Banks Wonder If Basel’s ‘Advanced Approaches’ Is Worth the Trouble
By John Heltman
WASHINGTON — The biggest banks are considering whether to abandon an effort to use their own internal models to help set capital requirements as they examine ways to streamline the post-crisis compliance landscape.  The largest banks fought hard to create the so-called advanced approaches framework in 2007 as part of Basel II, which let institutions with more than $250 billion of assets or $10 billion of on-balance-sheet international exposure develop internal models for assessing risk-based capital compliance.  The program was intended to let banks have a better chance to demonstrate their compliance — and potentially lower capital requirements — but several banking industry insiders are wondering if it’s worth the effort, given other safeguards in place that prevent them from holding lower capital.… Karen Shaw Petrou, managing partner at Federal Financial Analytics, said the advanced-approaches program is made less useful if risk-weighted assets are not the binding capital constraint that banks face. A recently enacted supplementary leverage ratio limits the largest banks’ ability to hold less capital. As a result, going through the costly process of developing granular models to assess risk-based capital is a pointless exercise.  “These advanced approaches do better track risk, but they’re very expensive to do, and why would a bank invest in all of that when the binding constraint is the leverage capital ratio anyhow?” Petrou said.… Petrou said the banks pushed for the provision in Basel II in part because the risk weighting in Basel I accords was so primitive, effectively treating secured loans from reputable borrowers the same as far riskier loans. That structure incentivized banks to engage in more risk taking, since the capital required to backstop a safe loan is the same as that required to backstop a risky one while the returns are far different.  “They wanted it in part because Basel I was stupid,” Petrou said. “That created a significant amount of structural risk-taking.