Risk Management under Basel IV

Risk Management under Basel IV

By Hendrik Sumpf FRM, Manager and Stefan Scheutzow, Manager, Finbridge.

A bit about Hendrik and Stefan:

Hendrik is Manager at Finbridge. He is specialised in running projects that interface between functional concept work and technical implementation in financial institutions. His recent projects in regulatory reporting and risk controlling encompass implementations of new regulatory requirements in liquidity, credit, and market risk as well as the broader BCBS 239 context.

Stefan is Manager and market risk team lead at Finbridge and responsible for the interpretation and implementation of current banking related regulations following Basel III. Stefan worked for several years in financial risk management covering supervisory requirements as well as quantitative risk models across capital markets and banking. Today, he is in charge of conducting impact studies for Finbridge clients on current treasury and capital markets related regulations such as FRTB and SA-CCR and develops achievable recommendations for implementation. He is also helping his clients to embed future supervisory requirements with their business strategies.

What are some of the top challenges of risk management under Basel IV? What are the key concerns right now? And what are the essential things to remember?

Just like under Basel III, regulatory uncertainty is still a major topic to face. With incoming regulations, consultations, FAQs and opinions on a daily basis banks will have to cope with volatile guidelines alongside implementations within their systems. This puts a big focus on agile and adjustable project environments for the years to come. Another layer is added through the ongoing updates of central multinational regulations, such as CRR or BRRD.

The regulatory package following and refining Basel III is designed to prevent regulatory arbitrage in all asset classes. With cost sensitive topics, such as IFRS 9, new securitisations framework and FRTB on the one hand and balance sheet management related topics, such as IRRBB, TLAC and MREL on the other hand central risk management faces a massive impact on banks return and turnover. This calls for risk related measures on portfolio optimisation and business strategies even for smaller corporations and a deeper look into complex KVA calculations.

From a technical point of view more intense computations require not only faster systems, but especially more effective methods of reconciliation and visualisation of data along enhanced interfaces between front office and risk systems.

Can you briefly explain some of the effects on capital ratios?

Banks face an increase in RWA due to more prudent assumptions in the underlying scenarios of both internal models and standardised approaches for market and credit risk.

To name but a few examples: Not only does the FRTB IMA make estimations of expected shortfall on high confidence levels mandatory and introduce stressed liquidity horizons to all asset classes. But also the FRTB SA’s correlation factors and risk weights assume a stress scenario that will lead to significant increases in RWA under the new market risk framework for most institutions regardless of model choice.

The credit risk portion of BCBS 424, among other things, introduces higher risk weights and CCF to the CRSA as well as input floors for PD, LGD and CCF to the IRBA. Large corporates and institutions are to be exempted from AIRBA application.

Our teams have put together quite extensive lists of such factors and are performing impact studies with our clients so that together we can brace for impact and derive measures to dampen the blow. However, the overall picture is that capital ratios will decline where the only alternative is to significantly adjust business models in order to circumvent those “pitfall” positions that are punished most severely in terms of capital requirements in the new frameworks.


Without giving too much away, could you please give an insight as to the current challenges of implementing under uncertainty.

Timing the perfect starting point to start implementation of upcoming regulations is an increasingly difficult task, but crucial to any project success for banks. Simply waiting for new regulations being finalised before starting implementation is not an option with legislative measures taking direct consequence in one’s own national discretion and massive impacts on business strategy and profit. Therefore, banks start to implement agile project teams to see first results on upcoming changes in banks’ processes as early as possible while still remaining flexible enough to adapt to any modifications of regulatory or strategic requirements.

How do you see the risk landscape evolving over the next 6-12 months?

On the micro level, we will see impacts of regulatory changes that have come into force recently – most notably the broad impact of IFRS 9 on risk management and reporting processes due to changes in risk provisioning for possible loan losses and asset categorisation. These have implications for calculation and reporting of own funds requirements, e.g. through shortfall calculations and a growing fair value measured baseline for the application of the prudent valuation framework. This is aggravated by uncertainties regarding regulatory changes scheduled for implementation in the coming months. There is, for example, still no finalised version of the prudent valuation ITS available, even though we are informed to expect the new templates to be included in DPM 2.8 with relevance for reporting date 31 December 2018. Additionally, we expect the finalisation of CRR 2 to be due beginning of 2019.

Taking a step back and looking at the evolving project landscape, we see banks putting more energy into projects with a strong focus on data integration. This is, firstly, driven by individual deadlines for BCBS 239 compliance due in the coming months. Secondly, there is a growing number of reporting requirements that seek to integrate reports on the previously separated Basel pillars or to bridge the gap between accounting, financial, and risk reporting: internally modelled behavioural cash flows in the updated AMM for Liquidity are an example for the former. The integration of COREP and FINREP figures in the new Disclosure requirements and the new COREP General Governments template are examples of the latter.

Lastly, on the macro view, we expect a decrease in the number of banks planning to keep their internal models for the calculation of capital requirements as a result from the increased cost imposed by the regulator through the direct effects mentioned above as well as the ongoing adaptations to special reportings focused on internal models (such as the ever changing SBP reporting package) and additional burdens such as the recent TRIM exercises. These issues increase opportunity costs of maintaining internal models. We are excited to see research into new technologies such as institutions probing into blockchain applications to syndicated lending or trade settlement. There is a strong need for technological innovation in banks not least caused by the competition imposed by FinTechs which we may only expect to grow further.

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