Banks Rebuff Basel Interest-Rate Plan as Fed Increase Looms

Global banks hit back at regulators’ “dangerous” plans to tackle interest-rate risk in loan books as markets brace for the U.S. Federal Reserve to raise borrowing costs as early as this week.

The Basel Committee on Banking Supervision has proposed overhauling its rules on interest-rate risk in banking books, including possible binding standards on how banks should measure their resilience to shock changes in benchmark borrowing costs. The draft pertains to customer loans and other assets lenders expect to hold for long periods, or to maturity, and whose current value can vary when rates change.

A standardized model for the “regulatory capital treatment of interest rate risks in the banking book is neither possible nor necessary,” the German Banking Industry Committee said in its response to the Basel group. “Quite the contrary: to our point of view, a regulatory standard approach is even dangerous.”

The Fed may begin raising borrowing costs this week after years in which central banks globally held rates at historic lows to kick-start growth after the worst financial crisis since the Great Depression. The European Central Bank, as well as monetary policy chiefs in Denmark and Switzerland, are among those to have pushed some rates below zero in a bid to spur bank lending and revive inflation.

‘Appropriate Capital’

The Basel committee, which brings together regulators including the Fed and the ECB, said in June it wanted to ensure that “banks have appropriate capital to cover potential losses from exposures to changes in interest rates.” Its public consultation on the proposal closed on Sept. 11.

Respondents said standardization across nations ignores the ways in which banks’ business models have developed over time in response to different risks. In turn, that opens the door to systemic risk.

“The most recent financial crisis has clearly shown how advantageous it was that uniform standards for the management of interest rate risks have not yet been developed in the industry,” the German industry group wrote. “An optimal interest rate risk management system needs to be adjusted to its particular business model.”

The view that standardization is inappropriate was echoed by the Institute of International Finance, the International Banking Federation, the Global Financial Markets Association, and the International Swaps and Derivatives Association. Saying that it’s a “strongly held view” in the industry, the global industry groups called the approach “not fit for purpose.”

Capital Levels

The groups added that they were concerned about Basel’s aim of ensuring comparability. “Imposing a standardized methodology leads to comparable numbers in the sense that they are computed in the same way,” they said. “It does not lead to comparable outcomes.”

The Basel regulator is updating rules set in 2004 that involve banks reporting to national supervisors on the the way they are handling risk. Supervisors then decide whether to impose higher capital levels or demand a reduction in the size of the position.

That has allowed the risk treatments to vary by jurisdiction and created incentives for lenders to move assets between the trading book, which holds risks that are typically priced daily, and the banking book, a process known as “capital arbitrage” that Basel says it wants to limit.

In its consultation, the regulator set out two options to strengthen the regime. One would inflict a stricter version of the current approach led by supervisors, and would force banks to disclose more information. The second option would impose minimum capital requirements set by Basel, a system that already applies to the trading book.

Rate Shock

That makes no sense when applied to the banking book, according to the British Bankers’ Association, whose members include HSBC Holdings Plc and Barclays Plc. The BBA argues that a capital charge should only apply if there are real losses, rather than a variation in earnings.

In the trading book, any fluctuation in the market value of a bank’s holdings from an interest-rate change immediately results in a loss or gain. “Hence it makes sense to capitalize the variability of the portfolio under the rate shock,” the BBA said in its response.

In the banking book, by contrast, “accrual streams” are locked in and recognized as profit or loss over the life of the transaction, not immediately. This means the banking book has “embedded value” that will be realized in the future, according to the BBA.

HSBC agreed that losses should be defined differently depending on which book they occur in.

“It is the definition of an expected future loss that varies significantly between the banking book and the trading book,” the London-based bank said in its submission. “This variance does not represent an inconsistency in the capital treatment of the risk, but a fundamental difference.”

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