World Economy

Basel May Restore Ratings Role in Credit Risk Rules

Basel May Restore Ratings Role in Credit Risk RulesBasel May Restore Ratings Role in Credit Risk Rules

The Basel Committee on Banking Supervision will probably restore a role for ratings companies as it revises rules for assessing credit risk, according to Chairman Stefan Ingves.

The global regulator will propose a revised standardized approach to measuring credit risk, which accounts for the “vast majority” of most banks’ risk-weighted assets, by the end of the year, Ingves said on Oct. 9 in a speech in Lima, Peru. It will follow up with a quantitative impact study early next year, he said, Bloomberg reported.

“In choosing a way forward for the revised approach, I expect the committee will follow the path of simplification rather than increasing complexity,” Ingves told a meeting of the Institute of International Finance, according to a text of the speech distributed in advance. “This is likely to include reintroducing a role for external credit ratings into the credit risk capital framework.”

Regulators are engaged in a multi-year overhaul of the rules governing banking after the 2008 financial crisis and the ensuing recession wiped out gains garnered under the looser directives governing the industry during the run-up to the crash. Among the casualties were credit-rating companies, whose over-optimistic assessments of the risks of bonds backed by subprime US home loans contributed to the severity of the crisis and prompted regulators to seek ways of reducing their influence.

 Risk Sensitivity

The stricter regulation that has been brought in is highlighting the need for adjustments to be made as it moves into the implementation phase. The Basel group is now working to finish the reforms, and is looking for ways of balancing “simplicity, comparability and risk sensitivity,” Ingves said. It also wants to reduce the variability of the risk weights that banks assign to similar assets, and to monitor the impact of the agreed reforms.

Ingves said the response to the regulator’s previous consultation on the standardized approach for credit risk were “vigorous and clear: not many of you liked the proposals. But few came up with any better ideas. With that as the starting point, the committee is now well advanced in revising the proposals.”

Ingves also said the Basel committee will consult by year-end on a revised standardized approach to assessing operational risk, “as well as a proposal to remove from the regulatory framework the Advanced Measurement Approach for operational risk.” The AMA allows the use of internal models subject to supervisory approval.

 Trading-Book Review

William Coen, secretary general of the Basel committee, had previously raised the possibility of scrapping models for operational risk.

The revised approach “will significantly enhance the risk sensitivity of the current standardized treatments of operational risk, and would apply to banks of all sizes and complexity,” Ingves said. “In addition to public consultation, we expect to conduct a quantitative impact study of the standardized measurement approach in early 2016.”

Ingves reiterated the Basel group’s intention to complete its review of trading-book rules by year-end.

“Revisions to the market risk rules have been going on for far longer than anyone cares to remember –- this work started before the financial crisis,” he said. “As the never-ending search for technical perfection has to end, pragmatic decisions need to be made to finalize the framework by the end of this year.”

Ingves said the Basel committee will “also be in a position around the end of this year to articulate the outcome of its strategic review of the capital framework.”