Regulatory capital requirements are dynamic, not static, in nature. This fact of regulatory life was further demonstrated by the announcement today by the Basel Committee on Banking Supervision of its Second Consultative Document (Document) that proposes further changes to the Standardized Approach for credit risk under the Basel III regulatory capital accord.
The Document’s proposed changes draw distinctions between jurisdictions that permit the use of credit ratings for regulatory purposes and those that do not. Under the Dodd-Frank Act, the United States is in the latter (no external ratings reliance) category. Among the Document’s many proposed changes to the Standardized Approach that are relevant to US banking organizations are the following:
- Requiring banking organizations to classify credit exposures into three different buckets (Grades A, B, and C), subject to downward due diligence-based adjustments
- Assigning a 75% risk weighting to “investment grade” corporate exposures
- Assigning an 85% risk weighting to “small and medium” corporate exposures
- Using loan-to-value (LTV) ratios as the “main driver” for exposures secured by real estate, and creating a three-category, risk-based classification system for such exposures
- Limiting the eligibility of financial collateral and guarantees (through supervisory “haircuts” and other means) as credit risk mitigants to “investment grade” mitigants
- Introducing increased due diligence requirements for assessing counterparty credit risk
As US banks already know, US federal bank regulators have made the Standardized Approach applicable to all but the smallest US banking organizations, so whatever the Basel Committee does in this area will have a broad ripple effect on corresponding US regulatory capital requirements. While official pronouncements on regulatory capital sometimes can be lengthy and dense, this relatively short Document is worth reviewing.
To submit comments on the Document, visit the Comments on Basel Committee documents page on the Bank for International Settlements website. Comments are due by March 11, 2016.