At the core of the global economy, banks play a pivotal role. They ensure the smooth flow of financial transactions, support economic development, and secure exchanges.
On this International Banks Day, it is welcomed to explore the challenges and opportunities for African banking systems, especially in light of the upcoming implementation of Basel IV.
Basel IV: Strengthening Solvency Standards for Financial Institutions
Financial markets are undergoing significant changes with the implementation of Basel IV, enhancing global prudential standards. As a reminder, Basel IV proposes more rigorous rules for calculating banking risks, specifying capital requirements, and reducing disparities between institutions and countries.
The primary motivation behind Basel IV is to enhance the resilience of banks in the face of major economic shocks. The agreement also aims to increase transparency in banking practices and ensure fair competition in the global market. Here is a summary of the main modifications introduced by Basel IV and their implications.
Credit Risk under Basel IV:
A complete overhaul of the standard approach to credit risk is at the heart of the reforms. Banks will need to adopt a more granular approach, especially for exposures to businesses, real estate, retail customers, subordinated debts, and equities. Additionally, Basel IV introduces two approaches for internal credit risk assessment: the IRB foundation approach and the IRB advanced approach. A capital floor aims to limit the benefits derived from internal models.
To recall, the Internal Ratings-Based (IRB) approach to credit risk allows banks to model their own data to calculate weighted assets, taking into account credit exposures to various borrowers such as retailers, businesses, financial institutions, and sovereigns. Two frameworks are presented: the IRB foundation approach where banks model only the probability of default, and the IRB advanced approach where banks can also model their own levels of loss in case of default (Loss Given Default: LGD) and exposure in case of default (Exposure-At-Default: EAD). LGD represents the absolute amount lost in the event of a borrower’s default, while EAD is the amount to which a bank is exposed at the time of the same default.
Operational Risk and New Approaches:
The advanced method for operational risk is abandoned in favor of the revised standard approach. Capital requirements will be calculated based on a bank’s income indicator and a 10-year historical loss indicator. A limitation on bank leverage is also introduced to restrict debt accumulation.
Review of the CVA Calculation Method under Basel IV:
The Credit Valuation Adjustment (CVA), measuring the counterparty default risk, undergoes a revision. Two modes of calculating the capital charge for CVA are proposed: the standard model and the advanced approach. The goal is to strengthen the sensitivity of equity to losses on a derivatives portfolio.
Impacts on the Operations of African Financial Institutions:
The revisions to standard approaches aim to increase risk sensitivity and comparability. However, these changes do not come without challenges. Financial institutions will need to mobilize considerable resources to comply with new regulatory guidelines, capital and cost of capital requirements are likely to increase.
Future Perspectives:
As Basel IV gradually takes effect from 2022, it is essential for African financial market players to closely monitor operational and financial impacts. Necessary adjustments for regulatory compliance could reshape the global financial landscape and influence the strategies of financial institutions in the years to come.
Resorting to risk mitigation and counterparty risk weighting solutions are avenues to explore in order to preserve the ability of African banks to finance the continent’s economy. Among these solutions is ETC Export Trading Cooperation’s Risk Division Guarantee.
With the European (A3-) and Pan-African (AA) ratings and the resulting weightings, ETC – Export Trading Cooperation’s individual or portfolio risk division guarantee, named Concentration Risk Bond (CRB), allows banks to mitigate and weigh the risks of their portfolios, comply with the maximum concentration ratio of large risks, support champion clients, and optimize hard capital (CET1) to generate leverage effects. The Concentration Risk Bond (CRB) is indeed an instrument ensuring solvency and resilience for the African banking system.
About ETC – Export Trading Cooperation:
ETC – Export Trading Cooperation is a European institution active in guarantee and financial services, rated (A3-/A-) with the European Securities and Markets Authority (ESMA) by an External Credit Assessment Institution (ECAI) in accordance with Regulation (EC) No 1060/2009. ETC is also rated on the financial markets of West and Central Africa (AA) by the Pan-African credit rating agency Bloomfield. ETC specializes in the technical and financial management of trade and investments internationally, particularly in Sub-Saharan Africa. ETC Export Trading Cooperation is an active member of SWIFT (Society for Worldwide Interbank Financial Telecommunication) with its Swift BIC (Business Identifier Code) ETCGIT2T, under category 2 known as NOSU (Non Supervised Entity active in the financial industry – category of unsupervised institutions active in financial services for banks and other FIs, financially sound, and majority-owned by one or more supervised financial institutions). Thus, the institution is capable of exchanging authenticated interbank financial messages with banks and other financial institutions (e.g., letters of credit, standby letters of credit, documentary collections, and others).
In summary, the 2023 Banks Day marks a crucial step for reflection to raise awareness and strengthen financial stability in Africa. Financial institutions are called upon to take a proactive approach to navigate successfully through the changing regulatory landscape while exploring innovative solutions to ensure the solvency and resilience of the African banking system.
