Banks Warned Off Capital-Arbitrage Trades by Basel Committee

  • Basel group says banks shouldn’t engage in such transactions
  • Transactions will draw ‘careful’ scrutiny, regulator says

Global regulators are cracking down on banks’ ability to lower their capital requirements with complicated trades.

The Basel Committee on Banking Supervision said on Thursday that so-called capital-relief or arbitrage transactions can reduce a bank’s capital charges without making the lender safer. The Basel group, whose members include the U.S. Federal Reserve and the European Central Bank, said these “complex, artificial and opaque” trades can undermine capital rules put in place since the 2008 financial crisis.

“Banks should therefore not engage in transactions that have the aim of offsetting regulatory adjustments,” the Committee said in a statement. “Any such transactions will be subject to careful supervisory scrutiny in the evaluation of risk transfer and the assessment of capital adequacy.”

The Basel Committee’s move follows research in the U.S. last year that found an increase in the number of banks using the transactions. A research unit at the U.S. Treasury Department said that the trades, and the limited data about them, can obscure the health of banks and spread risk through the financial system.

The Treasury’s Office of Financial Research said in a June 2015 study that 18 large banks purchased $38 billion in credit protection in the fourth quarter of 2014 for “regulatory capital relief” that wound up improving risk-based capital ratios.

“It is difficult for investors and counterparties to know the effect of these transactions on a bank’s risk,” the researchers said. U.S. regulators have gaps in their oversight about the hedge funds, private equity firms and other non-banks on the other side of the trades with banks, according to the report.

The Basel Committee said regulators have received many requests to review or approve transactions since the publication of global capital rules in 2010. The transactions have included shifts in tax assets, derivative contracts and guarantees or insurance policies.

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