Credit card capital charges will be lower under Basel II

Major banks will probably have to set aside a lot less capital as a cushion against losses from defaulting credit-card holders under the Basel II bank Accord than they do now, global banking supervisors said.

But protective capital against credit risk on the rest of their non-mortgage retail lending business will on average, under the Basel II internal ratings based (IRB) approach, be higher than it is now. The size of these average changes isn’t quantifiable at this stage, regulators said.

But they downplayed press reports today that this represented a deal that favoured US banks with their large credit-card businesses, in return for the US agreeing the settlement of the argument over the treatment of lending to small businesses that led yesterday to Germany lifting its objections to Basel II.

The Basel II capital adequacy Accord will determine from late 2006 how much of their assets major banks will set aside as a cushion against possible losses.

“Politics was a factor in the SME (small and medium-sized business) debate, but the credit-card issue stands on its own merits as a correct way of matching protective capital with the scale of risks actually faced by a bank,” one regulator said.

The compromise on SME lending centres on allowing banks to set aside on average 10% less protective capital against loans to smaller businesses than they will against loans to large corporations. Many loans to SMEs will be treated like retail loans to consumers as opposed to corporate loans.

Germany feared that the original Basel II proposals on loans to SMEs would stifle bank lending to smaller firms, regarded in many countries as the engine of economic growth.

The treatment of the credit-card business requires no compromise. The loss rate with credit cards is clearly a lot less volatile than with other forms of retail lending, which means much of it falls within the 'expected' loss category, and is therefore entitled to a lower capital charge.

Capital charges are principally intended as a protection against unexpected losses. While capital charges against credit-card lending will be lower than other forms of non-mortgage retail lending under Basel II, regulators will want to ensure that banks have budgeted properly to cover the expected loss rate.