March 24, 2016 / 3:14 PM / a year ago

Basel further reins in banks' use of capital models

3 Min Read

Appartment buildings are backdropped by scyscrapers of banks at Canary Wharf in London, Britain October 30, 2015.Reinhard Krause

LONDON (Reuters) - The world's largest banks will have less discretion over how much capital to hold against loans turning sour, global regulators proposed on Thursday.

Regulators want to cut complexity and inconsistency in capital requirements among big banks that use their own models, rather than methods set out by regulators, to add up credit risks.

Models typically point to lower capital requirements, a big advantage as credit risk accounts for 70 percent of a bank's capital buffer. Regulators suspect big banks of using models to make capital ratios appear stronger than they are.

The proposals from the Basel Committee of banking supervisors, whose rules are applied in all the world's main financial centers, mark a further erosion in the use of models.

Banks fear a "Basel IV" or step change in capital requirements compared with Basel III, which was introduced after the 2007-09 financial crisis.

Basel said the proposed rules wouldn't significantly increase overall capital requirements, and stopped short of the complete ban on models some Basel members had wanted since the crisis.

"The measures announced today largely retain the use of internal models for the determination of credit risk weighted assets, but with important safeguards that will promote sound levels of capital and comparability across banks," the committee's chairman Stefan Ingves said.

Basel is proposing to scrap models 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.

Banks would also not be allowed to use models for credit valuation adjustment (CVA) risks from counterparties to their derivatives trades.

Instead, banks would have to use the more conservative standard approach set by regulators.

The International Swaps and Derivatives Association said it was disappointed with the decision to eliminate the use of models for CVA risks, saying the standard approach has not been thoroughly tested to create the right incentives.

Basel also proposed a floor, meaning banks using models cannot hold less than 60-90 percent of the capital the standard approach recommends for credit risk.

The committee aims to finalize the rules by the end of this year but has not set a timeframe for when they would be introduced.

It offered further incentives to rein back model use.

Basel said it was reviewing a rule that requires banks using models to apply them to all calculations where models are allowed. This rule was aimed at stopping banks from using a mix of models or standard approach, depending on which came up with the lower capital requirement.

Furthermore, big banks that are allowed to use models could instead use the standard approach for all their capital calculations and still be deemed to comply with Basel's rules.

Reporting by Huw Jones; Editing by Mark Potter and Susan Fenton

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