Laying a solid foundation for the IRB Approach in Turkey

Turkey’s Banking Regulation and Supervision Agency (BDDK) is moving ahead with plans to permit the use of the Internal Ratings-Based (IRB) Approach to credit risk. Having relied on the Standardized Approach for some time, many banks will be eager to reduce their capital requirements by moving to more risk-sensitive IRB models. However, in order to do so, they must address a number of operational challenges.

The IRB Approach includes many more steps than the Standardized Approach. For example, in order to calculate their risk-based capital, banks must first compute their probability of default (PD) and then their risk-weighted assets (RWA). This requires the use of many more models and much more data than the Standardized Approach.

Banks have become accustomed to using spreadsheets and tactical systems to manage the comparatively simple Standardized Approach. However, this will no longer be possible if they adopt the IRB Approach: the number of models and volume of data involved mean banks will need to automate the entire process. They must now decide how they are going to do this.

A patchwork approach

Banks in other jurisdictions have experienced serious challenges because they have decided to use a patchwork of discrete tools to manage the different stages of the IRB calculation process. They have one tool for computing their PD, another for their RWAs and another for their risk-based capital. These banks have had to build integration layers between the different tools. Not only does this type of set-up lead to higher capital and operational costs, it also reduces transparency, increases the likelihood of integration errors and makes change more difficult.

To avoid these issues, banks in Turkey should work with a single calculation platform that can support all of the different models and data they need for the IRB Approach. This type of platform will allow banks to automatically feed the outputs of the PD calculations into the RWA calculations and so on, enabling them to compute their risk-based capital numbers in a truly straight-through process.

To maximize their return on investment, banks should ensure the same platform can also support other, non-IRB models, such as those required for International Financial Reporting Standard 9 (IFRS 9). The latter is particularly pertinent because, like the IRB Approach, it requires both financial and model data.

Data lineage

As well as reducing costs and the possibility of errors, banks that use a single strategic platform to manage their IRB models will benefit from complete data lineage information. This is particularly important following the implementation earlier this year of the Basel Committee on Banking Supervision’s 239 (BCBS 239) principles. It is also important because the BDDK is increasing its scrutiny of domestic systemically important banks (D-SIBs). To ensure they can respond quickly to queries from the regulator, D-SIBs need a visual map of data moving from their source systems to their final calculations and reports.

Finally, as they prepare to implement the IRB Approach, banks in Turkey should consider the flexibility of the regulatory calculation and reporting platform they use. This is important not only for adapting to changes to the existing requirements, but also for responding to the introduction of new requirements – which seem particularly likely for D-SIBs.

Many calculation and reporting tools on the market today require banks to convert their data through an extract, transform, load (ETL) process. This significantly increases time to market and total cost of ownership. In order to respond more quickly and ensure they are ready ahead of new regulatory deadlines, banks should use a platform with a flexible data model, which allows them to load their data in the format they recognize rather forcing them to go through pre-conversion. Banks should also have the flexibility to choose which database they use – this should not be dictated by their regulatory calculation and reporting platform.

The introduction of the IRB Approach in Turkey provides great opportunities for banks to reduce their capital requirements. Now is the time for banks to lay a solid foundation so they can take advantage of these opportunities.