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Banking on Basel loosening capital requirements

Sunday 28 March 2010 - by Luke Nelson


Dragomir, like Ashby and many others, recognises that there were loopholes in previous iterations of the capital requirements framework that need to be closed but thinks that the proposals put forward by the Basel Committee are not the best way forward. She even suggests that the new proposals actually contain negative incentives that encourage banks to engage in a greater amount of risky activity.

The members of the ESBG have highlighted a vast number of problematic areas within the proposals. The organisation is currently in the process of determining which of these it will prioritise in its response to the Basel Committee.

Bank of America EMEA director of treasury Brian Brown suggests that more clarification is needed around the levels of 'tier 2' capital held by banks. Measures outlined in the proposals seem to loosen restrictions around the proportion of tier 2 capital which could lead to regulatory arbitrage that could work in favour of some institutions.

Brown welcomes the moves to make 'tier 1' capital more transparent and restricted, suggesting that this is an appropriate means to achieve greater levels of prudence. However, he is concerned about some deductions from the 'tier 1' level - notably defined benefit pensions and other liabilities. The combination of the deduction of assets and the market value of liabilities could prove to be a major issue for some institutions, he says.


He also thinks that a problem might arise from the focus on stress-based credit risk compared with what has historically been a more default-based approach. Volatility, he said, may emerge from the introduction of the new ratios as firms seek to mitigate measures by showing that they have a hedge in place.

He says: "The effort to be more granular in the approach could actually ricochet back at you on the credit side of things."

On the counter-cyclical framework proposed by the Basel Committee, Brown suggested that in reality, calibrating capital with losses and positions at any given point in time would be hard to stay in compliance with and is therefore not particularly feasible. He also questioned the level of transparency the framework is likely to bring.

The December proposals are, according to Brown, good in principle - especially given what we have seen in the past couple of years. However, regulations must be made in a smart way; otherwise there is a serious risk of unintended consequences damaging the system.


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