Risk & Compliance

Basel Moves to Limit Banks’ Use of Risk Models

Regulators want to standardize risk assessment, rather than continue with the current hodgepodge of individual models.
Katie Kuehner-HebertMarch 28, 2016

In another step toward shoring up the financial system, global banking regulators have proposed limits on banks’ use of internal risk models to calculate how much risk they can take.

The proposed changes, the Basel Committee on Banking Supervision said, are intended to standardize risk assessment, rather than continue with the current hodgepodge of individual models.

“Addressing the issue of excessive variability in risk-weighted assets is fundamental to restoring market confidence in risk-based capital ratios,” committee chairman Stefan Ingves said in a news release.

The regulators stopped short of the complete ban on models some Basel members had wanted, choosing to scrap them only for loans to other banks and financial institutions, for equities holdings, and for loans to companies with total assets of more than 50 billion euros, a threshold that would capture about 200 companies.

Models would also not be allowed for credit valuation adjustment risks from counterparties to banks’ derivatives trades.

“The committee is counting on the nonbinding proposal to lessen potential risks to financial stability tied to the connections among global banks,” The Wall Street Journal said, noting that regulators believe a standardized approach will enable them to set a stricter framework based on their own expectations of default and calculations of potential losses.

“It is a clear indication that Basel has renounced models other than for favored asset classes, like mortgages, where they want to give banks leeway to support social and economic policy goals,” said Karen Shaw Petrou, a managing director of advisory firm Federal Financial Analytics.

The Basel Committee is accepting public comments on the proposal until June 24. After that, each country must begin their own process of applying the rules to their respective banks.

Since the financial meltdown, U.S. regulators have imposed tough new borrowing limits and the Federal Reserve has implemented rigorous annual stress tests.

“The U.S. is in a better position to make this adjustment with these rules than the European and U.K. banks,” Mayra Rodriguez Valladares, managing principal at consulting firm MRV Associates, told the WSJ.