Cost Expectations and Concerns About Payback Rise; North American Banks Still Lag European Counterparts
LONDON; July 25, 2005 – Despite increased efforts, banks are facing an uphill struggle in preparing for the Basel II Framework, which sets new standards in risk management and capital adequacy, according to results of a survey released today by Accenture.
The survey queried senior executives responsible for Basel II compliance at 63 of the largest banks in North America and Europe to gauge the response to the challenges posed by the Framework, which strengthens existing capital rules by making them more risk-focused and by aligning regulatory capital levels more closely with economic capital to better reflect market risks.
Findings indicate that most banks are finding implementation tougher than anticipated and are less certain about the benefits of compliance than last year, when Accenture conducted a similar survey. Nevertheless, the vast majority of respondents said that the regulation is a catalyst for moving toward a more risk-based culture — a key objective of the Framework — by focusing senior management more closely on risk practices and on securing funding for necessary technology.
Consistent with findings from last year’s survey, European banks are still much further along the Basel II implementation cycle than those in North America, perhaps reflecting a degree of complacency in light of last year’s decision by U.S. regulators to delay application of the Framework domestically. The Basel II rules are expected to take effect globally in January 2008, although in the United States only the largest internationally active banks are required to comply.
“We were expecting more progress than we found over the last 12 months,” said Paul Cartwright, managing partner of the Finance & Performance Management practice in Accenture’s Financial Services operating group. “On the other hand, we’re seeing a greater focus on moving forward on compliance, especially in North America. That’s good, because the survey indicates that complying with Basel II is more difficult than most bankers thought.”
Major survey findings include:
- Almost half (45 percent) of the executives interviewed said they expect to spend in excess of €50 million through 2007 on Basel II compliance, up significantly from 23 percent in last year’s survey. Banks now have a much better idea of their total cost of compliance than they did last year, with only 10 percent of survey respondents saying they remain unsure of the total cost, compared with 29 percent last year.
- Going beyond simple compliance, half (49 percent) of surveyed banks reported plans to leverage their Basel II capabilities with moderate or considerable further spending in more strategic solutions such as embedding best practices across their risk functions.
- Seventy-nine percent of respondents said they expect Basel II to improve their banks’ capital positions only slightly or not at all, an increase from 73 percent in last year’s survey.
- Reflecting the goal of the new rules to increase bankers’ focus on managing capital for business rather than regulatory needs, about half (48 percent) of respondents said that the Basel II implementation process has improved their enterprise-level economic capital framework. Asked for examples of Framework benefits, the greatest number of respondents — 83 percent — cited two areas equally, improved capital allocation and closer alignment of the risk and finance functions.
“We were surprised to see such high expectations for integration of risk and finance, given their traditional separation,” Cartwright said. “This should improve the quality of the data that support decision-making, particularly through a more risk-sensitive approach to profitability analysis and capital management.”
Long Road Ahead
Survey results also indicate that while preparations for Basel II implementation proceed, many banks have significant work remaining. Only three (5 percent) of this year’s respondents said their organizations have implemented at least one component of their Basel II programs. Across all geographies, the majority of banks are still designing or building their Basel II solutions. Even a reduction in respondent North American banks reporting early-stage gap analyses or designing solutions from 71 percent last year still shows half of 2005 surveyed institutions at this level.
In addition, only about two-fifths (39 percent) of North American banks have reached the ‘build and test’ phase of Basel II compliance — considered the benchmark of concrete progress towards implementing a solution — up from 21 percent last year. This compares with 82 percent of European banks attaining this stage this year, up from 67 percent last year.
The survey also shows that for many European banks, expected levels of spending on Basel II compliance are migrating higher. For instance, when asked their program estimates, 33 percent of European respondents in this year’s survey said they expected to spend between €51 million and €100 million, up significantly from only 16 percent last year. Conversely, surveyed banks expecting program costs of €26 million to €50 million declined from 22 percent last year to only 9 percent this year.
Lagging North American banks appear to not yet comprehend the full impact of Basel II on their organizations, as 39 percent reported they expect to spend no more than €25 million on their compliance programs.
“As European banks advanced further in the Basel II implementation cycle, they reported substantial increases in expected costs,” Cartwright said. “North American banks are earlier in the cycle and are probably underestimating compliance expense. Although many large North American banks already have the sophisticated risk measurement capabilities encapsulated in Basel II, most still face significant spending to get the underlying data right and to address the crucial Pillar 2 reporting requirements.”
Across both regions, for most banks the bulk of Basel II spending will be on credit risk and information technology systems, with operational risk requiring a far lower portion of the expense.
Benefits Less Clear
Bankers are generally less enthusiastic about the benefits from investing in Basel II compliance than they were last year, with notable regional differences. When asked how they viewed investing for business benefits beyond basic Basel II compliance, 60 percent of European participants said the business case was “strong” or “very strong,” compared with just 34 percent of North American respondents.
Across all geographies, there was a sharp decline in the positive perceptions of specific benefits from implementing Basel II. For example, only 35 percent of respondents in this year’s survey said they strongly agree that the Framework will improve capital allocation, down from 55 percent last year. In addition, only 19 percent of respondents in this year’s survey said they strongly expect enhanced market perception to result from compliance, down from 59 percent last year; and only 25 percent this year said they strongly expect enhanced process efficiency, down from 43 percent last year.
“Banks’ experience with Basel II continues to lower the industry’s expectations about what compliance will actually achieve and at what price,” said Cartwright. “Unfortunately, these cost concerns are overshadowing the positive long-term business case for many banks. Some are focused solely on cost, while others are looking at the major benefits and competitive advantage that modest additional investment can bring.”
The survey was designed and analyzed by Accenture and executed via telephone interviews with senior executives at 63 of the largest banks in North America and Europe during April and May 2005. The interviews, conducted by market research agency Kadence (UK) Ltd on behalf of Accenture, were based on a standardized, structured questionnaire designed to explore respondents’ views on key issues in relation to their implementation of the Basel II Framework.
Accenture is a global management consulting, technology services and outsourcing company. Committed to delivering innovation, Accenture collaborates with its clients to help them become high-performance businesses and governments. With deep industry and business process expertise, broad global resources and a proven track record, Accenture can mobilize the right people, skills and technologies to help clients improve their performance. With more than 115,000 people in 48 countries, the company generated net revenues of US$13.67 billion for the fiscal year ended Aug. 31, 2004. Its home page is www.accenture.com.