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08/01/2011

A study from Sia Partners : estimation of the implementation cost of the Basel III reform

The implementation of the prudential package Basel III will cost 210 million euros to Belgian banks and run for five years. The prudential reform "Basel III", aimed at aligning the banking regulatory framework with the extreme situations faced during the 2007 crisis, is taking shape progressively. Many impact studies have been published to assess the impact on the targeted amount of capital required but the operational costs of compliance to the banks have not yet been estimated.

In a study realized in the first quarter of 2011, Sia Partners, a consulting firm in management and business strategy, analyzes the impact of the implementation of this regulatory reform on all stakeholders of the Belgian banking scene. The cost of transformation and compliance for the whole Belgian banking industry, as estimated by Sia Partners, amounts to 210 million euros, with a price tag of 125 million euros for the four largest banks, and will require 5 years of implementation until 2015.

In comparison this cost is, depending on the banking institution progress, two to three times less than the implementation of the Basel II reform.

1. Background of the reform

The financial crisis of 2007, that has severely impacted the financial markets and more broadly the global economy, helped to highlight the lack of adequacy in the Basel regulatory framework for the banking industry. Until now this framework is mainly defined by the Basel second accord (known as "Basel II") and by the European amendments CRD II & III which are currently under implementation (Capital Requirements Directive).

Spurred by the G20 in Pittsburgh, the Basel Committee decided to undertake a comprehensive reform of the prudential framework to transform a banking environment that had become uncertain and volatile.
The first phase of the reform conducted in mid-2009 resulted in the publication of a document on market risks and continued in December 2009 by the release of two consultation documents setting out guidelines on the capital requirements as well as on liquidity management. During 2010 impact studies ensued, a readjustment of the aforementioned measures and the publication of a first calendar with timing targets.

2. Six main domains

To realise this study, Sia Partners reviewed the detailed requirements of the various texts published up to now and has structured a roadmap categorized in six major domains.

3. Cost of Compliance


Estimation methodology
The Sia Partners impact study is based on an analytical approach of evaluating the detailed cost of implementing a Basel III project for a "typical bank" ("bottom-up" approach") and then decline this model on to the first four banks in Belgium taking relative specificities into account (type of bank, NBI, balance sheet composition, complexity of the trading book, legal structure ...) This is complemented by a "top-down » approach aimed at comparing the results with global metrics or figures based on Sia Partners ‘expertise (benchmarks, comparison with reforms of similar scale). For the remaining players of the Belgian banking market a more arbitrary approach is undertaken resulting in a projection of implementation costs for the whole industry.

Sia Partners considers the domain related to market risk to be the most costly. Stress tests should be started as soon as possible (application from 01/01/2011 and regulation from 01/01/2012) and will fuel other domains, notably the one related to market risk:

This study suggests that investment in IT components (internal development / purchase of software) should be less important than for the Basel II reform. This is explained by the characteristics of the new regulation and the possibility, in most cases, to reuse existing tools by upgrading them.

For the Belgian market, Sia Partners estimates the total cost of implementing the Basel III reform to be around 210 million euros on projects spread over 5 years in average:

The cost of implementation relative to the four major banks in Belgium varies between 18 and 40 million euros. The most important costs will be encountered between 2011 and 2013. From 2015 on, costs will be limited to monitoring and progressive compliance (particularly for the "Own Funds" and "Counterparty risk" domains).

4. Synthesis

The « Basel III package », in all of its components, deals with elements or types of risk that were not or vaguely addressed in the Basel II reform. It thus follows the trend of taking into account in a comprehensive way all risks to which banking groups are subjected and this in a homogenous way for all countries. This last point is an essential element in the implementation of Basel III, which assumes there is no regulatory asymmetry between different financial zones.
Among the impacts on operations and practices of banks, the first consequences begin to emerge:

  1. Search for economies of the scale will be further strengthened, particularly to offset the cost of raising capital and the cost of setting up systems
  2. The concentration of small and medium size players will accelerate, and this rather across borders than on the domestic market
  3. Evolutions in the operational model of banks, which started several years ago, will continue due to strong scrutiny on certain activities (securitization, structured finance, market operations).

In the continuity of post-crisis developments undertaken in the majority of banking institutions, Basel III proves to be a new vector for transformation for the banking sector over the next five years.

Sia Partners

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