Banking institutions should prepare now for Basel IV regulations

in Regulatory/Compliance, 14.03.2022

The Basel Accords, overseen by the Basel Committee on Banking Supervision (BCBS) has issued a round of reforms and regulations in recent years. The Basel III final reforms, referred to as Basel IV, will be fully implemented by January 2025, which means banking institutions have less than three years to get ready. Many banks have delayed their preparation, and few have started reflecting on the challenges of Basel IV implementation. Beyond the size and the complexity of the risk and finance organization that could lead a bank to start earlier, other considerations encourage the smart set to begin early implementation of Basel IV principles now.

Let’s start with a recap on the Basel IV regulation and its timeline.

What is Basel IV?

Basel IV is the final brick of the Basel III reform and aims to strengthening the resilience of the EU banking sector against future crises. This reform benefits from the field-based feedback on the previous Basel reform. Basel IV regulation is structured around two packages.

The first package, which goes into effect in January 2023, includes:

  • Fundamental Review of the Trading Book (FRTB)
  • Counterparty Credit Risk
  • Net Stable Funding Ratio (NSFR)
  • Leverage ratio
  • Large exposure
  • Market risk
  • Intermediate EU parent undertaking

A second package, which goes into effect in January 2025, covers:

  • Credit risk – Standardized Approach to Credit Risk (SA CR)
  • Credit risk – Internal models
  • Credit risk – mitigation techniques
  • Market risk
  • Operational risk
  • Output floors
  • Sustainability
  • Credit Valuation Adjustment (CVA) risk

Basel IV implementation timeline

basel-IV-graph

Click on the image to enlarge

Why start working on Basel IV now?

Basel IV introduces changes that limit the reduction in capital that can result from banks’ use of internal models under the Internal Ratings-Based approach. This means that the risk function will be tasked with numerous regulations requiring more data collection, aggregation, transformation and reporting. Reflecting ahead of time on the regulation enables banks to better incorporate the new Basel IV processes within their process architecture and to avoid pitfalls and reporting quality issues. In this new era where good data is as good as gold, well-structured data, processes and organization is an invaluable asset.

For the Basel IV final package, here are the challenges to address before you begin to implement the regulation.

  1. Internal modeling vs standard model

The credit risk reform gives precedence to the standardized approach versus internal models.
All banking institutions (even the ones using internal models) will need to compute using the standardized approach. After criticism, the regulator, BCBS, has broadened this approach with the introduction of new parameters such as Standardized Credit Risk Assessment (SCRA). More depth has been added for banks and corporate risk measures, and Loan to Value (LTV) is considered for real estate exposure.

On the opposite, the output floors on the internal model-based approach reduce the interest for this approach. Banks need to analyze again the return on investment (ROI) of an implementation of internal models on a portfolio segment. As observed in quantitative impact study (QIS), more banks may abandon their internal models as the operational costs will be very high when running an internal model-based approach.

  1. Data management strategy

The Basel IV package also comes along with data management issues to address. The new regulation will have significant impacts on data structuring and governance. For instance:

  • Banks will need to modify building and transformation processes for some data and indicators, such as RWA.
  • New data will need to be collected and managed and banks will need to ensure data accuracy, completeness, security and timeliness.
  • Some data will be more critical than before, as in the cases of LTV, residential real estate flag, commercial real estate flag, etc., and a more sophisticated data management framework will be needed on those data. For instance, the controls will increase; golden sources will be created; and aggregation process documentation should be intensified.

With these moving parts in mind – and a scant few years to begin implementing new processes to satisfy Basel IV regulations – banks should start now. By reflecting on how to efficiently manage this new stress on data organization and IT architecture, they will have enough time to reduce silos and improve the quality of risk reports.

The clock is ticking, but KPMG is here to help. If you’d like support testing your bank’s preparedness or to further prepare for Basel IV regulations, please contact me.