MUFG head criticises internal modelling restrictions

Isda AGM: Mitsubishi UFJ Group CEO also sounds warning on sovereign risk weights and CVA

MUFG head hits out at internal modelling restrictions

The head of Japan's Mitsubishi UFJ Group has hit out at regulators' plans to curb the use of internal models to calculate capital requirements, and warned that increases in sovereign risk weights could have wider macroeconomic effects. He also called for a softer treatment of corporate exposures in the revamped credit valuation adjustment (CVA) capital rules.

In recent months, the Basel Committee on Banking Supervision has removed the ability for banks to use internal models to calculate capital in proposed operational risk and CVA rules, and curbed their use for loans and other credit exposures. One of the key reasons is to improve comparability between banks – benchmarking exercises have found wide discrepancies between banks when modelling risk-weighted assets for the same portfolio.

Nobuyuki Hirano, president and group chief executive officer of Mitsubishi UFJ Financial Group, said regulators may still be concerned by what they see as "excessively complex internal risk models that masked the actual situation and contributed to the global financial crisis". However, while improving comparability is important, he said it shouldn't be achieved at the expense of internal models.

"The solution is not to limit the use of internal models and allow only standardised models. A fundamental question I have is: who needs comparability? Regulators already get detailed information and are able to review and approve each bank's internal models. Who benefits? Markets and investors? Simple comparisons measured by a less accurate methodology can be misleading," said Hirano.

Hirano was giving a keynote speech at the 31st International Swaps and Derivatives Association AGM in Tokyo today (April 14). Mitsubishi UFJ is classed as a global systemically important bank by the Financial Stability Board, and sits in the same risk bucket as Bank of America Merrill Lynch, Credit Suisse, Goldman Sachs and Morgan Stanley.

Hirano also warned that a hike in risk weights for sovereign exposures may have wider economic effects. The Basel Committee is currently reviewing the regulatory treatment of sovereign exposures. A 2014 Basel report found that banks treat more than half of their sovereign exposures as risk free.

"It is clear that a zero risk weight for all sovereign business isn't realistic, but changing the weight of sovereign risks will directly affect the portfolio management strategy of financial institutions. They may hold sovereign debts of major countries. Therefore before taking action we need to carefully consider the various possible impacts, including assessment of alternative investors and possible changes in demands," said Hirano.

He warned that setting sovereign risk weights too high could lead to a mass sell-off of sovereign debt by financial institutions.

"No doubt that will lead to an interest rate hike, sovereign fiscal deterioration and separation of economic growth in the world," he said.

Speaking at a press briefing after the keynote address, Hirano also called for a softer treatment of corporate exposures in Basel's proposed amendments to the CVA capital charge, which covers variation in the market price of counterparty risk over the life of a derivatives trade.

At the end of March, the committee ruled out the use of internal models for calculating CVA capital, leaving banks with the more punitive standardised approach. Bilateral margining and central clearing in theory will cut banks' counterparty exposure, but this does not apply to most corporate exposures. Responding to a question from Risk.net, Hirano called for a relaxed treatment of corporate exposures.

"The CVA will give quite a negative impact for corporates' derivatives transactions, which are based on the real needs of the hedge. So we have strongly advocated that there should be different treatment of the interbank and corporate client derivatives transactions," said Hirano.