Moving too fast?

It took the best part of five years to finalise the meat of the Basel II framework, from the initial consultation document in 1999 to the publication of the agreed text in June 2004. Since the credit crisis struck, however, it has taken a mere three months to rewrite an important chunk of the Accord - the charge for incremental risk in the trading book.

The modification is meant to close a loophole in the framework - while the Basel Committee had yet to finalise a much discussed incremental default risk charge (IDRC), the crisis showed most losses experienced by banks were the result of downgrades, spread widening and a lack of liquidity, rather than actual defaults.

A change to the proposals was first mooted in April, in a paper published by the Basel Committee in which it announced steps to strengthen the resilience of the banking system. A consultation document on the incremental risk charge was subsequently released on July 22, along with revisions to the Basel II market risk framework - a time frame that would presumably have meant a few late nights for Basel Committee staff.

Risk managers have expressed a number of concerns. First, are regulators being nudged along a little too aggressively by politicians, keen to be seen doing something about banks' failings? Should more time have been spent developing these rules?

There's also, unsurprisingly, concern about the effect on capital levels. The previous IDRC had been criticised as potentially being too draconian, with risk managers claiming it would have led to significantly higher capital requirements and a far higher standard for default losses than for any other kind of market risk.

The latest document retains many of the controversial elements - in particular that the incremental risk charge be measured at a 99.9% confidence interval over a one-year capital horizon. However, the scope of rules has changed to encompass a broader range of risks beyond default - for instance, credit rating migration, spread widening and equity prices. There are worries these rules may, in effect, close off vast swaths of business, with capital levels too high to make certain products economical.

The consultation period will run until October and the new rules will come into play from 2010 - although the charge for risks other than default will be delayed until 2011. In that time, the Basel Committee aims to run quantitative impact studies to judge the effect of the new rules on capital levels. So, the committee is following the same tried-and-tested formula of consultations and analysis. However, it is important the baby is not thrown out with the bath water - new rules covering the trading book may be needed, but in keeping the politicians happy, will capital levels be lifted to a level that will constrain overall bank lending?

Nick Sawyer, Editor.