Banks Face Tougher Risk-Model Constraints in Basel Capital Plan

Global regulators are weighing tougher constraints on how banks measure the risk of losses on their investments in an bid to prevent them from downplaying the capital they need to guard against insolvency.

The Basel Committee on Banking Supervision said it’s examining options including tougher disclosure rules, “narrowing the range of modeling choices” available to lenders and “further harmonizing of supervisory practices,” as it seeks to tackle the problem of banks attaching very different levels of risk to similar assets.

The Basel group’s announcement follows a study of banks that showed “significant variation in the outputs” of “internal models used to calculate regulatory capital,” the Basel group said. The study covered banks’ trading books and echoed the findings of an earlier assessment published in January.

Banks’ ability to reduce their capital requirements by changing how they measure the risk of losses on their assets has prompted regulatory reviews and calls from some supervisors for more reliance on capital rules that aren’t risk sensitive. Bankers including Jamie Dimon, chief executive officer of JPMorgan Chase & Co., have said that flexible implementation of previous rounds of Basel rules in the European Union has allowed European lenders to hold less capital against some assets compared with their U.S. counterparts.

The Basel group today reiterated the main lines of its work in this policy area, following the publication of draft measures in October. While today’s announcement targets banks’ trading books, the committee is also carrying out similar work on assets that lenders intend to hold to maturity.

Policy Actions

The Basel committee indicated that it may not resort to setting strict limits on how low banks can make their assessment of the risk of loss on a particular asset.

The group’s studies “show that the use of floors may not necessarily lead to less variability across banks if the floors are themselves based on modeled inputs,” it said.

International standards set by the Basel committee require banks to meet minimum capital requirements, calculated as a percentage of their assets. The amount of capital that must be held is linked to the riskiness of the banks’ investments.

Bank of England Governor Mark Carney, in his capacity as chairman of the international Financial Stability Board, has also warned of “worryingly large differences” in the results produced by different banks’ risk models.

The Basel committee brings together regulators from 27 nations including the U.S., U.K. and Japan to co-ordinate rulemaking.

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