Basel IV Implementation: How Switzerland Paved the Way in Europe

In January 2023, the Swiss Financial Market Supervisory Authority (FINMA) set out requirements for selected Swiss entities to begin parallel reporting runs based on revisions reflecting the final round of the internationally agreed-upon final Basel III (aka “Basel IV”).

These parallel runs were designed to prepare institutions for the upcoming regulatory changes. They allowed entities to report under the existing Basel III framework and the forthcoming Basel IV standards simultaneously. 

The launch of the parallel reporting runs for Basel IV regulations underscored Switzerland’s reputation as a sophisticated financial hub with an appetite for proactively testing and implementing new global banking standards.

These standards significantly impact how banks manage and report on credit, market, and operational risks—from stricter regulations around real estate exposureand liquidity risk management to tightened capital requirements and related disclosure guidelines. In this spirit, the parallel run was widely expected to enable institutions and regulators to identify potential challenges and ensure a smoother adoption of the complex new rules.

Regardless of jurisdictional interpretation, the transition to Basel IV requirements represents a major increase in calculation scope and complexity with end-to-end impacts, as indicated by the graphic below of the most significant rule changes.
 

A lot of ink has been spilled as to why SVB, the most high-profile of the failed banks, collapsed. While no single factor explains all, here are some of the elements that contributed to its demise:

Overexposed/concentrated risk: SVB typically focused on a homogeneous set of depositors and borrowers, which propelled the bank’s growth in deposits and long-dated fixed-income securities.

Accumulation of unhedged interest-rate and liquidity-flight risks in the balance sheet: The Federal Reserve had raised interest rates multiple times in the preceding 12 months. Couple this with a U.S. regulatory framework that lacked sufficient incentives for banks to adjust their risk levels as well as substantial deductions from SVB’s available capital due to accumulated other comprehensive income (AOCI).

A downgraded economic context that caused depositors to withdraw cash to sustain their activities: This resulted in a first loss on bond portfolios that would, in isolation, have been manageable from a capital standpoint.

Rumors of imminent bankruptcy once the financial situation was communicated: This caused the stock to falter, initiating massive withdrawals and ultimately resulting in the bank selling its long-term, low-yield bonds that should ordinarily have been held to maturity.

A failed bailout: The lender of last resort refused the proposed solutions to cover the subsequent loss that exceeded the bank’s capital.
 

Hindsight is always 20-20, but those who fail to learn the lessons of the past are more likely to repeat them. Here are seven measures which may help firms avoid a similar fate to that of Silicon Valley Bank: 

1. Strengthen regulatory remediation: Matters Requiring Attention (MRA/MRIA) were left outstanding for extended periods of time. A heightened focus to proactively remediate this, in steady and measurable phases, is critical.
2. Evaluate Interest Rate Risk in the Banking Book (IRRBB): As mentioned, the rise in interest rates in the preceding year was a major contributing factor to SVB’s woes. Here, the economic value of equity (EVE) calculation is a simple but powerful measure to capture duration risk in the banking book, providing a clear picture of how a bank’s value might be affected in different interest rate scenarios.
3. Improve liquidity stress testing (LST): Your LST is only as good as its modeling assumptions, which should rely on granular data that is properly sensitive to business dynamics. Aim to model idiosyncratic scenarios on the same, complete, and reconciled data used for FR 2052a reporting.
4. Enhance deposit analytics: Gaining a better understanding of customer mobility is almost always smart. Place a heightened focus on account by ownership rights and capacity (ORC) that exceed the FDIC’s insurance limits.
5. Treasury consolidation of trading and banking books: Bolster your ability to simulate interest-rate (IR) curve movements and recompute IR gaps and other IRRBB metrics with full drilldown. Such measures help enhance transparency and identify areas that require adjustments or pose higher risks.
6. Balance sheet stress testing: To prepare for the unexpected, widen your scope of possibilities to identify vulnerabilities and ensure the bank has sufficient resilience to withstand shocks. Incorporate an expanded range of IR and FX rates and credit default swap (CDS) spreads in combination with behavioral models to create a more realistic view of how stress scenarios could unfold in practice.
7. Advanced analytics for market and counterparty credit risk: Implement enterprise-wide stress scenarios, calculating risk metrics such as value at risk (VaR) and potential future exposure (PFE), enforcing limits, and accounting for the financial impact of changing market conditions, including valuations adjustments (XVA) driven by rising credit risk (e.g., CDS spreads).

Tools and approaches like those outlined help construct a comprehensive framework for liquidity risk management in complex, fast-moving financial environments.
 

Sometimes the biggest risks are those you don’t see coming. As financial institutions think about ways to manage liability and meet regulatory requirements, trusted treasury management solutions can help give you an edge.

Whether it’s simulating the impact of interest-rate changes on assets and liabilities or consolidating risk data across departments and geographies, the right data at the right time can help stave off the kinds of perils brought into sharp relief by the 2023 banking crisis.

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