Tighter rules proposed for banks’ credit risk

The Riksbank, Sweden's central bank. Banks say the Basel committee is forcing another round of capital raising
The biggest lenders to corporates may have to hold even more capital as a result of proposed new rules that would curb how much flexibility banks have to assess the risk of their loan books.
The Basel Committee on Banking Supervision proposed on Thursday that banks be barred from using internal models when they calculate how risky certain assets are. Lending to other financial institutions and large companies, and holding equities are the areas most affected.

The proposals are the last part of a package of measures designed to make it easier to compare banks’ balance sheets and prevent them from gaming capital ratios that have been made tougher in the wake of the financial crisis.

Thursday’s paper focused on how banks assess credit risk in their banking books. Credit risk accounts for about 70 per cent, on average, of a lender’s risk-weighted assets — the denominator in the all-important fraction that determines a bank’s capital ratios. Banks come up with the RWA number by making a judgment on how risky various loans and other assets are. Other elements of RWAs include operational, market and counterparty risk — all of which BCBS has tightened the rules around.
“Addressing the issue of excessive variability in risk-weighted assets is fundamental to restoring market confidence in risk-based capital ratios,” said Stefan Ingves, chairman of the Basel committee and governor of the Swedish central bank.

Banks accuse the group of forcing another round of capital raising by the back door, which they have dubbed “Basel IV”. But policy makers have pushed back hard, arguing that their intention is not to raise overall capital but rather to simplify assessment methods and reduce wide divergences in how banks calculate risk.
“They continue the mantra here that their aim is not to increase capital, but the proposals give more grist to the mill for observers such as ourselves who maintain there is a Basel IV,” said Steven Hall, a partner at KPMG. “These are changes to significant elements” of banks’ risk assessment.

Curbing the use of internal models represents a u-turn from earlier iterations of Basel rules, which first permitted banks to use their own models 20 years ago. The presumption is that banks’ internal models are less conservative than standardised ones -- although an industry-funded study earlier this month found that there was “no evidence” lenders manipulated their RWAs.
Under the proposal, banks will have to use a standardised method of calculating the riskiness of loans to financial institutions and to large corporates with assets of more than €50bn. The Basel group believes there is so much publicly available information on the credit risk of such institutions, that banks are rarely able to provide a better estimate than an approach standardised by regulators.

Mayra Rodriguez Valladares, a regulatory consultant, welcomed the move to curb the modelling of interbank risk. “There is so much interconnection between banks that to allow them to have incredible flexibility on how they measure exposure to each other leaves investors and taxpayers at risk when banks underestimate each other’s risk.”

The regulators are still consulting on how to assess sovereign risk as part of separate proposals -- one of the most politically contentious elements of its work. They plan to launch a study to examine the impact of Thursday’s proposals on banks.
Additional reporting by Laura Noonan in London

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