Banks urge review of pro-cyclicality rules

The subprime crisis has sparked fears that regulators might insist banks hold higher regulatory capital, a result some bankers insist would choke off lending and push the global economy into a recession.

Regulators have already mooted the possibility of further capital charges. The Basel Committee on Banking Supervision, for instance, published a report on April 16 in which it announced its intention to enhance the capital treatment of complex structured credit products, liquidity facilities to support asset-backed commercial paper conduits and credit exposures held in the trading book.

The crisis has also renewed criticism over the perceived pro-cyclicality of the Basel II framework. Under current rules, a bank is required to hold less capital during the peak of the business cycle, but needs to increase regulatory capital levels as the cycle turns and default rates rise, claim critics. On top of this, bankers are concerned some supervisors could exercise the various national discretions available to them under Pillar II to hike up capital levels further.

Critics claim the opposite should be the case. They argue that low regulatory capital requirements at the peak of the business cycle might encourage banks to add additional risk, which could come back to haunt them when the cycle turns. Conversely, higher capital charges during the low point of economic cycles would impede a bank’s ability to lend, which could prolong the slump.

“Regulators are in favour of high capital ratios in good times. We should agree with them on this, but we need to educate them on the benefits of holding less capital during the downward part of the cycle,” argued Roar Hoff, head of group risk analysis at DNB Nor, at the recent Risk Europe conference in Stockholm.

Carl-Johan Granvik, chief risk officer at Nordea in Helsinki, concurs with the notion of holding more capital during boom periods, but claims any initiatives to raise capital charges during downturns would be counter-productive. “If supervisors do not recognise in their review process that in a downward market the buffers are there to be used, it will create a credit crisis each time we see a downwards ratings migration. This problem is prevalent to today’s turmoil, but it could very well be one of the drivers for the next crisis,” he says.

Wolfgang Hartmann, chief risk officer at Commerzbank, was even more blunt: “Higher regulatory capital charges would be the wrong approach and would definitely push us into a new credit crunch.”

See also:EC outlines changes to Capital Requirements Directive
Basel Committee to tighten up rules after crisis
Basel II backlash