Back to Articles
Banks to Hold More Capital Under Proposed Basel II Rules
The Basel Committee's proposed changes to Basel II for financial institutions worldwide would require banks to hold more capital than they do now against their trading books.
The proposals, published last month by the Bank for International Settlements, seek to update the Basel II framework in response to market events of the past 18 months, which have triggered global financial turmoil by making several changes to how banks calculate their minimum capital requirements.
Due to the underweighted regulatory capital requirements for the trading book under current rules, returns on equity on banks' trading activities were artificially high, said Standard & Poor's in a new report, titled: "Proposed Basel II Rules Would Require Banks To Hold More Capital Against Trading Risk." As a result this may have given some banks an incentive to develop their trading books excessively.
The proposed rules, if implemented, may discourage banks from taking on risk in a benign market environment by accumulating large trading positions that turn out to be hard to manage when market conditions deteriorate. It will also reduce the incentive for regulatory arbitrage between the trading book and the banking book.
"This will be more consistent with underlying market risks," said Standard & Poor's credit analyst Thierry Grunspan. "In our view, the proposed changes are positive, particularly as they are likely to improve the treatment of specific risk, illiquidity risk, as well as stressed market movement risk, which are underestimated in the current regulatory framework."
Fitch Ratings said the new proposals would impact structured finance globally, and the asset-backed commercial paper market in particular.
"Originally Basel II was intended to promote a level playing field by providing neither an incentive nor a disincentive for a bank to securitize assets," said Peter Winning, a director in Fitch's European structured finance team. "However, under the latest proposals for re-securitisation exposures there would be a clear disincentive for banks to provide liquidity facilities to ABCP conduits."
Some experts have said that Basel II, in its current form, proved a failure when it came to predicting or preventing the current banking crisis.
In an Internet question-and-answer session hosted by FT.com, Nouriel Roubini, chairman of RGE Monitor and professor of economics at New York University, said the supervisory system "relied on self-regulation that, in effect, meant no regulation.
"All the pillars of Basel II have already failed even before being implemented," Roubini said, but indicated he supports stricter rules, like those proposed by the Basel Committee.
"Since the pendulum had swung too much in the direction of self-regulation and the principles-based approach, we now need more binding rules on liquidity, capital, leverage, transparency, compensation and so on," he said.
The proposals are currently under consultation until April 17.
Back to Articles
