Basel Committee Report Could Cause Sea Change in Banking Policy

Basel Committee Chairman Stefan Ingves has announced a forthcoming report on risk-weighted assets that could fundamentally change international banking standards. The report, which Ingves says is due out “very shortly,” relies on “public disclosures by banks and a hypothetical test portfolio exercise” in which 15 banks participated.

Basel Committee Finds “Material Variation” in Risk Modelling

Ingves stated that the committee has found the following major issues with risk modelling at the 15 banks under analysis:

  • there is a material variation in risk weights for trading assets across banks (after
    adjusting for accounting differences and for differences in the riskiness of different
    bank portfolios);
  • certain modelling choices seem to be major drivers of the variation in risk weights;
  • the quality of existing public disclosure is generally insufficient to allow users to
    determine how much of the variation in reported risk weights is a reflection of
    underlying risk taking, and how much stems from other factors (eg modelling
    choices, supervisory discretions).

Basel’s Likely Response

“The on-going analysis has generated a wealth of information about risk modelling by banks,” Ingves said. Some possible responses include:

  1. Improvements in public disclosure practices.
  2. Limitations in the modelling choices for banks.
  3. Harmonizing supervisory practices.

The second and third options could lead to controversy, not to mention a backlash from banks. The publication of the report will likely intensify criticism of the Basel Committee. In particular, Banks have suggested that Basel wants to subsume the global banking system under rules that are insufficiently complex.

Yet Ingves is clear that he wants to avoid “zero variation” with regard to risk modelling. The key, he claims, is to strike a balance.

“Excessive variation in risk measurement is clearly undesirable. Finding the right balance is key,” he said. “The preliminary work suggests we may not have the balance right in the current set-up. But as with all of our work on implementation, it is necessary to identify the problems before we can set about correcting them.”

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