An 8-step framework for banks to prepare for FRTB changes

02 April 2019 Consultancy.uk

With FRTB expected to come into force in 2022, it is critical that banks implementing necessary changes remain on track for their compliance timelines. Whether a company is aiming for the mandatory Standardised Approach (SA) or the voluntary Internal Models Approach (IMA), the programs often represent a significant investment, requiring process, systems and cultural change. 

Drawing from its experience in helping banks meet the milestone set in their compliance timelines, Capco – a management and technology consultancy for the financial services industry – has developed an eight-point prioritisation framework for FRTB preparation and implementation. Natasha Leigh Giles, a Managing Principal at the consultancy, outlines the main dimensions of the framework: 

Prioritisation framework for FRTB

1. Front office operating model

For those who have already implemented the Volcker rule, the desks are well defined with monitoring and governance frameworks. However, for companies that have not been required to adhere to the U.S. regulation, there may be additional work involved in implementing desk-level controls as required under FRTB. The trading desk structure is especially important for banks planning to implement IMA, as this regime is applied at the desk level and requires that the full flow of the selected desk is able to pass the IMA requirements (including the modelability test for the risk factors). Key business decisions may be required if a desk trades complex products that are more aligned for SA treatment. 

2. Product scope

In order to reach the IMA status, products are required to be supported with additional data sets including historical market and reference data as well as risk factor pricing evidence. The opportunity for 2019 lies in refining the assessment on the feasibility of each product type to ensure a clear scope is agreed for the IMA environment. If the challenges are too complex or costly to overcome, such as access to historical market data, availability of price verification for the risk factors or significant enhancements to support computational capacities, then these products should be scoped out of the IMA program as soon as possible in order to save time and effort on continuing analysis. 

3. Client & trading activities

There is no need to wait until the FRTB implementation timeframe to undertake a holistic review of client and trading profitability – including the capital impacts. For example, running training and awareness campaigns within the front office can help the traders to understand the impacts of their activities and encourage changes in the way that they trade. By considering this holistically as a business and operational change, it can help keep the focus and resources on the primary (profitable) business in preparation for the compliance deadline. 

4. Internal controls

Methodology, reporting, auditability, and process governance for internal controls also need to be monitored in detail. We recommend having clearly defined processes accompanied by effective training across front-to-back office. For some banks, it will be beneficial to audit existing capital adequacy processes to ensure that findings are highlighted in advance of the implementation timeline and the appropriate focus is achieved within senior management.

5. Data & metrics

Financial institutions need to consider their overarching governance and ongoing management for the data (including ownership, quality control, golden source storage solutions, etc.) and the ongoing control framework for ensuring the data remains accurate and relevant for capital adequacy modeling. If there has not been a data lineage exercise already applied, this is a great opportunity to deliver business benefit, even in 2019. By creating agreed definitions, preferred sources, ownership and workflows for managing data quality, the benefits of more accurate data can already be applied to existing capital calculation models. 

Framework for FRTB

6. Model management & validation framework

In preparation for the FRTB regime, an opportunity for 2019 is to understand if there are gaps or control concerns to manage immediately. Model enhancements across SA and IMA will need to be productionized for output accuracy and refinement, however, these need to be maintained alongside existing Basel 2.5 BAU models and other concurrent changes e.g. LIBOR Transition. Business process optimization, testing environments and automation tools, documentation and model validation can all be reviewed for immediate benefits and prepare the process for a smooth implementation of the future FRTB models. 

7. Technology platform & testing environments

With regards to technology planning, the opportunity in 2019 is focusing on gaining agreement of the front-to-back FRTB future state architecture including the use of vendors as applicable. By ensuring a disciplined focus upon design and solution definition across all requirements, it provides a clear baseline for implementation planning and scheduling. Establishing a technology architecture which allows for FRTB data feeds, model enhancements, control definitions and accurate capital calculation outputs will provide the program with essential data and metrics needed for decision making. 

8. Leverging synergies

Once a baseline plan has been established, it is possible to identify synergies across other programs – such as the SA-CCR (Standardized Approach for Counterparty Credit Risk) or the IMM (Internal Models Methodology) – that could deliver overlapping benefits at reduced effort. Understanding requirements, defining the future state architecture, and implementing the change in a complex environment requires a mix of strategic principles and program management. Therefore, we consider it an opportunity for 2019 to take a centralized approach for data lineage and requirements gathering as this would be beneficial for optimizing capital costs across both the market and credit risk environment.

Conclusion

By considering each topic strategically in 2019, benefits such as data quality enhancements, strengthened internal controls and flexible test environments will not only bring immediate business value, but also set a solid foundation for a comprehensive FRTB implementation in the years to come. 

For more information on Capco’s model and the its approach in helping banks plan for FRTB, download the full whitepaper on the firm’s website.

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The business and operating models of digital-only banks

04 April 2019 Consultancy.uk

In recent years, several digital-only banks have successfully managed to nestle themselves in the banking landscape, with their popularity continuing to increase. Looking at it from the customer’s point-of-view, there is little difference between these FinTech unicorns; looking at the bigger picture, however, reveals significant variation in their business models. Matyas Fekete, a consultant at KAE, explores some of the main similarities and differences in digi-bank business and operating models. 

What about the profit?

Unlike in the UK, in most of continental Europe, bank accounts and corresponding banking services are historically paid-for services. The fact that digital banks offer most of their services free of charge has undoubtedly helped them build a large customer base. On the other hand, despite comparatively low set-up and minimised operational costs compared to that of traditional banks, and given the lack of revenue stemming from the typically no-fee model, profitability has proved difficult to achieve. Monzo, for instance, recorded a net loss of £30+ per customer in its most recent financial year. 

In the start-up world, it is customary to focus on expansion rather than profit – see the case of Uber, for instance. Still, while profitability might not be their number one priority in their early stages of development, it must be a long-term goal of any business. With their ever-growing customer base, digital banks are increasingly under pressure to turn their business from loss- to profit-making. 

Credit where credit is due

Digital banks pride themselves on their fair (often meaning “free”) proposition and have so far stayed clear of offering loans (including credit cards & overdrafts), traditionally amongst the most lucrative products for traditional providers. Though somewhat reluctantly, newcomers are also realising that offering lending products is one of the most straightforward ways to offset losses made on their free, often high-cost services (e.g. overseas ATM withdrawals). Monzo, N26 and Starling have recently started offering credit products to their customers, with their loan offering expected to be extended to a wide range of services, from mortgages to overdrafts. Correspondingly, creating a lending portfolio can also pave the way for launching an interest-paying savings offering – a proposition seen as a basic banking product that is yet to feature in most digital banks’ portfolios. 

The business and operating models of digital-only banks

The premium customer

While most digital banks offer most of their products for free, some have extended their offering by paid-for premium services in order to create a revenue stream. As these premium features – including different types of insurance, unlimited free transfers/withdrawals, faster payment settlement or concierge services – are often offered in a subscription format, customers are typically prompted to pay for the full package rather than just the desired service(s), providing a significant revenue stream for the bank. Revolut, for instance, was amongst the first digital banks in Europe to break even earlier this year, a feat largely due to revenue from its premium subscription.

SMEs like digital too

Traditional banks typically service small and medium sized businesses under their retail rather than corporate banking arm. Having their product offering tested with consumers, and consequently gaining a reasonable customer base, digital banks have also identified SMEs as an ideal segment to extend their target audience to. The five FinTechs profiled have already gone, or plan to go, down this path by following up their consumer solution with a business account. While both propositions are typically built on similar features, some providers charge businesses a monthly subscription (e.g. Revolut), while others apply additional fees to specific services (e.g. TransferWise), banking on the expectation that businesses are more likely to be willing to pay for banking – something they are already used to doing. 

The marketplace model

While most digital banks offer a wide range of banking services, some of these tend to come from partnering with third-party providers. For instance, Starling Bank’s only proprietary product is its current account, which serves as a basis for the provision of ancillary services, ranging from loans to insurance, to investment opportunities. Instead of developing these services in-house, Starling enables a select group of partnering financial service providers access to its platform in exchange for a fee. In effect, Starling is using its customer base to create a market for its partners, charging a commission for each acquired customer. 

In such cases of digital banks applying this marketplace model, the majority of their income often comes from partners rather than customers. Naturally, only banks with a large enough customer base can be successful in this set-up, underlining the current intensity of competition amongst digital banks.

Banking as a Service

While customer-centricity is heralded amongst the main USPs of digital banks, some are looking beyond offering consumer-facing services to diversify their revenue streams. Starling, which is among the few digital banks built on its own proprietary platform, has recently leapt into the Banking as a Service (BaaS) industry, making its technology available to other start-ups looking to launch a digital bank. Naturally, this raises the question whether the two offerings could threaten each other’s success. Generally, as long as such partners operate in different markets, the two business lines should be able to thrive alongside each other. Further along the line, however, such partners could easily end up expanding their banking solution into the same market(s) as they aim for global success, and by doing so, becoming direct competitors. 

Different approach, same result?

It is fair to say that consumers in Europe looking to bank with a digital-only provider would have a difficult time finding relative advantages/disadvantages amongst the leading players in the industry. Still, despite the limited surface-level variety, exploring the business models of leading digital banks reveals different approaches to the challenge of making money. Alongside the more straightforward method of offering paid-for premium features/subscriptions, some are banking on the value that access to their customer base offers to third-parties, while others outsource their technology to neobanks wanting to focus on the Fin rather than the Tech. With competition amongst digital banks heating up, it will be interesting to see which business model(s) prove to be the winning formula in the long term.