BASEL II - REDUX
Thread,
Some may find changes to the international bank regulation regime of interest. Though it's not quite everyone's cup 'o tea, I understand.....
riskcenter.com
February 25: Basel II Ready Risk Management Systems Are Being Launched, But How Relevant Will They Be?
Location: Paris
Author: Angelique van Engelen, RiskCenter Europe
Date: Monday, February 25, 2002
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The first risk management systems are being launched that are supposedly essentially Basel II ready, but the developers will likely have to supplement their efforts considerably once the vast colossus of banking risk management regulations themselves are ready for implementation.
Basel II’s three way approach –Basic/Foundation, Standardized and Internal Measurement- prescribes measures which imply that financial institutions have dynamic systems combining all elements of risk; documentation, methodology, risk mitigation techniques, reporting, control documentation & effectiveness, the capture of relevant risk events (internally & externally) and the calculation of a capital charge, which will be lower the more sophisticated a bank’s risk management system.
Most software designing companies are in the process of preparing systems that make banks ready to implement whichever option they choose out of the three regulatory capital approaches. They do this by adding modules to existing systems or by developing new ones. A key to success will be the technological flexibility which links the millions of issues that are to be addressed, controlled or simply registered so that when errors occur no one can be blamed for not having thought of them.
Despite the delay and the controversy surrounding the changes that Basel II will undergo before the new rules are ready to be implemented, the first systems designers are already beginning to offer their produce which they claim can cope with the realities of Basel II.
Unlikely? Maybe. A lot depends on the next few months when the impact is ascertained that the proposed regulation will have on the banking industry around the globe and when changes are implemented. The New Accord is scheduled to be by and large ready for implementation in 2005. The responses from the banking sector have been overwhelming and this is reflected in the length of time it has already taken the committee to work on the New Accord.
However, lured by the big bucks, the event of Basel II speed up a so far hesitant software design industry which is now working on issues such as operational risk, a concept that was still relatively new only some 24 months ago to these technology guys. Amelia Financial Systems, a UK based company, is regarded as one of the pioneers in the risk management solution development business, but even this company first started operational risk systems designs as recently as 1998. Only then, the company began to research Operational Risk. “With two questions in mind”, the company says. The first consideration was whether their designers could build the right software. The second question the company researched before it ventured out in this arena was whether the product would be viable, i.e. would anybody buy the software. Currently, the company has over 30 institutions across Europe that have bought their ORCAS system.
Most of the developers preparing for Basel II are boasting that they are making their systems as flexible as can be. Let’s hope they are successful. Because despite the almost constant hype over the rapid pace of technology, to come up with software solutions that are Basel II resistant is almost as revolutionary for the system design industry as for the banks that will use them and who themselves in some cases already are making drastic changes to their business mix to meet the capital charge requirement.
Those responsible to engineer the software solutions are not to be envied. Industry experts say that danger of new systems being developed now is that they simply are one big database of possible loss events despite the demands of the proposed new rules which imply way more intricate -but almost impossible to develop- systems.
They will also likely have to supplement their efforts made to date with new ones, to comply with changed requirements specifications once the definite version of the Basel Accord is achieved. Areas which are still subject to the greatest changes include asset securitization and specialized lending, where active dialogue with market participants is currently ongoing.
So far, it has seemed wise to engineer links between prospective loss events to risks and controls that is as comprehensive as the most stringent version of the Basel Accord stipulates. Most third party vendors market their produce on these points. Among the risks most difficult to quantify and pour into a system is operational risk. The New Accord itself will be a first official guideline on actually measuring this type of elusive risk, and the last word has not been said about the issue. The proposal’s version of operational risk was described by the FT as ‘crude’, ‘controversial’ and ‘almost certainly wrong’.
Amelia, which describes operational risk as ‘the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events’, has geared its systems to prevent loss events which come in at least three forms, internal text based reporting, externally reported events from third parties and from underlying internal transaction processing and MIS system databases (e.g. failed trades and error logs). “Which could result in the need to capture huge volumes of data. To ensure the viable and easy interchange of data we conclude that a standard needs to be put into place, based for example upon XML and associated industry specific initiatives such as XBML and FPML”, the company states in an article on its website.
Another third party company that is active in the field is Algorithmics Incorporated, a Toronto based enterprise risk management company. This firm is working with a number of unspecified clients to create an extension to its Algo Suite to meet the BIS II guidelines. The company is focusing on collecting, mapping and storing the inputs required to drive BIS II credit capital measures and provide calculations for all three BIS II regulatory credit capital approaches. The system also allows for the economic capital approaches, enabling institutions to compare their risk and reward across business lines.
Although the Basel Accord for some financial houses will mean a first acquaintance with operational risk management systems, most mainstream banks have to varying degrees built their internal risk management systems in some shape or format. Since the first proposal of Basel II was sent around for comment, a wave of actively all across the globe was set off. Banks and financial institutions are interpreting Basel II in as wide a sense as possible to achieve 'best practice' risk management processes including global limits management, credit portfolio management, clear collateral risk management all through systems which are designed to host changes in the near and medium term. In some countries financial institutions are even grouping together to jointly develop risk systems that will comply with Basel II. There are initiatives in Spain, where the savings banks association is working with over 40 banks to implement systems that will make them comply with both new domestic regulations and the Basel Accord. Germany’s savings and giro transfer bank association is assisting its members as well to meet the new requirements. |
