Basel Committee consultation papers released at the end of 2014 show that the trend to increasingly complex capital regulation is continuing, but also imply uncertainty about whether the existing regulatory approach can adequately capture banking risks.
One feature is the proposed addition of a “capital floor” requirement to supplement the Advanced Internal Models based calculation of required capital and the leverage requirement introduced as part of Basel 3.
This is reminiscent of a man uncertain of whether the buttons will hold his trousers up, and thus adds a belt and, just to be sure, attaches braces!
The second feature is the proposed revision of the Standardised Approach, to make it more “risk-sensitive” (and complex) and with risk weights more closely aligned with those of the Advanced Approach.
Taken together, the proposals imply: a lack of faith in sophisticated banks not “gaming” the regulations; recognition that the capital concessions for sophisticated banks have adverse competitive effects; reduced reliance on ratings agencies in regulatory settings; and recognition that continually increasing financial sector complexity hampers risk measurement.
More generally, it raises the question of whether the hugely costly experiment with relying (at least partially) on internal bank risk assessments for capital requirements, introduced in Basel 2, has been a failure, and whether higher, simpler, capital requirements would have been preferable.
This paper was prepared by Professor Kevin Davis, Research Director of the Australian Centre for Financial Studies, who was also a member of the Financial System (Murray) Inquiry.
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