The Basle Accord was promulgated in the late 1980s in the aftermath of the sovereign debt crisis. It dealt with the constituents of capital, risk weights (applied to banks' assets to measure their relative riskiness), target standard ratios and the arrangements for implementation, and introduced the minimum 8% ratio of capital to risk weighted items. The Accord has been criticized in recent years for its failure to measure the true economic risk faced by banks in the market, and in particular that the "one-size-fits-all" approach to credit risk which it adopts has created perverse incentives for banks to make higher-yielding but riskier loans.
The Committee published a consultative paper June 1999 setting out proposals for a wholesale reform. It invited comment from the banking industry by March 31, 2000, with agreement estimated to be in early 2001. The focus of this round is credit risk. The ultimate aim of many of the more sophisticated participants in the Basel process is to move the basis of credit risk exposure assessment to accept credit risk models, in the same way that market risk models are accepted in relation to trading book capital regulation. However, the draftsmen of the accord perceive that not everyone will have an acceptable credit risk model, and set out an interim credit risk assessment structure which, although it retains the broad asset classification used in the previous version of the Accord, is significantly more realistic than the existing structure.
GOVERNMENT EXPOSURES
Currently all claims on OECD central governments and central banks are weighted at 0%, i.e. treated as risk-free. The proposals are as set out in the table.
The losers will be those OECD countries who are not rated AAA/AA. For example, the Czech Republic (A-/Baa1), Korea (BBB-/Baa3), Mexico (BB/Ba2) and, notably in the EU, Greece (BBB/Baa1) will see an increase in the risk weighting of their debt held by banks subject to the new proposals. Winners will be non-OECD sovereigns with good ratings, such as the Caymans and Hong Kong (A/A3). Chile rated A-/Baa1 will benefit from the 50% weighting band. These non-OECD sovereigns will have to subscribe to the IMF's information disclosure standards to benefit from the new system.
BANK EXPOSURES
All claims on OECD banks and short-term claims on non-OECD banks (where the residual maturity is less than one year) currently enjoy a 20% risk weighting, with all other claims on banks rated at 100%. The proposals are as set out in the table.
The winners will be many non-OECD banks, currently weighted at 100%. For example, banks incorporated in the Caymans (rated AAA/AA) will enjoy a 20% weighting. Losers will be OECD banks incorporated in countries with single A ratings or below (where weightings will increase from 20% to 50%, or more).
CORPORATE EXPOSURES
All claims on companies are currently weighted at 100%. The proposals are as set out in the table.
Winners will be corporates with obligations rated AA- or above - many blue-chip corporations, highly rated insurance companies and AAA rated derivatives vehicles. In contrast, a weighting of 150% is proposed for claims on corporates rated below B-. (Curiously, this is lower than the 100% rating for unrated corporates - so that a corporate rated B- or below can give up its rating to improve the marketability of its debts).
This week's Learning Curve was written by Simon Gleesonat Allen & Overyin London.
