Bankers Oppose Regulators' Plan to Verify Models for Setting Capital

By Seiberg, Jaret | American Banker, April 24, 1996 | Go to article overview

Bankers Oppose Regulators' Plan to Verify Models for Setting Capital


Seiberg, Jaret, American Banker


Bankers and regulators are in conflict over how to verify the accuracy of the computer models used to set capital levels. The models must be accurate, they agree.

But they dispute how the industry should verify these programs, which use historical data and market forecasts to predict the performance of a bank's investment portfolio.

Regulators last month proposed requiring banks to compare computer model predictions against actual results. If the two differed more than four times a year, then the bank would have to boost capital levels.

"This ties the accuracy of a bank's model to the capital charge," said Richard Spillenkothen, director of banking supervision and regulation at the Federal Reserve Board. "It provides an incentive for a bank to have accurate models to measure risk."

Bankers, writing in comment letters due by April 8, have said this approach - known as back-testing - is unfair. They demanded a more flexible process.

The back-testing dispute is part of a larger market risk proposal the agencies are pushing. Regulators in July 1995 proposed tying a bank's capital requirements to its exposure to interest rate swings.

They gave banks the choice of using their own models or a program written by the international Basel Committee on Banking Supervision to determine their interest rate risk. The goal is to let banks with safer portfolios hold less capital.

Bankers applauded the decision to let them use internal models, saying this would reduce compliance costs. But the Fed, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corp. decided to amend the plan in March to include the back-testing rule.

Market risk models produce a "value at risk" figure, which shows a bank how much money it could lose or gain on a given day. These models are supposed to be 99% accurate, meaning the value at risk will exceed the model's prediction only once per 100 times.

The back-testing proposal requires a bank to verify that the gains or losses it actually incurred on a given day were within the range set by the model.

Banks would have to tally these results four times a year when completing call reports.

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Bankers Oppose Regulators' Plan to Verify Models for Setting Capital
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