A Kick up the Basel Committee

As this blog has been banging on for nearly two years now, the reputation of our financial institutions is at an all-time low.  Urgent action needs to be taken to restore confidence and kick-start the economy.  From the Basel Committee’s April 2013 report to G20 Finance Ministers and Central Bank Governors:-

‘Full, timely and consistent implementation of Basel III remains fundamental to building a resilient financial system, maintaining public confidence in regulatory ratios and providing a level playing field for internationally active banks’.

"Botta" building 
Aeschenplatz 1, Basel, Switzerland, from the BIS website

Achieving Basel III compliance looks like the obvious first step for banks on the road to regaining the confidence of their customers and the respect of the media.  If ever there was an opportunity to justify investment in holistic risk management, data control and improved management reporting systems, it surely is now! So what progress has been made so far?

January 1 2013 was a milestone on the long and winding road to Basel III, with the introduction of new minimum capital requirements for risk-weighted assets of:-

• 3.5% share capital
• 4.5% Tier-1 capital
• and 8% total capital

This was the first of many deadlines imposed on the twenty seven participating countries by the Basel Committee, but here we are in May, and how many countries have successfully complied with the new requirements?  Shockingly, but not surprisingly, the answer is: just eleven of them. Australia, Hong Kong, Canada, China, Mexico, Saudi Arabia, Singapore, Thailand, Switzerland, South Africa and Japan are the only participating countries which so far have embraced Basel III and complied with the January deadline. Of the rest, three countries (Argentina, Brazil and Russia) have issued final rules with a commitment to enforce them by the end of 2013, and the remaining thirteen have at least published their draft regulations.

In the USA official interpretation of the Basel III requirements has been unclear since late last year, when the Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency called off the January deadline.   In the UK Chancellor George Osborne has instructed the Financial Policy Committee to focus on “the near term economic recovery” regardless of the “trade offs’.  What does this mean for Basel III?

The new regulations around capital requirements have already been watered down in a bid to encourage bank lending, so the Chancellor’s orders seem to be following suit.  In his annual remit letter to Sir Mervyn King, the Chancellor said: “The remit recognises that there may be short term trade offs between the secondary objective of ... sustaining economic growth ... and addressing sources of systemic risk. It is particularly important, at this stage of the cycle, that the committee takes into account, and gives due weight to, the impact of its action on the near term economic recovery.”

Vince Cable added his voice to this argument in a recent interview with Sky News, saying:

The idea that banks should be forced to raise new capital during a period of recession is an erroneous one. This FPC exercise will prolong the time it takes for the British economy to recover by further depressing already-weak SME lending.

It is not surprising that Basel deadlines are being missed when these mixed messages are being sent out, and there is confusion about what the rules are.  Banks are struggling with the sheer volume of new regulations coming from every direction -the Basel Committee, government, Central Banks – and from lack of strategic guidance from senior management. Even if the bank executives get their act together and start giving clear direction to their planning and IT departments, it is doubtful that the budget and resources would be there to deliver effective new risk management systems that comply with Basel III and achieve international economic objectives.

The trick for the bank executives and CIOs will be to achieve compliance, realise their own business goals and serve their customers and investors, all on a limited budget.  Most large banks rely heavily on a collection of ‘legacy’ systems, in other words, IT infrastructure that has been around for many years.  This has the advantage of being tried and tested, but was not designed to cope with 21^st Century regulatory compliance and its ever-changing demands. Consequently a large bank will typically have to spend 80% of its IT budget on maintenance, that is, just to keep it functioning correctly.  That does not leave much to spend on new development and innovation.

The last few years have seen the big banks trying to meet all their financial targets and achieve the new capital requirements through a ruthless program of re-structuring, mergers, and shedding thousands of experienced staff.  It is therefore not entirely surprising that they are now finding it hard to build the joined-up IT systems required for survival in the 21^st Century, where effective communication and data-sharing across functions and department calls for intelligent, creative, highly-skilled, and experienced  resources.

What is the Basel Committee doing about it?  They are pretty good at monitoring progress, but do not have any teeth when it comes to policing the regulations. According to their April 2013 report::

The Basel Committee’s Regulatory Consistency Assessment Programme (RCAP) introduced in2012 is helping advance and deepen the Basel III reform efforts. The RCAP is monitoring progress in introducing regulations, assessing their consistency with the agreed international standards, andanalysing outcomes across banks and regulatory regimes...  issuing domestic Basel III-based rules alone does not guarantee effective implementation. Sound supervisory and industry practices along with rigorous enforcement and analysis of intended prudential outcomes are also required for effective implementation of the Basel III framework.