09 October 2001

The New Basel Accord: The Devil is in the (Calibration) Details - IMF Working Paper

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This technical paper considers characteristics of the capital requirements in The New Basel Capital Accord from 2001. The new Accord offers three alternative approaches: a new ‘standardized’ approach, and two IRB approaches. While the Committee sees these alternatives as fostering incentives to adopt the IRB approach, this dual approach will create a strong clientele effect in which so-called sophisticated banks will specialize in highly rated credits and shun lower quality credits because of the regulatory capital consequences. At the same time, these capital requirements create incentives for less sophisticated banks, which use the standardized approach to specialize in the lower quality credits. Under the proposed calibration, the new Accord has the potential to create a number of unintended consequences. The capital difference between the ‘standardized’ and the IRB approaches could create incentives that discourage banks from investing in credit risk models and encourage the least capable banks to bear larger credit risks. Because the IRB approaches are calibrated for three-year par credits, depending on the maturity or the value of the credit relation to par they include significant incentives to either invest in, or avoid investing in, specific credits. By including expected loss estimates in IRB capital requirements, the IRB approaches will discourage banks from making accurate loan loss provisions and discourage banks from investing in fairly valued distressed credits.

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