Basel III End Game for Financial Crimes Professionals

On July 27th, the Fed, FDIC, and the OCC released their long-awaited proposal to implement the final components of the Basel III agreement, also known as the Basel III endgame. Separately, the Fed also proposed adjustments to calculating the capital surcharge for global systemically important banks (G-SIBs) and extensive amendments to the Systemic Risk Report (FR Y-15).??

Broadly, the regulatory agencies estimate varied impacts, with an aggregate increase in Risk Weighted Assets by up to 24% for the largest banks.???

Beyond the numbers, the two proposals will present new challenges for financial crimes departments as banks adjust strategies around activities, products, and services in light of changing capital costs. For example, banks may become disincentivized from serving certain high-risk clients, which then may reappear on balance sheets nested within non-bank financial institution (NBFI) accounts. Further, data changes necessary to meet the new requirements may impact transaction monitoring systems.??

As such, this article recommends that financial crimes professionals:?

1. Follow and react to strategy changes?

1. Anticipate secondary market impacts?

1. Incorporate and use new data to benefit transaction and customer monitoring?

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Follow and react to strategy changes?

As banks reevaluate the most profitable use of their capital, financial crimes professionals should expect business model changes that affect product, customer, and delivery channel risk. These changes will affect customer risk rating models and risk assessments.?

For example, banks may choose to exit high operational risk activities. Such businesses with a history of operational risk loss events will be subject to higher capital charges.?

In another example, target customer portfolios may change, encouraging fewer clients and more limited exposure to unlisted companies, driven by the proposed reduction in risk weights for Investment Grade (IG) exposures. The proposed IG rating applies when obligors have securities listed on a recognized exchange.??

Anticipate secondary market impacts?

While some of the proposed rules may appear to reduce your institution's aggregate client risk, be wary: clients exited or in less-targeted sectors will go elsewhere and may end up back on your balance sheet. If banks are disincentivized from certain client groups, they inevitably will end up served by an NBFI. As such, your NBFI clients' transactions and your overall financial crimes risk could increase. In this scenario, you will exchange direct transactions with your bank for nested transactions in your NBFI clients' accounts.?

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Incorporate and Use New Data to Benefit Transaction and Customer Monitoring?

Banks' screening and transaction monitoring tools often interface with many source systems. Significant data changes are inevitable to meet the new capital requirements. Some of this data may have anti-money laundering (AML) implications from new counterparties to screen and more detailed customer loan-level data to monitor for AML or fraud.??

Moreover, given that there will be extensive data sourcing and enhancement projects, it may make sense to improve financial crimes data in parallel with these other uplifts.?

Further, certain aspects of the proposed rules may even highlight high-risk clients. One example comes from the increase in risk weighting of counterparty exposures to unregulated financial institutions (UFI). Reports flagging these clients will need to be reconciled with their know your customer (KYC) files and risk ratings.?

In sum, the Basel III endgame's strategic and operational challenges should be on the radar of financial crimes professionals as their institutions plan and execute their response. Leaders who anticipate the impact on clients, markets, and data will end-up with stronger financial crimes programs.