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Basel III Reforms: ‘Heads in the Cloud’ Time for Financial Institutions

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By Alexander Dorfmann, Senior Product Manager, SIX.

Cast your mind back to around this time 14 years ago, when a certain investment bank’s share price nose-dived amid major concerns that its short-term liabilities were far greater than its liquid assets.

That bank was Lehman Brothers, of course, and its downfall was underpinned by a fundamental failure to understand how much capital it needed to hold in reserve and how much liquidity has to be available to make its short-term liquidity payments. It was the equivalent of the man on the street walking around with a debit card without enough money on the card to pay for everyday essentials.

Almost one-and-a-half decades on, the issue of how financial institutions review their capital for operational, credit, and market risk are still major factors in the future of finance. First enforced back in the 1980s only to come into the mainstream after the 2008 crash, the fourth instalment of Basel comes into force in less than 24 months’ time. Two years will come around sooner than people think, and no bank wants to run the operational risk of failing to calculate exactly how much capital and liquidity is needed to protect themselves from credit losses and sharp price falls.

But unlike previous versions of the rules, this version of Basel is more evolutionary, rather than revolutionary. This is due to the fact that, like so many other regulations that already have the basic framework of rules in place, there are no dramatic changes required. The revised Basel rules are mainly a series of intricate details that have been tweaked to keep pace with increasingly complex financial instruments.

These minor alterations to Basel come as regulators continue to increase their focus on high-quality, accurate and transparent reference, and historical market data. However, no bank, particularly in the current economic climate, can afford to be running largescale internal regulatory projects for just a few small incremental changes right now.

The reality is that this version of Basel is a real driver for greater automation and cost efficiency. Accelerated by the new Basel capital framework for credit and market risk, this quest for greater efficiency could be marked by a shift from capital expenditure (CAPEX) to an operational expenditure (OPEX) approach. After all, it is not as if a bank has to disclose their client positions, it is all about what assets they hold.

Moving internal rule sets, financial products, and databases into a cloud environment should, in theory, free up working capital for a bank to invest into profit making areas for the business. A hosted solution forces the bank’s data providers to deliver high quality reference and market information in a format that can easily be integrated into existing reporting templates.

This is key as, ultimately, high-quality reference and market data are the foundations of strong regulatory data. Without this information, which is made much easier to analyze in a cloud environment, financial institutions will struggle to identify and address any non-modellable risk factors. The cloud allows firms to free up time and focus on higher value tasks such as interpreting and analyzing data.

All these years on, the vast majority of financial institutions have learnt the lessons of Lehman’s collapse and, as a result, have their credit, market, interest rate, and liquidity risk houses in order. While another incarnation of Basel will continue to steadily make the financial system more resilient to systemic risk, one can also see how banks could use the rule as an opportunity to seek out greater efficiencies across the business.

Just because a bank continues to build their capital requirements solutions on premise, as opposed to in the cloud, it does not mean they will go the same way of Lehman Brothers. They may find, however, that they are overtaken commercially by early cloud adopters who have the headspace to focus on higher value tasks without being weighed down by arduous administrative and operational tasks.

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