Bank associations hit out at Basel II failings

Both the Institute of International Finance (IIF) and the International Swaps and Derivatives Association are concerned about the excessive amount of national discretion regarding regulatory capital.

“The ultimate effectiveness of the new Accord depends on how it is implemented in each country,” said the IIF in a statement. “The IIF, which has repeatedly stressed the importance of consistency of implementation across the major markets, noted that much remains to be done for Basel II to deliver the full benefits of a level playing field and risk-sensitive capital adequacy regulation. Appropriate co-ordination between home and host supervisors is at the top of the list.”

Isda put forward a similar message: “Isda believes the number of [national regulator] discretions should be reduced to avoid serious inconsistencies.”

The IIF also criticised the Basel Committee’s decision to stagger the introduction of the new Accord. The two basic forms of compliance – the basic and standardised approaches for credit risk and the standardised and foundation approaches for operational risk – remain scheduled for the end of 2006. But the implementation of the advanced internal ratings-based approach for credit risk and the advanced measurement approach for operational risk were delayed until the end of 2007. “Without a common implementation date for all approaches, problems of international consistency and manageability may be exacerbated for internationally active banks,” said IIF managing director Charles Dallara.

Isda also hit out at issues around ‘double default risk’ linked to the purchase of unfunded credit protection, the treatment of counterparty credit risk arising from derivatives transactions and the use of portfolio credit risk monitoring.

Isda called the Basel Committee’s treatment of double default – where a firm has to set aside capital assuming a worst-case joint default scenario between the protection seller and the underlying credit on which protection is acquired – as “overly conservative”. The association said the Basel Committee’s treatment failed to recognise the greater protection provided by guarantors whose credit quality is not significantly correlated with that of the underlying asset. But the association said it remains hopeful that a more risk-sensitive treatment, designed on the back of research by the US Federal Reserve Board, could still be inserted into Basel II, although it did not provide further details.

The trade body added that the Committee had not addressed issues related to capital treatment of counterparty risks associated with derivatives transactions. But it welcomed the Committee’s decision to reassess the issue in conjunction with the International Organization of Securities Commissions (Iosco). “Isda and its member firms have met with the joint Basel/Iosco working group and is hopeful a change can be brought to the measurement of future exposure arising from both derivatives and securities financing transactions by the end of March 2005,” the association said.

On portfolio credit risk modelling, Isda noted the Committee had decided not to allow banks to use internal portfolio credit risk models to determine regulatory capital requirements following consideration of such an approach prior to its publication of its first consultative paper on the new accord in early 2001. But the association said the Committee’s prior concerns – that such models varied significantly across different organisations – have fallen significantly in the past three years. Isda believes the use of portfolio credit risk modelling has matured and urged regulators to review new evidence it is compiling on the matter.