Regulation: It’s still Basel IV

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Basel’s rule-makers rely too heavily on blunt standardized measures.

BIS tower-300
BIS Tower: home to the BCBS
When the Basel Committee on Banking Supervision (BCBS) pulled back from a proposed Pillar 1 capital charge for interest rate risk in the banking book – amid fears it would trigger a credit crunch – it was hailed as an act of regulatory forbearance. The market interpreted the move as the biggest coup for the banking industry since 2012 when the proposed leverage ratio and liquidity coverage ratios at the global level were made less onerous than was first feared.

But the argument that the BCBS is finally embracing a principles-based approach to liability management, in a bid to ensure capital requirements across the system won’t be hiked, will not wash.

Basel’s belief in blunt standardized measures imposed at a global level, with little recourse to local supervisory and lender differences – at the cost of hiking credit costs in low-risk portfolios – remains intact.

In December, Basel updated standardized framework proposals retaining the focus on credit ratings, and assigning higher risk weights for real-estate exposures, among other things. In March, it proposed curtailing the use of internal models for calculating bank capital requirements.

Lenders claim that the standardized approach should be complementary to liability management efforts, rather than the enforced backstop for risk-sensitivity.

Ripple effect

Changes to risk weights will have a ripple effect across the capital system – a fact, bankers say, regulators do not fully appreciate in their bid to finalize post-crisis reforms.

For example, higher risk weights to credit conversion factors will influence the leverage ratio, the large exposures framework – rules limiting the size of a bank’s concentration of exposures to a counterparty – and the threshold for a lender to be considered systemically-important. 

What’s more, if risk weights under the standardized approach rise, the Net Stable Funding Ratio framework would become more capital-intensive, while any increase in the risk-weights of the collateral pool for securitizations would further damage the economics of liquidity-transformation.

Underscoring the lack of joined-up thinking between financial rule-setting bodies, new accountancy norms increase the incentive to invest in internal models for capital optimisation and risk governance, just as Basel is launching a clampdown. 

New International Financial Reporting Standards (IFRS) come into effect in 2018 – at the behest of banking regulators fearing lenders in Europe were evergreening loans – and will transform how banks recognize credit losses in favour of 'expected loss’, away from the traditional practice of recording a loss when default occurs.

Basel is doing its best to balance risk sensitivity, simplicity and comparability of capital ratios, but the latest proposals – by virtue of overhauling internal models and increasing risk weights – smack of a new Basel IV accord.