22 June 2016

GFMA, ISDA, IACPM and JFMC respond to the Basel Consultation on Internal Risk Models

The GFMA, along with the ISDA, the IACPM and the JFMC, responded to the BCBS’s consultation on Reducing variation in credit risk-weighted assets – constraints on the use of internal model approaches.

The response (from The Global Financial Markets Association (GFMA), the International Swaps and Derivatives Association, Inc. (ISDA), the International Association of Credit Portfolio Managers (IACPM) and the Japan Financial Markets Council (JFMC)), highlights that the proposals amount to “the most significant conceptual change to the capital framework since the advent of Basel II, and, rather than improve the measurement and understanding of risk, would more likely do the opposite”. The Basel Committee’s previously stated objective of maintaining risk sensitivity is missing from the present consultation.

The response notes that the removal of risk sensitivity would distort capital allocation decisions and pricing to the detriment of banks’ customers and the global economy. Corporate lending, capital markets activity, project finance deals, aircraft, shipping finance and commodities finance, all necessary to support investment and economic activity, would be particularly affected by the proposals. Moreover, economies where market financing is still developing would also be likely to feel these effects more acutely. Consequently, these proposals are inconsistent with the pursuit of the growth agenda at the global level.

The response raises concerns that the cumulative effects of the current suite of Basel Committee proposals are all leading to increased risk-weighted-asset levels, with decreasing marginal benefits for society. A comprehensive analysis is required to avoid disproportionate and unnecessary increases in capital requirements.

The objectives set out in the consultation can be achieved without restricting internal modelling in the way and to the extent proposed. This is particularly true as major investments on the part of both industry and the regulatory community are under way to reduce unwarranted differences in modelled outcomes. These efforts should be allowed to take effect before fundamental changes are introduced.

The Associations put forward a number of alternatives for the Basel Committee to consider – for example, a constrained-IRB approach for exposures to banks and other financial institutions, where probability-of-default and loss-given-default risk parameters are set at regulatory prescribed levels.

Press release

Full response

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