An inconvenient truth in the financial services sector

17 August 2011

An inconvenient truth in the financial services sector
Kim Martens
By Kim Martens,
UK manager,
Projective

Can a concept as basic as a “single customer view” be the key to corporate survival?

The financial crisis is so 2009, but don’t let the backburner surprise you, as any chief information officer or chief risk officer out there will confirm. For them, the 2011 buzz words Basel III and the Dodd-Frank Wall Street Reform and Consumer Protection Act (referred to as Dodd-Frank) spell trouble. So what do they have in common and what’s up with that single customer view?

A quick stroll down memory lane

When Basel II was published in 2004, it gave regulators the means to enforce risk and capital management to protect the international financial system from insolvency and overall instability. The banking industry scrambled to comply by creating a Basel II risk-centric reporting framework that allegedly enabled a financial institution to determine its exposure to a single counterparty.

Yet in the years following Basel II, consultancy order books have been continuously filled with projects aimed at creating a one-click single customer view from various angles. Practical examples include:

• Amid all compliance scandals, banks improved their client on-boarding processes, to ensure that compliance, risk, legal, credit and all client facing account managers would share a single data set when evaluating a client’s risk profile.
• In cut-throat competition with lean and mean internet banks, account managers in Tier One banks were screaming for the next generation cloud 2.0 customer relationship management tools to boost cross-selling among their clientele by mining both internal data and external sources such as social media.

Lessons learned from these projects are identical across financial institutions: it is painstakingly difficult to get all stakeholders in a bank to even share the same definition of ‘a client’ as it is a multi-dimensional concept, let alone get all data related to this client extracted from dozens of systems that all have their own identifiers. Furthermore we’ve learned that those banks that have implemented a too narrow Basel II reporting framework have not been able to leverage this investment to create future-proof business value for other business lines.

2011 book of work

In response to the most recent meltdown of the financial services sector, a series of sweeping changes is meant to overhaul the existing financial regulatory framework. These changes are all transparency-centric in that history has now shown that legislation and guidelines are only as strong as the transparent reporting and control framework available to enforce them.

At the end of the ‘too big to fail’ era, regulators have set out on a quest to force absolute awareness and disclosure about the risk that a single counterparty poses to the entire financial system, to increase the system’s resilience and avoid spillover effects. This represents a shift in approach which is both radical and daring.

At 2,307 pages, 16 titles and 540 sections, the Dodd-Frank Act touches practically every aspect of financial services. One of the aims of the act is to set a universal standard for identifying parties to financial contracts. This will lead to the creation of a Legal Entity Identifier (LEI) for all entities engaged in financial transactions, to be used and reported upon by every financial institution.

Basel III in turn introduces new standards on bank capital adequacy and liquidity, necessitating banks to hold more and higher quality capital. For the first time, also non-risked based leverage and liquidity ratios have been defined to supplement the existing Basel II framework.

Threat? opportunity!

The challenge will be to leverage the current technology stack and refine it with a renewed focus on risk analytics and reference data (quality) management. Whereas the Dodd-Frank Act will require a significant effort to achieve compliance, Basel III will require a big effort to make it affordable.

Leveraging experience from projects across the industry, we have two pieces of advice:

• The Dodd-Frank Act LEI can be used as a leverage (or excuse) to finally solve the lingering problem of not having that single customer view. Not only is it the backbone for various types of commercial, financial and regulatory reporting, but it will equally be instrumental in data and system integration, which will reduce the overhead cost of data duplication. That said, the view of a client will have to be layered to fit the requirements of all stakeholders. Typical examples: through a common identifier, a client hierarchy tree structure with multiple overlays can be constructed for compliance, legal, credit etc.

• Basel III can be self-funding or even free up working capital: if used properly, the reporting framework acts as a mirror to the organisation. The Basel risk exposure and related capital adequacy and liquidity requirements are calculated through Risk Weighted Assets (RWA). Highly likely a significant portion of the capital lockup is avoidable, as reference data flaws in the end-to-end transaction chain cause unnecessarily high risk factors to be applied. Typical examples: a security without issuer or rating information, or an account without address data.
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