Global banks have improved their capital ratios but may be using friendly models that mask hidden dangers, according to the Bank for International Settlements (BIS).
“The calculation of regulatory capital largely depends on banks’ internal risk models,” the BIS wrote in its recently released annual report. “However, the outcomes of these models can differ across banks at a given time and within a bank across time for reasons other than changes in underlying risk.”
The BIS called the banks’ actions “window-dressing” that only raises questions about how internal models are used and whether regulators can properly assess the true amount of regulatory capital.
Most big lenders in the US and other countries already comply with Basel’s risk-based capital rules. These call for 4.5 percent in common equity and 6.0 percent of Tier 1 capital against its risk weighted assets. There is also a 2.5 percent buffer required as an emergency funding source to carry a bank through any future economic shocks. The rules assign weightings to assets based on their riskiness. For instance, corporate debt is given a heavier weight than government bonds, and requires more capital be held against it. The weighting affects the profitability of trading and investing in those assets.
But the different ways in which banks measure weights has prompted concern at the BIS. “The range of variation indicates that the interaction of risk-sensitive rules with the complexity of risk modeling has created a wide scope for inconsistency, which can seriously weaken both the credibility and the effectiveness of the framework,” the BIS said in its report.
As such, the BIS has planned on reviewing the models this year to “provide national supervisors with a clearer picture of the risk models of their banks in relation to those of international peers and will help the supervisors take action where needed.”