The great bank capital-fiddling party has further to go. Proposals from the Basel Committee on Banking Supervision on March 24 are supposed to limit the potential for lenders to understate the credit risk of their so-called risk-weighted assets. The global solvency standard-setter is on the right track, but its new ideas leave some aspects of the problem unaddressed.
Banks can currently choose from two generic ways to calculate their capital. The standardised approach means their regulator feeds assumptions over how much they could lose on different types of loans into a calculator that spits out a required level of capital. The "internal models" approach allows banks to use their own assumptions.
The internal method has some positives: banks can use decades of data to come to an accurate view. It also has negatives: less scrupulous players can hold less capital than they should.
It could have been worse for banks. In the aftermath of the financial crisis, some advocated moving to the standardised approach entirely. That would mean holding more capital and making lower returns. The benefit of a more kid-gloves approach is that lenders can more easily cope with low interest rates and struggling economies. The catch is that bank investors will continue to assign a credibility discount to the institutions whose equity capital they ultimately own.
Banks can currently choose from two generic ways to calculate their capital. The standardised approach means their regulator feeds assumptions over how much they could lose on different types of loans into a calculator that spits out a required level of capital. The "internal models" approach allows banks to use their own assumptions.
The internal method has some positives: banks can use decades of data to come to an accurate view. It also has negatives: less scrupulous players can hold less capital than they should.
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Basel now wants loans to big companies and banks to be worked out via the standardised approach. That's sensible, because there aren't sufficient volumes of those kinds of borrowers going bust in the past, so the data doesn't provide reliable loss assumptions. Less promising is a proposal that bank capital devised via internal models be no less than 60 per cent of what it would be via a standardised approach. Investors would have more faith in banks if the floor were more like 90 per cent, the upper level being consulted on.
It could have been worse for banks. In the aftermath of the financial crisis, some advocated moving to the standardised approach entirely. That would mean holding more capital and making lower returns. The benefit of a more kid-gloves approach is that lenders can more easily cope with low interest rates and struggling economies. The catch is that bank investors will continue to assign a credibility discount to the institutions whose equity capital they ultimately own.