Beyond Basel III: The Future of High Performance in Chinese Banks

Chinese banks face a number of specific challenges when it comes to implementing the Basel III guidelines.

Accenture looks at the implications of Basel III in some detail, and then outlines how Chinese banks should respond as they seek to comply while continuing to pursue high performance.

Basel III has moved up on the regulatory agenda in the wake of the recent financial crisis. The relatively closed and successful Chinese financial system will face several challenges when it comes to implementing Basel III guidelines:

• They have a heavy dependence on income from net interest margins—which in turn requires significant capital. Banks will face increasing pressure owing to Basel III’s stricter capital supervision rules.
  
  
• Saving rates are declining, thus exerting liquidity pressure on banks as they implement Basel III.

The combination of these factors will put long-term pressure on China’s banks to broaden their income sources and better manage risk by transforming their operating models. The challenge will be finding ways to save capital to meet Basel III requirements. At the same time, many banks are grappling with developing quality corporate clients, expanding their retail business, and expanding high-end financial services.

These goals are posing challenges in their own right, including: identifying quality clients; developing accurate pricing strategies; measuring the contribution made by clients and products to profit; determining how to accurately calculate risk exposures; and accruing sufficient capital reserves.

Basel III proposes five major changes:

• Adjustment in capital composition. Capital composition will now be defined more stringently and transparently. A major impact is that it significantly elevates banks’ primary capital adequacy ratio requirements.

• Enhanced risk coverage. In terms of credit risk, Basel III amends the current risk framework to simplify large exposure limit requirements and introduces the concept of risk exposure limits.

• Introduction of “Leverage Ratio.” This ratio expresses the relationship between Tier 1 Capital and Total Capital Exposure, setting the upper limit at 3 percent.

• Reduced “Pro-cyclicality.” A series of measures will be introduced to increase banks’ capital buffers when times are good, with the goal of making banks more resilient during economic downturns.

• Determination of the liquidity standard. All banks will have to meet minimum liquidity standards.

The challenges outlined are not solely confined to China. From the Basel Capital Accord to the New Basel Capital Accord III, banks have come under increasingly strict risk supervision.

At the same time, senior managers within banks have been looking beyond risk and asking how they can:

• Accurately estimate capital demand in the future.

• Address increasingly serious liquidity issues and increases in funding costs.

• Identify quality customers that will increase their profitability.

• Differentiate pricing strategies for different customers.

• Price and value complex financial products in complicated markets.

To meet the developing regulatory requirements presented by Basel III and to address the challenges arising as China’s commercial banks extend beyond corporate and residential housing-focused banking, Accenture recommends Chinese banks consider the following actions as they strive to achieve high performance in this new regulatory environment:

• Strengthen capabilities in quantitative risk analysis to meet the demand of risk supervision and regulation.

• Develop a broader business portfolio.

• Build up a platform that integrates the management of risk and performance to meet the requirement for highly efficient banks.

Albert Chan leads Accenture’s banking services for Greater China. As the head of Accenture’s professional team, he is responsible for business and technology consulting and outsourcing services to banking organizations in the region. He has 20 years of consulting experience.

Ying Wan is the head of research for the financial services industry at Accenture in Greater China. She has extensive research experience in credit risk management; market entry strategies of foreign financial institutions; strategic transformation of China’s financial institutions; and shareholder value analysis. Ying has worked in the financial industry for nearly 10 years and has held management positions at banks, securities and credit-rating companies. She became a CFA in 2003.

Jacky Yang is a manager at Accenture in Greater China. He provides in-depth consulting services in bank performance management, risk management and inter-bank capital market services. Jacky is also an expert on system contraction. He has eight years of experience in serving Chinese banks and advising large Chinese commercial banks.