Quant Congress USA: 'High risk of mis-calibration' in Basel III

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Supervisors risk mis-calibrating the Basel III package of changes to bank capital rules, thanks to a political rush to hasten implementation, warns Nico Meijer, chief risk officer at Bank of Montreal (BMO) Capital Markets.

"I would comment that this whole process has taken place within a highly compressed time frame. The process has become highly politicised and there's a high risk of mis-calibration," he said during Risk magazine's annual Quant Congress USA conference in New York.

While Basel II took years to develop, supervisors are under pressure to move from proposals to a final rule in the space of less than 12 months. The Basel Committee on Banking Supervision hopes to have a final draft ready in time for the November Group of 20 summit in Seoul, having published the original proposals last December. The rules are set to be implemented from the end of 2012.

Meijer focused on new minimum liquidity standards contained in the Basel Committee's recent proposals – in particular, the liquidity coverage ratio and net stable funding ratio. Many of the assumptions used in the ratios are conservative from an industry standpoint, he argued: "The conclusion of it all is that we would be required to raise more capital." For Canadian banks, hundreds of billions of dollars of extra funding would be required – "levels that might exceed the capacity of the market to supply those funds", he added.

Implementing the liquidity standards would involve investment in infrastructure and reduced profitability at banks. Ultimately, the measures would have an impact on the pricing of financial products and availability of credit, he said.

The process has become highly politicised and there’s a high risk of mis-calibration

Meanwhile, the narrow definition of high-quality liquid assets adopted by the Basel Committee could cause particular problems in some jurisdictions, given differences in market structure. "If you expect banks to survive any crisis, you're going to drive so much leverage out of the system that you will create negative economic consequences," he warned.

Meijer added it would be "interesting to see what the impact is on bank equity prices, once the impact of the capital and liquidity rules is better understood" by analysts.

Nevertheless, the recent liquidity crisis has demonstrated the shakiness of relying on wholesale funding markets and disregarding contingent liquidity risks, he conceded. These included committed credit lines and downgrade triggers, for example. "Off-balance-sheet exposures can quickly come back on balance sheet during a crisis, thanks to reputational risk," he said.

BMO has had its own problems in this area, which Meijer readily admitted. The bank was forced to rescue its structured investment vehicles because they had stakeholders "we could not afford to neglect", he said.

 

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