accenture basel iii going beyond compliance

7/23/2019 Accenture Basel III Going Beyond Compliance

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Basel III RWA OptimizationGoing Beyond Compliance


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1. Introduction 3

2. Basel III RWA Optimization 5

2.1 Key determinants of RWA 5

2.2 Focus Topics for Basel III RWA Optimization 5

2.3 Challenges to Basel III RWA Optimization 13

2.4 Going beyond compliance 14

3. How Accenture Can Help 15

4. Conclusion 17

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Contents


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In the post-financial crisis environment,

the global banking industry facesa number of difficult challenges.These range from pressures causedby the erosion of earnings, to risingoperating costs, to an increasinglycomplex infrastructure, to proliferatingregulatory requirements. Theserequirements have been implementedin part as a response to the financialcrisis, to increase the stability of thefinancial markets and to prevent furthernegative impact on the economy. One

major focus represented by Basel III is on strengthening global capital andliquidity rules.

Key components of the Basel IIIframework include: a stricterdefinition of capital; increasedcapital requirements for counterpartycredit risk arising from derivatives,repurchase agreements (repos) andsecurities financing activities; and theintroduction of higher capital ratios, anon-risk-based leverage ratio and a new

global liquidity standard.1These newrequirements, and the associated highercapital and liquidity costs, put furtherpressure on the profitability of banks.Banks may review and adjust theirbusiness model and funding strategy tofulfill the new rules on the one hand,and go beyond compliance and restoreprofitability to protect shareholdervalue on the other. Basel III, therefore,can be much more than a regulatorymatter; it can be a business issue with a

regulatory trigger.

The capital squeeze resulting from

Basel III is also making the optimizationof risk-weighted assets (RWA) a keytopic of discussion around the newframework. RWA optimization is not anew topic as many banks have conductedcorresponding projects in the past andhave implemented different measures.With Basel III, however, RWA optimizationcan become more important, as anincrease of the capital base - which isvital for the survival and growth of banks- is limited. Furthermore, with Basel III

and the higher capital requirements forcertain instruments, topics and methods,new concerns and levers can becomethe focus of attention. These have notbeen the focus of past RWA optimizationconsiderations. Basel III RWAoptimization can be seen as an extensionof the Basel II RWA optimization.2

Figure 1 summarizes the Basel III capitalrequirements that can lead, all otherthings being equal, to a reduction ofthe available regulatory capital (due

to the stricter definition of capital)and an increased RWA (enhanced riskcoverage); these results should be seenagainst the background of increasedcapital ratios.

Definition of capital

Basel III introduces a new definitionof capital to increase the quality,consistency and transparency of thecapital base. Common equity (i.e.,

common shares and retained earnings)must be the predominant form ofTier 1 capital. Further, Tier 2 capitalis simplified and reduced, Tier 3capital is eliminated, and regulatoryadjustments are harmonized andgenerally applied at Common EquityTier 1 capital (CET 1 capital). Finally,Basel III changes the disclosurerequirements and introduces a newlimit system of the capital components.

Altered risk coverage

In addition to the reforms to the Basel IIframework by the Basel Committee onBanking Supervision (BCBS) in 2009 andthe amendments made in the EuropeanCapital Requirements Directive III(CRD III) applicable to EU member states increased capital requirements for thetrading book and complex securitizationpositions, stressed value-at-risk capitalrequirements for the re-securitizationof the banking and trading books Basel III adds the following reforms:

calculation of the capital requirementsfor counterparty credit risk (CCR) basedon stressed inputs; introduction ofa capital charge for potential mark-to-market losses (credit valuationadjustment, CVA) for OTC derivatives;increased asset value correlation inthe IRB approach for exposures tocertain financial entities; strengtheningstandards for collateral managementand initial margining; raising CCRmanagement standards.

In addition, for Basel III, in May 2012the BCBS published a consultativedocument for a fundamental review ofthe trading book, which includes severalmeasures to improve trading bookcapital requirements.3

1. Introduction

1. See Accenture (2012): Basel III Handbook for an extensive summary of Basel III; http://www.accenture.com/us-en/Pages/insight-basel-iii-handbook.aspx

2. Basel III may also lead to an increased level playing field regarding RWA, i.e., the RWA figures of institutions across regions are typically becoming more comparable.An analysis of RWAs between regions as well as over time can be found in Accenture (2012): The New Importance of Risk-Weighted Assets across Europe;http://www.accenture.com/us-en/Pages/insight-new-importance-risk-weighted-assets-across-europe.aspx

3. BCBS (2012): Fundamental review of the trading book; http://www.bis.org/publ/bcbs219.pdf


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Figure 1: Increased capital requirements in Basel III

Higher capital ratios

While the total capital ratio underBasel III will remain eight percent ofRWA, CET 1 capital ratio increasesfrom two percent to 4.5 percent andthe additional Tier 1 capital ratio is 1.5percent, leading to a Tier 1 capital ratioof 6 percent. Tier 2 capital decreases

by reducing the ratio to 2 percent ofRWA. In addition to the total capitalratio Basel III introduces a capitalconservation buffer of 2.5 percent ofRWA which applies at all times, as wellas a countercyclical capital buffer inthe range of 0 to 2.5 percent dependingon macroeconomic circumstances. Forglobal systemically important banks(G-SIBs) an extra buffer of 1 to 2.5percent will be implemented.4

On a national level, additional capitalbuffers (e.g., for systemic risk) might beimposed. All the buffers are to be metwith CET 1 capital.

Our focus is on RWA optimization, i.e.on optimizing the denominator of thefraction in Figure 1.5There are alsoseveral measures on the capital side

which banks might consider in an effortto fulfill regulatory requirements and torestore profitability.6

It should be noted that in some regionssuch as the European Union (EU), theBasel III requirements are implementedthrough own legal instruments (in theEU through the Capital RequirementsRegulation (CRR) and the CapitalRequirements Directive (CRD IV)). The

final versions of these documents havenot been published yet, so that bankshave to deal with the implementationof the new requirements and RWAoptimization measures, although severalaspects which might have a materialimpact on the capital requirementsare still in discussion. Several aspectsof the CRR and CRD IV also have to be

specified by technical standards releasedby the European Banking Authority(EBA). Many of them will be publishedin the next few years after Basel IIIis in force. Ultimately one questionis whether all regions will implementBasel III as planned, or if we will seemajor content-related deviations, delaysor even non-implementation in somecountries, as was the case with Basel II.

Source: Accenture

4. The bucketing approach of the BCBS to determine the magnitude of additional loss absorbency for G-SIFIs includes for the highest populated bucket a buffer of 2.5% ofRWA at all times; there is an initially empty top bucket with a buffer of 3.5% of RWA. See BCBS (2011): Global systemically important banks: assessment methodology and theadditional loss absorbency requirement; http://www.bis.org/publ/bcbs207.pdf

5. This document focuses on regulatory capital within pillar 1 of the capital framework. The optimization of the economic capital (pillar 2),e.g., by consideration of intra- and inter-risk dependencies is not covered.

6. See Accenture (2011): Capital Optimization. Realign your operations to limit the capital squeeze;http://www.accenture.com/us-en/Pages/insight-capital-optimization-summary.aspx

18%

16%

14%

Lower Tier 2 capital -max. 50% Tier 1 capital

Upper Tier 2 capital

Max. 50% of Tier 1 capitalinnovative hybrid capitalmax. 15% of Tier 1 capital

Total capital: CET 1 capital,Additional Tier 1 capitaland Tier 2 capital

SIBs capital buffer extra cushion CET 1(1-2.5%)

Basel II/II.5

Basel III

Capital

Risk-Weighted Assets

Requiredcapital ratios

=

Increased Tier 1 capital (going concern)

Simplification and reduction of Tier 2capital (gone concern)

Elimination of Tier 3 capital

New eligibility criteria and limits forcapital components

Increased RWA for counterparty creditrisk (CCR) calculation based onstressed inputs

Introduction of a capital charge forpotential mark-to-market losses ofOTC derivatives (CVA)

Increased asset value correlation (AVC)

in the IRB approach for exposures tolarge regulated and non-regulatedfinancial entities

Introduction of capital charge forspecific wrong way risk

Further strengthening of standards forcollateral management and initial margining;raising CCR management standards

Countercyclical capitalbuffer extra cushionof CET 1 (0-2.5%)

Capital conservationbuffer extra cushionof CET 1 (2.5%)

12%

10%

8%

6%

4%

2%

0%

CET 1 capital

Additional Tier 1 capital

Tier 2 capital

Tier 3 capital

Tier 2 capitalmax. 100%of Tier 1capital

Basel II/II.5 Basel IIl

Capital conservation buffer

Countercyclical capital buffer

SIBs capital buffer

Tier 1 capital

Tier 3 capital


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2.1 Key determinantsof RWAAccenture has identified the followingas key determinants influencing theRWA of banks. For a more detaileddiscussion see Accenture (2012): TheNew Importance of Risk-WeightedAssets across Europe:

Business model

The business model is one of the

key factors of banks RWA, whichcan affect the portfolio and balancesheet structure. Banks with largetrading and investment bankactivities and securitization positionscan be more affected by the newcapital requirements of Basel IIIthan commercial banks focusing ontraditional customer loans. Evenfor commercial banks, however, RWAoptimization can be crucial, consideringthe increased capital requirements andthe limited possibility to increase CET 1

capital through the capital marketsor by retaining earnings. The businessmodel is an important factor of the riskprofile of a bank.

Risk management

The approaches used to calculate thecapital requirements for credit, marketand operational risk and the modelsused for estimating the risk parameters,policies, and monitoring or recovery

procedures often have a significantimpact on RWA.

Data quality andIT infrastructure

Additionally the RWA is often influencedby the IT infrastructure, data availabilityand data quality. For instance thecorrect mapping of transactions to theasset classes or the quality of PD andLGD estimations often depend on theavailability and quality of data. This isa key aspect under Basel III as severalRWA optimization measures requiredata that is not always available in some

banks systems.

Supervisory practices

Different supervisory practices such asthe criteria for cycle adjustments (e.g.,point-in-time vs. through-the-cyclemodels), the definition of a downturn, orthe validation and approval process ofIRB models might also impact the RWA.

Accounting standards

Finally, accounting standards can havea material impact on RWA and theymay also explain some of the RWAdifferences between banks in differentregions [examples can be found inAccenture (2012): The New Importanceof Risk-Weighted Assets across Europe].The interaction of developments inregulatory and accounting standardspointed out by the European BankingFederation creates a number ofbeneficial issues worth examining in

greater detail.7

2.2 Focus Topics forBasel III RWA OptimizationIn the early stage of Basel IIimplementation many banks focused onregulatory compliance rather than onRWA optimization, and potential RWAreliefs were often not fully utilized.Market developments forced banks tofocus more on RWA optimization and

many banks implemented corresponding

projects, often with a focus on creditrisk (such as the implementation of IRBapproaches) and in the course of doingso realized significant capital relief. Thenew regulatory requirements of Basel IIIreinforce the importance of RWAoptimization measures focusing, at leastin part, on new topics and levers suchas Credit Valuation Adjustment (CVA).Figure 2 provides an overview of RWAoptimization focus topics; while some ofthe aspects are Basel III specific, others

are not but may need to be evaluatedor re-evaluated in light of the newrequirements. It should be noted thatthere are overlaps between the topics.

While Figure 2 provides a genericoverview, the focus topics of a concreteRWA optimization project can dependon the specifics of the bank and theassociated key risk drivers. Furthermore,the RWA impact of Basel III can varybetween the different business units; forinstance, it may be significantly smaller

for the retail business compared to thetrading units.

For identifying and implementingRWA optimization measures it isimportant to consider not lookingsolely at RWA figures but also at theimpact on profitability. Otherwise,banks can run the risk of reducing oreliminating RWA-consuming activitieseven though they are profitable andtherefore beneficial to building upthe capital base through retainedearnings. The dependencies withother Basel III topics such as liquidityratios should also be considered.

Accentures experience showsthat sometimes, in addition tothe RWA figure, the expected loss(EL) in the form of a scaled RWA leading to a RWA equivalentas key metric be considered inRWA optimization projects.

2. Basel III RWA Optimization

7. European Banking Federation (2012): Interaction of developments in the regulatory and accounting frameworks;http://www.ebf-fbe.eu/uploads/0201-2012-BC-Interaction%20between%20Regulatory%20%20Accounting%20Framework.pdf


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Figure 2: RWA optimization focus topics

Focus Topics

Review and validationImpact analysis

Definition of target situationDerivation and prioritization of RWA optimization measures

Implementation of RWA optimization measures

Active RWA, portfolio and balance sheet management

Go beyond compliance/restoring profitability

Approaches &Models

Approaches forcredit, marketand operationalrisk

Processes withdirect andindirect impacton RWAcovering front,middle and backoffice operations

Approachesand modelsCCR

Credit valuationadjustment(CVA)

Centralclearing

Asset valuecorrelation(AVC)

Focus topics Basel II and Basel III RWA Optimization

Focus topics Basel III RWA Optimization

Businessmodel underBasel III

Portfoliostructure

Collateralmanagementcredit risk

Collateral

managementmarket risk

IT infrastructure

Data quality

Clientstructure

Productstructure

Models and

methods

ProcessesCounterpartyCredit Risk (CCR)

Business Model/PortfolioOptimization

CollateralManagement

IT &Data Quality

1 3 4

5

6

7

8

9

10

12

13

14

15

11

2

Source: Accenture


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2.2.1 Approaches and Models

1. The regulatory approaches formeasuring credit, market andoperational riskare one of theRWA optimization levers.

Many of the larger banks haveimplemented internal approaches for

market risk and the Internal RatingsBased (IRB) approach for credit riskfor a large portion of their portfolios.For operational risk, it seems that onlymajor banks are using an AdvancedMeasurement Approach (AMA).For banks not using an AMA theimplementation of such an approachcould lead to a RWA relief. In thepast, several banks evaluated theimplementation of an AMA, not leastdue to the fact that the relevant

indicator (gross income) used in thebasis indicator approach and in thestandardized approach increased,leading to higher capital requirements.Data quality issues and the highsensitivity of internal operational riskmodels (low frequencies and highimpact events) often prevented animplementation in the past.

With Basel III many larger banks areonce again considering implementationof an AMA to reduce RWA. Within the

standardized approach for operationalrisk the potential for RWA relief may liein the correct and complete mappingof transactions and their incomes topre-defined business lines which areassigned different beta factors.

For banks using the standardizedapproach for credit risk theimplementation of an IRB approachcould lead to lower RWAs. Whether theeffect is positive depends in part on the

underlying portfolio. For, a portfoliowith poor credit quality customers, forexample, the standardized approachmight be better from a pure RWApoint of view. The move from the IRBapproach back to the standardizedapproach is an option that may runcounter to the regulators expectations,as Basel III includes several measures toreduce reliance on external ratings.

Banks not currently using an internalmodel for market risk should considerswitching to a more sophisticatedapproach, as this often leads to asignificantly lower RWA compared tothe standardized approach. Internalmodels can allow sophisticatedoptimization methods for Value at Risk(VaR) such as marginal VaR. In addition,

internal models can lead to a betterunderstanding and risk management ofthe banks own portfolio.

2. The models and methodsfor calculating risk parametersare another lever forRWA optimization.

For credit risk this refers to the modelsand methods used for calculating theprobability of default (PD), loss given

default (LGD) and exposure at default(EAD) including the estimation of creditconversion factors (CCF) which haveoften been within the scope of pastRWA optimization projects. Accenturesexperience indicates that the LGD andCCF estimation is often not optimal inthe context of RWA optimization; forinstance, lack of data availability andpoor data quality can lead to high LGDand CCF values driving up regulatorycapital requirements. Some bankshave also reduced the complexity oftheir models to avoid achieving greateraccuracy at the expense of higher RWAs.

With Basel III and the consultativedocument Fundamental Review of theTrading Book published by the BaselCommittee on Banking Supervision(BCBS)8, market risk models andmethods are now part of the focusof many Basel III RWA optimizationprojects. This review follows therevisions to the market risk framework

in July 2009 (Basel II.5) which didnot fully address the shortcomings ofthe Basel II framework. Key elementsof the proposals are: A more objectiveboundary between the trading bookand the banking book to reduceregulatory arbitrage; moving fromvalue at risk to expected shortfall;stress-based calibration of models;incorporating market illiquidity risk as

well as measures to reduce model riskin the internal models-based approach(by strengthening requirements fordefining the scope of portfolios andstrengthening the internal modelstandards) and a revised, more risk-sensitive standardized approach.

8. BCBS (2012): Fundamental review of the trading book; http://www.bis.org/publ/bcbs219.pdf


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2.2.2 Processes

3. Risk management processesare levers which have often notreceived sufficient attention inpast RWA optimization projects, assome of these projects focused onquick wins and easy-to-implement

measures such as the optimizationof calculation engines.

However, experience indicates thatthere is a perceived need to verifysustainability of process improvementsby monitoring them, including thecollateral re-evaluation process and therating process. This lever can becomemore important, not only due to highercapital requirements but also from acost perspective. RWA optimization

projects can benefit from a holistic viewof the processes, and from taking frontoffice processes into consideration.One example would be increasing theresponsibility of customer managers

for their clients RWA by providinginformation about the risk weight andRWA consumption of credit applicationsrelative to benchmarks. If these valuesare outside a defined range, additionalRWA reduction measures could berequested for approvals.

One approach is to increase collateral

while reducing the complexity and thelatitude given customer representativesby the development of a relativelysimple collateral handbook and systemsupport, including check boxes for bothquantitative and qualitative criteria.Another example is the optimizationof RWA reporting, including thevisualization of RWA consumption anddevelopment for different products,portfolios or business lines.


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2.2.3 Counterparty CreditRisk (CCR)

4. The new capital requirementswithin counterparty credit risk area key RWA driver of Basel III.The requirements and theirimpact depend, in part, onthe approaches and modelsused by banks, as some of therequirements refer only to theInternal Model Method (IMM), forinstance the stressed calibrationof the Effective Expected PositiveExposure (EEPE).

Others, such as the CVA capital charge,affect many banks, no matter whichapproach is used. Within the IMM

there can be several challenges whichinfluence the RWA, ranging fromsufficient coverage of the relevantproduct types by the IMM to effectivecollateral management (especially intimes of volatile markets) to correctmapping of transactions and collateralsto netting/margining sets.

5. In addition to the defaultrisk capital requirements forCCR, Basel III introduces an

additional capital charge (theCredit Valuation Adjustmentor CVA) that covers the riskof mark-to-market losses onthe expected counterpartyrisk to OTC derivatives; it doesnot refer to centrally clearedor defaulted transactions.

There are two different approacheswhich can be used for the calculation

of the CVA capital charge. Banks withIMM approval for CCR risk, and approvalto use the market risk internal modelsapproach for the specific-interestrate risk of bonds must calculate

the additional capital charge bymodeling the impact of changes in thecounterpartys credit spread on theCVAs of all OTC derivatives using theinternal VaR model. Other banks mustcalculate a standardized CVA capitalcharge. Within this method own fundsrequirement, portfolio levels have to becalculated using the given formula.

An internal Accenture CVA impulsesurvey conducted in Germany,Switzerland and Austria in mid-2012uncovered the following:

The CVA capital charge is themain Basel III driver for theRWA increase leading often toa rise of the total CCR capitalrequirements by about 100%.9

Only the largest banks use the

advanced CVA approach, which doesnot always lead to significantly lowerRWAs compared to the standard CVAapproach. The difference betweenthe approaches varies considerablybetween banks. Often the economicpoint of view is decisive in using themore sophisticated approach.

The impact of the CVA capital chargeon profitability can differ considerablybetween banks. Some major banks arealready restructuring their portfolios

to reduce the CVA impact while othersare planning to do so. Other, smallerbanks currently focus on increasinghedging and collaterals.

For many major banks, CVAdata quality has a high priorityfrom a regulatory as well asan economic perspective.

One of the key challenges isregulatory uncertainty, as most banksexpect further changes to the currentCVA requirements.

To reduce the RWA impact somebanks are considering and alreadyimplementing different measuresincluding:

Maximizing utilization of nettingand collaterals.Due to the increasedimpact of non-netted or collateralizedexposures, one area of concentration

is on increasing the use of collateralfor derivatives transactions wheneverpossible. This refers in particular tonew transactions, but can also havesignificant impact upon already existingcontracts, thus justifying additionalefforts to renegotiate these contracts.

Reducing maturity of OTC derivatives/usage of break clauses.The maturityof transactions is one of the maindrivers of the CVA capital charge,and therefore measures to reduce the

effective maturity of transactions areoften given a high priority. One directapproach is the use of unconditionalbreak clauses which are often used inthe course of the limit system. The breakclause should specify that the bank maycancel the transaction at an identifieddate without particular conditions,meaning the break clause would not belinked to changes in the rating of thecounterparty, the economic situationor other events not controlled by the

bank. If these requirements are met, thebank may use the date of the first breakclause as the effective maturity insteadof the transaction, instead of the actualmaturity instead of the transaction.

9. It should be noted that the indicated increase in the capital requirements dates to the completion of the survey.As banks are currently considering/implementing RWA optimization measures, the figures may have changed.


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An additional method to reduce theeffective maturity is based on thecalculation of the CVA charge in thestandardized approach. This takesinto account the maturity of thecounterparty which can be averagedacross its transactions. Many banks arecurrently calculating CVA on transactionlevel (based on the transaction maturity)

and aggregate the CVA on counterpartylevel in a second step. Better outcomesmight be achieved by first averagingthe maturity across the differenttransactions of the counterpartyand then calculating the CVA on thecounterparty level.

Exposure classes which are exemptedof the CVA charge:Although theregulations are not final yet (see, forinstance, regional implementationof Basel III requirements in the EU)there are several exposure classeswhich might be excluded from theCVA capital charge. The identificationof these classes (such as transactionswith small non-financial firms) andthe implementation of additionalrequirements (for example, confirmingthe business need of a transaction) isanother possible approach to minimizethe RWA effects. Experience showsa reduction of more than 50 percentof the total CVA capital charge for

certain global banks if transactionsconcluded with non-financialcounterparties to reduce the riskof the underlying activity would beexcluded from the CVA capital charge.

Improving data qualityThe CVA rulescreate additional requirements for datacollection, processing and assurance.This can be especially important ifthe CVA figures are used not onlyfor reporting purposes but also foractive management and pricing ofderivative transactions, as for example,data quality issues might lead to anerroneous allocation of costs. We haveseen poor data quality resulting frominput systems or from the process chainas when unilateral CSA agreementsare not properly processed lead tosignificantly higher CVA capital charges.Examples for reducing the CVA capitalcharge by improving data qualityinclude, depending upon the approach

used: an adequate and correct gatheringof netting (ISDA) and collateral (CSA)data; sufficient history of market data;timely information of credit eventsand/or defaults; reconciliation ofcounterparty reference data; and datacleansing regarding outdated ratings.

In addition to the aforementioned

RWA reduction measures, banks shouldconsider integrating the CVA capitalcharge into the pricing of derivatives.Currently, the CVA capital charge isoften not included in the pricing. Thismight lead to arranging a transactionwith a low or even negative marginconsidering the new requirement, withthe increased capital costs not covered.

6. An optimization measure toreduce the negative impact of

the CVA capital charge is centralclearing or clearing throughcentral counterparties (CCPs).

In this context dependency with otherregulations should be considered, asthe G20s reform package to reducethe systemic risk of OTC derivativesrequires that all standardized OTCderivatives should be traded onexchanges or electronic platforms, asappropriate. The G20 also requires that

all standardized OTC derivatives shouldbe cleared through CCPs and that OTCderivative contracts should be reportedto trade repositories. In the EU theserequirements are implemented throughthe European Market InfrastructureRegulation (EMIR). Non-centrally clearedOTC derivatives should be subject tohigher capital requirements (CVA).10

Banks can centrally clear transactionseither as a clearing member (directparticipant) or as a client (clearing

through clearing member) thoughthere are strict requirements tobecome a clearing member. Dependingon the role of the bank, differentrisk weights apply.11It should alsobe noted that CCPs currently offerthe possibility for central clearingonly for selected products.

For RWA optimization, future as wellas existing transactions can be clearedcentrally by negotiating with the

counterparties to cancel the existingtransaction and conclude a new onewith the same conditions, clearing itcentrally (known as back loading). Thiscan lead not only to a reduction of theBasel III capital requirements, it can alsoprevent a potential CVA capital chargeincrease due to rating changes of thecounterparty.

7. Basel III increases the riskweights on exposures to financialinstitutions relative to the non-financial corporate sector in theIRB approach by increasing thecorrelation coefficient by 25percent for exposures to largeregulated financial entities and toall unregulated financial entities

(Assets Value Correlation orAVC).12

Depending on the probability ofdefault (PD) of the counterparty,this can lead to an increase of RWAby approximately 20 to 35 percent.Basel III RWA optimization projectscan benefit from evaluating thepossibility of reducing the relevantcounterparties or their exposure,focusing on those with poor creditquality. One of the challenges in doing

this is the availability of data such asconsolidated balance sheet informationto identify the relevant entities.

10. BCBS, IOSCO (2012): Margin requirements for non-centrally-cleared derivatives. Consultative document; http://www.bis.org/publ/bcbs226.pdf

11. See BCBS (2012): Capital requirements for bank exposures to central counterparties; http://www.bis.org/publ/bcbs227.pdf

12. Basel III (BCBS) considers institutions as large if the total assets, on an individual firm level or on a consolidated group level, are greater than or equal to US $ 100 billion.The CRR includes a threshold of EUR 70 billion.


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2.2.4 Business Model/Portfolio Optimization

8. To fulfill the new regulatoryrequirements of Basel III,especially the increased capitaland liquidity requirements,and to restore profitability,banks may need to adjusttheir business models.

The extent of the adjustment for eachbank may depend upon, among otherfactors, their current business model(as the impact of Basel III varies bydifferent business lines), the overallhealth of the bank, and the derived riskand funding strategy within the newframework. Recently, many banks havetaken actions such as shrinking their

capital markets businesses or reducingportfolios with high RWA consumption,such as structured credit portfolios.

Other measures might include astronger focus on specific customersegments such as retail and small andmid-sized enterprises, an adjustmentof the products and services offered,or optimization of the group structureto reflect the economic and politicalconditions in the different geographies.This could mean reducing direct and

indirect holdings of financial entitiesor selling off group entities andminority interests. In reviewing thesepossibilities, it is important to considernot only the RWA but also the possibleimpact on profitability.

9. Basel III RWA optimizationmeasures could includea quantitative andqualitative adjustment of

the portfolio structure.Certain portfolios such as trading assetsmight have a significantly lower oreven negative return on equity underBasel III so that it can be beneficial toanalyze a reduction or run-down of theinvestment portfolios or of the asset-backed securities. The quality of theportfolio can also be improved to reducethe RWA, for instance, by reducing thenumber of high-risk customers (thosewith a high probability of default) in

the banking portfolios. Deepeningthe impact on other Basel III topics,above all the liquidity ratios, should betaken into account along with otherdependencies. Finally, banks should

consider implementing an active RWAportfolio management program.

10. Measures to optimize theclient structurecould includefocusing on customers with goodcredit quality (low PD) or oncustomer segments which benefit

from the new requirements.In this context, it should be noted thata reduction of the risk weights of smalland medium sized entities in the IRBapproach is currently under discussionwithin the Basel III implementation inthe EU. This could reduce the RWA ofsuch positions by about 25 percent fromBasel II through the introduction of anew scaling factor in the IRB risk weightfunction. One prerequisite may be thatthe banks have the relevant data to

classify a customer as an SME accordingto the revised definition.

11. Several banks have started toanalyze their product structure,taking into account the impactof Basel III and other regulationssuch as IFRS, and to derive RWAoptimization measures to reducethe regulatory impact.

In doing so, banks should considerthe relative RWA impact, that is, therelative RWA increase of a product ona standalone basis, and the absoluteRWA impact, that is, the absoluteRWA increase in a portfolio context.Possible RWA optimization measuresrefer primarily to derivatives exposuressuch as the reduction of maturitiesof OTC derivatives. In addition to newtransactions, the possibility of changingexisting transactions through increasingcollateral or central clearing should alsobe taken into consideration.

In optimizing the product structurethe Basel III liquidity ratios liquiditycoverage ratio (LCR) and net stablefunding ratio (NSFR) play an importantrole and should be considered. Manybanks are currently taking differentactions to increase LCR and NSFR,including moving to long-term depositsand reducing short-term funding.Adequate pricing might also be

implemented to counteract the impactof the Basel III liquidity ratios.

2.2.5 Collateral Management

12. Optimization measures inthe area of credit risk collateralmanagementhave been one ofthe key focus topics of someBasel II RWA optimizationprojects covering, among other

elements, the correspondingprocesses in the front-, middle-and back-office as well as aspectsof data quality.

Measures taken by financial institutionsto improve processes include theperiodical re-evaluation of collateral.In many cases, collateral was notconsidered eligible in the calculationengine due to the non-fulfillment ofqualitative criteria. Improving data

quality of collateral in the sourcesystems and the central data poolcan lead to a further significant RWAreduction. A validation layer can helpto analyze the collateral trail fromthe source system to the calculationengine and highlight a potential lossof principally eligible collateral. Dueto the increased default rates incertain regions and segments as wellas the ongoing capital pressure, banksshould consider analyzing whether all

optimization possibilities have beenrealized in the past and whether theimplemented or optimized processes arefunctioning well.

13. The use of collateralandhedging for risk mitigation ofmarket riskhas been commonpractice for many years.

Derivatives are often used to reducethe different types of market risk,

such as foreign exchange (FX) risk.In light of the increased volatility inthe financial markets as seen in shareprices and exchange rates, this canstill be an important part of risk andtherefore of RWA reduction. At themoment, the review of the trading bookbecomes the focus of attention forRWA optimization considerations, e.g.,the optimization of models consideringthe new requirements (highlighted insection 2.2.1). A further question is howto deal with measures currently used to

optimize the RWA but which might notbe feasible in the future, for instancethe reduction of market risk betweenthe trading and banking book throughthe use of arbitrage.


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2.2.6 IT and Data Quality

14. A properly organizedITfunction can deliverRWA optimization.

Basel III optimization measuresmight require improvements to ITincluding new interfaces or new

data fields for identifying relevantcounterparties and transactions.Good IT systems are necessary foractive, predictive RWA management.

15. Poor data quality, on the otherhand, can lead to a significantlyhigher RWA than needed.Because of increased regulatorypressure, RWA optimizationmeasures focusing on the

improvement of data qualityareoften gaining in importance.

In making IT and data improvements,banks should take into consideration notonly the new Basel III topics but alsoolder concerns such as credit risk, as notall potential upgrades have been made.Other measures for considerationmight include:

Unification of data formats for riskand finance data. Due to the evolution

of data requirements and the ability ofbanks IT systems to manage data theremight be disparities among the dataformats of different units or even withinsingle units. This can lead to deficienciesin general data availability, with dataused by one unit often not known by, oravailable to, other units. In such cases,collateral data in the credit systemmight not be available for applicationwithin the trading system to reduceRWA. Another potential problem is the

increase in the data management effortdue to the need to transform data fromone unit to meet the requirements ofanother unit. Such activity can also beassociated with possible errors in thetransformation process.

Clear responsibility for data ownership.Defining clear responsibilities for theownership of risk and finance datafosters an environment in which newdata and modifications of data canbe controlled and supervised by a

dedicated unit.

Thus the implications for the datarecipients often can be minimized,which can be important since, based onnew or changed regulations, specificcollateral is generally considered asnon-eligible although such collateralmight still be used for risk mitigation byother units.

Availability of RWA/risk data forpricing in the front office. Many banksdo not automatically use their riskdata for pricing purposes in the frontoffice units, and those that use suchdata often work with approximationsinstead of directly calculated riskcosts. This is often due to missing riskdata in the front office units. This isnot only a RWA optimization issue,but it can also influence a banksprofitability. By using risk data fordecisions in the front office, RWA couldbe reduced and profitability increased.

As described, there are several measuresbanks can take in an effort to optimizeRWA. Some of them are specific toBasel III while others are not and mighthave been previously considered. Forthese measures, it may be necessary toanalyze whether all possibilities havebeen taken into consideration and if theplanned RWA effect has been realized.

Whatever actions banks are consideringto help reduce the regulatory andeconomic RWA impact, they shouldconsider implementing with deepinvolvement of senior management anew framework which can enable themto maintain focus on RWAs and allowfor an active steering of this key metric.This framework could include:13

Better understanding of the dynamicsand key drivers;

Reporting capabilities both internal(within the bank) and external (toregulators and investors);

Full integration into the annualplanning process;

Mechanisms to monitor and controlthe evolution of RWAs on an ongoingbasis;

Forecasting and simulation processes;and

Support from robust analytical

capabilities.

13. See also Accenture (2012): The New Importance of Risk-Weighted Assets across Europe;http://www.accenture.com/us-en/Pages/insight-new-importance-risk-weighted-assets-across-europe.aspx


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2.3 Challenges to Basel IIIRWA OptimizationThe implementation of Basel III RWAoptimization measures is associatedwith a number of challenges, including:

Business challenges. Basel III andrelated RWA optimization measures

can challenge the business model andthe funding strategy of banks. Seniormanagement may be called upon tomake decisions on potential adjustmentsand prioritize them, considering notonly the impact on RWA but also on thebanks profitability. These might includereducing the trading portfolio; adjustingproduct portfolios; or placing a strongerfocus on certain customer segments orregions. These are often business-drivendecisions to determine how the businessmodel of the bank should look underthe new regulatory framework. Anotherimportant consideration is the inclusionof higher capital and liquidity costs inproduct pricing.

Organizational challenges. Changes tothe business model might also affectthe organizational structure, as someunits might be reduced or merged withothers while new units are established.Several banks are establishing,for instance, a CVA desk which is

responsible for the valuation andpricing of derivatives. In this contextclearly defined responsibilities can beimportant. Does the CVA desk have theultimate ownership for the developmentof new methods and models or isapproval required by the risk controlunit or function? Another example isthe implementation of a central unitresponsible for managing the increasingcomplexity of risk and finance data.Additionally, the implementationof Basel III and RWA optimizationmeasures may require coordinationbetween the different units as well aswithin the group.

Beyond these concerns, the availabilityof resources in quantitativeand qualitative terms can be animportant challenge for a successfulimplementation. Qualified and dedicatedresources are often required to keep up-to-date with all the regulatory changesand publications and to determine the

correct actions for the bank. Training, aswell as the transfer of knowledge andknow-how within the organization isoften key.

Functional challenges.Basel III andmany RWA optimization measuresare characterized by a high degree ofcomplexity, which can be increased bythe interdependencies between differentareas and the impact on profitability.Currently the Basel framework is underreview, in part to find a proper balancebetween the complexity of regulatory

requirements and risk sensitivity.

Technical challenges. Many banks alsoface the challenge of implementingthe new requirements in light of theaforementioned complexity, the shorttime available for implementation andregulatory uncertainties (for example,the final data requirements are notknown as of today). As many banksexpect further or changed requirementsin the future a flexible IT infrastructuremay be required. Finally, the shorterreporting periods can challenge theperformance of the IT systems.

Data challenges.The requirements ofBasel III and the interdependenciesamong the various matters underregulation lead also to increasedcomplexity of data requirements,especially in the area of counterpartycredit risk and the new liquidity ratios.Data availability, data completeness,data quality and data consistency

can be critical for a successfulimplementation of Basel III and RWAoptimization measures.

Regulatory challenges.One of thekey challenges many banks are facingin Basel III implementation and RWAoptimization projects is to deal withthe regulatory uncertainty as it relatesto implementing the requirementsalthough the final regulations theCRD IV package in Europe, for example are not yet published. While several

proposals are currently under discussion,depending on the final rules the Basel IIIimpact on RWA may vary considerably.There are also many aspects whichrequire finalization over the next fewyears. In the EU the European BankingAuthority (EBA) is expected to publishbinding technical standards during thistime. Until these are released and amarket standard is established banksare faced with the prospect of providingtheir own interpretations.


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2.4 Going beyond compliance

As we have seen, Basel III RWA optimization is concernedwith more than just regulation. We believe that banksshould consider going beyond compliance in an effort torestore profitability and protect shareholder value whileestablishing the new capital and liquidity framework.

Targeted implementations of optimization measures as wellas active balance sheet management are key elements tooffset at least part of the Basel III impact. Active balancesheet management can benefit from consideration ofassets and liabilities as well as a geographical optimizationof the balance sheet within the group. While manybanks have already addressed their balance sheets,for instance by reducing the trading portfolio, there isoften still room for further optimization through such

measures as growing retail deposits or reducing short-term funding. Pricing can offer additional opportunitiesfor improving profitability, as current pricing often doesnot fully reflect regulatory costs. It is also suggested thatdetailed actions be analyzed and implemented withinthe scope of Basel III RWA optimization projects.


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The demands and challenges of Basel III

implementation and associatedmeasures to optimize RWA and restoreprofitability are numerous and complex,calling for an efficient and structuredapproach. In working with bankingclients across the globe on theirresponse to the Basel III requirements,Accenture uses a tested and target-oriented three-stage approach alongwith our inventory of dedicated tools.Our approach is modular, flexible andscalable and takes into account each

clients specific situation. This canallow not only for an efficient Basel IIIimplementation but also for appropriatemeasures to mitigate the negativeeffects of Basel III on the bank.

The first stage is devoted to ananalysis of the banks current situation,including a Basel III impact analysis, thedefinition of the target situation andthe identification of the scale and focusof the project. Accenture has developedproprietary Basel III Diagnostic and RWA

Optimization Tools with a modular set-up to help identify actions necessary tomeet the requirements, optimize RWAand determine measures to restoreprofitability (see Figure 3).

In the second stage, based onthe results of stage one, the banktypically establishes priorities forimmediate action while planning forimplementation. The planning processis designed to take the banks specificcharacteristics as well as its ownstrategic priorities into consideration.

This stage also involves estimating the

implementation effort and uses businesscases to verify the measures neededin a detailed implementation plan (seeFigure 3).

Stage one and two together build theBasel III RWA optimization preliminaryreview, which is target-oriented andcan be conducted with the help ofour dedicated tools, often within afew weeks, depending on the size andcomplexity of the banks business.

During the third stage, the plan isimplemented, using project planningtools designed to identify and correctdeviations from the project plan. WithAccentures help the Basel III RWAoptimization implementation can beeffectively conducted by a dedicatedteam of functional and technicalpersonnel with extensive projectmanagement experience in the riskand banking area, using our testedproject management tools (see Figure

3). During the entire implementation ofRWA optimization measures, efficientprogress reporting is used to monitorand steer the predefined RWArelief target.

Our RWA Optimizationapproach is modular, flexibleand scalable and takes intoaccount the specific context

of each client

3. How Accenture Can Help


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Figure 3: Accentures Basel III RWA optimization approach

With our extensive managementexperiencewe can analyze your as-is

situation quickly, support you in your

Basel III RWA impact analysis and

define the target situation

Our Basel III and RWA tools can

identify gaps between the banks

situation and the Basel III regulatory

requirements and help you to identify

measures to optimize RWA and

restore profitability

Based on the Stage 1 results we cansupport the derivation and prioritization

of your action options

Create an implementation planthat

respects your priorities and focus

The Effort Estimatorcan deliver a

resilient estimate of the implementation

effort

Based on Business Caseswe can help to

validate and prioritize the measures in a

detailed implementation plan

The Accenture Delivery Methodcan support the planned

implementation in terms of time,

budget and quality parameters

Project management tools, Risk

and Issue Management, Progress

Tracking and Status Reporting can

identify deviations from the project

plan and target achievement and

initiate counteractive measures

Established project management

experiencein the Basel and RWA

optimization fields in functional,

technical and process-related areas

Stage 1:

As-Is-Analysis, Impact Analysis

& Definition Target Situation

Stage 2:

Derivation and Prioritization

Options and Implementation

Planning

Approach and tools

Stage 3:

Implementation of Optimization

Measures

Source: Accenture


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17

The new Basel III requirements present

major challenges to banks aroundthe world involving their capital andliquidity requirements as well as theirrisk management. One of the key issuesarising from the new capital frameworkis the optimization of RWA. AlthoughRWA optimization is not a new topic itmay be gaining in importance due tothe increased capital requirements, thestricter definition of capital as well asthe higher capital ratios within Basel III.There are a number of levers which

can be used in an effort to reduce theimpact on RWA. It is important to notethat Basel III RWA optimization maymean more than just fulfilling regulatoryrequirements; it can also help torestore profitability.

The implementation of Basel III andRWA optimization measures canalso lead to changes in the businessmodel and funding strategy of banks.Therefore, it can often represent morethan a regulatory concern; it can be a

core business concern with a regulatorytrigger. A comprehensive, target-oriented implementation and monitoringprogram, as well as active, predictiveRWA and balance sheet managementcan be essential to generating potentialimprovements in RWA and profitability.

Accenture works with banks in anumber of areas to address Basel III andRWA optimization issues and help setpriorities for the near, mid- and longerterm. With our extensive experienceacross a wide variety of aspects of riskmanagement, and long-time projectmanagement experience in Basel-relatedareas including functional, technicaland process-related assignments,Accenture is well suited to help bankschart a course in the Basel III landscape.

Accenture brings to bear a wealth of

highly experienced professionals, testedassets and tools to assist in identifyingthe gaps to effectively implementBasel III and related RWA optimizationmeasures, in addressing risk andissue management, progress trackingand status reporting, in identifyingdeviations from the project plan, targetachievements, and in initiating measuresto get back on the path to completion.

We believe that the real challenge forbanks will be to build upon the actionsmandated by Basel III to create strongercapital and risk structures. Banksthat meet and surpass the Basel IIIrequirements may not return to levelsof profitability experienced before theglobal financial crisis, but they can bein position to be well-prepared for thenew era and achieve high performancewithin their industry.

4. Conclusion


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Accenture Risk Management (2011):Capital Optimization. Realign youroperations to limit the capital squeeze.Accessed at: http://www.accenture.com/us-en/Pages/insight-capital-optimization-summary.aspx

Accenture (2012): The New Importanceof Risk-Weighted Assets across Europe.Accessed at: http://www.accenture.com/us-en/Pages/insight-new-importance-risk-weighted-assets-across-europe.aspx

Accenture (2012): Basel III Handbook.Accessed at: http://www.accenture.com/us-en/Pages/insight-basel-iii-handbook.aspx

Basel Committee on BankingSupervision (2010): Basel III: A globalregulatory framework for more resilientbanks and banking systems (December2010; rev. June 2011). Accessed at:http://www.bis.org/publ/bcbs189.pdf

Basel Committee on BankingSupervision (2010): Basel IIIInternational framework for liquidityrisk measurement, standards andmonitoring. (December 2010). Accessedat: http://www.bis.org/publ/bcbs188.pdf

Basel Committee on BankingSupervision (2011): Global systemicallyimportant banks: assessmentmethodology and the additional lossabsorbency requirement. (November2011). Accessed at: http://www.bis.org/publ/bcbs207.pdf

Basel Committee on BankingSupervision (2012): Fundamental reviewof the trading book. ConsultativeDocument (May 2012). Accessed at:

http://www.bis.org/publ/bcbs219.pdf

Basel Committee on BankingSupervision (2012): Capital requirementsfor bank exposures to centralcounterparties. Accessed at: http://www.bis.org/publ/bcbs227.pdf

Basel Committee on BankingSupervision, International Organizationof Securities Commissions (2012):Margin requirements for non-centrally-cleared derivatives. ConsultativeDocument (July 2012). Accessed at:http://www.bis.org/publ/bcbs226.pdf

European Banking Federation (2012):Interaction of developments in theregulatory and accounting frameworks.Accessed at: http://www.ebf-fbe.eu/uploads/0201-2012-BC-Interaction%20

between%20Regulatory%20%20Accounting%20Framework.pdf

References
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Authors

Dr. Michael Auer

Michael is executive director AccentureRisk Management, Munich, responsiblefor German-speaking markets. Michaelhas 18 years of industry and consultingexperience in financial services and riskmanagement across Europe working

with global institutions to transformtheir business and risk capabilities. Hisextensive experience in risk management mainly in the areas of market, creditand operational risk, risk and regulatorymatters and operating models helpsexecutives and their multinational firmsbecome high-performance businesses.

Dr. Georg von Pfoestl

Georg is senior manager Accenture RiskManagement. Based in Vienna, Georg

has 9 years of experience in the area ofrisk management with a focus on creditand liquidity risk, regulatory matters andRisk-Weighted Assets optimization. Withhis experience as a banking inspector atthe Austrian National Bank, his pragmaticknowledge from working with regionaland international financial institutionsacross German-speaking markets andhis technical skills pertaining to Basel IIand Basel III regulatory requirements, heguides companies on their journey to

high performance.

Bettina Tuerk

Bettina is a manager AccentureRisk Management. Based in Vienna,Bettina has 10 years of consulting andindustry experience in the area of riskmanagement with a focus on credit risk,regulatory matters, stress testing andRisk-Weighted Assets optimization. Withher solid banking industry experienceand comprehensive knowledge of Basel II

and Basel III regulatory requirements andissues, she supports companies on their

journey to high performance.

Christian Bergner

Christian is a consultant AccentureRisk Management. Based in Frankfurt,Christian has 5 years of experience inrisk management focused on regulatorycompliance, Risk-Weighted Assetsoptimization and credit risk. With hisindustry and consultancy experienceworking with banks and financialinstitutions in German-speaking markets,Christian uses his technical capabilitiesand regulatory requirement knowledgeto guide companies in enhancing theircompliance programs and initiatives onthe journey to high performance.

About AccentureManagement ConsultingAccenture is a leading provider ofmanagement consulting services

worldwide. Drawing on the extensiveexperience of its 16,000 managementconsultants globally, AccentureManagement Consulting works withcompanies and governments to achievehigh performance by combining broadand deep industry knowledge withfunctional capabilities to provideservices in Strategy, Analytics, CustomerRelationship Management, Finance &Enterprise Performance, Operations, RiskManagement, Sustainability, and Talent

and Organization.

About Accenture RiskManagementAccenture Risk Management consultingservices work with clients to create andimplement integrated risk managementcapabilities designed to gain highereconomic returns, improve shareholdervalue and increase stakeholderconfidence.

About AccentureAccenture is a global managementconsulting, technology services andoutsourcing company, with more than323,000 people serving clients inmore than 120 countries. Combiningunparalleled experience, comprehensivecapabilities across all industries andbusiness functions, and extensive researchon the worlds most successful companies,Accenture collaborates with clients tohelp them become high-performancebusinesses and governments. The companygenerated net revenues of US$30.0 billionfor the fiscal year ended Aug. 31, 2014. Itshome page is www.accenture.com.

DisclaimerThis document is intended for generalinformational purposes only and does not

take into account the readers specificcircumstances, and may not reflect themost current developments. Accenturedisclaims, to the fullest extent permittedby applicable law, any and all liability forthe accuracy and completeness of theinformation in this document and for anyacts or omissions made based on suchinformation. Accenture does not providelegal, regulatory, audit, or tax advice.Readers are responsible for obtaining suchadvice from their own legal counsel orother licensed professionals.

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