Banks Tell Basel to Back Off Credit-Risk Capital Restriction

  • Institute of International Finance responds to Basel proposal
  • IIF says Basel credit proposal could have ‘material’ impact

Banks are stepping up opposition to looming capital standards, with one of the financial industry’s largest lobbying groups warning that regulators risk slowing the global economy with a clampdown on lenders’ ability to judge the health of their own borrowers.

The Basel Committee on Banking Supervision’s proposed curbs on banks’ use of internal models to assess risks would have a “material impact” on lending to financial institutions, corporations and other borrowers, the Institute of International Finance wrote in an 83-page letter to the regulator. The IIF called on the Basel Committee, whose members include the U.S. Federal Reserve and the European Central Bank, to grant banks more leeway in assessing the riskiness of borrowers, particularly large corporations.

“In the post-crisis period, when many economic sectors in both developed and emerging markets still highly rely on banks as the main source of funding, reducing the alignment of capital and risk could negatively and unnecessarily affect the availability and pricing of credit to the economy,” according to the IIF’s letter, dated June 3 and released on Monday. The group represents about 500 firms, including JPMorgan Chase & Co., Deutsche Bank AG and BlackRock Inc.

‘Hasty Outcomes’

The IIF, which offered a list of suggested changes to Basel’s proposal, said it is collecting data to provide an estimate of the rule’s impact. The Basel Committee said it would accept comments on the credit-risk proposal until June 24. IIF released the letter ahead of the deadline to give regulators more time to review suggestions and to help Basel avoid “hasty outcomes” in its plan to complete the rule by the end of the year.

The letter was published in advance of a two-day Basel Committee meeting that begins on Wednesday. It’s the latest effort in the industry’s campaign against a raft of proposals from the regulator over the last year that seek to rein in banks’ ability to assess risks that are then used to determine capital requirements.

While the Basel Committee has said it will “focus on not significantly increasing capital requirements” with the new restrictions, the industry says the regulations will have far-reaching effects that come on top of rules already put in place following the 2008 credit crisis. The regulator says its wrapping up work on the post-crisis framework known as Basel III.

‘Massive’ Impact

Executives across the industry, including Deutsche Bank Chief Executive Officer John Cryan, have branded the latest set of proposals for credit, operational and market risks as “Basel IV” and say they amount to a broad rewrite of capital standards.

“I’m not the biggest fan of Basel IV,” Cryan told investors last week. “The new rules that are coming in, I think, will impinge on what we do.”

Iain Mackay, group finance director of HSBC Holdings Plc, said in May that banks would be “pretty much stuffed” if Basel sticks to its plan, saying “the numbers are massive” for the impact of the proposed rules.

Basel proposed in March to remove the option for lenders to use their own models to determine how much capital they need to fund exposures to financial firms, equities and large corporations, forcing them to use a standardized method set by regulators. The plan, which still needs to be completed and implemented by national regulators, was Basel’s effort to reduce variations in how banks model the same risks and to ensure sufficient levels of capital at lenders.

Capital Charges

Critics argue that lenders have too much freedom to game the standards by using and adjusting internal models to reduce their capital charges. The industry rejects this assertion, saying that models allow lenders to ensure capital is attuned to the risk of different types of assets and, according to the IIF, that they are a better tool than a “blunt capital framework.”

The IIF called for revisions in how different types of risks are assessed in the proposal, saying that Basel’s plan tends “to overstate risk on the best credits, but understate it on the weakest.” The letter calls for more risk-sensitive standards for lending to banks, financial institutions and corporations.

Anat Admati, a professor of finance and economics at the Stanford Graduate School of Business, challenged the IIF’s reasoning.

‘Inadequate Requirements’

“The lesson from the financial crisis was not that we need more risk sensitivity of capital requirements, but rather that the Basel approach had failed by allowing banks to operate at dangerously low equity levels through both inadequate requirements and through the complex risk-weighting approach that encouraged ‘innovations,’ created more distortions and increased systemic risk,” Admati said.

Reforms enacted since the crisis “do not reflect these lessons or any valid analysis,” she said. “They continue to tolerate dangerous indebtedness and maintain the flawed approach to risk calibration.”

Among the pleas is a change to Basel’s restrictions for lending to large corporations. The regulator banned the use of internal models for lending to corporations with at least 50 billion euros ($57 billion) in total assets. The IIF said internal models should be allowed subject to “more stringent rules, such as requiring banks to demonstrate that they have a sufficient number of defaults to develop sound models.”

The IIF said the standardized approach would result in banks seeing lower returns on capital for lending to investment-grade corporations. As a result, lenders would be encouraged to “progressively shift their portfolios towards the higher-risk, high-yield segments,” and perhaps force investment-grade borrowers to seek credit outside of regulated banks, the IIF said.

Should Basel retain an asset threshold in the rule, the IIF said it should be raised to 100 billion euros, which would “still capture a material number of corporate groups, and would minimize the scope of the blunt standardized approach’s adverse consequences on strong investment-grade credits.”

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