Basel committee looks to close risk loophole

Global banking supervisors are seeking to close a regulatory loophole that made it easier for banks around the world to own the complex assets that have caused huge losses during the current credit crisis. A proposal on Tuesday by the Basel Committee on Banking Supervision could overhaul the way banks calculate risk on their trading books and make it more costly to hold the kind of structured debt products that brought losses to banks such as UBS, Citigroup and Merrill Lynch. However, the measures may trigger protests from banks, not least because they could further undermine profits and make it harder to distribute complex products to investors. The committee is seeking industry comment on its proposal but plans to issue an interim version of the new requirement – an Incremental Risk Charge (IRC) – later this year and have the final version ready by January 2010. The move is part of the wide-ranging regulatory response to the credit crisis and the instability it has caused to the financial system and the real economy. Christopher Cox, chairman of the US Securities and Exchange Commission, said the proposed IRC would also apply to investment banks. “The market turmoil has had a severe impact on many commercial and investment banks,” he said. “The incremental risk guidelines and related changes to the Basel II framework will contribute to a safer and sounder financial system.” There are two main thrusts to the new capital charge. The first expands the types of risk to be assessed when calculating capital charges beyond those captured in so-called value-at-risk models. For debt products, capital will be charged against default risk, along with risks related to ratings downgrades, price changes and market liquidity. The second thrust expands the time scale over which those risks must be calculated. VaR models typically calculate such risks over 10 days; the IRC will require risks be calculated with 99.9 per cent certainty over a full year. The purpose of this change is to align the standard on banks’ trading books, where they hold securities, with the standards in their traditional loan books. “The committee also believes the proposed IRC framework would be less vulnerable to regulatory arbitrage and would more effectively promote forward looking risk measurement approaches,” the paper said.