Local Realities in Road to Basel II   Vineet Khanna : The Financial Express Published on May 24, 2004

 

Since the publication of first draft of the Basel II Accord over two years ago, we have seen significant developments in the way banks are approaching their Basel II programs. While the Reserve Bank of India (RBI) has provided its opinion that banks with business mix greater than 20 per cent from abroad should adopt the framework, a few banks regardless of the business mix have started working towards adopting this framework.

 

The appeal of the Accord is multifold as it incorporates sensitivity to banks' internal methodologies and provides incentives for better risk management, versus a 'one-size-fits-all' approach. The banking industry has started recognising that the Basel II Accord evolves from being a single step to a comprehensive and consistent program of risk improvement. It will help if the dynamic requirements of regulators, business managers, risk managers and finance professionals are examined, validated and incorporated.

 

It is also vital to maintain coordination between business and IT, the two mainstays of the implementation as without this, Basel II implementation will surely fail. Most banks in developed countries have completed the program analysis phase, and the data analysis phase is well under way. The emphasis now is moving to the implementation of a tactical solution and identifying the target-operating model for achieving compliance.

 

In India, private sector banks that are already investing in technology face teething problems that include appointing a final internal authority, who will be building and maintaining this solution. Surprising, as it may seem, we witness a significant disconnect between business/risk managers and IT across the majority of Basel II programs. To enable IT to deliver this policy-driven technical solution, clear requirements are a must-have, as are robust communication and coordination plans.

 

The majority of the public sector banks lack data due to late computerisation. At the outset then, this means huge scale IT investments to have the one critical element to implement Basel II successfully. Data availability is important, but what is almost never discussed is the framework to capture such data. Take the case of operations risk:

 

There are a set of mature approximation techniques to migrate international operational risk loss data in the Indian context. While they allow for scaling based on size indicators and time adjustments they also provide the necessary richness about loss events. Remember, because these operational risk events are rare in nature and a bank in India may never have experienced that event but it is still exposed to it!

 

The big flavour of Basel II - credit risk - according to the New Basel Capital Accord, internal ratings must be grounded in banks' historical experience and empirical evidence. This follows from the fact that data analysis and statistical modelling are the fundamental basis of any internal rating system.

 

What this essentially translates into is the right data model to collect and store a minimum of 3-5 years worth of historical data. In addition to this, they need to ensure data integrity and timeliness of figures, be able to assess not only the rating grades but combine them with models for assessing 'Exposure at Default', the 'Loss Given Default' for various maturity spectrums.

 

This is when Risk Intelligence, a key component of the Business Intelligence suite, is the default requirement. Risk Intelligence empowers banks by providing them control to access, integrate and analyse data to provide timely risk intelligence across credit, market and operations risk.

 

Undoubtedly, Risk Intelligence is the vanguard for banks to effectively meet the deadline of 2006, demanding that its presence among banks become the norm rather than exception to the rule. However, before selecting the symbiotic business-IT approach, there are three main strategic considerations that need to be borne in mind by all banks:

 

v      The Accord will continue to evolve, most likely as smaller, iterative modifications rather than the wholesale accord changes witnessed so far.

 

v      Banks will need to build enough flexibility into their technical architecture - enough to incorporate these changes as well as Risk Managers' recommendations.

 

v      Banks will also need to consider the integration of their Basel II solution with the existing technical infrastructure and any other major systems implementations that are already planned.

 

v      Finally, as the Basel II program matures into the strategic implementation phase, banks need to ensure that the solution chosen is able to deliver the enhanced benefits that should be derived from Basel II.

 

Thus, questions that need to be comprehensively answered by banks today are the following:

 

v      Has our logical data model been validated by and mapped back to the Basel II Accord?

 

v      Do our reporting tools give us insight into the capital calculation as well as performing the required regulatory reports?

 

v      Do we have robust data capture, cleansing and management practices in place?

 

Banks need to realise that the Basel II Accord is not a once-only requirement but an evolutionary program of risk improvement. The relevance of the technical solution adopted will be gauged against its ability to keep pace with these changes.

 

Requirements of the regulators, business managers, risk managers and finance professionals will evolve. To meet this challenge, it is vital to maintain coordination between business and IT. The course you set today will determine your ability to meet the challenges of tomorrow.