Basel III – New financial regulations are on your doorstep…. Buyer Beware!

Basel III – New financial regulations are on your doorstep…. Buyer Beware!

Basel III is one more step in a journey toward greater industrialisation of risk management in financial services. The new rules are not just a framework for capital adequacy, regulatory supervision and market disclosure: they will dramatically impact the way financial services will operate in the next few years and the way suppliers work with the industry.

The impact for suppliers to financial services organisations will be very significant. Not only will the need for specific industry expertise be crucial but the existence of commercial relationships with financial services companies will require specific governance, skills and processes – not to mention capital.

Key messages for financial services firms:

  • While several institutions will require significant capital increases the largest firms are already adequately capitalised. Still there may be a race for more capital as directed by individual country regulators (Switzerland has already acted on this). Further rules around leverage and liquidity reduce the ability of institutions to take risks they cannot absorb. Some pre-2008 business models were not sustainable and regulators want to avoid a repeat.
  • While Basel II was rather lenient in the definition of Capital, Basel III is far more specific and Capital is now a far more solid item and the bar for acceptability of near capital has been raised very substantially. Assumptions behind Basel II artificially gave a sense that events were all normally distributed while reality is that long tail risks and correlations do drive systemic risk. In other words the regulators are now focusing on the 5% of cases because that is where banks may fail and not the 95% where business is as usual.
  • Liquidity has become a key regulatory dimension and a major focus for regulators.
  • Stress testing (as directed by regulators) and last will and testament processes will continue to force institutions to limit their risk taking. Indirectly, consumer finance may become more attractive (especially if covered bonds and other asset securitisation transactions are revived) while more concentrated risk activities may become challenging.
  • Despite the fact proprietary trading is making headlines the activity was marginal at most regulated institutions and it was actually well controlled. Still the activity is attracting a lot of media attention.
  • A significant responsibility in the financial crisis rests with regulators who did not adequately regulate and monitor risk. Staff is being added in numbers and skill
  • While accounting is the starting point for regulatory oversight, ratios will require harmonisation given differences in accounting frameworks and the way ratios are currently calculated.

Key messages for service providers:

  • Enterprise Risk Management (ERM) is the crux of the matter and service providers will be included in the scope of ERM when regulated. The regulators will increasingly look at the “ecosystem” of specific financial services firms. Despite the fact a given financial services firm has ultimate responsibility, the service provider will be in-scope when the regulator looks at the totality of the ERM.
  • Systems and controls, operations and board expertise are wholly inadequate today. Regulators will regulate the ecosystem (as per above) and not just the regulated entity. It is still not clear exactly how this will be done but expect far more reviews of outsourcing contracts and governance by the regulators. Depending on the country this process may be very invasive.
  • The case of IBM and DBS and the de facto capital penalties levied by the Monetary Authority for Singapore (MAS) may be a model for the future because while the approach may have been used elsewhere, disclosure of the penalties by regulators may force change on both vendors and clients. Regulators may use public disclosure to “embarrass” service providers and force them to change even if they are not directly regulated themselves.
  • Significant focus needs to be on asymmetrical situations especially on principal and agents cases where there is an incentive for moral hazard. Effective ERM from culture to reporting will require superior information management and systems and individuals with the right expertise.

Both buyers and sellers of outsourcing services in the Financial Services market need to start preparing right now. The regulators are now at the head table!

Also, check out our White Paper “The Strategic Impact of New Financial Regulation 2010”.

Posted in Regulation Comments: one


One Response to Basel III – New financial regulations are on your doorstep…. Buyer Beware!

  1. art says:

    Basel III

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