivities specific businesses under the around the output floor where banks new approaches. continue to follow IRB approaches.

Systems and data Reporting The aggregate impact Reforms will drive The reforms lead to of the reforms for banks significant new data and new and more granular system requirements. disclosure requirements. of all sizes represents •• The new calculation approaches and •• Historically only disclosed on a substantial challenge risk monitoring will mean additional reported accredited approach data requirements, e.g., LTV applied. This will change as banks requiring a strategic ratios, SME boundary definition, now need a myriad of reports on transactor/revolving retail credit different approaches. response. definition, reference data. •• Banks will need to evidence common data inputs, e.g. exposure/ trade populations, to the standardised and IRB approaches as a basis for the output floor. •• IT architectures will need to support parallel calculation of SA and IRB RWAs and associated risk management. •• The increased frequency and complexity of calculations will require performance improvements that if not delivered will drive a move to end user computing to enable important decisions.

How Deloitte can help

•• Our experts have decades of Basel implementation experience from which to draw.

•• We are ready to help identify the specific impacts to your organisation and to review your current strategy and change portfolio to help inform decision making in the near and longer term.

Deloitte can support you in

1. Getting to the right understanding of the capital impact across portfolios with the root causes: •• Basel capital impact tool. •• Heat mapping of critical areas of capital increase. •• Capital efficiency identification.

2. Designing and setting out a clear approach and response for your firm: •• Programme design and investment prioritisation. •• Strategy setting. •• Business model design.

3. Delivering a compliant solution with transparency to all underlying changes: •• Basel compliance check-list. •• Article/requirement level Self-assessment tool, with transparency of changes from previous regulation. •• Ongoing compliance monitoring tool (ProAct).

4. Building and embedding an effective banking book reform solution: •• Basel data dictionary and model. •• Build vs buy guidance. •• Pre-populated strawman requirements.

Contacts

Thomas Spellman Julian Leake Vishal Vedi Partner, Basel Leader Partner, UK FS Risk Advisory Leader Partner, EMEA Banking Leader Tel: +44 20 7303 0019 Tel: +44 20 7303 1223 Tel: +44 20 7303 6737 Mob: +44 7919 545295 Mob: +44 7798 807853 Mob: +44 7768 711459 [email protected] [email protected] [email protected]

James Robertshaw Hubert Justal Henrik Sandin Director, Risk Advisory Director, Risk Advisory Senior Manager, Risk Advisory Tel: +44 20 7007 9735 Tel: +44 20 7007 0484 Tel: +44 20 7303 5831 Mob: +44 7920 547861 Mob: +44 7795 612980 Mob: +44 7825 904276 [email protected] [email protected] [email protected]

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