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Business Impact Of Basel II Begins To Sink In

by Mary Swire,, Hong Kong

01 June 2006

Financial services institutions worldwide are recognizing and embracing a new era of banking, instigated by Basel II, according to a new survey published by leading professional services provider Ernst & Young.

E&Y stated that the results of the poll show that processes and systems will significantly change, along with the way that risks are managed, signifying a new era and fresh dynamic in the global financial services marketplace.

The survey, conducted by the Economist Intelligence Unit, polled banking executives at large banks around the world. Over 40% of respondents were located in Europe, 25% in North America and 24% in the Asia/Pacific region.

“Basel II is recognized as more than a regulatory requirement. Our survey indicates that senior banking executives are beginning to appreciate the long-term impact of Basel II on their own organizations and banking as a whole,” noted Hong Kong-based Phillip Straley, Partner, Global Financial Services Risk Management at Ernst & Young.

Over three-quarters of banks surveyed for ‘Basel II: The Business Impact’ believe these regulations will change the competitive landscape for banking. Those organizations with better risk systems will benefit, at the expense of those who have been slower to absorb change. Eighty-five per cent of respondents believe that economic capital would guide some, if not all pricing. Greater specialization is also predicted, due to an increased use of risk transfer instruments.

“The expectation is that the new risk information required by Basel II will change product pricing and portfolio management – with more loan trading and greater use of derivatives, including in Asia as these markets continue to develop," Straley explained.

"The more sophisticated, larger banks, that have the ability to leverage the new risk data, will gain a significant advantage. There will be winners and losers,” he added.

The majority of respondents (over 70 per cent) believe that portfolio risk management will become more active, driven by the availability of better and more timely risk information, as well as the differential capital requirements resulting from Basel II.

“This could improve the profitability of some banks relative to others, and encourage the trend towards consolidation in the sector in the Asia Pacific region,” Straley commented.

One major concern uncovered by the survey was that the majority of respondents cited Pillar 1 challenges - which should be well advanced by now - as a key focus for 2006, alongside those challenges presented by the implementation of the other two pillars.

“Banks continue to work on embedding Basel II into credit risk processes, model validation and technology planning,” Eric Hansen, Senior Manager, Global Financial Services Risk Management at Ernst & Young Hong Kong, explained.

“Intense effort will be required for new credit processes to be embedded and understood across organizations. The survey results also indicate that work on Pillars II and III lags even further behind, and results on this are consistent for Asia Pacific," he added.

Over half of the respondents felt that internal stakeholders, in particular senior management and front office staff, require education on Basel II.

“With IFRS and (for U.S. SEC registrants) Sarbanes-Oxley reporting initiatives largely behind them, Basel II is now higher on the executive agenda. While banks understand that disclosures could greatly impact how external stakeholders evaluate their business, only 25 per cent of banks name it as key priority for 2006.” Hansen stated.

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