Large, internationally active "core" U.S. banks that are faced with complying with Basel II's new risk-based capital requirements are doing their best to implement systems in preparation for the final rule. But without clear-cut guidelines -- or even an idea of when the rule will be finalized -- knowing what systems and technologies to deploy is difficult.
"We are trying to steer ourselves to a moving target," says Brendan Nedzi, managing director and division head of the portfolio management division at Bank of New York ($86 billion in assets), of the Basel II rules that U.S. regulators eventually will implement. While the government debates the specifics, the New York-based bank has been working to put in place systems flexible enough to incorporate changes to the ultimate rule, Nedzi relates.
On March 26, the federal banking agencies stopped accepting comments on their Basel II notice for proposed rule making (NPR). The NPR outlines how Basel II would be implemented in the United States. The agencies received 80 comment letters with assorted opinions on the provisions of the U.S. Basel II proposal and how they would differ from the international and globally accepted Basel II accord. Although regulators originally targeted Jan. 1, 2008, as the first date available for U.S. banks to run a parallel four-quarter run period before operating under the new guidelines, at the pace things are moving, many suspect that that date will be pushed back further.
Basel II not only concerns the group of core U.S. banks; it also is of interest to those banks that will have the opportunity to "opt in" to reap the benefits of lower capital requirements and the business benefits of reallocating that capital. Even the smallest U.S. banks are keeping an eye on the provision to gauge how their businesses will be affected.
Meanwhile, while specific rules are debated in the U.S., some banks across the globe have begun using the more sophisticated capital-allocation calculations for which Basel II allows. Aided by newly implemented technologies based on complex data warehouses, these international banks have met compliance mandates and are now beginning to look at ways to leverage their investments in Basel II technology beyond compliance and use newly freed-up capital to benefit the bottom line.
Around the world, banks are spending millions of dollars to implement Basel II frameworks. According to a recent study from the Boston Consulting Group (Boston), large banks -- those with assets of more than 100 billion euros (US$136 billion) -- will spend at least US$68 million on implementation, and 20 percent of those banks will spend twice that amount.
Banks in Canada were among the first to have to comply with their country's Basel II rules. Toronto-based CIBC (US$292 billion in assets) has been working on its Basel II implementation plan since at least 2004 and on certain aspects since the Bank for International Settlements (Basel, Switzerland) released the first comprehensive Basel II paper more than six years ago, says Sanjiv Talwar, CIBC's SVP of credit risk analytics.
According to Talwar, in January 2005, CIBC "fast-tracked" its selection process for a Basel II solution and signed contracts just four months later, in May. "We looked at multiple vendors and there were multiple leaders in the space," Talwar recalls, noting that the criteria the bank was looking for in a solution included the breadth of the solution, underlying data models to correspond with the bank's own data warehouse, cost and functionality. CIBC also was interested in a solution that it could leverage beyond purely Basel II capital allocation, he adds.
After putting a few vendors "through some drills," including examining their track records and talking with existing clients, CIBC chose Cary, N.C.-based SAS' Credit Risk Management solution, Talwar relates. The bank leverages the solution to develop Basel II compliance models, produce credit-risk scorecards and perform advanced analytics on its portfolio, he says.
In a Gartner (Stamford, Conn.) report issued in late 2006, SAS is described as one of the leading vendors in the field, with the greatest breadth of vision. Other vendors noted in the report include SAP (Walldorf, Germany), Reveleus (Mumbai), SunGard (Wayne, Pa.) and FinArch (Merelbeke, Belgium). The companies evaluated for the survey had to fit some stringent inclusion criteria, according to Douglas McKibben, research VP, Gartner, and one of the authors of the report. Basel II offerings are defined by data, calculation engines and reporting capabilities, he relates.
In the United States, however, regulators haven't provided much guidance on which technologies to implement. "In most areas of risk management, it is our intention to have institutions retain their ability to choose which specific methods they employ," said Federal Reserve Gov. Susan Schmidt Bies in February while giving an update on Basel II to the Global Association of Risk Professionals in New York. "In other words, the guidance identifies an acceptable range of practice for banks. Within this range, a bank could use several types of approaches and methodologies."
In choosing its Basel II systems, Bank of New York had several primary goals, the bank's Nedzi says. The top goal was, of course, that it enable Basel II compliance and be flexible enough to incorporate changes to the rules, according to Nedzi. But the bank also wanted to ensure that the systems could incorporate changes to the bank itself over time -- something it encountered recently as a result of its merger with Mellon Financial Corp. And finally, the bank needed a system that could be leveraged for purposes other than Basel II compliance.
Bank of New York chose to partner with Algorithmics -- also identified as an application leader in the space by Gartner -- to develop a ratings platform. The bank worked with Algorithmics to create an internal, credit-ratings solution tailored to fit its specific needs, Nedzi says. That solution was implemented in April 2006. The Toronto-based vendor now markets a generic version of that ratings product to other financial institutions.
Data Quality and Integration Challenges
But choosing the right solution is only half the battle, experts warn. "Implementations are difficult," points out Edward Shea, FRS North America director of product strategy and alliances. FRS (Brussels and London) provides regulatory and compliance solutions to financial institutions and has been identified as a "niche player" by Gartner. "It's a long and complicated process," Shea says. "There are sometimes 40 different systems you are pulling data from. Everything has to be looked at."
And when it comes to the data needed to support Basel II calculations, banks are running into major problems, according to David Rogers, SAS global product marketing manager for risk. Basel II is a very data-driven story, he says. And the underlying quality of the data that is being stored in banks' warehouses is not good enough to drive Basel II calculations, Rogers asserts.
Banks are devoting about 60 percent to 70 percent of their Basel II implementation spend on cleaning and preparing data, Rogers says. "You have to look at data requirements and map that back to the original source," he explains. "Key to this are ETL [extract, transform and load] tools and metadata."