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The technical consultation announced by the Basel Committee on Banking Supervision, which sets global bank safety rules, takes aim at banks that have been exploiting a regulatory loophole by buying credit protection on risky loans but deferring or spreading out the premiums for several years.
Global regulators have taken a much tougher line, saying they plan to amend the hard-fought Basel III deal to close the loophole. Banks can continue to use CDS to hedge their losses but they must reflect the cost of the insurance upfront and take a hefty capital charge on it, the consultation says.
The move comes at a time when regulators are fighting to reassure investors and politicians that Basel III will make the financial sector safer and that banks will not be able to evade the new rules by “optimising” their balance sheets to make them appear less risky.
“The proposed changes are intended to ensure that the costs, and not just the benefits, of purchased credit protection are appropriately recognised in regulatory capital", the Basel committee said.
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