July 1, 2015 / 3:32 PM / in 2 years

Global regulators propose tighter credit risk rules for banks

LONDON (Reuters) - Global banking regulators have proposed a more comprehensive set of rules for banks to set aside capital to cover losses from their exposures to other lenders and limit fallout in a crisis.

A sign for Bank Street and high rise offices are pictured in the financial district Canary Wharf in London October 21, 2010. REUTERS/Luke MacGregor

During the financial crisis some banks suffered big losses on their derivatives contracts due to weaker creditworthiness at banks on the other side of their trades.

The value of derivatives had to be written down when it became obvious that counterparties may not meet their obligations.

Since then capital requirements to cover such “credit valuation adjustments” (CVA) have been beefed up but the Basel Committee of banking supervisors wants to extend them to “reduce the incentive banks currently have to leave some of their risks unhedged”.

A wider set of risks would be factored into the CVA, such as daily changes in risks from markets, and not just changes in the creditworthiness of the counterparty itself.

The additions also play catch up with reforms in accounting that require banking assets to be priced at fair value or the going market rate, to reflect falls in prices more quickly to that banks respond in a timely way.

Banks typically use their own internal models for estimating CVA risks, but regulators suspect banks of downplaying the amount of capital needed.

Basel may decide that in the final CVA rule, banks must use a “standardized” approach written by regulators.

“A basic approach for CVA risk is also proposed for banks that are less likely to regularly compute CVA sensitivities to a large set of market risk factors, owing to the nature of their trading operations,” the committee said in a statement.

The proposals dovetail with Basel’s broader review of capital rules for trading books, due to be finalised by the end of this year.

The committee said it will carry out impact surveys before deciding how much extra capital banks would have to hold under the new proposals.

Reporting by Huw Jones; Editing by Keith Weir

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