The Basel II Accord, which is compulsory and must be adopted worldwide, stipulates that banks must have new procedures for measuring and mitigating against credit and operational risk.
This places the onus on banks to rigorously assess both forms of risk and to build an action plan to reduce exposure to it. This needs to be done well in advance of the 2007 deadline to ensure banks are properly prepared.
Adding to this time pressure, banks must have two years of Basel II-compliant historical risk data to work with by that deadline. Yet the research reveals that most banks are not currently in a position to meet this requirement.
According to the KPMG survey, carried out between October and November last year, many banks are falling behind on their projects to implement the Accord, with around half still only in the pre-study or assessment phase.
Amongst UK banks, progress is generally greater – but they have concerns over the cost of implementing Basel, lack of IT flexibility, and uncertainty over how the regulator will be assessing the robustness of the systems they have developed. Many banks are also concerned about the disclosure requirements under Basel.
These concerns reflect both the considerable amount of information that will need to be published, and the danger of misinterpretation by the markets.
Globally, around 10% of banks are still establishing their Basel teams – and in the Asia Pacific region this climbs to as high as 22%, says the report.
Only 8% of banks have reached the testing and validation phase of their project on credit risk (although this rises to 15% in the Americas). Yet testing and validation is one of the key phases of the overall project and one that often proves difficult to complete. Banks therefore need to be reaching that stage soon, at least for their main portfolios – but for a large number of banks, this does not look likely.
Although many banks are struggling to keep their Basel project on track, there is a clear consensus amongst them of the benefits of implementing the Basel requirements. The most widely perceived benefit is an improved credit rating system, followed by improved management of operational risk. A reduction in capital requirements was only the fourth most highly rated benefit.
The survey also found that banks are generally concentrating more on their credit risk programmes than on operational risk, and are taking a more advanced approach on the credit risk side too.
The main barrier to complying with the Accord was, according to respondents, the cost, with half saying that their total Basel budget was less than $1 million. For a handful of banks however, budgets stretched to in excess of $40 million.
Other widely cited concerns were lack of time, lack of data for operational losses, inflexibility of existing IT systems (a concern in Europe especially) and, in the Asia Pacific region primarily, a shortage of Basel experts.
According to Jane Leach, Basel partner in KPMG's Financial Services practice in the UK:
"Whilst European banks are relatively ahead of the pack, they cannot afford to be complacent. Many of them are not as advanced in their projects as perhaps they should be. The inflexibility of IT systems emerged as a particular concern in Europe, and as IT is vital to the success of Basel, this needs to be addressed as a priority.
"In the UK specifically, it is notable that the area giving banks the most concern is that of supervisory review. Clearly, banks feel unsure of how the FSA will be assessing the robustness of the systems that they have developed. The cost of Basel and the level of internal resources were also prominent concerns."