A Simpler, Gentler Basel?
By Barbara Rehm
Get ready for Basel 3.5. Now that regulators have finished fixing Basel III’s numerator, they are turning their attention to the denominator. The rules the U.S. adopted last month make major changes — purifying what counts as capital, hiking the total amount required, slapping on a series of buffers to further insulate the largest banks and creating a global leverage ratio as a floor. But one big problem remains — RWA, or risk-weighted assets. “Basel III fixes a lot, but it really does not fix the shenanigans on the denominator of the ratio,” says one senior U.S. regulator. “Basel III will leave the denominator, for the most part, totally at the mercy of internal models.” Our largest banks use internal models to determine how risky an asset is and then assign it a capital charge. No bank does it the same way and no regulator uses the same approach to approving the models. So it’s not much of an exaggeration to say Basel III’s denominator is calculated in as many ways as there are banks. As a result, outsiders don’t understand, much less trust, the results. That’s why regulators are now turning their attention to RWA. How do I know? Current and former regulators called to ask why I didn’t write about a report the Basel Committee on Banking Supervision issued in July. It was titled “The Regulatory Framework: balancing risk sensitivity, simplicity and comparability.” With a title like that, it’s easy to see how I missed it. The only attention this report got was a good ribbing from Karen Shaw Petrou, who noted that what “seems like an incontrovertible policy objective apparently requires a 24-page consultation that parses the pros and cons of simplicity and comparability with such exactitude (not to mention in so much ill-translated prose) as to make even these worthy ideals seem strangely troubling.” And the Federal Financial Analytics managing partner isn’t wrong. The paper is anything but simple.