Rudin Says He Favors Internal Modeling for Canada Bank Risk

Jeremy Rudin, head of Canada’s bank regulator, says he favors allowing banks to do their own internal modeling to measure risk.

That would give banks an incentive to invest the resources “necessary to keep their risk models accurate and up to date,” Rudin, head of the Ottawa-based Office of the Superintendent of Financial Institutions, said in a speech in Montreal.

Global regulators are debating how far global banks can reduce their capital requirements by using internal risk-assessment models. The Basel Committee on Banking Supervision, an international group of standard setters, is working on a package of measures to overhaul banks’ risk-measurement by toughening its rules on when and how internal models can be used.

“At OSFI, we constantly reinforce that it is the banks themselves that determine the risks they want to assume, risks they must subsequently measure, monitor and manage,” Rudin said. “Internal risk measurement models can be very helpful in that regard, especially for large banks that have the data and the resources to develop and maintain models.”

While supervisors say the step is necessary to make sure that lenders can’t game the system, banks are warning that some of the plans would be punitive and dim incentives for them to continue refining their approaches.

Unique Nature

Rudin said that any global standards will need to recognize the “unique” nature of Canada’s banking system, particularly the large share of low-risk mortgages held by the nation’s lenders. Under Canadian rules, mortgages of homes bought with less than a 20 percent downpayment need to be insured.

“We want to ensure that the regime determined by these deliberations will be suitable to Canada’s financial system,” Rudin said.

One issue undermining confidence in internal-ratings based modeling is the wide range of risk weightings across lenders, Rudin said.

“The wide variation in risk weightings that we observe across banks suggests that we are not getting the full benefit when it comes to internal models,” Rudin said. “So we are supportive of efforts to reduce unjustifiable differences in risk weights.”

Leverage Ratios

Andy Haldane, the Bank of England’s executive director for financial stability, board members of the U.S. Federal Deposit Insurance Corp., and Daniel Tarullo, the Federal Reserve governor in charge of bank supervision, are among supervisors to have advocated a simplification of existing Basel rules, notably by placing more reliance on leverage ratios -- a type of capital requirement that doesn’t allow banks to take into account the riskiness of assets they hold.

Rudin indicated his support for that approach, saying today that one way to minimize the problem is with the use of a “constraining” simple leverage ratio that would be applied from “time to time.”

Restrictions should also be placed on the models when data on severe losses is limited, such as risks associated with government debt and top-rated corporations.

“We are prepared to consider new restrictions on the use of models when the data on severe losses are limited,” said Rudin. “For instance, we must be wary of modeling certain types of risk, such as in the areas of sovereign debt and AAA-rated corporations.”

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