Delegates at a recent FINEX Global Breakfast Briefing heard directly from the Financial Services Authority (FSA) about the new regulatory landscape, which will focus on stress testing and dynamic risk management. The impending implementation of Basel III (January 1, 2013) a new global regulatory standard for the banking industry, raises a number of big questions for the industry.
Financial institutions in the UK are, of course, very interested in the changing focus of UK regulators as the Bank of England takes charge under the auspices of the Prudential Regulatory Authority (PRA).
The old approach to regulation was portrayed as compliance and numbers driven with PhD quants in banks negotiating with PhD quants at the FSA – discussing the finer details of “model assumptions”. However the new approach is not only going to be about the widely expected Basel III reforms on capital and liquidity, but about “risk management in periods of stress”.
It’s thought the new PRA will challenge senior management at financial institutions to ensure they are planning for massive “potential stresses” and that they have the necessary capital buffers to remain “going concerns”.
The PRA will “seriously challenge” a financial institution’s business model and its ability to withstand stress conditions.
And in truth, in my view, against a backdrop of perhaps the worst financial crisis in history the importance of stress testing cannot be over emphasised.
The FSA state that the new prudential regulator will have a very different focus. If a business does not meet its “threshold conditions” the regulatory agencies will require firms to sell assets, raise capital or engage in other appropriate loss absorption methods.
The FSA paint a picture of a pro-active regulator that will use the data at its disposal to benchmark banks against their peers and identify concentration risks. The regulator will also challenge a bank’s assumptions about the prudential valuation of illiquid assets – i.e. what these assets would really be worth in a fire sale.
What’s clear in my mind is that as the PRA takes shape at the end of the first quarter this year financial institutions are going to need to adapt from a purely compliance driven approach (which relies on models) to a culture of dynamic risk management planning.