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The importance of being IRB
07 December 2017
The push and pull of regulatory change will produce an influx of new IRB firms with the goal of maintaining the competitive edge.
The push from the standardised approach
The Basel Committee on Banking Supervision (BCBS) has long had its sights on reducing variability in risk-weighted assets (RWAs). The Basel IV package of regulatory reforms proposed by BCBS will greatly increase the capital requirements of firms following the standardised approach to credit risk. Firms with significant concentrations of secured assets in higher risk segments such as Buy-to-Let and Income Producing Real Estate or with higher Loan to Value ratios will be hit the hardest. They should look at the alternative approach to Capital Management: The Internal Ratings Based (IRB) approach. The revised RWA’s under IRB consume proportionately less capital leaving more to lend and thereby increasing economic viability and profitability.
The pull into IRB
With IFRS 9, it is likely that you have already upped your game in terms of your model sophistication, data management, and Governance. This brings IRB more in reach than ever for smaller firms who have long discounted the move to IRB, concerned with complexity and cost. Historically, IRB has required robust statistical models underpinned by substantial internal data volume and history. To build and manage these tools and achieve regulatory compliance is typically a four to six-year journey with significant associated investment. This, however, is set to change…
In October, the PRA published proposed amendments to the Supervisory Statement following consultation CP5/17. These regulatory changes will remove the cost and data barriers to entry enabling smaller firms to adopt IRB. The use of external data to build models will now be acceptable and with model Experience tests being reduced to one year, firms could be up and running in under three years.
IRB brings more than reduced capital
Moving to IRB is a clear statement of intent of your ambitions and will elevate the status of your firm with investors and regulators alike. IRB promotes robust risk management frameworks and controls and improves data management in a time where understanding the complex data your organisation holds is critical in maximising customer and portfolio value.
Why IRB now?
There are clear benefits of transitioning to IRB, although the new regime will bring significant changes to your firm. The lead time required to complete this programme of work coupled with the expected arrival of Basel IV in the early 2020’s means IRB planning must begin now.
IRB offers significant capital benefits in the face of squeezed interest margins and increased competition from the rise of challenger banks. With the BCBS having just announced significant reforms to Basel III, including an aggregate output capital floor of 72.5%, the quantum of that future benefit is becoming clearer to quantify.
The large banking organisations already know the size of that benefit for their smaller peers and realise that their time in holding that competitive advantage is running out. Your competitors are likely to be looking at IRB now to reap the rewards. This makes it even more critical to plan now and maintain the competitive edge.
Jaywing have unrivaled experience in credit risk modelling in the UK and have developed and validated model frameworks and data architectures that have resulted in IRB compliance for our clients.
Our capital experts are currently advising many firms in the preliminary stages of their IRB programme helping them to plan effectively and efficiently for the changes ahead in light of the evolution of the regulation. Read about how Jaywing is supporting Paragon Bank to achieve IRB compliance through a partnership approach.