Sponsor's article > Algo Capital: Algorithmics’ solution for Basel II

Basel II presents financial institutions with a significant challenge. It demands that institutions take a more integrated, enterprise approach to risk management, both across risk types and across economic and regulatory capital calculations. These changes will have a profound impact on an institution's data collection, risk and capital calculations, and reporting processes and systems.

However, the long-term benefits could be great, including lower capital requirements, lower cost of capital, higher credit ratings, increased operational efficiency, and improved competitiveness.

But while appreciating the aims and the potential benefits of a full Basel II implementation, many institutions are being forced to tackle a number of pressing short-term tasks in order to meet the imminent deadlines of the Basel II's various phases. The problem institutions face is how to fulfill these tactical, incremental compliance obligations while still keeping their eye on a full enterprise Basel II solution, which satisfies all three pillars and provides tangible business benefits. The answer is to ensure that the tactical responses are compatible with an overall Basel II architecture, and that the short-term projects lay the foundations for a strategic enterprise solution.

Basel II is complex and far-reaching. It affects financial institutions in different ways according to where they are in the evolution of their risk management and capital allocation methods. Every institution will be at a different stage in its response to Basel II, and each one will have its own perspective and its own objectives in meeting the regulatory requirements.

These objectives will be driven partly by the economic and regulatory environment of the country or region in which the institution is located. Other factors, such as the history of the institution and the impact of mergers and acquisitions, can play a role as well. But most often the objectives of Basel II projects are dictated by the vision and leadership within the institution itself. How do the senior executives in the institution see their business? Where do they want to take it? Is Basel II part of this strategy, or is it a distracting regulatory obligation to be dealt with in a minimalist fashion?

The differences in vision and circumstances of institutions has led to a wide range of approaches and projects across the industry, all with the common goal of Basel II compliance. These approaches can range from building an infrastructure for internal models and finding a quick solution to compute and report minimum regulatory capital for Pillar I, to having a flexible engine that will effectively support Pillar II and management needs, to introducing an operational risk infrastructure. Others might have greater ambition, such as the complete integration of risk and finance and the creation of an enterprise architecture for risk adjusted performance measurement (RAPM).

These approaches and objectives will change over time, as institutions move through the various stages of meeting the Basel II deadlines. Eventually, the objectives should evolve towards a full Basel II solution, implemented such that the institution can maximize the business benefits of having a comprehensive capital framework and enterprise risk management capabilities. This is why the incremental, tactical responses should be compatible with an overall architecture that can deliver both Basel II compliance and optimal allocation of capital.

Furthermore, by tackling short-term tactical compliance projects within an overall long-term architecture, an institution can decouple the phases of a strategic Basel II implementation. Instead of having to plan, resource and begin the execution of a full-scale Basel II implementation now, the institution can focus on its most pressing needs, meeting its immediate compliance deadlines, but with the knowledge that the tactical projects are the foundation stones of what will ultimately be a full solution. This approach not only reduces immediate costs, but also avoids the risks associated with large-scale implementations. This is particularly important because Basel II breaks new ground in some of its requirements, and many institutions will need to introduce some systems and processes where they will have had little experience or expertise.

Basel II demands that banks improve their ability to measure their credit risk and forecast exposures, while at the same time allowing the use of risk mitigants, such as guarantees and collateral, to reduce regulatory capital. For many institutions, this requires new capabilities in terms of being able to represent the full multilevel engagement with counterparties in order to allocate collateral and guarantees correctly, as well as a new repository for mitigants and the ability to value and track collateral, and optimize its application.

Basel II also, for the first time, introduces a capital charge for operational risk. Although all institutions will have some processes in place to manage this risk, Basel II sets out new requirements in terms of being able to identify, assess, measure and monitor the risks in the operational systems and processes. Institutions must now gather from across the organization assessments of operational risks, as well as key risk indicators and internal loss data, and be able to manage and analyze this information to improve operational risk management practices and to calculate regulatory capital.

Algo Capital by Algorithmics addresses the tactical needs of institutions in order to meet immediate Basel II deadlines, while at the same time offering
a full strategic solution - and all using the same proven and consistent architecture.

Algorithmics offers a number of modular components that tackle the fundamental tasks of Basel II, including the measurement of credit exposure and the use of credit risk mitigants, the consolidation of risk and capital data, the assessment of economic capital, operational risk management and the computation and reporting of regulatory capital. These components can be implemented individually to satisfy tactical requirements, but will also operate in conjunction with one another to form the basis of a complete Basel II solution. Because the underlying infrastructure is the same for all the components and for an overall Basel II solution, institutions can take a phased approach to their implementation, where the introduction of each component to meet a short-term need also builds on the other components to create a long-term solution at low immediate cost and low project risk.

Algorithmics has more than 15 years of experience in developing and implementing risk management systems for more than 150 global clients, including many of the world's largest banks. It has one of the largest dedicated enterprise risk management teams, and with its strategic Basel II architecture, technology, services, partnerships and years of experience, Algorithmics can help ensure that institutions meet all the requirements of Basel II on time and on budget.

Download the Algo Capital brochure for more information at

http://www.algorithmics.com/solutions/capital/algocapital_brochure.pdfAlgorithmics