FINANCIAL SERVICES UPDATE

SPOTLIGHT
Coming to Grips with Basel II
Commercial banks throughout the world may be forgiven if the specter of Basel II dampens a few New Year's celebrations.
The sequel to the Basel Committee on Banking Supervision's 1988 Basel I risk assessment guidelines, the new accord goes into effect on January 1, 2007. For commercial banks Basel II represents a mixed bag of tradeoffs.

On the plus side, Basel II promises to help shield banks from risk by spelling out new rules calculating risk using the accord's so-called "three pillars." The first defines mathematical models banks create to evaluate risk in each financial product class. The second and third pillars address risk control and management processes for comparing a bank's operational structure and risk profile.

Reducing risk
One of the prime goals of these calculations is making sure financial institutions set aside enough capital to cover failures of various products, such as loan or credit-card defaults. Another result will be a more accurate picture of performance, some executives believe.

Few banks argue with Basel II's goals. A recent Oracle-sponsored survey by the Economist Intelligence Unit (EIU) found that 52 percent of the participating banks saw better risk management as the prime benefit of the accord, while 28 percent hoped that implementing the management procedures would boost their credit ratings. Sixteen percent believed Basel II could hone their competitive edge. "[Basel II] is critical to meeting Britain's Financial Services Authority expectations that the bank can prove that its calculations have been performed consistently and reliably," says Nick Sandall, a partner at consulting firm Deloitte.

Costs and consequences
The bad news is that banks can't just flip a switch and become Basel II compliant. Estimates place the cost of new technology, process reengineering, and training at tens of millions of dollars. For example, James Liu, executive vice-president of risk
management at Hua Nan Financial Holdings, a US$42B-asset bank based in Taiwan,
expects to pay about $10 million for a full implementation.

It's a steep price tag, but the costs of noncompliance may be even higher, even though compliance isn't compulsory. Regulators in individual countries may force commercial banks to comply while investors indirectly push banks in that direction by favoring Basel II adherents, who potentially would achieve better credit ratings, higher earnings, and healthier stock prices. Among the banks surveyed by the EIU that expected to face adoption pressures, 54 percent thought regulators would provide the primary push, while 16 percent thought competitive pressures would be most significant and 10 percent believes shareholders would be the primary force.

Technology and tools
With Basel I, banks often took a piecemeal approach to meeting the accord's financial management requirements. Fortunately, banks now have highly integrated solutions to address Basel II and future management needs.

For example, Oracle E-Business Suite Financials offers a single data model that enables commercial banks to pull information from a variety of applications, including those from independent software vendors, and consolidate that information through the Oracle Customer Data Hub for a an essential single source of truth. Integration headaches also ease because all of the components come from a single vendor. Banks that use the Oracle approach keep system administration costs low with the centralized e-Business suite management tools.

To specifically meet Basel II requirements, Oracle provides tools for credit, market and operational risk measurement. Basic, standard and internal calculation options are pre-built and delivered in an advanced data warehouse based framework for consistency and accuracy to integrate risk measurement systems beyond capital adequacy computation and create a complete audit trail for supervisory review.

As a result of its agreement to purchase a 41 percent equity interest in i-flex, Reveleus' parent company, Oracle will work with i-flex to offer the Reveleus Basel II Solution. The Solution provides a framework to implement multiple approaches — Standardized, FIRB and AIRB for Credit Risk or Basic Indicator, Standardized and AMA for Operational Risk. Banks can simultaneously configure them as different "runs" within the Reveleus Basel II Rules Framework to measure the impact of the capital computations under different approaches and to periodically compare results.

The Reveleus Basel II Solution also integrates Market Risk Capital requirements as a result of foreign exchange and money market trading operations and computes the capital coverage for Operational Risk using three different approaches. All the necessary credit concentration risk reporting for Basel II's Pillar II and the quantitative and qualitative disclosure requirements for Pillar III are combined with the total capital reporting for Pillar I.

The Solution provides a series of interrelated rules that cover processes for
computing regulatory capital, per Pillar I requirements. This includes pre-built rules for handling various exposure types as well as collaterals and credit risk mitigants. Rules also exist for assigning risk weights, computing effective maturity, add-ons for OTC derivatives, and other computations.

The Reveleus Basel II solution also enables banks to configure differing rules for consolidated calculations in the head office and different rules for entities operating in other countries, according to local supervisory guidelines.

These capabilities and more, part of Oracle's comprehensive platform for enterprise risk management, reduce the cost and complexity of Basel II compliance.