Bloomberg coverage today of Basel’s new interest-rate risk (IRR) standards draws heavily on comments from FedFin managing partner Karen Petrou. As you will see, Karen points out that the proposal addresses a risk that is at least as much the result of monetary and regulatory policy as bank risk-taking.

We will shortly provide an in-depth analysis of the Basel proposal, which includes two options: an extension and nominal toughening of the Pillar 2 supervisory IRR standards and a new minimum capital charge. The latter would prove not only costly, but also a back-door assessment against sovereign holdings. Basel is also considering a direct risk weighting for this paper’s credit risk, but progress on that will be even slower than that on IRR, in our view.

In the near term, stress testing will be the most significant constraint on IRR, although the extent to which this is in fact addressed is uncertain due to the continued focus of most stress tests on credit, not liquidity or interest-rate risk. A new capital charge related to IRR could also create significant regulatory-arbitrage opportunities for insurance companies – which hold large books of low-rate, long-term paper – and hedge-fund trading operations already advantaged by the absence of a market-risk capital charge.  

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