Banking & Financial Services. White Paper. Basel III Capital Disclosure Requirements The Way Forward For Banks

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1 Bakig & Fiacial Services White Paper Basel III Capital Disclosure Requiremets The Way Forward For Baks

2 About the Author Rekha George Rekha George is part of TCS BFS Fiace & Reportig Practice. She is a Chartered Accoutat ad certified i Iteratioal Fiacial Reportig Stadards (IFRS) by The Istitute of Chartered Accoutats of Idia. Prior to joiig TCS she worked at various orgaizatios i areas of accoutig, fiacial reportig ad compliace, taxatio ad auditig amog others. I her curret role at TCS as a fuctioal cosultat, she is ivolved i cosultig i areas such as IFRS, fiacial reportig ad Foreig Accout Tax Compliace Act (FATCA).

3 I the aftermath of the fiacial crisis, Basel Committee o Bakig Supervisio released the third Basel Accord (BASEL III) i 2010, which cotais ehaced regulatios with respect to the 'three pillars' of Basel framework (1) miimum capital requiremets (2) supervisory review ad (3) market disciplie. These ehaced regulatios are proposed to stregthe the resiliece of the bakig sector. Basel III proposals iclude capital disclosure requiremets aimed to improve the comparability ad trasparecy of the bak's capital positios. The Basel Committee oted that the iadequate level of detail i capital disclosures ad the lack of cosistecy i the way it was reported by baks had made it difficult to assess capital positios durig the crisis period. This was a major hurdle faced by market participats ad supervisors i their effort to assess capital positios ad pla corrective actio. This paper discusses the major chages proposed by Basel III with respect to capital disclosures ad suggests the way forward for baks. It also provides isight o how baks ca beefit from itegratig their risk, fiace ad treasury fuctios to achieve compliace with respect to this disclosure requiremet.

4 Cotets 1. Itroductio 5 2. Major chages i capital disclosure requiremets 5 3. Timelies 5 4. Commo templates to report the compoets of regulatory capital 6 5. Disclosure of a full recociliatio of capital 7 6. The way forward for baks 8 7. Risk ad fiace itegratio 8 8. Coclusio 9 9. Referece 10

5 Itroductio The Basel Committee o Bakig Supervisio (BCBS) released the third Basel Accord (BASEL III) to address the issues ad weakesses i the bakig sector that had cotributed to the fiacial crisis Basel III cotais proposals to ehace the capital disclosures made by baks ad thereby addresses the issue of iadequacy i capital disclosures ad lack of trasparecy ad comparability of a bak s capital positios. This paper discusses the major chages proposed by Basel III with respect to capital disclosures ad ad how it addresses the iadequacies i the existig disclosure practices It also recommeds the way forward for baks to achieve compliace ad the various beefits that the idustry would derive from the same. Major chages i capital disclosure requiremets The ew capital disclosure requiremets address the issues of isufficietly detailed disclosure ad lack of cosistecy i reportig betwee baks ad across jurisdictios. These issues were highlighted by the Basel Committee as the mai hidrace i udertakig detailed assessmets of the capital positios of baks ad 1 comparisos of their capital positios o a cross- jurisdictioal basis. The major chages proposed with respect to capital disclosures are: 1. Use of commo templates to report the compoets of regulatory capital 2. A full recociliatio of all regulatory capital elemets to the published fiacial statemets 3. Disclosure of mai features of regulatory capital istrumets issued ad terms ad coditios of all istrumets icluded i the regulatory capital 4. Disclosure of calculatio of ratios ivolvig compoets of regulatory capital Timelies These disclosure requiremets are effective from Q3 of Therefore baks are required to implemet these ew requiremets from the first set of fiacial statemets relatig to a balace sheet date o or after 30 Jue The reportig frequecy is the same as for their fiacial statemets. 1 Compositio of capital disclosure requiremets 'Basel Committee o Bakig Supervisios' Rules Text, Jue

6 Commo templates to report the compoets of regulatory capital Basel III has icorporated a commo template that baks must use to report the breakdow of their regulatory capital. Use of this template is expected to ehace the cosistecy ad comparability i capital disclosures betwee baks ad across jurisdictios. It icludes two templates: (i) durig the trasitio phase (ii) whe the trasitio period for the phasig-i of deductios eds o 1 Jauary To maitai uiformity ad comparability across jurisdictios, baks should refrai from makig adjustmets to the commo disclosure templates used to disclose their regulatory capital positio. However, a few exceptios are allowed to take care of laguage differeces ad to reduce reportig of uecessary iformatio. Also, i cases where the atioal implemetatio of Basel III applies a more coservative defiitio of a elemet listed i the template, atioal authorities may choose betwee oe of the two approaches available, esurig that impact of the differet defiitios are clear from the disclosures. The two approaches available are: Approach 1: I the atioal versio of the template, maitai the same defiitios of all rows as set out i the commo template. Baks are required to report the impact of the more coservative atioal defiitio i the desigated rows for atioal specific adjustmetsapproach 2: I the atioal versio of the template use the defiitios of elemets as implemeted i that jurisdictio, clearly labellig them as beig differet from the Basel III miimum defiitio, ad require baks to separately disclose the impact of each of these differet defiitios i the otes to the template. The aim of both approaches is to provide all the iformatio ecessary to eable market participats to calculate the capital of baks o a commo basis Durig the trasitio phase, baks are required to use a modified versio of the disclosure template i a way that captures existig atioal treatmets for regulatory adjustmets. This is to esure cosistecy ad comparability across baks ad across differet jurisdictios durig the trasitioal period a) Advatage of usig commo templates Use of commo templates would esure uiformity betwee baks i presetatio of regulatory capital compoets The commo templates prescribed are quite detailed ad would esure disclosure of importat details like deductios from tier 1/ tier 2 capital ad compoets of Tier 2 capital. b) Some commo criticisms agaist usig the commo templates: Such detailed iformatio may ot be useful for most of the users. Oly a summary of the major compoets of capital is usually required. 6

7 Due to the atioal discretio that is allowed o trasitioal arragemets, the trasitioal templates may lack the comparability that would make them useful. 2 Compositio of capital disclosure requiremets Basel Committee o Bakig Supervisios Rules Text, Jue 2012 Bakig istitutios disclosures are boud ot oly by regulatory agecies, but also by other agecies such as the Securities ad Exchage Commissio (SEC) i the U.S for public-traded bakig orgaizatios. Such agecies may also have disclosure requiremets which ca further complicate matters. Data preseted usig the commo templates may ot be really comparable as accoutig stadards ad approach to regulatory cosolidatio differs betwee jurisdictios. Disclosure of a full recociliatio of capital Baks are required to adopt a three step approach to show the lik betwee the balace sheet i their published fiacial statemets ad the umbers that are used i the capital disclosure template. This requiremet aims to address the issue of discoect betwee the umbers used for the calculatio of regulatory capital ad the umbers used i the published fiacial statemets. The three steps ivolved are: Step 1: Disclose the reported balace sheet uder the regulatory scope of cosolidatio. Step 2: Expad the lies of the balace sheet uder the regulatory scope of cosolidatio to display all of the compoets that are used i the compositio of capital disclosure template. Step 3: Map each of the compoets that are disclosed i step 2 to the compositio of the capital disclosure template set out i the commo capital disclosure template Baks are ot subject to a fixed template ad the disclosure level would vary with the complexity of the balace sheet. A bak ca skip a step if there is o further iformatio added by that step. a) Advatages of a full recociliatio of capital Disclosure of a full recociliatio of capital would eable users of fiacial statemets to readily idetify the compoets used for the calculatio of regulatory capital from the Balace Sheet. Such a detailed disclosure would esure trasparecy ad cosistecy i disclosures ad would thereby ehace the comparability of baks capital positio across jurisdictios. b) Some commo criticisms agaist disclosure of full capital recociliatio: For large complex bakig groups, the recociliatio statemet could be complicated because of a large umber of likages betwee the data as per capital disclosure statemet ad the balace sheet. A recociliatio prepared as per these requiremets might be too volumious ad most of the data might ot be of much value to the users. 7

8 Preparatio of such a statemet would require cosiderable time ad effort ad may still fail to serve the purpose due to lack of oe-to-oe correlatio i some cases. Istead of a lie by lie mappig, it would be useful if baks provide arrative explaatios of the sigificat differeces. This would meet the user s eed for summarized iformatio which is relevat ad readily comprehesible. The way forward for baks The Basel III capital disclosure requiremets etail that baks put i sigificat time ad resources i order to achieve compliace. Baks have already iitiated various measures i respose to the Basel III requiremets. The objective behid these measures is ot just to attai compliace but also to achieve icreased efficiecy ad lower compliace costs. As this could ivolve sigificat ivestmets i the IT systems, ecessary budgetig for the costs would be required. Actio poits for baks to achieve compliace: (i) Review the curret fiacial reportig ad regulatory reportig systems ad idetify the gaps with regard to the ew capital disclosure requiremets (ii) Idetify the areas of overlap betwee the two fuctios ad esure that such activities are performed by oe fuctio oly ad the results are available to the other fuctios (iii) Idetify the modificatios required to cover the gaps idetified (iv) The modificatios ad ehacemets should ot be limited to just the reportig systems but to the data capturig level as well. The focus should be o maximizig automatio (v) As a step towards aligig the fiacial ad regulatory reportig systems to the ew Basel III disclosure requiremets, baks should frame appropriate data maagemet ad goverace policies for esurig data quality (vi) Pla a complete itegratio of the fiacial reportig, regulatory reportig ad the risk fuctio for the log ru Risk ad fiace itegratio By itegratig the risk ad fiace fuctios, baks ca put i place a system which would take care of both regulatory reportig ad fiacial reportig. There would be a sigle data repository, with a commo data model that serves the requiremets of both the fuctios thereby elimiatig duplicatios i data, processes ad related resources. With ew techologies evolvig i this area, upgradig the IT systems would allow baks to realize multiple beefits i terms of better regulatory compliace, icreased efficiecy, ad also cost effectiveess i the log ru. 8

9 While some of the data required for the commo templates ad the recociliatio would be i the fiacial reportig system, some would be i the regulatory reportig system. There would still be other data which would be i the risk maagemet system like compoets relatig to expected loss provisios. Further, with regulators isistig o these figures to flow i from the systems rather tha through maual processes, ehacig automatio will help baks improve the quality ad efficiecy of reportig. High automatio levels i reportig ca be possible oly through itegratio of the fiace, regulatory ad risk systems. Coclusio Baks have already iitiated various measures i respose to the Basel III requiremets. The objective behid these measures is ot just to attai compliace but also to achieve icreased efficiecy ad lower compliace costs. Iitiatives take by baks iclude, improvig liquidity risk maagemet processes, optimizatio of Risk Weighted Assets (RWA) through model refiemet ad other measures, Itegratio of risk ad fiace fuctios etc. Istitutios are also tryig to idetify the value such iitiatives would brig to the busiess over ad above compliace ad other related beefits. The beefits iclude the followig: (i) Efficiet use of capital: Capital is aalysed at the most graular level for the compliace requiremet ad this facilitates uderstadig capital better ad puttig it to the best use. (ii) Cost optimisatio: Viewig the various reportig requiremets i total ad udertakig a plaed ad holistic approach to meet these requiremets traslates to cost savigs ad cost optimisatio as compared to a siloed or a fragmeted approach. (iii) Efficiecy i reportig: Havig the systems ad processes which support reportig i multiple formats / chaels without duplicatio i data capture / processig ehaces efficiecy. Greater the syergies betwee the various disclosure / reportig requiremets, greater are the efficiecies achieved. (iv)liquidity maagemet: Basel III has assiged lots of importace towards liquidity maagemet. The availability of iformatio at a graular level supports this fuctio i baks. (v) Busiess itelligece: The compliace iformatio gathered for regulatory reportig ca be leveraged ad used i areas like performace maagemet frameworks, comparisos with idustry bechmarks ad i defiig the risk appetite of the bak. Such compliace requiremets should ot be see as yet aother regulatory requiremet. Baks should also look at the potetial value add esurig such compliace would brig to the busiess. While plaig for regulatory compliace, baks should take a plaed ad futuristic approach which takes ito accout all the reportig requiremets. Quick fixes may prove to be iefficiet ad expesive i the log ru ad may ot add value to the busiess. 9

10 Referece [1] New Capital Disclosure Requiremets Are Iteded to Provide More Clarity by Kathlee A. Scott, New York Law Joural, 11 July [2] Commets o the BCBS' Cosultative Documet o the Defiitio of Capital Disclosure Requiremets, Adres Portilla (IIF) ad Eli K. Peterso (The Clearig House), 17 February [3] Commets o BCBS' Cosultative documet o Defiitio of Capital Disclosure Requiremets by Iteratioal Bakig Federatio, 13 March 2012: [4] Commets o the Cosultative documet: Defiitio of capital disclosure requiremets, Global Fiacial Markets (GFMA), 17 February

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