Academic journal article ABA Banking Journal

Basel Committee Calibrating Effects of Capital Changes

Academic journal article ABA Banking Journal

Basel Committee Calibrating Effects of Capital Changes

Article excerpt

The second round of comments on the proposed new risk capital rules has been sent to supervisors, yet there are still large issues to be defined within the reforms. In keeping with the spirit of a working partnership among bankers and supervisors, the Basel Committee on Banking Supervision asked banks in May to fill out questionnaires and send data on their operational risks.

To date, the incentives for bankers to cooperate have focused on reducing their regulatory capital charges (a carrot which the securitization process has already shown to work quite well) through adoption of advanced risk controls. Supervisors expect this to be helped along eventually by two more incentives: the lure of better stock prices and the pressure of more visible peer standards that will come after expanded market disclosure.

"When it comes to assessing share values, uncertainty can often breed doubt," explained Federal Reserve Governor Laurence Meyer, in his keynote address at May's Risk Management Association (RMA) conference on capital management "It seems reasonable to expect, as a long-run proposition, that more accurate market valuations of bank equities will follow better disclosure."

Today's low p/e multiples for bank stocks, relative to other industries, are assumed to be a reaction to the opacity of bank risk. It is hoped that the market will reward greater transparency with a better stock price premium, all other factors being equal. Simultaneously, investors may assume that banks not disclosing their internal standards and track records probably have something to hide. Their stock price multiples will fall, negating any higher earnings gained from riskier activities. At the core, these penalties will be relative, providing disincentives to move far away from the standards of global peer groups.

The effectiveness of these incentives and penalties will ultimately depend on proper calibration of the regulatory model, as well as the existence of an agreed dataset, According to Governor Meyer, "[T]he market will not believe or use risk disclosures unless it believes that the underlying risk measures, like ratings and the probabilities of default, have been validated. …

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