WASHINGTON - Two reports due today from the Basel Committee on Banking Supervision raise new doubts about customizing capital requirements to fit individual banks, and propose added disclosures to enhance market discipline.
Supervisors have been debating for several years whether regulatory capital requirements could mirror a bank's own system for measuring risk and determining capital needs. When the Basel Committee issued a plan last June to update minimum capital standards, it gave a tentative nod to the notion.
The committee has been pushed in that direction by U.S. banking regulators, most notably by Federal Reserve Board Chairman Alan Greenspan.
"We must try to embrace the internal models of banking organizations to create in fact the capital requirements to meet the risks they face," Mr. Greenspan said in a speech last May. "It's what is inevitable."
However, today's report from the Basel Committee concludes that even banks with the most sophisticated internal rating systems suffer from inconsistent and inaccurate measurements of risks and disagree on the definitions of basic concepts such as "default" and "loss."
The paper, "Range of Practice in Banks' Internal Ratings Systems," is an effort to identify best practices among internationally active banks. It draws on a survey of 30 institutions across the G-10 countries whose regulators view their internal rating systems as "well developed." The survey was supplemented by presentations on internal risk management systems from banks and other industry experts.
According to the 44-page report, internal risk-assessment models are hampered by limited sources of data on the probability of loan defaults. They also lack analytical tools for determining the size of potential losses in the event of defaults, the report said.
It further stated that banks use such disparate methods to measure risk that regulators would need to adopt different approaches for supervising and validating each bank's system. The report also found that even bankers do not appear to have confidence in the data that their risk management models produce.
"While a number of the banks surveyed have clearly developed advanced risk measurement capabilities, it is less clear in some cases whether the information emerging from these measurement systems is genuinely integral to the risk management of the bank at this time," it said.
The report laid out several elements that the Basel Committee considers essential if the internal risk assessment approach is to be used as the basis for setting regulatory capital.
In addition to banks' having a reliable internal ratings system, a method of assigning loans of different grades to specific regulatory capital "buckets" would have to be in place. The bucket into which a loan is placed determines how much the bank must retain as capital. The number of buckets and the percentage of capital assigned to each also would have to be determined.
The second report outlines three areas in which the Basel Committee believes banks should disclose more data: structure of capital, risk exposures, and capital adequacy.
A New Capital Adequacy Framework: Pillar Three, Market Discipline concludes that supervisors "have a strong interest in facilitating transparency as a lever to strengthen the safety and soundness of the banking system."
The market should be aware of the "nature, components, and features" of a bank's capital, which the committee said will indicate the institution's ability to absorb financial losses. Also, banks should make it clear when they make use of "innovative, complex, and hybrid capital instruments."
For each category of risk, Basel recommends, banks should reveal sufficient information about the bank's management strategies and stress-testing results to allow the market to fairly assess its exposure to potential loss.
Comments on both papers are being accepted until March 31, the same deadline for comments on the June 1999 capital proposal.
Separately on Friday, Fed Gov. Laurence H. Meyer said the central bank in mid-February will detail the data that these institutions should be providing to investors.
"Public disclosure is not going to be easy for bankers, because it may well bring new pressures that they may not like in the short run," Mr. Meyer said in a speech sponsored by the National Bureau of Economic Research, "but the alternatives - more supervision and regulation - are not easy either."
Mr. Meyer said the Fed is likely to recommend that large banking companies disclose information about residual risks held in securitizations, distribution of credits by internal risk classifications, and concentration of lending by industry, geography, and borrower.
Though the disclosures would not be mandatory - and Mr. Meyer did invite industry input - it is clear that regulators want the largest banks to be more transparent to investors soon. The Basel Committee on Banking Supervision last summer said market discipline will become a pillar of oversight.
On Friday, the Fed released a study analyzing the role that subordinated debt could play as a market discipline tool. "While the Fed is not committed to a specific policy as yet, my own view is that subordinated debt will be shown to be quite useful as a supplement to supervision," Mr. Meyer said.
He said 36 of the 50 largest bank holding companies, as well as eight of the largest 50 banks, already issue it.
