Basel III and Its Implications for the

World Banking System

 The Group of 20 Summit scheduled
for November in Seoul will provide a
forum for a wide range of economic and
fiscal issues, ranging from World Bank
governance to fossil fuel subsidies. The
world’s biggest economies cannot be said
to have a common economic strategy, but
they will be discussing action on a number
of common matters, including banks’
capital structures, liquidity and exposure
to risk.

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The stated purpose of the G20 Seoul
Summit is to create a foundation for
balanced, sustainable growth in the
global economy as the world emerges
from the recent financial crisis. But
what does this mean for the financial
institutions that will ultimately have
to implement and follow a more
comprehensive set of regulatory rules
in the future?
As this paper is going to print, it is now
apparent that the G20 will defer final
decisions on some of the key aspects of
Basel III until 2011 rather than during
this meeting. While this is perhaps not a
surprise given the political make-up of
the G20, debate will continue after this
latest summit on the specifics of capital
structure and on other critical issues
such as establishing a methodology for
identifying banks that are “too big to
fail” – and what additional regulatory
requirements will apply to this elite
group.
Since the London Summit in April
2009, the Group of 20 leading
countries (G20) has been working
to reform financial rules in light of
the ongoing global fiscal crisis. In
parallel, the world financial system
has been facing challenges on nearly
every level. While banks’ senior
managements have grappled with
important strategic issues, regulatory
authorities worldwide are mindful of
what happened, or nearly happened, to
the banks within their purview. These
regulators have, in many cases, been
granted expanded powers and new
enforcement “teeth.”
More than ever, regulators are seeking
to act in concert, cooperating to
develop frameworks that extend across
geographies. While the regulators’
position is logical—systemic problems
in one bank, or within one country,
can clearly have a significant if not
drastic impact on banks around
the world—it has proven extremely
difficult to define and agree, let alone
impose a common standard on banks
that have different starting points,
that are accustomed to operating
within different prudential guidelines,
and have different expectations as
to acceptable margins, compensation
structures and disclosure requirements.
Given this complexity, and the
outcomes of the previous three G20
forums, our expectation is that the
clarity desired by many in the industry
will still be lacking at the conclusion
of the Seoul meetings. It therefore
raises some interesting questions: Is
Basel III a destination, or the next
point along a longer journey? Will
there be a level playing field across
the banking sector, and, if so, when?
And, by extension, until the rules are
clear, is it advantageous for banking
leaders to keep things as they are, or
to put in place key components of the
anticipated reforms before they are
required?
From where we sit today, there are
simply too many complexities and
inter-relationships across the disparate
geographies and economies which
make up the G20 to believe that
the timelines and/or requirements
of the recently structured Basel III
will accelerate or result in higher
requirements for capital. However,
we fully expect that additional
requirements and modifications
will emerge as banking institutions,
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economic leaders and political
leaders work together to implement
a solution that provides the stability
desired without overly affecting the
still nascent financial and economic
recovery cycle.
Following the Seoul G20 Summit we
believe that a number of countries
will not wait any longer and will push
forward independently with specific
requirements for the institutions
operating in their geographies.
Obviously, the US has passed
significant measures with the recent
Dodd-Frank regulation. In Switzerland,
the authorities have defined additional
capital requirements above the
base of Basel III, the “Swiss Finish”.
These acts are likely to become less
isolated in the coming months as other
geographies also follow this trend to
build their local priorities alongside
the continuing Basel III development,
but with increasing attention to their
local agendas and less to the global
construct.
4
In considering whether it is position to devote the necessary
advantageous for banks to push ahead management resources needed to
with their own regulatory agendas focus on customers, competitors and
against this evolving structure, it is profitability as opposed to internally
easy to forget that, in many cases, focused regulatory metrics and ratios.
banks and regulators’ best interests
are not mutually exclusive and may, We also believe that by taking these
in fact, run along parallel paths. The pro-active steps these leaders can help
challenge for banks is to chart a to set the direction for the industry
course that rewards both shareholders and make the issues and debates
and customers while avoiding not regarding the consequences (intended
only unacceptable levels of risk but and unintended) more tangible for
business practices that perpetuate both the industry and the regulators.
the kind of boom-and-bust cycle seen
all too often in recent years. Banks
and regulators, after all, share a vital
common interest in protecting the
world’s financial system.
It is our view, therefore, that it is
advantageous for banks to progress
the main elements of Basel III directly
now—instead of waiting for the ink
to dry on the final reforms sometime
in the future. The direction has been
set and those institutions which can
move ahead rapidly will be in a better
The Basel III Landscape
While many banks are still in the
process of compliance with the Basel
II regulatory standards, the new
guidelines proposed under Basel III will
be an important topic during the G20
discussions in Seoul.
In the broadest strokes, a global
consensus is building among G20
leaders that will lead to the following
changes:
1. Capital ratios will increase. Basel
III calls for banks’ common equity to
increase from 2 percent to 4.5 percent,
to be phased in by January 1, 2015.
2. Tier 1 capital requirements, which
include common equity and other
qualifying financial instruments based
on stricter criteria, would increase
from 4.5 percent in 2013 to 6 percent
as of 2019. Certain types of capital,
such as contingent convertible bonds,
will no longer be classified as Tier 1.
3. In addition to the higher Tier 1
requirements, a “capital conservation
buffer” of 2.5 percent may be required
so banks can absorb losses during
periods of financial and economic
stress. Banks that draw down on the
buffer will face constraints on earnings
distributions such as discretionary
bonuses and higher dividends.
4. Over and above the new Tier 1
and capital conservation buffer
requirements, a “countercyclical
buffer” remains a topic of discussion.
5. In addition to the capital
requirements, a non-risk based
leverage ratio mandating that Tier 1
capital be no less than 3 percent of the
bank’s total exposure is expected to
receive broad support.
6. Banks will be asked to take
responsibility for defining and
articulating liquidity risk tolerances
that are appropriate to their business
strategy and for their role in the
financial system, with sound processes
for identifying, measuring, monitoring
and controlling liquidity risk.
7. Senior management will be
expected to establish a liquidity risk
management framework that is robust
enough to ensure maintenance of
sufficient liquidity and to withstand
both institution-specific and market-
wide stress events.
8. New liquidity standards will include
a liquidity coverage ratio (LCR)
dictating that high-quality liquid
assets must equal net cash outflows
over a 30-day time period; in addition,
a net stable funding ratio (NSFR) will
require that the available amount of
stable funding match the required
amount of stable funding.
9. Banks will operate with simplified
limits for large exposures and with a
new limit for inter-bank exposures.
Inter-bank exposures will be treated
like other exposures, regardless of their
maturity, and limited to 25 percent of
the bank’s own funds.
10. “Systematically important”
financial institutions will be singled
out for special treatment. They
will receive regulatory scrutiny
in the areas of capital adequacy,
liquidity and transparency, and their
compensation structures—a topic of
focus in countries such as the UK—will
be dramatically re-shaped, either
voluntarily or by regulatory directive.
It should be noted that Basel III now
calls for implementation of these
standards over a transition period of
as long as eight years. Since most
banks have already undertaken steps in
these directions, Basel III’s capital and
liquidity requirements do not appear
overly burdensome, but there will be
impacts. Capital is becoming more
expensive and there will be an impact
on credit availability and on overall
bank margins, but estimates vary
widely and there is broad agreement
that Basel III takes the industry in the
right direction.
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Different Region, Different Experiences
The Seoul meeting will draw
attention to contrasts and
comparisons among banking
institutions in the Americas,
Europe and Asia-Pacific
regions. When we examine the
current state of play among
major banks in these regions,
we see more differences
than similarities. A downturn
that affected these regions
unevenly has been followed by
a recovery that is progressing
at different speeds in different
countries. These differences
have pressured some banks
into mergers and sent others
scrambling to raise capital.
Others are deleveraging by
selling off assets or otherwise
exiting non-core businesses.
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In Europe, the large global banks
and the better-capitalized banks in
Northern Europe have emerged from
the downturn in better comparative
shape to the majority of institutions in
Southern Europe. The European central
bank put tremendous emphasis on the
importance of Tier 1 capital and most
institutions in this category adhered to
a regimen of deleveraging while adding
capital, in many cases through public
offerings.
The smaller scale banks and mutual
structures in Europe such as the
building societies in the UK, the
Sparkassen (savings and loans)
and Landesbanken (state banks) in
Germany and the cajas (regional
savings banks) in Spain have been
pressed to raise capital without always
having ready access to the capital
markets. European banks in this group
have historically relied to a greater
extent than US banks on “softer”
forms of capital such as preferred
stock, and the balance sheets have
included investments in insurers and
minority investments in banks that will
no longer be treated as Tier 1 capital
under Basel III.
In recent weeks we have seen a
number of European banks turn to the
equity markets to raise capital and
bolster balance sheets for the period
ahead. The reasons vary by institution,
but are clearly a combination of
the increasing regulatory pressures,
higher volatility in the markets, and
preparation for some to make future
business model changes through either
geographic or product line expansion.
Global banks in Europe (as well as
in the United States) will no doubt
re-examine their trading operations,
due to new capital required to support
trading. Similarly, new restrictions
on securitization will make it harder
for large European (and US) banks
to package and sell loans to avoid
capitalization requirements. A number
of investment banks will continue to
explore changing the focus of their
business model to increase retail
operations and secure other, less
volatile, streams of revenue into the
future.
In the Americas, there have been
significant differences among the
experiences of banks in Canada, Brazil
and Mexico (mostly good) and banks in
the United States (mostly not as good)
in dealing with the downturn and the
recovery. Major US banks have cut
dividends, tightened lending standards
and engaged in ongoing consolidation
while bolstering their own capital
structures.
In an Accenture survey conducted
after the passage of the Dodd-
Frank bill, 66 percent of US financial
institutions surveyed said that
regulatory changes will require re-
thinking of existing business models.
Among the initiatives that US banks
said they need to undertake are:
1) Incorporating and integrating
risk management into performance
management metrics;
2) Doing a better job of automating
financial and regulatory reporting;
3) Building better, more accurate
pricing and valuation models for each
customer offering;
4) Conducting deeper analysis of
counterparty exposures to avoid
the “domino effect” that was so
destructive in 2008; and
5) Designing better products to reflect
both changing customer attitudes
toward risk and new economic and
regulatory realities.
In Asia, many major banks have already
met or exceeded proposed Basel III
capital requirements. Asian banks’
experience with the financial crisis of
1997 led many institutions to make
risk management a top management
priority, and banks in this region
tended to avoid taking large positions
in structured products, which became
an issue for many banks in the West.
Historically, the flow of “best practice”
information for this industry has been
from west to east. However, in this
topic area we now see much more
balance and increasingly a sharing of
perspectives in both directions. No one leading to increased operational risk.
region has a monopoly on what is the Banks especially in the emerging
right approach. countries are still operating on
old platforms and a multitude of
Many Asian banks, however, are interdependent systems that are
facing market saturation in their home challenging to fully integrate. One key
markets and are reviewing growth area that would require significant
strategies—including entering new investment is in the area of global
countries or launching new products— limits and exposure management,
that entail significant credit and especially given their more regional
operating risks. footprint and increased market
exposure. Asian banks’ ambitious
Asian banks confront other risks, growth plans depend on opening up
as well. For instance, Asian banks new markets, but doing so without
have been hampered in their growth necessary investments in talent and
strategies by an overall scarcity of technology will create unanticipated
talent. Major initiatives—such as operational risk—exemplified by
expansion into emerging economies recent events which damaged banks’
or the entry into capital market reputations while inconveniencing
activities—have been slowed while customers.
banks develop or recruit the talent
needed to undertake such efforts.
As talent is identified and developed,
leading Asian banks can be expected
to explore growth capital markets and
transactional banking; in lending to
small and medium-sized enterprises;
and in wealth management.
Banks in larger, more economically
developed Asian countries such as
South Korea and Singapore confront
major operational challenges when
entering less developed markets. Many
banks in countries such as Indonesia
and Thailand are not yet Basel II
compliant in terms of their capital
structures. Outright acquisitions
require an injection of capital as
well as investment in operations and
information technology.
Many Asian banks, especially in rapidly
growing markets such as China, have
ample capital and their relatively
low leverage creates pressure for
growth. The major Chinese banks are
responding to this pressure, in part,
by expanding their presence in the
capital markets, both through alliances
and through internal development.
Managing such growth, however, is
difficult without the necessary talent
and corresponding operational controls
in place.
While many Asian banks have robust
capital structures and low leverage,
there has been a consistent level
of under-investment in technology
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Seeking high performance under Basel III
How should banks seeking high
performance be looking at risk in light
of Basel III and the expected G20
guidelines?
Generally—as was the case under
Basel II—banks will continue to use
internally developed risk modeling for
both lending and trading activities.
The higher capital requirements will
decrease the absolute risk associated
with these businesses, and the more
sophisticated banks in all markets
will continue to improve their risk
models. However, as history has shown,
effective risk management is not only
about the models.
Accenture sees three major areas in
which banks can begin to improve their
overall risk management.
First, banks must accelerate the
process of integrating the risk and
finance functions. The chief financial
officer and the chief risk officer must
work from a single set of information,
and must share an understanding of
the inter-relationships among credit,
market and operational risk. Enterprise
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risk management must become a
reality rather than a stated objective.
Risk must be seen as a growth and
profitability-enhancing capability, not
as a back-office or compliance-centric
function.
Second, banks must improve their
overall data management. Under Basel
III, banks will need to consolidate
positions from their trading desks, and
make their “trading book” match up
more seamlessly with their “banking
book.” Banks have always applied a
rigorous approach to the P&L explain
process. They have also been very
focused on meeting the reporting and
output requirements for the regulators.
To manage going forward, they will
need to apply a significantly increased
level of focus and rigor to the quality
and maintenance of data across the
full suite of activities from front office
through to back office. Standard risk
models will remain and it will be up to
the banks to ensure that their own data
and models are up to the task.
The rise of the chief data officer—a
new and senior level position at
many banks—is a reflection of banks’
recognition of this need.
Third, banks must prepare for what
we call “intelligent growth.” In Asia,
for instance, lending to small and
medium enterprises (SMEs) represents
a major opportunity for banks in
anchor economies such as South
Korea, Singapore and Australia. In
entering these new markets, however,
banks can mitigate both credit and
operating risk by using analytics and
automating credit scoring to make the
lending process more efficient and
less risk-prone. Financial reform is
important for restoring the confidence
of shareholders and customers, and
everyone will have more faith in banks
that evidence both financial stability
and sound risk management practices.
Getting there, however, is easier said
than done.
Because of these markedly different
economic and regulatory environments,
there are no “one size fits all”
recommendations for institutions
examining the course of the Basel III
process and their next steps following
the G20 meeting in Seoul. As per our
comments at the beginning of the
paper, we do not expect the forum to
agree to specific resolution on Basel
III or to be in a position to publish
formal guidelines much beyond what is
understood today.
Based on this our view remains that:
Banks will be better off undertaking
comprehensive risk assessments on
their own, rather than waiting for
formal directives to be finalized. Banks
can expect more, rather than less
regulation in the future, and the nature
of this regulation is changing rapidly.
Rather than ticking off a regulatory
checklist, newly empowered regulators
are using much broader judgment to
determine banks’ true condition. They
are developing benchmarks based on
global standards and international best
practices and using such benchmarks
aggressively. Compliance with this
new regulatory environment places
burdens on banks’ leadership, but
it also provides forward-looking
institutions with the opportunity to set
the standard and create value through
effective, flexible risk management
processes.
The G20 process is clearly important
as it provides a regular and high profile
forum for global leaders to turn their
attention and the global spotlight on
the establishment of a more robust and
more uniform set of financial rules and
a consistent timeline for adherence.
The playing field will never be perfectly
level, but Accenture believes that
the banks which approach Basel III
in a proactive and holistic manner
and incorporate the principles of the
regulation throughout their operations—
as opposed to viewing the requirements
as a separate set of compliance
activities—will be in a better position
to compete effectively on a global
basis and will be better positioned for
success over the longer term.
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Appendix: Basel III Guidelines

2013 2014 2015 2016 2017 2018 as of 2019

Min. Core Tier 1 Capital 3.5% 4.0% 4.5% 4.5% 4.5% 4.5% 4.5%
Ratio (% of RWA)

Capital Conservation 0.625% 1.25% 1.875% 2.5%

Buffer (% of RWA)

Min. Core Tier 1 plus 3.5% 4.0% 4.5% 5.125% 5.75% 6.375% 7.0%
Capital Conservation
Buffer (% of RWA)

Phase-in of deductions 20% 40% 60% 80% 100% 100%

from Core Tier 1

Min. Tier 1 Capital 4.5% 5.5% 6.0% 6.0% 6.0% 6.0% 6.0%
(% of RWA)

Min. Total Capital 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0%
(% of RWA)

Min. Total Capital plus 8.0% 8.0% 8.0% 8.625% 9.125% 9.875% 10.5%
Capital Conservation
Buffer (% of RWA)

Countercyclical Buffer range between 0 – 2.5% (common equity or other fully loss absorbing capital)

Capital instruments that Phased out over 10 year horizon beginning 2013
no longer qualify as Non- (reduction of 10% per year)
Core Tier 1 Capital or Tier
2 Capital

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11
About the authors
Steve Culp
Steve is the managing director –
Accenture Risk Management. Based
in London, Steve has 20 years of
experience working with our global
clients to deliver programs across:
strategy definition, risk management,
enterprise performance management
and large scale finance transformation.
Prior to his current role, Steve was the
global lead for Accenture’s Finance &
Performance Management consulting
services for global banking, insurance
and capital markets institutions. With
his extensive risk management and
performance management experience
and business acumen, Steve works
with our client executives and their
teams on the journey to becoming
high-performance businesses.
Copyright © 2010 Accenture
All rights reserved.
Accenture, its logo, and
High Performance Delivered
are trademarks of Accenture.
10-2481 / 11-2446
Kyo-Sik Bae
Kyo-Sik is executive director, Risk
Management. Based in Seoul, Kyo-
Sik has nearly 15 years of experience
in the areas of CTSS (Core trading,
settlement services), investment
banking, credit lending processing and
risk management. His deep financial
services experience, broad knowledge
of market risk, credit risk and risk
data, and very strong technical skills
around compliance matters helps
executives and their firms become high
performance businesses.
About Accenture
Accenture is a global management
consulting, technology services
and outsourcing company, with
approximately 204,000 people serving
clients in more than 120 countries.
Combining unparalleled experience,
comprehensive capabilities across all
industries and business functions,
and extensive research on the world’s
most successful companies, Accenture
collaborates with clients to help them
become high-performance businesses
and governments. The company
generated net revenues of US$21.6
billion for the fiscal year ended Aug.
31, 2010. Its home page is
www.accenture.com.
Christopher Loh
Christopher is director - Risk
Management, Singapore, responsible
for Southeast Asia. Christopher
has over 13 years of industry and
consulting experience in financial
services and risk management
across Asia and the United Kingdom
where he worked with regional and
global corporations to transform
their business and risk capabilities.
His extensive experience in risk
management, risk and regulatory
compliance, operating model and
strategy, credit transformation,
operational efficiency, banking
transformation and capital
management helps client executives
and their firms become high
performance businesses.
About Accenture Risk
Management
Accenture Risk Management
works with clients to create and
implement an integrated risk
management capability designed
to gain higher economic returns,
improved shareholder value and
increased stakeholder confidence
in an uncertain global economy.
Our work helps companies cost-
effectively align risk and reward to
fuel growth and drive better business
performance while also protecting
the interests of shareholders and
other key stakeholders. Operating
globally across a wide variety of
industries and functions, we provide
clients with a unique combination
of resources—strategic consulting,
systems integration and technology
delivery at scale, outsourcing and
change management services—to
embed risk management throughout
the enterprise. Find out more at
www.accenture.com/riskmanagement.