Basel Committee plans new default risk capital requirements

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The Basel Committee is planning to introduce a new requirement for capital to be held against default risk, in response to widespread difficulties institutions have experienced during the global credit crunch.

At the end of its October meeting, the Committee announced it “has been working to introduce new standards for banks to hold capital against the default risk associated with complex, less liquid credit products in the trading book”.

“The Committee agreed to seek public consultation on the proposed standards and to assess their impact on banks' capital requirements,” it continued.
The Committee offered no further details on the proposals or a timeframe within which it expects to commence consultation.

The announcement was not wholly unexpected. Earlier this year, the Committee initiated a review of jurisdictions' approaches to supervising and regulating funding liquidity risk, taking into account lessons learned from the recent market turbulence. The review focuses on how liquidity risk is assessed by banks and supervisors under the assumption of stressed market conditions, as well as the risks related to off-balance-sheet exposures.

Basel II has come in for criticism in recent months over the role it might or might not have played in lessening the impact of the subprime mortgage meltdown. Observers have suggested the accord has encouraged the securitisation of mortgage pools to move the holdings off balance sheet, thereby avoiding the requirement to hold capital against them, and deepening the crisis.

The Committee, however, reiterated its belief that Basel II has paid dividends for compliant institutions since the subprime crisis began and pledged to continue to watch market events intently to identify exactly what effect the accord is having.

“Committee members agree that Basel II implementation will help make the capital base more relevant to banks' changing risk profiles and that the Committee will closely monitor its impact. The framework will also serve to create incentives for better risk measurement and management, including for securitisation exposures,” the Committee concluded.