WASHINGTON - Regulators must fundamentally rethink their planned overhaul of international capital standards, according to bankers from around the globe.
Industry comments on the June 1999 proposal urge the Basel Committee for Banking Supervision to more precisely assess the risk posed by various types of assets by relying on banks' internal models for setting capital needs.
"We don't think the June proposal went far enough in terms of differentiating credit quality," said Adam M. Gilbert, a managing director in J.P. Morgan's corporate risk management group. "Ultimately we believe that they will need to head toward a full internal models approach."
Regulators first adopted an international capital standard in 1988. But because it only recognized four different levels of risk, bankers have found myriad ways around the system, something regulators call capital arbitrage.
Under current rules, banks must hold 8% against any corporate loan as capital. A loan to a Fortune 500 firm requires the same capital backing as a loan to an Internet start-up. Some argue that this raises the level of risk in the banking system by encouraging banks to make riskier loans.
Under the proposal, loans to corporations would be slotted into three categories, depending in part on the debt ratings of borrowers issued by firms such as Standard & Poor's and Moody's Investors Service. For instance, loans to a company with a AAA debt rating would only require 1.6% capital, while loans to companies rated B-minus or below would require 12% capital.
"There are still too few buckets and the buckets are arbitrary," said John J. Mingo, a former Federal Reserve Board official who helped the Robert Morris Associates trade group write its comment letter.
Mr. Mingo, a risk management consultant in Livingston, Mont., also urged regulators to rely on banks' internal systems, explaining that banks often hold much more capital than required for certain assets, but less against safer assets.
"Banks set economic capital in a continuum from 0% to 30%," Mr. Mingo said. "With [the proposal] it is still the case that for any given asset the regulatory capital is going to be significantly different from economic capital."
Dennis Oakley, a managing director with Chase Manhattan Bank and the primary author of a detailed response from the International Swaps and Derivatives Association, agreed the proposal fails to sufficiently differentiate among assets with different probabilities of default.
"If you want to achieve the goal of not having regulatory arbitrage and you want to have economic risk and regulatory capital be consistent, you need to have more granularity," Mr. Oakley said.
The association's opinion represents a broad sector of the international banking community. In addition to Chase, banks that helped draft the letter include Citibank, J.P. Morgan, Credit Suisse, Deutsche Bank, ABN Amro Bank, and Barclays Bank.
In its comment letter, the International Swaps and Derivatives Association proposed an alternative means of setting capital requirements for bank assets, using a matrix with asset maturity on one axis and the probability of default on the other. It produces 198 separate risk weightings, which could be applied to a benchmark capital standard analogous to the Basel Committee's current 8% requirement.
The association said its plan has the added benefit of being accessible to both banks that use internal ratings systems and those that use ratings agencies because both can be translated into default probabilities.
"We wanted to have an easy tool that would allow banks who develop their own ratings systems and those that rely on external ratings to map to the same grid," Mr. Oakley said.
Robert Morris, the trade group for lenders, made a similar proposal, but substituted the maturity measurement with the percentage of the loan the bank expects to lose if the borrower defaults.
Federal Reserve Bank of New York President William J. McDonough, who is chairman of the Basel Committee, said after a recent speech that he expects a revised proposal to be released by January.
It will be open for public comment for three to four months.