UK bankers fear capital floors higher under latest Basel II plans

The official was commenting on the statement on progress with the Basel II bank capital adequacy Accord issued earlier today by the Basel Committee on Banking Supervision, the architect of the Accord and the body that effectively regulates international banking. The BBA represents both foreign and UK banks based in Britain.

The BBA welcomed the overall statement as “a substantial step forward” in progress with the Accord, but not the last word. “We need the numbers and we need to test them,” the spokesman said.

The risk-based Accord will determine from late 2006 how much capital major banks must set aside as a cushion of reserves to guard against banking risks. A key aim is to encourage banks to use advanced models to measure the risks they face. Banks using advanced approaches should enjoy lower capital charges than banks using cruder methods.

The Basel Committee said today that it was dropping its earlier proposal that capital charges against operational risks for banks using advanced approaches should not initially fall below 75% of what they would be using the simpler standardised approach.

The Basel regulators had initially proposed a floor for banks using the advanced internal ratings-based (IRB) approach to measuring credit risk of 90% of the foundation IRB, the BBA spokesman said.

The existence of floors reflects regulator concern that the advantages of using advanced approaches shouldn’t be too great until Basel II is bedded down and any problems ironed out. Critics said the floors act as a disincentive to banks to use the advanced approaches.

Under the new approach announced today there would be a single capital floor for the first two years after the Accord comes into effect that would be related to the capital rules of the current and simpler Basel I accord that dates from 1988.

For the first year of the Accord’s operation, “IRB capital requirements for credit risk together with operational risk capital charges cannot fall below 90% of the current minimum required”, the committee said. Minimum protective capital under Basel I must be at least 8% of a bank’s risk-weighted assets.

The floor in the second year of Basel II will be 80% of the Basel I requirements.

The Basel Committee said it would be prepared to keep the floor in place beyond 2008 if problems emerged.

The BBA fears that the wording of today’s statement implies that the floor has been extended to both the advanced and foundation IRBs, and overall represents a higher a floor in practice than those proposed in the committee’s earlier proposals.