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Basel III Mortgages: Australia - Key Themes and Strategic Approach


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The point of view explores the new Basel III reforms and the significant impact they will have on data and systems in Australia. The piece offers a strategic approach to Basel III Mortgages and outlines five key questions Australia’s banks need to ask as they prepare for additional regulatory obligations.

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Basel III Mortgages: Australia - Key Themes and Strategic Approach

  2. 2. Copyright © 2018 Accenture. All rights reserved. 2 OVERVIEW How we got here? On February 14, 2018, the Australian Prudential Regulation Authority (APRA) released the Basel III discussion paper, canvassing how it proposes to introduce the new finalised Basel requirements issued by the Bank of International Settlements into the Australian context. 2014 2017 2020 2021 20222018 Financial System Inquiry final report published (Dec) APRA released strengthening of capital rations paper (July) APRA released discussion paper & QIS (Feb) Final Basel III Standards to be released (Jan) Basel III to be in effect (Jan) Fundamental Review of the Trading Book (FRTB) to be implemented (Jan) While largely following the Basel III reforms published in December 2017, APRA has focused on two key policy initiatives aligned with the 2014 Financial System Inquiry (FSI) recommendations. This will further strengthen the domestic regulatory framework. It endorsed the benefits of a strong and well- capitalised banking system to set regulatory capital requirements as unquestionably strong for the banking sector. APRA’s ‘Unquestionably Strong’ capital benchmark It addressed the structural weaknesses in the residential mortgage sector, encouraging competitive neutrality by raising the average Internal Ratings Based (IRB) mortgage risk weights and reducing the difference between the standardised measures. Align Capital with Risk (e.g. Mortgages) Figure 1: Implementation Timeline
  3. 3. Copyright © 2018 Accenture. All rights reserved. 3 NEW REQUIREMENT STRATEGIC APPROACH TO BASEL III MORTGAGES APRA focuses on the localised Australian retail mortgage book in addition to achieving strong capital (CET1) and a revised RWA framework 1 ACHIEVING STRONG CAPITAL REQUIREMENTS Raising the minimum capital benchmark requirements of Common Equity Tier 1 (CET1) by: • Increasing 150 bps for ADI’s using the IRB approaches. • 50 bps for standardised banks under the existing Basel II approach. STRENGTHENING THE RISK WEIGHTING FRAMEWORK2 Placing constraints on modelling and providing a floor based on the standardised approach. • 50 percent of standardised RWA on January 1, 2022. • Incrementally increasing each year up to 72.5% until January 1, 2027. RISK SEGMENTATION IN THE MORTGAGE BOOK3 Segmenting Australia’s residential mortgage book into two distinct categories: • Owner-occupied loans • Investment property & interest only loans FACILITATING SERVICEABILITY OF LOANS4 Highlighting serviceability requirements for approval of loans: • Encouraging compliant standard origination and underwriting. • Ensuring a minimum 7 percent interest rate floor to approve the loan. CET1, Jan 20 RWA, Jan 22 Retail, Jan 22 Loans, Jan 22 Strengthen the sector to better handle future adversity & periods of financial stress Standardised floor imposed at 72.5% More granular risk weights using Loan to Value Ratio (LVR) categories Interest rate approval floor assessment at 7 percent. Source: APRA. “Feb 2018 Revisions to the capital framework for ADIs.” Page 67
  4. 4. Copyright © 2018 Accenture. All rights reserved. 4 Source: APRA, ‘Revisions to the capital framework for authorised deposit taking institutions’, Discussion Paper, 2018 CAPITAL BENCHMARK REQUIREMENTS OF CET1 TO RISE TO 150 BASIS POINTS BY 2020 NEW REGULATORY COMMON EQUITY TIER 1 MINIMUMS ACHIEVING UNQUESTIONABLY STRONG CAPITAL REQUIREMENTS • APRA reaffirmed its mandate of achieving unquestionably strong capital ratios published in July 2017, which drew on international comparisons to increase the quality and quantum of capital for the domestic sector. • In this paper, APRA concluded that it is necessary to raise the minimum capital benchmark requirements of Common Equity Tier 1 (CET1) by 150 basis points for ADI’s adopting the IRB approaches and 50 basis points for standardised banks as per the existing Basel II approach. • APRA requires that ADI’s meet these new capital benchmarks by January 1, 2020 at the latest. Assumes normalised capital surplus Current surplus includes a margin in anticipation of unquestionably strong This is illustrative of the effective impact of future changes in risk-weights & other framework changes 8% 8% 9.5% Dec 16 Jan 20 Jan 21 9.5% >10.5% >10.5% Minimum regulatory requirements Capital surplus
  5. 5. Copyright © 2018 Accenture. All rights reserved. 5 INTRODUCTION OF A CAPITAL FLOOR BASED ON THE STANDARDISED APPROACH BY 2022 OUTPUT FLOOR APPLICATIONSTRENGTHENING THE RISK WEIGHTING FRAMEWORK • The objective is to reduce the flexibility and competitive advantage of IRB institutions by promoting greater consistency across firms in the industry. • Align capital requirements to risk exposures and risk weighting between the standardised and IRB approaches to minimise the amount of capital benefit that can be obtained. • APRA will impose the floor consistent with the Basel III framework. This is proposed to commence at 50% of standardised RWA on January 1, 2022, incrementally increasing each year to 72.5% until January 1, 2027. Source: APRA, ‘Revisions to the capital framework for authorised deposit taking institutions’, Discussion Paper, 2018 Output Floor is applied to each major risk category. As per the output floor framework, the banks’ risk-weighted assets must be computed as: CR CCR CVA SEC Op. RiskMarket Risk 𝑹𝑾𝑨𝒔 = 𝐦𝐚𝐱 𝑹𝑾𝑨𝒔 𝑰𝑴 𝒐𝒓 𝑺𝑨 ; 𝒇 ∗ 𝑹𝑾𝑨 𝑺𝑨 RWA determined using the approach that the bank has supervisory approval to use in accordance with the Basel capital framework RWA computed using the standardised approach to be used Floor will be implemented during the phase-in (2022- 2027) according to the following scale: 1January 2022: 50% 2023: 55% 2024: 60% 2025: 65% 2026: 70% 2027: 72.5% EFFECTS Introducing risk-based measures which limit the extent to which banks reduce their capital requirements. Increasing comparability between banks using internal models and standardised approaches. Reinforcing the credibility of banks’ internal risk- weighted calculations.
  6. 6. Copyright © 2018 Accenture. All rights reserved. 6 Risk segmentation in the mortgage book Source: APRA, ‘Revisions to the capital framework for authorised deposit taking institutions’, Discussion Paper, 2018 COMPLIANCE & SEGMENTATION OF MORTGAGE BOOK REQUIRES EXTENSIVE DATA CAPTURE AND ANALYSIS NEW REQUIREMENTS FOR OWNER- OCCUPIED AND INVESTOR LOANS • APRA proposes to continue applying the risk weighting banding associated with the LVR profile of the loan similar to the current APS 112 treatment and consider LMI as investor loans will attract a higher risk weight and capital impost. • APRA proposes to address the structural concentration of systemic risks within Australia’s residential retail book by segmenting the portfolio into two distinct categories: • Owner-occupied loans which are deemed as lower risk segments due to the lower historical characteristic losses and • Higher risk loans defined as investment property, interest only loans (investor loans) and loans to Small Medium Enterprises (SME) secured by residential properties, which are materially dependent on the cashflow profile of the secured property. RISK WEIGHTINGS FOR RESIDENTIAL MORTGAGE EXPOSURES AS PER STANDARDISED APPROACH Risk weighting Type ≤50 ≤60 ≤80 ≤90 ≤100 ≤100 Standard: Owner-occupied 20% 25% 30% 40% 50% 70% Other residential mortgages (high risk and SME) 30% 35% 45% 60% 75% 85% Non standard 100%
  7. 7. Copyright © 2018 Accenture. All rights reserved. 7 • APRA proposes to update its criteria for standard residential mortgages to align with the Basel III reforms and serviceability parameters outlined in Prudential Practice Guide APG Residential Mortgage Lending (APG 223). • Banks need to ensure that their standard origination and underwriting practices meet serviceability and operational requirements. • Mortgages that don’t meet the criteria will be deemed non-standard mortgages and attract an additional capital impost incurring a risk weight of 100% due to higher operational risk caused by greater susceptibility to market changes. New operational serviceability requirements Source: APRA, ‘Revisions to the capital framework for authorised deposit taking institutions’, Discussion Paper, 2018 ENCOURAGING SERVICEABILITY & OPERATIONAL REQUIREMENTS ServiceabilityValuation Marketability
  8. 8. Copyright © 2018 Accenture. All rights reserved. 8 BIG IMPACT REQUIREMENTS DATA AND SYSTEMS: THE FOCAL POINT * Internal Model Method – Counterparty credit risk Key impact to banks across departments from the new Basel III risk management framework Who What Level impact Bank departments AuditRisk Mgmt. Internal Validation Product Control Financial Control Accounting Organisation Front Office IT Data & System CapitalModels Organisation Risk Mgmt. IT Risk Mgmt. Internal Validation Audit Risk Mgmt. Organisation Risk Mgmt. Impacts include data quality, Architecture, Taxonomy, Lineage and Technological Systems. This will also have flow through impacts to management and regulatory reporting including D2a and Pillar III Disclosures. Changes will impact capital usage and allocation, product pricing, balance sheet & limit management. Banks should overlay impacts to their strategy; capital forecasts; risk appetite & risk strategy to understand portfolio, product and business strategy implications. Impacting the internal measurement of risk, Basel III provides an opportunity to develop mature and accurate risk based customer profiles and pricing models. This will allow banks to derive more meaningful insights & analytics at the portfolio and customer level. Organisational impacts include internal policies, processes & systems across the value chain through imposing additional serviceability and operational obligations. Banks should consider implications at the customer and facility management level to better originate, manufacture and distribute their products. High impact 20%-30% Low impact <20%Significant impact >30%
  9. 9. Copyright © 2018 Accenture. All rights reserved. 9 Basel III Reform Capital Framework           Fundamental Review of the Trading Book           Responsible Lending        Residential Mortgage Lending Guidance 223        Advanced Approach to Credit Risk Capital (APS 113)         Prudential Standard APS 110        Banking Executive Accountability Regime (BEAR)       Modernised Economic and Financial Statistic (EFS)      BCBS239 Risk Data Aggregation       IFRS9 Financial Instruments        Royal Commission Recommendations (Observations)       DUE TO OVERLAPS IN DATA, BANKS SHOULD CONSIDER A SYNERGISED REGULATORY CHANGE Observations on implicit requirements for compliance SYNERGICREGUATIONS Expressly identified within standard
  10. 10. Copyright © 2018 Accenture. All rights reserved. 10 Banks need to answer five key questions to assess their readiness in the wake of additional regulatory obligations ARE YOU READY? 1. Are you capturing the right data? Banks need to understand what data they require to capture at origination to meet new serviceability and operational requirements which has flow on impacts to management and regulatory reporting. 2. Do you have limitations in your current systems and infrastructure? Banks need to assess their technology and infrastructure systems to understand existing limitations and gaps which could possibly hinder meeting these new obligations. Basel III provides an opportunity to strategically address these limitations and use appropriate tools to improve the processes. 3. Do you have the resources and capability to meet these requirements within the regulatory timeframe? Basel III will demand developing new models and reporting capabilities that will impact multiple systems. The banks need to know how they will respond and adapt to these new changes considering the competitive regulatory initiatives and market priorities. 4. How will the changes impact your incentive scheme and front office conduct and behaviour? Banks need to ensure that they incentivise, capture and document accurate information to meet these new obligations and equip the business units with the right tools and adequate risk knowledge to leverage it optimally. 5. Do you have the right resources, capabilities and understanding of data commonalties across the regulatory change agenda to best meet these new requirements? Banks need to approach these regulatory changes adopting a strategic approach in gathering requirements across the customer lifecycle and understand the cross-over with other relevant regulations.
  11. 11. Copyright © 2018 Accenture. All rights reserved. 11 STRUCTURE OF ACCENTURE FINANCE, RISK & COMPLIANCE (F&R) GLOBAL PRACTICE We are 8,000+ Finance & Risk professionals providing services to leading Financial Services companies in nearly 50 countries. Streamline and integrate models Align data for analytics Deliver technology solutions Develop talent and organisation We combine our industry knowledge and our functional expertise powered by analytics. Banking Capital Markets Insurance Operations TechnologyDigital Consulting
  12. 12. Copyright © 2018 Accenture. All rights reserved. 12 TALES SIAN LOPES Managing Director, Finance, Risk and Compliance Australia & New Zealand +61 419 163 178 CONTACT US ANDREW ATTARD Manager, Finance, Risk and Compliance Australia & New Zealand +61 418 668 424
  13. 13. Copyright © 2018 Accenture. All rights reserved. 13 ABOUT ACCENTURE Accenture is a leading global professional services company, providing a broad range of services and solutions in strategy, consulting, digital, technology and operations. Combining unmatched experience and specialized skills across more than 40 industries and all business functions— underpinned by the world’s largest delivery network—Accenture works at the intersection of business and technology to help clients improve their performance and create sustainable value for their stakeholders. With approximately 442,000 people serving clients in more than 120 countries, Accenture drives innovation to improve the way the world works and lives. Visit us at Accenture, its logo, and High Performance Delivered are trademarks of Accenture. The views and opinions expressed in this document are meant to stimulate thought and discussion. As each business is unique requirements and objectives, these ideas should not be viewed as professional advice with respect to your business.