Learn how U.K.-based Egg plc—the world's largest online bank—has turned compliance with Basel II into an opportunity for growth. With Oracle Regulatory Capital Manager, Egg can calculate regulatory capital by using the most advanced methods prescribed by the Basel Accord. In addition, the bank can audit, edit, and review calculations, ensuring optimal regulatory capital strategy. This article also includes: An indepth look at Egg's partnership Oracle and Deloitte A list of Basel II-related resources. Q&A with TowerGroup's Guillermo Kopp An overview of Oracle Regulatory Capital Manager

As Published In November 2004

Banking on Compliance
By Carol Hildebrand

For Egg Plc, Basel II is an opportunity for growth.

For many companies, regulatory compliance means a lot of investment for little return. After all, many of today's new regulations, such as Sarbanes-Oxley, the Patriot Act, and now the Basel II Accord, require hefty infusions of time and resources into developing the new policies and procedures required as well as amending the information systems that underpin them.

Snapshot Egg plc www.egg.co.uk Year launched: 1998 Number of employees: 2,200 in the U.K. Annual sales: From Hoovers: 2003 US$1.8 billion Oracle products & services: Oracle Financial Services applications, including Regulatory Capital Manager and Financial Data Model

Business and technology leaders at U.K.-based Egg plc—the world's largest online bank—chose to approach the impending Basel II compliance deadlines a little differently, however. They saw it as an opportunity to grow the business.

One of the larger mandates of Basel II (see the "About Basel II" sidebar) includes operational risk in its methods of calculating the amount of capital an institution must set aside to cover risk. Many banks are confronting the difficult task of determining how they will comply with the most optimal level of risk available under the accord.

Opportunity Hatches

And that's where the opportunity comes in, says Chris Wilson, head of the Finance and Risk Value Programme for Egg. "Basel II can create a self-regulated, risk-based approach to capital allocation," says Wilson. "The amount of capital that will be required will be a function of the level of risk in writing the business and the risk control environment within the organization. And we are looking at it as an opportunity to write more business, using the same capital."

To do so, Egg must adhere to all three pillars of Basel II. Pillars 2 and 3 are what Wilson calls "variable" pillars, designed to ensure that banks have a risk control and management process in place that is matched to their operational structure and risk profile, as well as covering disclosures to the market and financial authorities. Pillar 1, however, deals with the mathematical models that banks must build to calculate the risk of each product class. That calculation results in the percentage of capital that

Introducing Regulatory Capital Manager Egg will begin implementation of Regulatory Capital Manager, a new module in the Oracle Financial Services Applications (OFSA) product family, sometime at the beginning of 2005. Regulatory Capital Manager allows banks to calculate regulatory capital by using the most advanced methods prescribed by the Basel Accord. It also allows financial services institutions to audit, edit, and review calculations to make sure that the institution is pursuing the optimal regulatory capital strategy. Regulatory Capital Manager embeds and automatically generates Pillar 3 External Reports. Organizations can also leverage regulatory capital results to implement a risk-adjusted performance management framework, so that financial services companies can turn regulatory mandates into a key driver of profit. Underlying the Regulatory Capital Manager solution is Oracle's comprehensive Enterprise Management Foundation. This single data model allows financial services institutions to pull information from a variety of applications, including those from independent software vendors, and consolidate that information through the Oracle Customer Data Hub so that enterprises receive complete and integrated business intelligence—a single source of truth.

must be set aside to cover the risk of failure in that product—bad debt or defaulting on a credit card program, for example. In the past, that calculation was done more generically, and, according to Wilson, "Certain products got crucified that shouldn't have, and vice versa. Banks can now choose from more-complex models capturing credit and operational risks, and more-mature control structures will be rewarded with lower capital charges by the Financial Services Authority (FSA)."

The models are key to Egg's next goal: being able to regulate its own capital allocation. Doing so means that Egg will be able to run its risk models and submit them to the FSA—the British equivalent of the SEC—for approval, but the approval process is long and rigid and requires a thorough audit of the mathematical models. "We realize that passing that audit is not going to be an easy process," says Wilson.

According to Nick Sandall, a partner at Deloitte who is involved in the Egg project, "It is critical to meeting the FSA's expectations that the bank can prove that its calculations have been performed consistently and reliably, and we're confident that this solution will meet this expectation."

Business Intelligence at the Center

Wilson says that technology lies at the heart of Egg's Basel II strategy. Wilson and his crew turned to Deloitte and Oracle for help and advice, and the team crafted a plan for Basel II that also covered Egg's International Accounting Standards and Sarbanes-Oxley compliance programs. And, as Egg replatformed its finance and treasury functions, they were included in the overall Finance and Risk Value Programme so as to exploit the synergies.

About Basel II The Basel Capital Accord, or Basel II, updates 1988 European capital rules for risk-management practices that align capital with operational, credit, and market risks for banks operating internationally. Basel II also mandates new regulatory methods for calculating capital to support operational risk. Oracle Resources Up Close and Personal See what your peers—and competitors—are doing to resolve their compliance issues, and view demos of Oracle's corporate performance management and Customer Data Hub solutions at Oracle OpenWorld, December 5-9, in San Francisco. Responding to Change Find out what Oracle customers have to say, and get the executive perspective on Oracle's solutions for the financial services industry. oracle.com/industries/financial_services/T2_Financial_RO3.pdf The Efficient Enterprise Oracle's corporate performance management (CPM) solution is a set of performance management tools that includes activity-based costing, performance analysis, enterprisewide planning and budgeting, and the balanced scorecard. Read how these tools have been utilized by leading financial institutions. www.financetech.com/oracleFinancial

"Deloitte was heavily involved at the consultancy and implementation level," says Wilson. "We set up multiple work streams to cover various areas of risk, such as wholesale, retail, and operational, and brought key Egg people into the process."

Chief among the efforts was making sure that the mathematical models were populated with accurate and timely data.

"We needed very good product and customer data, because the amount set aside for bad debt is not trivial," points out Wilson. Making sure Egg had the right data available at the right time meant new data marts and data-accuracy scorecards.

And all of that data needs to flow transparently through the company. "That data needs an audit trail to prove it's consistent and accurate," says Wilson. Egg decided to augment its existing customer data warehouse and feed the scrubbed data into a Basel II data mart, which will then feed a Calculating and Reporting Database (CRD), which holds the calculation models. "Oracle is working heavily on the CRD database, which is based on its technology," notes Wilson. Once the CRD is up and running, Egg will be able to feed the data into the Basel II module within Oracle Financial Services applications.

The company is well on its way to meeting its deadline for capital allocation regulation. "We have our models built for about 70 percent of our products, and the data mart will be finished in the next couple of months," says Wilson. In fact, Egg is already running numbers on its models and presenting the results to management.

Although it's clear that nothing comes with a guarantee, Wilson says the bank's work has paid off on numerous levels. "It's actually a great opportunity to reassess which products we want to sell and how we sell—and in the end, we'll enhance our understanding at the customer level of where risk lies."

And, if all goes according to plan, Egg will have more capital to invest. But Wilson thinks the exercise was worthwhile, regardless. "Even if we don't end up saving capital, this is the right thing to do," he says. "It made us think about risk and value. And as a bank, that can only be a good thing."

Q&A TrendWatch: Q&A with Guillermo Kopp, of TowerGroup, on 2005 trends in financial services What business and technology trends should you watch out for in financial services in 2005? We spoke with Guillermo Kopp, vice president of financial services strategies and IT investments at TowerGroup, a research firm focused on the global financial services industry. He had the following insights. Profit: What do you see as the biggest business/IT trend? Kopp: That of enterprise risk and compliance and the changes they're driving. There's a lot of duplication in IT spending for regulatory mandates, as a result of the typical fragmentation in most financial services institutions, which operate by line of business, product line, and geographical region. With such a setup, needless to say, responding to regulatory mandates happens in a fragmented and duplicative fashion. But the Basel II Accord introduces the concept of operational risk across the company, and fragmented silos can't offer an enterprise view of operational risk. As a result, companies are starting to think more horizontally across the hierarchy, looking at ways of combining and integrating their systems for each compliance mandate. Profit: That sounds like a project that goes beyond regulatory compliance. Kopp: It is. For many companies, this is an opportunity to retool; what's changing now is the magnitude of the investments required—not just Basel II but also Sarbanes-Oxley and so on. Financial service functions are under pressure to work more efficiently. There's a lot of duplication in the back office, so here's an opportunity to create more-robust processes. It's about operational efficiency in the long run, and the only way to improve that is to look at new ways of doing things—new processes and processing. So companies are looking at new technology that enables redefinition of business processes in a more horizontal way. Profit: What about offshore outsourcing? Will it continue to gain traction among financial services companies? Kopp: Institutions don't like to talk about outsourcing, because of the political ramifications, but more and more are doing it. According to our research, IT spending on outsourcing in the financial services industry is growing at a rate of 28 percent annually, compared to 4.5 percent in industries across the board. That said, people look at the IT spending situation with a narrow perspective. They see terrible cuts in certain vertical industries, and it's true. On the other hand, there has also been significant growth in pocket areas of spending. Risk management is one, and the transformation of branches and delivery is another area. For many companies, it's a matter of using their internal IT sources for sensitive and mission-critical projects and finding external options for the commodity work. Profit: Has IT edged any closer to its goal of aligning itself with business? Kopp: The alignment of IT with business strategy continues to be of significant importance. For example, we're seeing the governance of the IT function become more business-oriented than before, and the CIO is becoming more of a party in the business discussions, which has changed the makeup of the job function a little. It requires business knowledge on the part of IT people and, at the same time, an understanding of which business problems can be solved with IT rather than starting with the technology first, which is what we see now. As a result, we see about half of CIOs today in financial services firms coming from a business background rather than a technical one. The role of the CIO is to be more of a negotiator and liaison, and those are business skills rather than technical traits.