Basel Accords and Cross Reference Data
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Basel Accords:
Basel I and Basel II accords were introduced in 1988 and 2004 by Basel committee to set common standards for banking regulations and to improve the stability of the international banking system. The accords lay out the rules to be followed by the national regulators in such matters as setting the minimum capital requirements. Currently committee has 12 formal member countries Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States.
The Basel accords have three Bases: measurement of the minimum capital requirements, supervisory review, and market discipline. The accord suggested two approaches that can be followed by banks to calculate their required regulatory capital: the standardized approach or the internal ratings based approach.
The standardized Approach:
The purpose of the approach is to set the risk weights according to the credit rating of the customer. In this approach, the credit rating must be made by an organization outside the bank such as a credit rating agency, e.g. Standard & Poor’s. Two significant implications of setting capital according to credit ratings are
1. It puts pressure on the rating agencies
2. It requires the bank to have a system that can monitor and repossess the rating for every transaction.
Which Rating agencies Basel is referring to?
Standard & Poor’s (S&P), FITCH, and Moody’s all three agencies are external credit rating agencies that are Basel compliant.
Cross-reference data:
Let’s first understand the meaning of cross-reference in simple English, cross-reference is a note, especially one printed in a book, index, or library catalog, that tells a reader to look in another specified place for information. Similarly in financial world, cross-reference data is the data provided by third party for a company, security, or transaction.
To get compliant with Basel accord’s standardized approach, banks need rating information for the securities they are dealing with provided by credit rating agencies mentioned above. They can easily get that rating but the challenge is; there is no globally recognized common identifier that can identify a security/company uniquely. In the absence of global identifier it is very difficult to cross-reference rating information to a security. All credit rating providers assign their own unique identifier to security so as bank.
Challenges in cross-referencing:
No common unique identifier is available that can cross-reference the information.
All agencies follow their own naming convention for the security which might not be same as naming convention your firm is following.
Feeds contain additional information as well which need to cross-reference.
Our Cross-referencing solution:
Our cross-referencing solution fills the gaps mentioned above. We have an intellectual solution that will reside behind your firewall while extracting rating information from different feeds and assign those ratings to securities based upon security name and other available information. For more details about our Cross-referencing solution please visit http://creditdimensions.com/
Benefits of using cross-referencing solution:
Daily updated rating information will be available for your systems.
As solution will be available behind your firewall there are no possibilities that any confidential information will be accessed by outside firms without your approval.
If other departments also require similar information, it can be provided in any desired format i.e. CSV, Excel, and XML formats. This will remove any redundant work of cross-referencing in that department.
The standarised approach is required for banks, bank holding companies, thrift institutions and savings associations that are not subject to advanced approaches of Basel II. But for some of the large banks that are internationally active, will have to follow more advanced approach that would entail them to build their own processes and empirical models to calculate and assign a PD score(Probability of Defualt) to their each loan. This PD will be nothing but conclusion of their ratings for each loan. This in effect means they have to come up with an internal process to rate such loans and assign a PD score. Based on this then they can calculate their LGDs (Loss given Defualt) for each loan. All these parameters will be required to calculate their Risk Weighted Assets (RWA). And subsequently the required capital will be some fixed percentage of RWA.
The point I am trying to drive home here is that the role of counterparty management in these calculation plays an important role. It is not only the Data cross referencing that will be required but even the counterparty enrichment will be of immense importance. Just to illustrate the point think of a COUNTERPARTY that has a wrong domicile. It will lead to a different PD rating, PD score and subsequently a different LGD then it would have received had the domicile been identified correctly. So in the end game this will eventually mean at organisational level, the institution has to incurr a capital charge for all such bad data in their systems, which I am sure wont be taken lightly by senior management of any financial institution and they would love to get this thing right at all costs because the benefits of doing this are far greater than the associated costs.
Additionally we should also keep in mind the timelines by which all banks across different countries have to be ready for BASEL II. When I say ready I mean their risk management processes should be well defined and working in production environment. The difference in timeline for implementing this will also throw some light where this work is coming close to parallel and where this work is still in its elementary form.