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•	 Cognizant Reports




Gearing Up For Basel III
Stringent data reporting and risk management requirements will compel
banks to significantly overhaul their IT infrastructure to not only comply
with sweeping regulatory change but also to power new operational
efficiencies and create market differentiation.

     Executive Summary                                      operations. Given the pressure on margins,
     In its depth and scope, Basel III is unlike anything   we believe that banks need to go beyond the
     the banking business has seen. A combination of        standard applications of the new technologies.
     micro- and macro-prudential norms, the global          By building strong capabilities in the areas that
     regulatory mandate (which rolls out this year          are the focus of these regulations, banks can
     through 2018) 1 requires banks to increase their       differentiate themselves from their competitors.
     quality of capital by focusing on liquidity and        Key imperatives for banks as they prepare for
     common equity; improve supervision of firm-wide        Basel III include:
     risk management; and provide detailed report -
     ing on regulatory capital and the calculation of       •	 Undertake a fundamental analysis of individ-
     capital ratios. It mandates adherence to ratios           ual businesses to identify growth drivers.
     such as liquidity coverage and net stable funding,     •	Strengthen data management practices to
     which are aimed at strengthening banks’ short             create a single source of truth for all functions.
     and long-term liquidity. Most prominently, Basel III   •	 Embed key functions such as liquidity and risk
     is transforming risk management into a function           management into related processes across the
     that fortifies banks’ sound functioning.                  organization.
                                                            •	Invest in technologies that can free up
     These changes will necessitate a fundamental              resources to focus on core activities.
     review of each bank’s operating model. Many            •	 Improve project management capabilities to
     banks will need to decide which businesses                realize greater benefits from IT investments.
     and geographies to focus on and which to exit.
     Almost all banks will need to invest in technology     Overall Impact
     capabilities to meet Basel III’s stringent data        The impact of Basel III on banks is manifold,
     reporting and risk management requirements.            ranging from capital (see Figure 1, next page)
                                                            and liquidity requirements to technology and
     While these investments will strain bank bal -         strategy implications. The new key capital ratio
     ance sheets, they will also create opportunities       is set at 4.5%, more than double the current
     to extract additional efficiencies from day-to-day     2%. In addition, there is a new buffer of 2.5%;




      cognizant reports | march 2013
banks with capital within the buffer zone will              counterparty is likely to default. Surveys have
face restrictions on dividend payments and dis-             found that several banks are not in a position to
cretionary bonuses. According to an estimate by             calculate CVA instantaneously.4
McKinsey & Co., the capital requirements under
Basel III could reduce return on equity (RoE) for           Global     systemically       important     financial
banks by about 4% in Europe and 3% in the U.S.2             institutions (G-SIFI) will incur a 1% to 2.5% capital
                                                            surcharge. These banks will
Basel III’s liquidity ratios constitute a “first of         need to meet the enhanced One estimate
its kind” attempt at regulating bank liquidity. Its         capital requirements by
                                                                                               suggests that
liquidity coverage ratio (LCR) will require banks           using retained earnings, rais-
to maintain cash-like assets in the short term; the         ing fresh equity or reducing G-SIFIs will need
net stable funding ratio (NSFR) will determine a            their risk-weighted assets to raise another
one-year-horizon liquidity buffer. For banks that           (RWAs), as the risk weight-
                                                                                               $566 billion to
are unaccustomed to holding high-quality capital            age for certain assets will
in the short term, adjusting to these requirements          rise under the new regime. meet Basel III’s
will entail significant costs, which may be further         One estimate suggests that capital
inflated by the increased market demand for such            G-SIFIs will need to raise
                                                                                               requirements.
capital.                                                    another $566 billion to meet
                                                            Basel III’s capital requirements. One outcome
Basel III will also create technological challenges.        of this has been a shedding of non-core assets
For one, the proposed rules require banks to                by banks globally, particularly in Europe (see
report their liquidity metrics on a daily basis.            Figure 2, next page). For example, Citigroup’s
Banks will, therefore, need to begin collecting data        non-core assets declined from 34% in 2009 to
points, which could run into several thousands,             10% of total assets as of June 2012.5
across the organization. The mandated enhance-
ments to banks’ risk management infrastructures             Banks operating in multiple countries will also
will also pressure their technology infrastructure.         have to deal with other regulations, such as
Basel III also includes a credit value adjustment           the Dodd-Frank Act in the U.S. (for more on this
(CVA) charge that must be calculated over and               regulation, read “Implications of Dodd-Frank for
above the default counterparty risk charge that             the U.S. Banking and Financial Services Indus-
was proposed in Basel II.3 This calculation needs           try”), European Market Infrastructure Regulation
to be carried out on a real-time basis; it involves         (EMIR) and the Markets in Financial Instrument
analyzing various trades and determining which              Directive (MiFID) in the EU.




Basel III Capital Requirements Present the Biggest Challenge
    18%

    16%
                                                             16.5%
    14%
                                       14.5%                 13.0%
     12%       13.0%                   11.0%                 10.5%
    10%         9.5%
                                        8.5%                   8.0%
     8%                                                                    Minimal Capital Requirement
                7.0%
     6%                                6.0%                                Conservation Buffer: 2.5%
                4.5%                                                       Countercyclical Buffer: 0.0% — 2.5%
     4%
                                                                           G-SIBs Buffer: 1.0% — 3.5%
     2%

     0%

           Common Equity               Tier 1            Total Capital
Source: “The Road to Basel III Implications for Credit, Derivatives & the Economy,” Deutsche Bank, 2012.
Figure 1



                                   cognizant reports       2
Investment Banks                                        as corporate lending, private banking and retail
The financial crisis exacted a heavy toll on            stock brokerage.8 While such moves are feasible
the investment banking business, effectively            for large banks, the combination of a weak econ-
ending an era of record profits. Five years later,      omy and stringent regulations make it difficult
it remains a rollercoaster ride for these orga-         for mid-size and smaller banks to juggle all these
nizations (see Figure 3, page 4). In the face of        initiatives.
declining revenues and risk-averse investors, sev-
eral large banks have responded by slashing their       Corporate Banking
investment banking business. Regulations such           Basel III’s impact on non-capital market entities
as the Volcker Rule — a part of the Dodd-Frank          is expected to be milder, but it will nevertheless
Act in the U.S. that restricts proprietary trading      alter corporate banks’ lending practices. Higher
by banks — have added to the pressure on invest-        capital ratios and liquidity requirements could
ment banks (for more on the Volcker Rule, read          increase lending costs and force banks to reduce
“Volcker Rule Compliance: Preparing for the Long        their lending to large corporations and/or stop
Haul”). Similar laws are likely to be enacted by        lending to certain heavy industries altogether.
European countries.6                                    Several signs indicate that this may be already
                                                        happening. France’s Société Générale and BNP
As Basel III dawns on the investment banking            Paribas announced plans to scale back their
landscape, it is expected to usher in additional        aircraft and shipping financing operations. The
challenges. The trading business, for one, is           Royal Bank of Scotland sold its aircraft leasing
expected to be impacted significantly. Basel III’s      business in January 2012.9 There are rumblings of
market risk and securitization framework will           similar moves in the U.S., as well. Meeting Basel
force banks trading in OTC derivatives to hold          III’s capital requirements is expected to be tough
more capital (2% of total exposure to counter-          for banks with assets of less than $500 million.10
parties7) for market and counterparty risk provi-       The rules are expected to adversely impact mort-
sioning. Banks will be forced to shed lower-rated       gage and real estate lending.11
assets, which will impact their trading businesses.
                                                        Such moves could, however, open opportunities
These factors are forcing a rethink of the role of      for banks from relatively better-off regions,
investment banking in organizations with diversi-       such as Asia, to expand into new markets. For
fied business models. This reassessment comes           example, Société Générale exited the Egyptian
as many large banks undertake across-the-board          market after selling 77% of its stake to Qatar
reductions in variable costs. Some wholesale            National Bank, allowing the state-backed lender
banks have made a move into businesses such             to expand into new markets.


Growing Non-Core Asset Market in the EU
Non-core asset transactions have increased by more than three-fold between 2010 and
2011 and have made a strong start in 2012.
                                               €36.0 bn

                                             Other, ¤4.0 bn
                                                                                    €26.6 bn
                                            Portugal, ¤4.2 bn
                                                                                 Other, ¤2.0 bn
                                                                                  Italy, ¤1.9 bn
                                            Ireland, ¤15.0 bn                    Spain, ¤3.7 bn

                                                                                  UK, ¤3.6 bn
             €10.8 bn
                                                                                Germany, ¤4.3 bn
          Other, ¤1.2 bn                     Spain, ¤4.0 bn
        Switzerland, ¤2.1 bn
                                                                                 France, ¤11.1 bn
                                              UK, ¤8.8 bn
            UK, ¤7.5 bn

               2010                               2011                             June 2012
Source: “A Growing Non-Core Asset Market,” PricewaterhouseCoopers, July 2012.
Figure 2



                                 cognizant reports      3
Hedge Funds                                                  have declined, would make these accounts more
For hedge funds, Basel III — combined with the               expensive for retail banks to maintain.16
Volcker Rule, the EMIR and MiFID – will create
considerable challenges. The additional CVA                  Custodian Banks
charge under Basel III is expected to increase               For custodian banks, the unfolding regulations
the cost of trades and affect trade volumes.                 present an opportunity to play a larger role for
Mandatory trading of OTC derivatives through                 buy-side clients. Basel III, the U.S. Dodd-Frank
exchanges will also increase the cost of OTC                 Act and the EMIR are expected to boost demand
derivatives trading.12                                       for higher quality collateral. According to the
                                                             Tabb Group, the clearing mandate would require
Additionally, LCR and NSFR are expected to                   between $1.6 trillion and $2 trillion in additional
inflate costs for hedge fund clients. As a result,           collateral.17
some banks are separating their hedge funds
operations into standalone entities13 or winding             As institutions that hold billions of dollars in
down operations to focus on core businesses.14               collateral, custodians are in a position to
Given that most of these regulations are still in            capitalize on the growing demand.18 In fact, orga-
flux, the prolonged uncertainty is believed to be            nizations such as BNY Mellon, BNP Paribas and
hampering many firms’ decision-making.                       the U.S. Depository Trust & Clearing Corporation
                                                             (DTCC) have launched initiatives that enable a
Retail Banks                                                 smooth flow of collateral across borders.19
The impact on retail banks will be similar to that
on corporate banks. Nevertheless, compliance will            Dealing with Basel III
mean allocation of resources and planning for the            The double whammy of stringent regulations
short term. The requirement to maintain greater              and weak economic growth is forcing banks to
capital reserves will hamper lending.                        review every aspect of their businesses. While
                                                             compliance remains the top priority, banks are
In the U.S., several community and small banks               continuously seeking to enhance efficiencies
have expressed concerns that Basel III capi-                 in their day-to-day operations to prepare for a
tal norms could undermine their ability to                   prolonged period of tight margins and high costs.
issue mortgages.15 Banks with substantial retail
deposits will no doubt find it easier to comply              As regulatory capital increases its presence on
with the higher capital requirements. For others,            banks’ balance sheets, the focus is likely to shift
building a larger deposit base could entail higher           toward initiatives to increase return on equity.
costs. Also, the ensuing competition for deposits,           RWAs are set to increase under Basel III’s new
which have grown only modestly as saving rates               regulatory regime, prompting banks to reduce




Tough Times Not Over Yet for Investment Banks
                                                                                  -18%          HSBC
                                                                               -24%             Citi
                                                                              -27%              JPMorgan
                                                                            -30%                Barclays
                                                                 -57%                           Average
                                                                -60%                            Goldman Sachs
                                                              -65%                              RBS
  Pretax profits
                                                           -73%                                 Deutsche Bank
  12 months to Q2 2012 vs.
                                                           -73%                                 BNP Paribas
  12 months to Q2 2011
                                                         -76%                                   BofA Merrill Lynch
                                                        -77%                                    Morgan Stanley
                                                       -80%                                     Credit Suisse
                                  -130%                                                         Société Générale
             -179%                                                                              UBS
   -202%                                                                                        Nomura

Source: “Institutions are Struggling to Find a Sustainably Profitable Model‚” Financial News, August 13, 2012.
Figure 3



                                    cognizant reports        4
such assets. Banks with strong internal ratings-      Among Basel III’s efforts to mitigate risk are
         based models for rating assets could apply them       various micro-prudential regulations, including
         to quickly and effectively reduce RWAs.               capital, liquidity and leverage control through
                                                               various ratios; CVA charges; rigorous data report-
  Banks are exposed           Industry estimates suggest       ing requirements; and restrictions on leverage
                              that several banks are falling   and counterparty exposures. These are supple-
     to multiple risk         short of the required levels     mented by macro-prudential regulations, such
        types, and an         of capital.20 Few banks have     as mandates to enhance firm-wide supervision
     overhaul of risk         issued fresh capital to fill     and governance of risk management practices
                              this gap, suggesting that the    and regular stress testing. In anticipation of the
        management            markets might not respond        impending regulations, banks have already begun
practices is crucial if       positively to attempts to        assessing their approaches to various functions
  they are to survive         raise capital. Banks are,        and processes, such as collateral management
                              therefore, left with no choice   and calculation of counterparty risks.
       future shocks.         but to take a hard look at
         their businesses and scale back in areas that can-    Basel III also requires banks to fundamentally
         not contribute to the maintenance of the required     review their trading books. The first step in this
         levels of RWAs and deliver return on equity.          direction is the requirement for banks to hold sig-
                                                               nificantly more capital against risky instruments
         It is also becoming imperative for banks to extend    such as securitized and structured products.
         operational efficiencies wherever possible. This      More recently, regulators have proposed changes
         could be achieved through a combination of            to the boundary between banks’ trading and
         strategies, such as partnering with third-party       banking books. The proposed changes include:
         experts, pursuing M&As or creating shared ser-
         vices platforms. Banks that have invested heavily     •	 Linking the inclusion of an instrument in a
         in creating IT infrastructure to support processes      trading book to its tradability, followed by
         such as counterparty risk management internally         daily valuation and quarterly reporting of the
         could even provide these platforms as a service to      instrument.
         other players in the industry.                        •	Basing capital requirements on risks that
                                                                 threaten banks’ solvency.
         Nonetheless, compliance with Basel III will drive
         many banking processes from silos into a more         By any measure, these regulations are significant
         integrated, collaborative and efficient operat-       and, when implemented, will change the way risk
         ing model. Functions such as risk management,         management is perceived
         which have hitherto been comparatively isolated,      and practiced by banks. The
                                                                                             While Basel III
         will now have a say in nearly all bank decisions.     need for a firm-wide view compliance means
         Banks may also choose to invest in advanced data      of risk will mean that banks higher costs in the
         analytics to find and implement ways to optimize      will have to embed the risk
         high-value business processes. Risk analytics,        function into all of their
                                                                                             form of technology
         for example, can be deployed on data collected        processes, which will require investment
         from various execution environments to enhance        technology to collect and and process
         risk-related processes, such as credit risk model-    analyze data on a daily basis
         ing and calculating risk indicators.                  to monitor various levels of
                                                                                             reorganization, it
                                                               exposure and arrive at more also presents banks
         Expanding Role of Risk Management                     informed decisions.           with an opportunity
         Banks’ enterprise risk management capabilities
         were found lacking in areas such as liquidity risk    While Basel III compli-
                                                                                              to assess their
         in the days leading up to the global financial cri-   ance means higher costs operations and look
         sis. Basel III is perhaps the largest effort under-   in the form of technology for opportunities to
         taken by global regulators to make banks more         investment and process
         secure. In today’s globally connected markets,        reorganization, it also pres-
                                                                                                 create efficiencies.
         risk has also become global. Banks are exposed to     ents banks with an opportunity to assess their
         multiple risk types, and an overhaul of risk man-     operations and look for opportunities to create
         agement practices is crucial if they are to survive   efficiencies. In the long run, it will influence banks
         future shocks.                                        to move to a culture of risk and evidence-based


                                         cognizant reports     5
decision-making. Research firm Celent expects                     processes that banks will be required to under-
organizations across the capital market spectrum                  take will revolve around aggregating, standard-
to spend $35 billion in 2012 on risk management                   izing and analyzing data to derive high-quality
and risk-related compliance. Meanwhile, a survey                  insights for internal and regulatory consumption.
by American Banker Executive Forum found                          Regulatory data reporting has become stringent,
that a growing number of small banks (with less                   and in some cases, ad hoc reports will be required
than $100 million of assets) wish to implement                    to respond to random checks by regulators. The
enterprise risk management in 2012.21                             quality of the underlying data, therefore, will
                                                                  become highly important from the bank, regula-
Technology Implications                                           tor and market perspectives. Inconsistencies in
Almost all the regulations under Basel III have                   data could attract further regulatory scrutiny and
a direct or indirect technology implication for                   also affect a bank’s credibility.
banks. Most of the subsequent technology
enhancements will be focused on improving                         Take for example, collateral management under
data management practices. Many activities/                       Basel III. Banks that use internal models for



     Quick Take
Basel III Implementation Timeline

                              2011     2012      2013       2014        2015      2016    2017      2018        2019
                                                         Parallel Run
  Leverage                     Supervisory                                                        Migration
                                                  Jan. 1, 2013 - Jan. 1, 2017
  Ratio                        Monitoring                                                         to Pillar 1
                                                Disclosure starts Jan. 1, 2015
  Minimum Common
                                                3.50%        4%        4.50%      4.50%   4.50%    4.50%        4.50%
  Equity Capital Ratio
  Capital Conservation
                                                                                  0.63%   1.25%    1.88%        2.50%
  Buffer
  Minimum Common
  Equity plus Capital                           3.50%        4%        4.50%      5.13%   5.75%    6.38%         7%
  Conservation Buffer
  Phase-in of deductions
  from CET1 (including
  amounts exceeding                                         20%         40%       60%     80%       100%        100%
  the limit for DTAs,
  MSRs and financials)
  Minimum Tier 1 Capital                        4.50%      5.50%       6.00%      6.00%   6.00%    6.00%        6.00%
  Minimum Total Capital                         8.00%      8.00%       8.00%      8.00%   8.00%    8.00%        8.00%
  Minimum Total Capital
  plus Conservation                             8.00%      8.00%       8.00%      8.63%   9.25%    9.88%        10.50%
  Buffer
  Capital instruments
  that no longer qualify
                                                         Phased out over a 10-year horizon, beginning in 2013
  as non-core Tier 1
  capital or Tier 2 Capital

  Liquidity Coverage          Obser-
                                                                      Introduce
  Ratio                       vation
                                                                      minimum
                              period
                                                                       standard
                              begins
  Net Stable Funding                   Obser-
                                                                                                  Introduce
  Ratio                                vation
                                                                                                  minimum
                                       period
                                                                                                   standard
                                       begins
Source: Basel III New Capital and Liquidity Standards, FAQs, Moody’s Analytics
Shading indicates transition periods. All dates are as of January 1 of the given year.


                                       cognizant reports          6
calculating collateral will need to set up a            Banks are aware of the imperative to improve
            collateral management unit. This unit will be           data management. Many have set in motion
            responsible for calculating and making margin           organizational changes to
            calls, managing disputes and reporting margins          realign their businesses with Banks that succeed
            on a daily basis. For this, banks will need to source   emerging regulations. A in the highly
            data from different functional areas across             survey22 by the Professional
                                                                                                  regulated future
            product and exposure types and eliminate dis-           Risk Managers’ International
            crepancies to ensure data integrity. Moreover,          Association and SunGard will be those that
            the bank, or a unit therein, will need to report the    found that banks are slowly not only ensure
            data to senior management and conduct annual            but surely moving away
                                                                                                  their systems
            reviews to mitigate margin disputes. If discovered      from the exploratory phase
            by regulators, this would incur financial penalties.    to implementing systems meet regulatory
            Clearly, in addition to the investment involved,        to improve risk manage- requirements
            creating such a process will require organization-      ment. However, banks that
                                                                                                  but also, in
            wide buy-in and cooperation.                            succeed in the highly regu-
                                                                    lated future will be those doing so, unlock
         However, the reality at several banks is that data         that not only ensure their opportunities
         continues to be managed in silos. Bank depart-             systems meet regulatory
                                                                                                  to drive down
                              ments use systems that suit           requirements but also, in
 According to a 2011 department-specific needs                      doing so, unlock opportuni- costs and create
                                                                    ties to drive down costs and technology-led
report by the Tower and store data in varying,
                              incompatible formats. Inte-           create technology-led differ-
     Group, mid-tier grating these disparate sys-                                                 differentiators.
                                                                    entiators.
 banks’ data output tems will be a time-consum-
grew 150 times over ing and costly undertaking,                     Benefiting from Technology
                              especially since the amount           Investment
 the previous seven of data generated by banks                      As the impacts of Basel III fully take shape, banks
      to eight years. has exploded in the past                      face a paradox: They need to make technology
                              decade. According to a 2011           investments for regulatory compliance, even as
         report by the Tower Group, mid-tier banks’ data            margins are squeezed and budgets constrained.
         output grew 150 times over the previous seven to           In such a scenario, banks need to find ways to
         eight years.                                               extract more from their IT investments. Basel III
                                                                    and the other upcoming regulations offer banks
            Eliminating data silos will be central to achiev-       an opportunity to review and enhance their
            ing compliance. This, in turn, will require banks       business processes and change management
            to rebuild their aging infrastructures. Stopgap         programs. As they invest in technologies man-
            or minimal efforts might work in the short run,         dated by the regulations, banks can identify ways
            but they will have adverse consequences over            to use them for purposes beyond compliance.
            time as individual regulations come into effect.
            Banks need to draw up blueprints on the basis of        The first step would be to create enterprise-wide
            their current levels of preparedness and the time-      views of key factors such as liquidity, risk and
            line for Basel III implementation. In the case of       data by eliminating silos across the organization.
            collateral management, foresight and planning           This could help banks identify processes and
            will allow banks to utilize their assets optimally      systems that have similar underlying technology
            and manage collateral schedules more efficiently.       to introduce operational efficiencies and enhance
                                                                    decision-making.
            Moreover, banks that achieve the integrated data
            management levels required under Basel III will         Liquidity and Capital
            be able to deploy advanced analytics to mine            Strong liquidity management, for example,
            insights that can drive efficiencies in various         will not only help senior management better
            processes. Cloud-based solutions under the              understand the bank’s liquidity position and
            pay-per-use model can help banks turn Cap-Ex            prepare for adverse liquidity situations, but it
            to Op-Ex and create savings through server and          would also offer insights into related process
            software virtualization.                                optimization initiatives, such as portfolio




                                             cognizant reports      7
management and loan origination. Embedding            decision-making. Such a system will not only be
          a liquidity perspective into processes such as        able to present a consolidated view of histori-
          product management can help banks enhance             cal activities, but it will also forecast impending
          their offerings and exploit niche market opportu-     scenarios within a set of parameters. The ability
          nities. Similarly, embedding their capital require-   to predict future scenarios will aid in regulatory
          ments into their pricing engines can allow banks      reporting, as well as other areas. For example, by
          to allocate capital optimally.                        analyzing customer data related to credit cards
                                                                and deposits, banks can deduce ways to improve
        Merge Similar Risk Types                                various offers and marketing initiatives.
        Converging different risk management systems
        that share common underlying processes onto             The Road Ahead
        a single platform can help banks increase oper-         Banks face the daunting task of meeting stake-
                             ational efficiencies. For          holder, regulator and customer expectations
Each bank will need example, anti-fraud and                     while complying with stringent new regulatory
     to undertake a anti-money-laundering sys-                  requirements that are gradually taking effect,
                             tems can be merged. By             compliments of Basel III. This will force them to
 deep-dive analysis consolidating these data                    seek more innovative ways of creating opera-
   of its businesses sources, banks will also be                tional efficiencies and market differentiation.
and extract benefits able to deploy analytics
                             more efficiently and cost-         Each bank will need to undertake a deep-dive
        to satisfy all effectively and improve                  analysis of its businesses and extract benefits to
       stakeholders. data reporting.                            satisfy all stakeholders. Top management will be
                                                                under pressure to make prudent IT investments.
          Leverage In-house Capabilities                        Clearly, there is no one-size-fits-all approach.
          For banks that have built capabilities to sup-        Existing business models will dictate the approach
          port in-house operations (in areas such as risk       that banks adopt. The optimal solution could well
          management),     the    stringent    regulatory       lie in a combination of strategic decisions that
          environment offers a chance to capitalize on          revolve around creating operational efficien-
          these investments by offering them as a service       cies and collaborative work environments that
          to smaller and emerging market players.23             optimize cross-functional processes.

          Stress Testing                                        Moreover, industry participants can find
          Banks that have invested in stress-testing            additional avenues for complying with Basel
          technology can use these methods to improve           III by partnering with third-party experts,
          their crisis management techniques.                   delivering cloud-powered services to smaller
                                                                and emergent players, divesting businesses that
          Big Data for Big Efficiencies                         drag down capital or merging with synergistic
          Collating and consolidating large chunks of data      institutions. Such measures can help organiza-
          across data types (such as documents, images,         tions succeed in a risk-averse marketplace that is
          video, etc.), as well as applying meta data manage-   increasingly driven by complex global regulations.
          ment and predictive analytics, can help improve




                                          cognizant reports     8
Footnotes
	 Basel III will be implemented between 2013 and 2018, with key milestones revolving around capital
1

  requirements, leverage ratios and liquidity requirements. The conservation buffer is expected to be
  implemented by 2019.
2
    	“Basel III and European Banking: Its Impact, How Banks Might Respond, and the Challenges of
     Implementation,” McKinsey & Co., 2011.
3
    	 Basel II was the second of the Basel Accords issued by the Basel Committee on Banking Supervision
      in 2004.
4
     	 Brooke Masters, “Few Banks Able to Calculate CVA Swiftly,” Financial Times, July 22, 2012.
5
    	 “Fitch Affirms Citigroup Inc.’s Ratings; Outlook Stable,” BusinessWire, July 18, 2012.
6
    	 Leigh Thomas and Lionel Laurent, “France Pledges Crackdown on Banks’ Proprietary Trading,” Reuters,
      November 15, 2012.
7
    	 Brooke Masters, “Banks to Hold More Capital Under Basel III,” Financial Times, July 25, 2012.
8
     	 “Dream Turns to Nightmare,” The Economist, Sept. 15, 2012.
9
    	 Michael Watt, “Basel III Blamed for Aircraft Financing Drought,” Risk.net, May 9, 2012.
10
     	Richard Suttmeier, “Changing Basel and FDIC Rules Present Challenges for U.S. Banks,” The Street,
      June 13, 2012.
11
    	Ted Carter, “Strong Reaction from Community Banks Cited for Basel III Delay,” Mississippi Business
     Journal, Nov. 16, 2012.
12
     	Ben Gunnee, “Soapbox: Preparing for Basel III,” The Actuary, Aug. 1, 2012.
13
     	Kelly Bit, “Barclays Said to Plan Spinoff of Arbitrage Team as Hedge Fund in January,” Bloomberg,
      Nov. 23, 2011.
14
     	Katharina Bart, “UBS to Cut 10,000 Jobs in Fixed Income Retreat,” Reuters, Oct. 30, 2012.
15
     	Ted Carter, “Strong Reaction from Community Banks Cited for Basel III Delay,” Mississippi Business
      Journal, Nov. 16, 2012.
16
     	“Liquidity: A Bigger Challenge than Capital,” KPMG, May 2012.
17
     	Michelle Price, “Industry Looks to Ease Collateral Crunch,” Financial News, Dec. 17, 2012.
18
     	Dominic Hobson, “Custodians Are Afraid to Exploit the Looming Collateral Shortage,” Thomas Murray,
      Aug. 14, 2012.
19
     	Michelle Price, “Industry Looks to Ease Collateral Crunch,” Financial News, Dec, 17, 2012.
20
     	Brooke Masters, “Banks Face €350 bn Basel III Shortfall,” Financial Times, Dec. 15, 2011.
21
     	Penny Crosman, “Nine Trends Reshaping Risk Software,” American Banker, January 2012.
22
     	
     “SunGard/PRMIA Survey Finds Basel III is Driving Focus on Risk, But Implementation Is Limited,”
     Sungard, June 6, 2011.
23
     	
     Nina Mehta, “UBS Starts Unit Providing Services for Quantitative Hedge Funds,” Bloomberg,
     Aug. 20, 2012.




                                    cognizant reports      9
References
•	“Progress Report on Basel III Implementation,” Bank for International Settlements, October 2012.
•	“The Road to Basel III: Implications for Credit, Derivatives and the Economy,” Deutsche Bank,
  January 2012.

•	“The Markets in 2012: Foresight with Insight,” Deutsche Bank, Dec. 6, 2011.
•	“Wholesale & Investment Banking Outlook: Reshaping the Model,” Morgan Stanley, Oliver Wyman,
  March 23, 2011.

•	
 Philipp Härle, Matthias Heuser, Sonja Pfetsch, Thomas Poppensieker, “Basel III: What the Draft
  Proposals Might Mean for European Banking,” McKinsey & Co., April 2010.

•	“Basel III Proposals Could Strengthen Banks’ Liquidity, But May Have Unintended Consequences,”
  Standard & Poor’s, April 15, 2010.

•	
 “Principles  for Sound Liquidity Risk Management and Supervision,” Bank for International
  Settlements, September 2008.




Credits

Author and Analyst
Akhil Tandulwadikar, Senior Research Associate, Cognizant Research Center

Subject Matter Expert
Anshuman Choudhary, Director, Cognizant Business Consulting, Banking and Financial Services

Design
Harleen Bhatia, Creative Director
Suresh Sambandhan, Designer



About Cognizant

Cognizant (NASDAQ: CTSH) is a leading provider of information technology, consulting, and business process
outsourcing services, dedicated to helping the world’s leading companies build stronger businesses. Headquartered
in Teaneck, New Jersey (U.S.), Cognizant combines a passion for client satisfaction, technology innovation, deep in-
dustry and business process expertise, and a global, collaborative workforce that embodies the future of work. With
over 50 delivery centers worldwide and approximately 156,700 employees as of December 31, 2012, Cognizant is a
member of the NASDAQ-100, the S&P 500, the Forbes Global 2000, and the Fortune 500 and is ranked among the
top performing and fastest growing companies in the world.

Visit us online at www.cognizant.com for more information.



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                                        Phone: +1 201 801 0233               London W2 6BD                        Chennai, 600 096 India
                                        Fax: +1 201 801 0243                 Phone: +44 (0) 207 297 7600          Phone: +91 (0) 44 4209 6000
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­­ Copyright 2013, Cognizant. All rights reserved. No part of this document may be reproduced, stored in a retrieval system, transmitted in any form or by any
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Gearing Up For Basel III

  • 1. • Cognizant Reports Gearing Up For Basel III Stringent data reporting and risk management requirements will compel banks to significantly overhaul their IT infrastructure to not only comply with sweeping regulatory change but also to power new operational efficiencies and create market differentiation. Executive Summary operations. Given the pressure on margins, In its depth and scope, Basel III is unlike anything we believe that banks need to go beyond the the banking business has seen. A combination of standard applications of the new technologies. micro- and macro-prudential norms, the global By building strong capabilities in the areas that regulatory mandate (which rolls out this year are the focus of these regulations, banks can through 2018) 1 requires banks to increase their differentiate themselves from their competitors. quality of capital by focusing on liquidity and Key imperatives for banks as they prepare for common equity; improve supervision of firm-wide Basel III include: risk management; and provide detailed report - ing on regulatory capital and the calculation of • Undertake a fundamental analysis of individ- capital ratios. It mandates adherence to ratios ual businesses to identify growth drivers. such as liquidity coverage and net stable funding, • Strengthen data management practices to which are aimed at strengthening banks’ short create a single source of truth for all functions. and long-term liquidity. Most prominently, Basel III • Embed key functions such as liquidity and risk is transforming risk management into a function management into related processes across the that fortifies banks’ sound functioning. organization. • Invest in technologies that can free up These changes will necessitate a fundamental resources to focus on core activities. review of each bank’s operating model. Many • Improve project management capabilities to banks will need to decide which businesses realize greater benefits from IT investments. and geographies to focus on and which to exit. Almost all banks will need to invest in technology Overall Impact capabilities to meet Basel III’s stringent data The impact of Basel III on banks is manifold, reporting and risk management requirements. ranging from capital (see Figure 1, next page) and liquidity requirements to technology and While these investments will strain bank bal - strategy implications. The new key capital ratio ance sheets, they will also create opportunities is set at 4.5%, more than double the current to extract additional efficiencies from day-to-day 2%. In addition, there is a new buffer of 2.5%; cognizant reports | march 2013
  • 2. banks with capital within the buffer zone will counterparty is likely to default. Surveys have face restrictions on dividend payments and dis- found that several banks are not in a position to cretionary bonuses. According to an estimate by calculate CVA instantaneously.4 McKinsey & Co., the capital requirements under Basel III could reduce return on equity (RoE) for Global systemically important financial banks by about 4% in Europe and 3% in the U.S.2 institutions (G-SIFI) will incur a 1% to 2.5% capital surcharge. These banks will Basel III’s liquidity ratios constitute a “first of need to meet the enhanced One estimate its kind” attempt at regulating bank liquidity. Its capital requirements by suggests that liquidity coverage ratio (LCR) will require banks using retained earnings, rais- to maintain cash-like assets in the short term; the ing fresh equity or reducing G-SIFIs will need net stable funding ratio (NSFR) will determine a their risk-weighted assets to raise another one-year-horizon liquidity buffer. For banks that (RWAs), as the risk weight- $566 billion to are unaccustomed to holding high-quality capital age for certain assets will in the short term, adjusting to these requirements rise under the new regime. meet Basel III’s will entail significant costs, which may be further One estimate suggests that capital inflated by the increased market demand for such G-SIFIs will need to raise requirements. capital. another $566 billion to meet Basel III’s capital requirements. One outcome Basel III will also create technological challenges. of this has been a shedding of non-core assets For one, the proposed rules require banks to by banks globally, particularly in Europe (see report their liquidity metrics on a daily basis. Figure 2, next page). For example, Citigroup’s Banks will, therefore, need to begin collecting data non-core assets declined from 34% in 2009 to points, which could run into several thousands, 10% of total assets as of June 2012.5 across the organization. The mandated enhance- ments to banks’ risk management infrastructures Banks operating in multiple countries will also will also pressure their technology infrastructure. have to deal with other regulations, such as Basel III also includes a credit value adjustment the Dodd-Frank Act in the U.S. (for more on this (CVA) charge that must be calculated over and regulation, read “Implications of Dodd-Frank for above the default counterparty risk charge that the U.S. Banking and Financial Services Indus- was proposed in Basel II.3 This calculation needs try”), European Market Infrastructure Regulation to be carried out on a real-time basis; it involves (EMIR) and the Markets in Financial Instrument analyzing various trades and determining which Directive (MiFID) in the EU. Basel III Capital Requirements Present the Biggest Challenge 18% 16% 16.5% 14% 14.5% 13.0% 12% 13.0% 11.0% 10.5% 10% 9.5% 8.5% 8.0% 8% Minimal Capital Requirement 7.0% 6% 6.0% Conservation Buffer: 2.5% 4.5% Countercyclical Buffer: 0.0% — 2.5% 4% G-SIBs Buffer: 1.0% — 3.5% 2% 0% Common Equity Tier 1 Total Capital Source: “The Road to Basel III Implications for Credit, Derivatives & the Economy,” Deutsche Bank, 2012. Figure 1 cognizant reports 2
  • 3. Investment Banks as corporate lending, private banking and retail The financial crisis exacted a heavy toll on stock brokerage.8 While such moves are feasible the investment banking business, effectively for large banks, the combination of a weak econ- ending an era of record profits. Five years later, omy and stringent regulations make it difficult it remains a rollercoaster ride for these orga- for mid-size and smaller banks to juggle all these nizations (see Figure 3, page 4). In the face of initiatives. declining revenues and risk-averse investors, sev- eral large banks have responded by slashing their Corporate Banking investment banking business. Regulations such Basel III’s impact on non-capital market entities as the Volcker Rule — a part of the Dodd-Frank is expected to be milder, but it will nevertheless Act in the U.S. that restricts proprietary trading alter corporate banks’ lending practices. Higher by banks — have added to the pressure on invest- capital ratios and liquidity requirements could ment banks (for more on the Volcker Rule, read increase lending costs and force banks to reduce “Volcker Rule Compliance: Preparing for the Long their lending to large corporations and/or stop Haul”). Similar laws are likely to be enacted by lending to certain heavy industries altogether. European countries.6 Several signs indicate that this may be already happening. France’s Société Générale and BNP As Basel III dawns on the investment banking Paribas announced plans to scale back their landscape, it is expected to usher in additional aircraft and shipping financing operations. The challenges. The trading business, for one, is Royal Bank of Scotland sold its aircraft leasing expected to be impacted significantly. Basel III’s business in January 2012.9 There are rumblings of market risk and securitization framework will similar moves in the U.S., as well. Meeting Basel force banks trading in OTC derivatives to hold III’s capital requirements is expected to be tough more capital (2% of total exposure to counter- for banks with assets of less than $500 million.10 parties7) for market and counterparty risk provi- The rules are expected to adversely impact mort- sioning. Banks will be forced to shed lower-rated gage and real estate lending.11 assets, which will impact their trading businesses. Such moves could, however, open opportunities These factors are forcing a rethink of the role of for banks from relatively better-off regions, investment banking in organizations with diversi- such as Asia, to expand into new markets. For fied business models. This reassessment comes example, Société Générale exited the Egyptian as many large banks undertake across-the-board market after selling 77% of its stake to Qatar reductions in variable costs. Some wholesale National Bank, allowing the state-backed lender banks have made a move into businesses such to expand into new markets. Growing Non-Core Asset Market in the EU Non-core asset transactions have increased by more than three-fold between 2010 and 2011 and have made a strong start in 2012. €36.0 bn Other, ¤4.0 bn €26.6 bn Portugal, ¤4.2 bn Other, ¤2.0 bn Italy, ¤1.9 bn Ireland, ¤15.0 bn Spain, ¤3.7 bn UK, ¤3.6 bn €10.8 bn Germany, ¤4.3 bn Other, ¤1.2 bn Spain, ¤4.0 bn Switzerland, ¤2.1 bn France, ¤11.1 bn UK, ¤8.8 bn UK, ¤7.5 bn 2010 2011 June 2012 Source: “A Growing Non-Core Asset Market,” PricewaterhouseCoopers, July 2012. Figure 2 cognizant reports 3
  • 4. Hedge Funds have declined, would make these accounts more For hedge funds, Basel III — combined with the expensive for retail banks to maintain.16 Volcker Rule, the EMIR and MiFID – will create considerable challenges. The additional CVA Custodian Banks charge under Basel III is expected to increase For custodian banks, the unfolding regulations the cost of trades and affect trade volumes. present an opportunity to play a larger role for Mandatory trading of OTC derivatives through buy-side clients. Basel III, the U.S. Dodd-Frank exchanges will also increase the cost of OTC Act and the EMIR are expected to boost demand derivatives trading.12 for higher quality collateral. According to the Tabb Group, the clearing mandate would require Additionally, LCR and NSFR are expected to between $1.6 trillion and $2 trillion in additional inflate costs for hedge fund clients. As a result, collateral.17 some banks are separating their hedge funds operations into standalone entities13 or winding As institutions that hold billions of dollars in down operations to focus on core businesses.14 collateral, custodians are in a position to Given that most of these regulations are still in capitalize on the growing demand.18 In fact, orga- flux, the prolonged uncertainty is believed to be nizations such as BNY Mellon, BNP Paribas and hampering many firms’ decision-making. the U.S. Depository Trust & Clearing Corporation (DTCC) have launched initiatives that enable a Retail Banks smooth flow of collateral across borders.19 The impact on retail banks will be similar to that on corporate banks. Nevertheless, compliance will Dealing with Basel III mean allocation of resources and planning for the The double whammy of stringent regulations short term. The requirement to maintain greater and weak economic growth is forcing banks to capital reserves will hamper lending. review every aspect of their businesses. While compliance remains the top priority, banks are In the U.S., several community and small banks continuously seeking to enhance efficiencies have expressed concerns that Basel III capi- in their day-to-day operations to prepare for a tal norms could undermine their ability to prolonged period of tight margins and high costs. issue mortgages.15 Banks with substantial retail deposits will no doubt find it easier to comply As regulatory capital increases its presence on with the higher capital requirements. For others, banks’ balance sheets, the focus is likely to shift building a larger deposit base could entail higher toward initiatives to increase return on equity. costs. Also, the ensuing competition for deposits, RWAs are set to increase under Basel III’s new which have grown only modestly as saving rates regulatory regime, prompting banks to reduce Tough Times Not Over Yet for Investment Banks -18% HSBC -24% Citi -27% JPMorgan -30% Barclays -57% Average -60% Goldman Sachs -65% RBS Pretax profits -73% Deutsche Bank 12 months to Q2 2012 vs. -73% BNP Paribas 12 months to Q2 2011 -76% BofA Merrill Lynch -77% Morgan Stanley -80% Credit Suisse -130% Société Générale -179% UBS -202% Nomura Source: “Institutions are Struggling to Find a Sustainably Profitable Model‚” Financial News, August 13, 2012. Figure 3 cognizant reports 4
  • 5. such assets. Banks with strong internal ratings- Among Basel III’s efforts to mitigate risk are based models for rating assets could apply them various micro-prudential regulations, including to quickly and effectively reduce RWAs. capital, liquidity and leverage control through various ratios; CVA charges; rigorous data report- Banks are exposed Industry estimates suggest ing requirements; and restrictions on leverage that several banks are falling and counterparty exposures. These are supple- to multiple risk short of the required levels mented by macro-prudential regulations, such types, and an of capital.20 Few banks have as mandates to enhance firm-wide supervision overhaul of risk issued fresh capital to fill and governance of risk management practices this gap, suggesting that the and regular stress testing. In anticipation of the management markets might not respond impending regulations, banks have already begun practices is crucial if positively to attempts to assessing their approaches to various functions they are to survive raise capital. Banks are, and processes, such as collateral management therefore, left with no choice and calculation of counterparty risks. future shocks. but to take a hard look at their businesses and scale back in areas that can- Basel III also requires banks to fundamentally not contribute to the maintenance of the required review their trading books. The first step in this levels of RWAs and deliver return on equity. direction is the requirement for banks to hold sig- nificantly more capital against risky instruments It is also becoming imperative for banks to extend such as securitized and structured products. operational efficiencies wherever possible. This More recently, regulators have proposed changes could be achieved through a combination of to the boundary between banks’ trading and strategies, such as partnering with third-party banking books. The proposed changes include: experts, pursuing M&As or creating shared ser- vices platforms. Banks that have invested heavily • Linking the inclusion of an instrument in a in creating IT infrastructure to support processes trading book to its tradability, followed by such as counterparty risk management internally daily valuation and quarterly reporting of the could even provide these platforms as a service to instrument. other players in the industry. • Basing capital requirements on risks that threaten banks’ solvency. Nonetheless, compliance with Basel III will drive many banking processes from silos into a more By any measure, these regulations are significant integrated, collaborative and efficient operat- and, when implemented, will change the way risk ing model. Functions such as risk management, management is perceived which have hitherto been comparatively isolated, and practiced by banks. The While Basel III will now have a say in nearly all bank decisions. need for a firm-wide view compliance means Banks may also choose to invest in advanced data of risk will mean that banks higher costs in the analytics to find and implement ways to optimize will have to embed the risk high-value business processes. Risk analytics, function into all of their form of technology for example, can be deployed on data collected processes, which will require investment from various execution environments to enhance technology to collect and and process risk-related processes, such as credit risk model- analyze data on a daily basis ing and calculating risk indicators. to monitor various levels of reorganization, it exposure and arrive at more also presents banks Expanding Role of Risk Management informed decisions. with an opportunity Banks’ enterprise risk management capabilities were found lacking in areas such as liquidity risk While Basel III compli- to assess their in the days leading up to the global financial cri- ance means higher costs operations and look sis. Basel III is perhaps the largest effort under- in the form of technology for opportunities to taken by global regulators to make banks more investment and process secure. In today’s globally connected markets, reorganization, it also pres- create efficiencies. risk has also become global. Banks are exposed to ents banks with an opportunity to assess their multiple risk types, and an overhaul of risk man- operations and look for opportunities to create agement practices is crucial if they are to survive efficiencies. In the long run, it will influence banks future shocks. to move to a culture of risk and evidence-based cognizant reports 5
  • 6. decision-making. Research firm Celent expects processes that banks will be required to under- organizations across the capital market spectrum take will revolve around aggregating, standard- to spend $35 billion in 2012 on risk management izing and analyzing data to derive high-quality and risk-related compliance. Meanwhile, a survey insights for internal and regulatory consumption. by American Banker Executive Forum found Regulatory data reporting has become stringent, that a growing number of small banks (with less and in some cases, ad hoc reports will be required than $100 million of assets) wish to implement to respond to random checks by regulators. The enterprise risk management in 2012.21 quality of the underlying data, therefore, will become highly important from the bank, regula- Technology Implications tor and market perspectives. Inconsistencies in Almost all the regulations under Basel III have data could attract further regulatory scrutiny and a direct or indirect technology implication for also affect a bank’s credibility. banks. Most of the subsequent technology enhancements will be focused on improving Take for example, collateral management under data management practices. Many activities/ Basel III. Banks that use internal models for Quick Take Basel III Implementation Timeline 2011 2012 2013 2014 2015 2016 2017 2018 2019 Parallel Run Leverage Supervisory Migration Jan. 1, 2013 - Jan. 1, 2017 Ratio Monitoring to Pillar 1 Disclosure starts Jan. 1, 2015 Minimum Common 3.50% 4% 4.50% 4.50% 4.50% 4.50% 4.50% Equity Capital Ratio Capital Conservation 0.63% 1.25% 1.88% 2.50% Buffer Minimum Common Equity plus Capital 3.50% 4% 4.50% 5.13% 5.75% 6.38% 7% Conservation Buffer Phase-in of deductions from CET1 (including amounts exceeding 20% 40% 60% 80% 100% 100% the limit for DTAs, MSRs and financials) Minimum Tier 1 Capital 4.50% 5.50% 6.00% 6.00% 6.00% 6.00% 6.00% Minimum Total Capital 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% Minimum Total Capital plus Conservation 8.00% 8.00% 8.00% 8.63% 9.25% 9.88% 10.50% Buffer Capital instruments that no longer qualify Phased out over a 10-year horizon, beginning in 2013 as non-core Tier 1 capital or Tier 2 Capital Liquidity Coverage Obser- Introduce Ratio vation minimum period standard begins Net Stable Funding Obser- Introduce Ratio vation minimum period standard begins Source: Basel III New Capital and Liquidity Standards, FAQs, Moody’s Analytics Shading indicates transition periods. All dates are as of January 1 of the given year. cognizant reports 6
  • 7. calculating collateral will need to set up a Banks are aware of the imperative to improve collateral management unit. This unit will be data management. Many have set in motion responsible for calculating and making margin organizational changes to calls, managing disputes and reporting margins realign their businesses with Banks that succeed on a daily basis. For this, banks will need to source emerging regulations. A in the highly data from different functional areas across survey22 by the Professional regulated future product and exposure types and eliminate dis- Risk Managers’ International crepancies to ensure data integrity. Moreover, Association and SunGard will be those that the bank, or a unit therein, will need to report the found that banks are slowly not only ensure data to senior management and conduct annual but surely moving away their systems reviews to mitigate margin disputes. If discovered from the exploratory phase by regulators, this would incur financial penalties. to implementing systems meet regulatory Clearly, in addition to the investment involved, to improve risk manage- requirements creating such a process will require organization- ment. However, banks that but also, in wide buy-in and cooperation. succeed in the highly regu- lated future will be those doing so, unlock However, the reality at several banks is that data that not only ensure their opportunities continues to be managed in silos. Bank depart- systems meet regulatory to drive down ments use systems that suit requirements but also, in According to a 2011 department-specific needs doing so, unlock opportuni- costs and create ties to drive down costs and technology-led report by the Tower and store data in varying, incompatible formats. Inte- create technology-led differ- Group, mid-tier grating these disparate sys- differentiators. entiators. banks’ data output tems will be a time-consum- grew 150 times over ing and costly undertaking, Benefiting from Technology especially since the amount Investment the previous seven of data generated by banks As the impacts of Basel III fully take shape, banks to eight years. has exploded in the past face a paradox: They need to make technology decade. According to a 2011 investments for regulatory compliance, even as report by the Tower Group, mid-tier banks’ data margins are squeezed and budgets constrained. output grew 150 times over the previous seven to In such a scenario, banks need to find ways to eight years. extract more from their IT investments. Basel III and the other upcoming regulations offer banks Eliminating data silos will be central to achiev- an opportunity to review and enhance their ing compliance. This, in turn, will require banks business processes and change management to rebuild their aging infrastructures. Stopgap programs. As they invest in technologies man- or minimal efforts might work in the short run, dated by the regulations, banks can identify ways but they will have adverse consequences over to use them for purposes beyond compliance. time as individual regulations come into effect. Banks need to draw up blueprints on the basis of The first step would be to create enterprise-wide their current levels of preparedness and the time- views of key factors such as liquidity, risk and line for Basel III implementation. In the case of data by eliminating silos across the organization. collateral management, foresight and planning This could help banks identify processes and will allow banks to utilize their assets optimally systems that have similar underlying technology and manage collateral schedules more efficiently. to introduce operational efficiencies and enhance decision-making. Moreover, banks that achieve the integrated data management levels required under Basel III will Liquidity and Capital be able to deploy advanced analytics to mine Strong liquidity management, for example, insights that can drive efficiencies in various will not only help senior management better processes. Cloud-based solutions under the understand the bank’s liquidity position and pay-per-use model can help banks turn Cap-Ex prepare for adverse liquidity situations, but it to Op-Ex and create savings through server and would also offer insights into related process software virtualization. optimization initiatives, such as portfolio cognizant reports 7
  • 8. management and loan origination. Embedding decision-making. Such a system will not only be a liquidity perspective into processes such as able to present a consolidated view of histori- product management can help banks enhance cal activities, but it will also forecast impending their offerings and exploit niche market opportu- scenarios within a set of parameters. The ability nities. Similarly, embedding their capital require- to predict future scenarios will aid in regulatory ments into their pricing engines can allow banks reporting, as well as other areas. For example, by to allocate capital optimally. analyzing customer data related to credit cards and deposits, banks can deduce ways to improve Merge Similar Risk Types various offers and marketing initiatives. Converging different risk management systems that share common underlying processes onto The Road Ahead a single platform can help banks increase oper- Banks face the daunting task of meeting stake- ational efficiencies. For holder, regulator and customer expectations Each bank will need example, anti-fraud and while complying with stringent new regulatory to undertake a anti-money-laundering sys- requirements that are gradually taking effect, tems can be merged. By compliments of Basel III. This will force them to deep-dive analysis consolidating these data seek more innovative ways of creating opera- of its businesses sources, banks will also be tional efficiencies and market differentiation. and extract benefits able to deploy analytics more efficiently and cost- Each bank will need to undertake a deep-dive to satisfy all effectively and improve analysis of its businesses and extract benefits to stakeholders. data reporting. satisfy all stakeholders. Top management will be under pressure to make prudent IT investments. Leverage In-house Capabilities Clearly, there is no one-size-fits-all approach. For banks that have built capabilities to sup- Existing business models will dictate the approach port in-house operations (in areas such as risk that banks adopt. The optimal solution could well management), the stringent regulatory lie in a combination of strategic decisions that environment offers a chance to capitalize on revolve around creating operational efficien- these investments by offering them as a service cies and collaborative work environments that to smaller and emerging market players.23 optimize cross-functional processes. Stress Testing Moreover, industry participants can find Banks that have invested in stress-testing additional avenues for complying with Basel technology can use these methods to improve III by partnering with third-party experts, their crisis management techniques. delivering cloud-powered services to smaller and emergent players, divesting businesses that Big Data for Big Efficiencies drag down capital or merging with synergistic Collating and consolidating large chunks of data institutions. Such measures can help organiza- across data types (such as documents, images, tions succeed in a risk-averse marketplace that is video, etc.), as well as applying meta data manage- increasingly driven by complex global regulations. ment and predictive analytics, can help improve cognizant reports 8
  • 9. Footnotes Basel III will be implemented between 2013 and 2018, with key milestones revolving around capital 1 requirements, leverage ratios and liquidity requirements. The conservation buffer is expected to be implemented by 2019. 2 “Basel III and European Banking: Its Impact, How Banks Might Respond, and the Challenges of Implementation,” McKinsey & Co., 2011. 3 Basel II was the second of the Basel Accords issued by the Basel Committee on Banking Supervision in 2004. 4 Brooke Masters, “Few Banks Able to Calculate CVA Swiftly,” Financial Times, July 22, 2012. 5 “Fitch Affirms Citigroup Inc.’s Ratings; Outlook Stable,” BusinessWire, July 18, 2012. 6 Leigh Thomas and Lionel Laurent, “France Pledges Crackdown on Banks’ Proprietary Trading,” Reuters, November 15, 2012. 7 Brooke Masters, “Banks to Hold More Capital Under Basel III,” Financial Times, July 25, 2012. 8 “Dream Turns to Nightmare,” The Economist, Sept. 15, 2012. 9 Michael Watt, “Basel III Blamed for Aircraft Financing Drought,” Risk.net, May 9, 2012. 10 Richard Suttmeier, “Changing Basel and FDIC Rules Present Challenges for U.S. Banks,” The Street, June 13, 2012. 11 Ted Carter, “Strong Reaction from Community Banks Cited for Basel III Delay,” Mississippi Business Journal, Nov. 16, 2012. 12 Ben Gunnee, “Soapbox: Preparing for Basel III,” The Actuary, Aug. 1, 2012. 13 Kelly Bit, “Barclays Said to Plan Spinoff of Arbitrage Team as Hedge Fund in January,” Bloomberg, Nov. 23, 2011. 14 Katharina Bart, “UBS to Cut 10,000 Jobs in Fixed Income Retreat,” Reuters, Oct. 30, 2012. 15 Ted Carter, “Strong Reaction from Community Banks Cited for Basel III Delay,” Mississippi Business Journal, Nov. 16, 2012. 16 “Liquidity: A Bigger Challenge than Capital,” KPMG, May 2012. 17 Michelle Price, “Industry Looks to Ease Collateral Crunch,” Financial News, Dec. 17, 2012. 18 Dominic Hobson, “Custodians Are Afraid to Exploit the Looming Collateral Shortage,” Thomas Murray, Aug. 14, 2012. 19 Michelle Price, “Industry Looks to Ease Collateral Crunch,” Financial News, Dec, 17, 2012. 20 Brooke Masters, “Banks Face €350 bn Basel III Shortfall,” Financial Times, Dec. 15, 2011. 21 Penny Crosman, “Nine Trends Reshaping Risk Software,” American Banker, January 2012. 22 “SunGard/PRMIA Survey Finds Basel III is Driving Focus on Risk, But Implementation Is Limited,” Sungard, June 6, 2011. 23 Nina Mehta, “UBS Starts Unit Providing Services for Quantitative Hedge Funds,” Bloomberg, Aug. 20, 2012. cognizant reports 9
  • 10. References • “Progress Report on Basel III Implementation,” Bank for International Settlements, October 2012. • “The Road to Basel III: Implications for Credit, Derivatives and the Economy,” Deutsche Bank, January 2012. • “The Markets in 2012: Foresight with Insight,” Deutsche Bank, Dec. 6, 2011. • “Wholesale & Investment Banking Outlook: Reshaping the Model,” Morgan Stanley, Oliver Wyman, March 23, 2011. • Philipp Härle, Matthias Heuser, Sonja Pfetsch, Thomas Poppensieker, “Basel III: What the Draft Proposals Might Mean for European Banking,” McKinsey & Co., April 2010. • “Basel III Proposals Could Strengthen Banks’ Liquidity, But May Have Unintended Consequences,” Standard & Poor’s, April 15, 2010. • “Principles for Sound Liquidity Risk Management and Supervision,” Bank for International Settlements, September 2008. Credits Author and Analyst Akhil Tandulwadikar, Senior Research Associate, Cognizant Research Center Subject Matter Expert Anshuman Choudhary, Director, Cognizant Business Consulting, Banking and Financial Services Design Harleen Bhatia, Creative Director Suresh Sambandhan, Designer About Cognizant Cognizant (NASDAQ: CTSH) is a leading provider of information technology, consulting, and business process outsourcing services, dedicated to helping the world’s leading companies build stronger businesses. Headquartered in Teaneck, New Jersey (U.S.), Cognizant combines a passion for client satisfaction, technology innovation, deep in- dustry and business process expertise, and a global, collaborative workforce that embodies the future of work. With over 50 delivery centers worldwide and approximately 156,700 employees as of December 31, 2012, Cognizant is a member of the NASDAQ-100, the S&P 500, the Forbes Global 2000, and the Fortune 500 and is ranked among the top performing and fastest growing companies in the world. Visit us online at www.cognizant.com for more information. World Headquarters European Headquarters India Operations Headquarters 500 Frank W. Burr Blvd. 1 Kingdom Street #5/535, Old Mahabalipuram Road Teaneck, NJ 07666 USA Paddington Central Okkiyam Pettai, Thoraipakkam Phone: +1 201 801 0233 London W2 6BD Chennai, 600 096 India Fax: +1 201 801 0243 Phone: +44 (0) 207 297 7600 Phone: +91 (0) 44 4209 6000 Toll Free: +1 888 937 3277 Fax: +44 (0) 207 121 0102 Fax: +91 (0) 44 4209 6060 Email: inquiry@cognizant.com Email: infouk@cognizant.com Email: inquiryindia@cognizant.com © ­­ Copyright 2013, Cognizant. All rights reserved. No part of this document may be reproduced, stored in a retrieval system, transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the express written permission from Cognizant. The information contained herein is subject to change without notice. All other trademarks mentioned herein are the property of their respective owners.