Basel II / III

Basel II marks a move away from formulaic regulatory capital calculations to a more risk- and principles-based three-pillared approach to capital management.

• The first pillar of minimum capital levels includes operational risk, along with more familiar credit and other financial risks (e.g. liquidity risk).
• The second pillar is a supervisory review process that seeks to encourage improvements in risk management by linking regulatory capital requirements to the firm’s internal capital adequacy assessment (ICAAP) and the soundness of its internal control structures.
• This is augmented by the market discipline of a third disclosure pillar.

The investment needed to comply with Basel II has been huge. The potential payback should include a more sophisticated and systematic approach to risk management, and in turn a more informed and forward-looking basis for decision-making and greater strategic assurance in the face of the ever increasing complexities and uncertainties of modern banking business.

Embedding the information, control frameworks and other key aspects of Basel compliance into the heart of the business could help banks to realise the competitive benefits.

In practice, embedding is likely to require the development of a common language that bridges the operations and priorities of frontline and risk and compliance teams, underpinned by a more assertive and business–orientated approach from risk and compliance personnel. Indeed, one of the factors that mark out world class risk functions is the ability and confidence to make an understanding of risk an indispensable element of tactical and strategic management. The key benchmarks for success are the extent to which risk information is being actively used to formulate decisions; the extent to which the risk function is aligned with its business partners and, ultimately, whether the risk function is in the right place to support a viable risk management culture.

More broadly, many banks may need to redefine key aspects of their business model in the post-Basel era to ensure that risk is fully incorporated into the overall strategy and direction of the institution. This includes building the risk appetite into business planning and ensuring that it is a key criterion in performance measurement and senior management’s assessment of progress against objectives.

How PwC is assisting financial services organisations

PwC is helping banks to embed Basel II and develop more effective and business-orientated risk functions capable of delivering the business benefits of their investment in compliance.