COMMENTARY: Internal models scrutinised
Bank lobbyists spoke with Risk.net before the draft rules were published and the document almost exactly matched the worst-case scenario they sketched out – the IRB would be prohibited on bank and other financial institution exposures, as well as for large corporates. Banks would also be barred from modelling loss given default and exposure at default for other corporate names. Probability of default would be floored for many loan types.
The death of op risk capital modelling has already provoked fierce criticism from the industry, and the IRB proposals are likely to add to the ill feeling. Speaking before the consultation was published, one lobbyist said: "This is a huge deal, and they are just sweeping it under the carpet as minor tweaks to the framework."
Separately, banks argue International Financial Reporting Standard 9 loan loss provisions should be offset by a reduction in capital to reflect the larger loan loss provisions they will have to hold from 2018.
"Logically, additional IFRS 9 provisions should mean less need for capital buffers as a safety net," said Chris Spall, London-based partner and global leader on IFRS financial instruments at consultancy firm KPMG. "However, this is not an exact science, and it is questionable that regulators will have the confidence to apply a lighter capital touch, given the ongoing challenges that have continued to emerge over the last eight years."
At the moment, credit losses on loan portfolios and other portfolios are not recognised until there is evidence they have become impaired. Banks are struggling to implement the accounting standard's requirement to use forward-looking assessments of expected losses. Banks using the Basel II IRB approach to credit risk can obtain limited relief against loan loss provisions.
STAT OF THE WEEK
At the end of 2015, credit risk accounted for 64% of Barclays' risk-weighted assets (RWA) total – or £230.4 billion ($333 billion) – with £160.9 billion calculated using the advanced IRB and the remainder subject to the standardised approach. At Deutsche Bank, credit risk is 62% of the RWA total – or €242 billion ($273 billion). That is composed of €210.2 billion of advanced IRB exposure, €5.3 billion of foundation and €25.5 billion of standardised.
QUOTE OF THE WEEK
"People were over-enthusiastic when the carve-out [from a requirement to insert bail-in clauses into thousands of derivatives contracts] was first introduced. The industry has railed against the sheer volume of so many things but it has by and large managed to make regulatory deadlines. So I think the UK Prudential Regulatory Authority response would be: 'You've done it for everything else, why can't you do it here?' There is an element of crying wolf on the industry's part."
Claude Brown, partner, Reed Smith
ALSO THIS WEEK
Clearing head Murray quits Deutsche for BNY Mellon
Dealers overpricing CLNs, research suggests
Indian rate options underlyings insufficient, say traders
Swiss eye Saron for risk-free rate
EC seeks redo of controversial Mifid II commodity provisions
Spot market for Asian LNG gaining momentum, traders say
Putting a price on long-term life insurance business (part II)
Fund industry defends use of credit lines as liquidity backstop
Why raiding CCPs' initial margin would be bad policy
Network theory takes root in post-crisis financial markets