Navigating BNM’s Proposed Regulatory Capital Reform
Bank Negara Malaysia (BNM), the central bank of Malaysia, recently released three exposure drafts (ED) outlining its proposed transition to Basel III reporting requirements and implementation guidance. Expected to take effect in 2025 – in less than two years’ time, BNM’s reforms aim to enhance the regulatory capital adequacy framework for financial institutions.
All locally incorporated banks are impacted. They must explore the significance of these changes and understand the challenges and timelines they face in adapting to the new requirements.
A new era of regulatory capital adequacy calculations
The EDs regarding Basel III reporting released at the end of last year and in January 2023 cover three key areas: operational risk, central counterparties, and the Standardized Approach (SA) for credit risk. When finalized, these reforms will replace the existing Capital Adequacy Framework (Basel II) and the Capital Adequacy Framework for Islamic Banks, ushering in a new era of capital adequacy calculations.
BNM’s approach to Basel III
As the EDs make evident, BNM has chosen to implement Basel III reporting partially rather than by adopting the complete framework known as “Basel IV”. This approach aligns with international standards while considering local requirements and conditions, as per Basel’s provision for jurisdictional nuance and interpretation.
It is essential to note that some elements of Basel III reporting, such as the securitization framework, SA‑CCR (standardized approach for counterparty credit risk), and BA/SA-CVA (Basel III revisions for credit valuation adjustment), have not yet been fully aligned and are expected to be implemented after 2025. The marketplace is awaiting further regulatory guidance covering those aspects.
Reform elements aligned with the latest BCBS regulation
- New asset classes such as specialized lending, acquisition, development, and construction financing (ADC), covered bonds, etc
- Changes to risk weights (RW) include additional parameters for unhedged exposures with currency mismatches, residential real estate (RRE), and commercial real estate (CRE). RRE/CRE are now subject to repayment types, loan-to-value (LTV), and the counterparty’s RW
- New exposure at default (EAD) formula for netting sets and haircut floors for securities financing transactions (SFTs)
- Introduction of reform requirements such as the standardized credit risk assessment approach (SCRA), due diligence, etc
- Catch up on a regulation regarding equity investments in funds (EIF) and central counterparties (CCPs)
For operational risk: Adoption of a business-indicator component–based approach with BNM-specific requirements whereby the internal loss multiplier (ILM) is set to 1.For capital adequacy overall: Adoption of the Standardized Approach Floor.
- For credit risk: As stated previously, any changes regarding SA-CCR and BA/SA-CVA are not likely to be effective until after 2025
- For market risk: The fundamental review of the trading book (FRTB) also continues as is for now
Reforms call for extended change-management programs
BNM’s proposed Basel III reporting reforms mark a significant departure from the previous framework. Complying with its complex new requirements will require most banks to substantially modify their systems and processes to address local rules and calculation changes and have access to precise analytics to understand the impact of this reform on regulatory capital.
Firms will need to replace in-house legacy systems and outdated code and/or vendor systems/solutions that lack comprehensive coverage and flexibility. With less than two years to implement, those impacted must take immediate action to prepare.
Pillars 1 and 3 are also in the mix…
Furthermore, there will be a substantial shift in how banks must submit Pillar 1 reports and make Pillar 3 disclosures. These changes increase the burden of allocating intermediary and risk-weighted assets (RWA) results to Pillar 1 and submission files. Additionally, certain aspects such as SA-CCR and CVA will undergo changes post the 2025 implementation. These significant changes will extend the duration of change-management programs beyond what banks in other countries may face.
Dealing with functional and technical challenges of Basel III reporting reform
Given the extent and complexity of BNM’s changes, the tight timeline for implementation, and the expected changes still to come, financial institutions must tackle reform immediately.
The transition to Basel III reporting introduces various challenges including the need to:
- Comprehensively architect data and source strategic data to handle large data volumes and transparently support complex calculations utilizing the same data sources.
- Maintain precise, transparent, end-to-end data lineage to validate data and calculation accuracy, especially given the magnitude of BNM’s Basel III reporting changes.
- Instill transparency into data aggregation, calculation, and reporting to analyze the data at multiple levels of consolidation and rule treatment.
- Smoothly integrate with other reporting to prevent discrepancies in complex Basel III reporting allocations and ensure reporting logic.
- Efficiently run scenarios and stress-tests on granular data. In addition to meeting the SA floor requirement, business users will require the ability to run various scenarios on more detailed source data and simulated datasets. This capability is essential for assessing current and future risks and identifying opportunities.
- Align the trading and banking books to lay the foundation for a strategic approach to credit and market risk.
Comprehensively addressing these challenges represents an opportunity for financial institutions to put the right tools into place and eliminate reliance upon disparate data sources and manually driven, error-prone processes. At this juncture in the Malaysia Basel journey, it is mission critical for impacted banks to seek a solution that can handle massive data volumes, ensure auditable compliance with regulatory capital requirements and other standards, provide accurate and timely Basel III reporting, facilitate stress testing and what-if analysis, and strengthen BCBS-aligned governance.
With the right tools and strategies in place, financial institutions can navigate this transition successfully, ensuring regulatory compliance and positioning themselves for a resilient and competitive future.