STANDARD & POOR’S plan to introduce a new risk-adjusted capital framework will duplicate and potentially undermine the regime developed under the Basel II capital accord, say two international financial bodies.
The Institute of International Finance and the Risk Management Association said Standard & Poor’s proposed methodology would be too simplistic and potentially penalise institutions that had good risk management standards and reward those that didn’t.
“The industry supports the credit risk methodology contained in the Basel II Framework because of its sensitivity to the risk profile of each institution,” the IIF and RMA said in their joint submission to S&P last month, following the release of the plan in April.
“The proposed new treatment by Standard & Poor’s is less risk-sensitive, and it will penalise low-risk institutions and benefit firms with less robust risk management systems.”
However, S&P has sought to allay concerns, stating in a later revision of the framework released last month that their risk-adjusted capital ratio (RAC) will be applied first only in countries where Basel II hasn’t been implemented, such as the US.
The rating agency says this will help the assessment and comparability of capital adequacy “particularly during the long and complex transition period to Basel II”.
It specifically highlights the different speeds and ways in which Basel II is being applied in different jurisdictions.
The RAC, it says, will provide a relatively simple, common measure for its analysts to measure risk-adjusted assets worldwide.
For those countries that have implemented Basel II, the regulatory capital requirements in place will be the “starting point”, S&P states.
The rating agency says a number of “trade-offs”had been made in the implementation of Basel II, the risk measurement techniques used and the discretion allowed to national regulators which would “impede comparability of results across and within countries”.
S&P said the internal estimates made by banks of their risks could also be lacking because they have mostly been developed in a benign environment.
“Some banks will still communicate for several years on Basel I ratios, others on ratios calculated according to the standardised methodology and others on a combination of Basel II methodologies,” S&P said in its updated report. “Published regulatory ratios will become very complex to assess and compare.”
The rating agency also criticised Basel II for not addressing all of the shortcomings of Basel I.
“In particular, regulatory treatment for the trading book has not changed materially and still understates – to a significant extent – the underlying risks in a stress environment.”
As a result, it said, further in-depth analysis and adjustments were needed to “facilitate interpretation and international comparisons” and it had developed the RAC to provide its analysts with a “simple measure of risk-adjusted assets that will be globally comparable and will neutralise the largest effects of differences in national application, regulatory options and banks’ internal risk measurement systems”.