Risk Management

Regulators Want to Fix Bank’s Risk Models

There is too much variability in the credit risk banks are assigning to different kinds of assets, says the the Basel Committee on Banking Supervis...
Matthew HellerOctober 9, 2014
Regulators Want to Fix Bank’s Risk Models

Global banking regulators are considering several technical measures to address “excessive” variability in how banks evaluate credit risk, according to the head of the Basel Committee on Banking Supervision.

it-riskThe committee is preparing a report on credit risk assessment for the Group of 20 nations that will be published next month. Secretary General Bill Coen tells Bloomberg in an interview that the committee is considering “a number of technical fixes … that would constrict the degrees of freedom banks have” in assigning credit risk and measuring capital needs.

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

Among those fixes, Coen said, are “things like a non-risk-based leverage ratio and the introduction of floors or benchmarks, which is requiring banks to publish what [their] capital requirement[s] would be if they used the simpler standardized, non-model based approaches.”

Coen’s comments reflect regulators’ concern that some global banks have improved their capital ratios since the financial crisis in part by understating the riskiness of their assets. The Bank for International Settlements, a sister organization of the Basel committee, has compared the practice to “window dressing.”

“Studies by the BIS and the Bank of England have found unexplained differences in risk weightings for identical assets,” Bloomberg notes, adding that at the same time, the euro-area debt crisis has cast doubt over rules allowing sovereign debt to be generally treated as risk-free.

“A lot of our analytical work shows that there isn’t a single factor that leads to variability of risk weightings from bank to bank,” Coen says. “It’s a variety of drivers.”

That diversity means there isn’t a silver bullet for fixing the problem, Coen says. The committee’s report will in part aim to improve transparency, for example, by forcing banks to publish capital ratios based on different models.

The Basel committee has said that relying only on the leverage ratio may create additional risks because it gives banks no incentive to make a judgment of an asset’s propensity to create losses.

“The committee’s position is that there must be both a leverage ratio along with a risk-weighted approach — the belt-and-braces approach,” Coen says. “Banks can arbitrage one, but you can’t game both.”

Source: Bloomberg Banks Face Basel Clampdown on Risk-Model Variation