The Bank for International Settlements has tweaked its capital rules, announcing:
At its 8-9 July meeting, the newly expanded Basel Committee on Banking Supervision approved a final package of measures to strengthen the 1996 rules governing trading book capital and to enhance the three pillars of the Basel II framework.
Most of the modifications have to do with securitizations. The document Enhancements to the Basel II framework gives the details; the most interesting – to me! – extracts are:
During the recent market turmoil, several banks that provided LFs to ABCP programmes chose to purchase commercial paper issued by the ABCP conduit instead of having the conduit draw on its LF. The LF provider then risk weighted the ABCP based on the paper’s external rating. As a result, the LF provider benefited from the external rating on the commercial paper when assigning a risk weight to that paper, even though the rating was due in large part to the bank’s own support of the conduit in the form of the LF.
That particular loophole has been plugged!
In a nod to the political needs of the Canadian government, GMD facilities (which became one of the scapegoats for the non-bank ABCP fiasco) have been eliminated:
More specifically, paragraph 580 states that banks may apply a 0% CCF to eligible liquidity facilities that are only available in the event of a general market disruption (ie where more than one SPE across different transactions are unable to roll over maturing commercial paper, and that inability is not the result of an impairment in the SPEs’ credit quality or in the credit quality of the underlying exposures). Paragraph 638 states that an eligible liquidity facility that can only be drawn in the event of a general market disruption is assigned a 20% CCF under the SF. That is, an IRB bank is to recognise 20% of the capital charge generated under the SF for the facility.
The framework has been changed to eliminate paragraphs 580 and 638, in the SA and IRB Approach, respectively. This eliminates any favourable treatment accorded to market disruption liquidity facilities under Basel II.
I asked OSFI if they had any examples of a GMD line causing problems for a bank when the the GMD line was independent of reputational concern. With their customary aplomb, OSFI has declined to answer the question.
The section on Supervision discusses reputational risk:
Reputational risk can be defined as the risk arising from negative perception on the part of customers, counterparties, shareholders, investors, debt-holders, market analysts, other relevant parties or regulators that can adversely affect a bank’s ability to maintain existing, or establish new, business relationships and continued access to sources of funding (eg through the interbank or securitisation markets).
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A bank should incorporate the exposures that could give rise to reputational risk into its assessments of whether the requirements under the securitisation framework have been met and the potential adverse impact of providing implicit support.
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Reputational risk also arises when a bank sponsors activities such as money market mutual funds, in-house hedge funds and real estate investment trusts (REITs). In these cases, a bank may decide to support the value of shares/units held by investors even though is not contractually required to provide the support.
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For instance, to avoid damaging its reputation, a bank may call its liabilities even though this might negatively affect its liquidity profile. This is particularly true for liabilities that are components of regulatory capital, such as hybrid/subordinated debt.
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By providing implicit support, a bank signals to the market that all of the risks inherent in the securitised assets are still held by the organisation and, in effect, had not been transferred. Since the risk arising from the potential provision of implicit support is not captured ex ante under Pillar 1, it must be considered as part of the Pillar 2 process.
There are also changes to calculation of market risk for the trading book:
In October 2007, the Basel Committee on Banking Supervision (the Committee) released guidelines for computing capital for incremental default risk for public comments. At its meeting in March 2008, it reviewed comments received and decided to expand the scope of the capital charge. The decision was taken in light of the recent credit market turmoil where a number of major banking organisations have experienced large losses, most of which were sustained in banks’ trading books. Most of those losses were not captured in the 99%/10-day VaR. Since the losses have not arisen from actual defaults but rather from credit migrations combined with widening of credit spreads and the loss of liquidity, applying an incremental risk charge covering default risk only would not appear adequate. For example, a number of global financial institutions commented that singling out just default risk was inconsistent with their internal practices and could be potentially burdensome.
The incremental risk charge (IRC) is intended to complement additional standards being applied to the value-at-risk modelling framework.
This is a major issue for insurers. Assiduous Readers may recall that one of the issues regarding capital adequacy of insurers is their practice of estimating bond risk without consideration of price; if the rating – or their internal analysis – indicated a 0.1% chance of default, say, that’s what was used for risk purposes, regardless of whether the bond was trading at governments +10bp or governments +500bp. To some extent this is rational; to some extent it ain’t. The question of how forcefully this idea is applied to the investment book of insurers will be a fascinating subject over the next few years.
These BIS tweaks further extend into the calculation of market risks.