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- Basel III Endgame Deep Dive; The Bank that Continues to Strike Out with Regulators
Basel III Endgame Deep Dive; The Bank that Continues to Strike Out with Regulators
Also: Risk Management & Poker Playing ; Data & IT Risk
Naeem Qasim
September 13, 2024
Hello everyone! In the Risk Queue this week, we take a deep dive into the recent announcement of Basel III proposal. We also have the other key stories that firms are focused on!
-Enjoy, Naeem, CEO & Founder - Risk On Q
PICKS:
Banks - Basel III is coming
Regulatory Focus - Wells Fargo’s Regulatory Struggles Continue
AI - Deloitte Provides Insights from Recent Bank Survey
Risk Headlines
The Basel III Endgame- Revised Proposal Discussed by Fed Chair Barr -source Brookings Institution.com
Key Points:
Capital requirements: The revised proposal increases capital requirements for GSIBs by 9%, down from 18% in the original proposal. This is significant as it directly impacts the bank's ability to lend and invest, affecting profitability and growth strategies.
Treatment of unrealized gains/losses: Including these in regulatory capital for banks over $100 billion could lead to 3-4% increase in capital requirements. This affects balance sheet management and could increase volatility in reported capital ratios.
Scaling back requirements for mortgages and retail lending: This could preserve competitiveness in these key markets, especially important for regional banks.
Focus on trading activities: Maintaining higher capital requirements for trading and derivatives at large banks could impact business models and potentially lead to shifts in market activity.
Tiered approach: Different requirements based on bank size and complexity could affect competitive dynamics in the industry.
Reproposal process: Allowing for additional comment periods suggests potential for further adjustments, requiring ongoing engagement with regulators.
These changes reflect an evolving understanding of banking risks and regulation in the post-2008 and post-2023 banking stress environment. They suggest a more nuanced approach to financial stability that attempts to balance multiple objectives. Below we have provided a deep dive and review of the proposal that Banks will need to consider.
Aspect | Original Proposal | Revised Proposal | Implication |
|---|---|---|---|
GSIB Capital Increase | 18% | 9% | Still significant but more manageable; could lead to strategic shifts |
Unrealized Gains/Losses | Not included | Included for banks >$100B | Potential for increased capital ratio volatility; may impact investment strategies |
Mortgage/Retail Lending | Higher requirements | Scaled back | Could stimulate lending in these areas; potential economic boost |
Trading Activities | Higher requirements | Maintained higher requirements | Continued pressure on trading operations; potential for business model changes |
Banks $100-250B | New requirements | Fewer new requirements | Reduced regulatory burden for mid-sized banks; competitive implications |
Executive | Critical Concern | Potential Impact/Actions |
CFO | Capital Requirements Increase: 9% increase in common equity tier 1 capital requirements for GSIBs; Reduced from original 18% proposal | - Impact on profitability; Affects ability to deploy capital; Requires strategic planning for capital allocation; May lead to scaling back or exiting certain activities |
Focus on Trading Activities: Maintained higher capital requirements for trading and derivatives activities | - Impact on return on equity for trading operations; May require reassessment of business model; Potential scaling back of trading activities; Need to increase efficiency; Possible spinning off of some operations | |
Inclusion of Unrealized Gains/Losses in Regulatory Capital:; Estimated 3-4% impact on capital requirements for non-GSIBs; Potentially larger impact for GSIBs | - Introduction of volatility in reported capital ratios; Complicates capital planning; May affect investor perceptions of stability; Requires review of investment portfolio strategy; Need for more sophisticated hedging approaches | |
CIO | Inclusion of Unrealized Gains/Losses in Regulatory Capital | - Re-evaluation of investment strategy; Shift towards shorter duration securities; Increased focus on held-to-maturity portfolios; Implementation of sophisticated hedging strategies; Potential reduction in securities portfolio size; Impact on liquidity management and earnings |
Maintained Higher Capital Requirements for Trading Activities | - Pressure to shift capital from trading to investment portfolio; Expanded mandate for investment portfolio to generate returns; Need for new, higher-return investment strategies; Potential opportunities for internal hedging services | |
Overall Increase in Capital Requirements (9% for GSIBs) | - Pressure to generate higher returns from investment portfolio; Need to optimize investment strategies for capital efficiency; Increased focus on risk-adjusted returns; Favoring assets with lower risk weights | |
Chief Treasurer | Inclusion of Unrealized Gains/Losses in Regulatory Capital | - Need for more dynamic liquidity management; Reassessment of liquidity buffer size and composition; Impact on funding strategy and potential credit ratings; Diversification of funding sources; Adjustment of debt issuance strategy; More integrated approach to asset-liability management |
Overall Increase in Capital Requirements (9% for GSIBs) | - Reassessment of optimal mix of equity and debt funding; Potential increase in reliance on equity or hybrid instruments; Impact on return on equity (ROE); Optimization of capital allocation; Adjustment of internal funds transfer pricing; Revision of stress testing scenarios and contingency funding plans | |
Tiered Approach Based on Bank Size and Complexity | - Reassessment of cost of funding and pricing strategies relative to smaller competitors; Influence on decisions about potential acquisitions or divestitures; Optimization of internal capital and liquidity allocation across different jurisdictions; Consideration of regulatory burden thresholds in strategic planning | |
CRO | Risk-based Tiering of Capital Requirements / Focus on Trading Book Risks | - Comprehensive review and potential overhaul of the bank's risk management framework; Development of more sophisticated risk models and measurement tools; Optimization of capital allocation across different business lines; - Thorough review of the bank's trading risk management practices; Implementation of more stringent risk limits; Enhancement of real-time risk monitoring capabilities |
A.I. Risk / Technology Risk
Deloitte Survey on Data Evolution in Banking & How Gen AI is Growing - source deloitte.com
Key Points:
The 2024 Banking Data Analytics Survey by Deloitte provides insights into how banks leverage data analytics to drive business outcomes. There is a growing trend toward integrating advanced analytics and artificial intelligence into banking processes. Also, a big focus is on building robust data governance frameworks to ensure data quality and compliance. Challenges identified include data silos, legacy systems, and the need for skilled talent to manage and interpret data effectively. In 2023 alone, US banks planned to spend north of $5 billion on data initiatives.
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Key Points:
The article underscores the urgent need for financial institutions to bolster their IT risk management and operational resilience in light of the impending DORA regulation. This comprehensive legislation demands a holistic approach to digital security, encompassing everything from incident response to third-party risk management. The stakes are high, with severe penalties for non-compliance, but the article also highlights the opportunity to leverage AI-powered solutions for efficient compliance and enhanced operational resilience.
Regulatory News - Fines, Losses, & Rules
Wells Fargo Commits to Regulators to Fixing Financial Crime Controls - After Claims the Bank Allowed $490 Million Ponzi Scheme - source wsj.com
Key Points:
This is the latest chapter in Wells Fargo's ongoing struggle with regulatory compliance, specifically in the realm of financial crime prevention. This new agreement with the Office of the Comptroller of the Currency (OCC) indicates that despite previous regulatory actions and internal efforts, the bank continues to face significant challenges in maintaining robust anti-money laundering (AML) and sanctions risk management practices. The mandated board-level compliance committee indicates a push for increased accountability at the highest levels of the organization.
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Fed Governor Michelle Bowman On the Future os Stress Testing & the Stress Capital Buffer Framework - source federalreserve.gov
Key Points:
Governor Michelle W. Bowman discussed the benefits and challenges of the stress testing program, emphasizing its importance in assessing the resilience of banks during economic stress. She highlighted several concerns with the current stress testing framework, including year-over-year volatility in results, the link between stress testing outcomes and capital requirements, the lack of transparency, and overlaps with other capital requirements. She suggested that the stress testing process could be improved by addressing these issues, promoting greater transparency, and considering multiple stress scenarios to better understand firm-specific and broader financial stability risks.
Bowman also emphasized the need for a more transparent and fair reconsideration process for stress capital buffers and suggested that the compliance framework for these buffers should allow more time for banks to adjust. She called for a strategic reform of the stress testing framework to ensure it remains relevant and effective in promoting bank safety and financial stability.
Risk Data to Geek Out On
Key Points:
This video by the WSJ is one to watch. Playing poker with top Wall Street traders reveals several key insights that are applicable to trading and investment:
Risk Management: Both poker and trading require effective risk management. Players and traders must assess the potential risks and rewards before making decisions, emphasizing the importance of patience and strategic thinking.
Decision-Making Under Uncertainty: Poker teaches players to make decisions based on incomplete information, a skill that is directly transferable to trading. This involves understanding probabilities and managing emotions during decision-making.
Psychological Acumen: Successful poker players and traders need to read others and manage their own emotions. This psychological insight helps in anticipating opponents' moves in poker and market movements in trading.
Strategic Thinking: The ability to think several steps ahead and adapt strategies based on opponents' actions is crucial in both poker and trading. This involves analyzing not just the current situation but also predicting future developments.
Handling Variance: Both poker and trading involve dealing with variance in outcomes. Players must be comfortable with the idea that sometimes good decisions lead to bad outcomes and vice versa, and they need to maintain focus and discipline through these fluctuations3.
These parallels highlight the importance of strategic thinking, risk management, and psychological insight in both poker and trading, providing valuable lessons for those involved in financial markets.
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Thank you for reading,
Naeem
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