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The Institute of International Finance (IIF) has denounced regulators’ proposals to give banks less freedom to use their own models to decide how much capital they need to support their loan books.
Regulators want a simpler and more consistent approach to risk treatments after several reviews found that individual banks’ models produced vastly different risk assessments of identical types of loans.
But the IIF wrote in a strongly worded letter to the Basel Committee on Banking Supervision (BCBS) that the proposed solution was overly simplistic and dangerous.
“Our primary concern with the committee’s proposals is less about models, and more about the bluntness of the approach that the committee proposes to replace these with,” wrote the IIF’s regulatory affairs chief Andres Portilla.
Banks use so-called internal models to determine their risk-weighted assets, which in turn are a key input into capital ratios, the main measure of financial strength.
Brad Carr, a colleague of Mr Portilla’s at the IIF, said the review of credit risk models was the “number one issue for banks” among a suite of new regulations. The other measures will overhaul the way banks measure risk in their trading books and calculations of their day-to-day operational risks. Regulators have said that the overall package, which some banks refer to as Basel IV, is not designed to increase capital requirements.
In its submission to the BCBS, the IIF said that the proposals, which would allow less variation in risk scores for loans, would “understate risk on the best credits but overstate it on the weakest”.
As a result, the IIF said, a bank using the new rules could earn a return on capital of 11.4 per cent on a low-quality borrower with a risky BB- credit rating. Right now that loan generates a return on capital of just 7.7 per cent today.
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