Banks must brace themselves for consequences of Basel II Accord

With implementation planned for 2006, financial institutions must make tough decisions now.The information technology and systems changes implied by the Basel II Accord are said to be the largest and most expensive technology challenges faced by financial services institutions. Assuming that Basel II reaches implementation in 2006 without major changes, then banks, unless they are smaller US institutions, appear to have no choice. They have to accept one of the approaches designated and bear the cost and market consequences. As many organisations begin to take steps down the path to Basel II compliance, management must be extremely cautious.

While many of the changes are systems related, banks must not view Basel II as simply a systems and technology problem. Basel II is essentially a core business issue that is critical to the future of banks; and any related project will be best handled by people with both domain and strategic knowledge. It is, therefore, essential that banks do not fall into the trap of abdicating the key decision making to the technologists. Banks must maintain management and business control if Basel II is to be successfully implemented.

Although there is a huge opportunity, undoubtedly pushed by vendors, to use the Basel II process to streamline banks’ information infrastructures – such as replacing legacy systems – there are also inherent dangers. Massive cost, unclear strategy and an inability to assess return on investment could turn this regulatory compliance project into a financial and operational nightmare.

The Basel II saga is finally coming to a head and the coming months will require banks to make some tough decisions. Many in Europe may go down the advanced IRB (internal ratings based) approach as the US authorities have dictated for their so-called top 10 institutions. But this will not suit everybody. The US has rejected Basel II for the bulk of its banks on cost grounds. Others, particularly smaller banks across the world, may not have similar saviours to bail them out. They will need to choose.

Several major questions remain. Which cost centre in the bank will pay for the changes? What is the core advantage of this complex process? How will success be measured? And what is the technical strategy? However reluctant banks may be, this seemingly technical issue is absolutely critical to their future. Decision time is now.