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Basel to cut banks’ reliance on ratings
From the Financial Times of Mon, 22 Dec 2014 20:16:08 GMT

Banks’ scope to use credit rating agencies to assess the risks in their portfolios will be sharply reduced as global regulators push through new standards aimed at making lenders safer.

The Basel Committee on Banking Supervision said it wanted to reduce firms’ reliance on external ratings and compel banks to improve their own assessments of the risks of loans going bad when calculating capital requirements.

Analysts said the measure marked an important step towards paring back the influence of the agencies in the realm of bank regulation.

It was coupled with an initiative that will limit banks’ ability to game the system through their use of internal models to calculate capital.

“The era of credit ratings being used in bank regulation could be slowly coming to an end globally. This is quite revolutionary,” said Gerald Podobnik, head of capital solutions at Deutsche Bank.

A spokesperson for Moody’s said: “We have long advocated reducing mechanistic reliance by regulators on any single risk indicator, including credit ratings. We believe our ratings will continue to serve market participants as a valuable source of insight on credit risk.”

Banks in the US are already heavily restricted in their ability to rely on credit rating agencies, which were widely criticised for failing to spot risks brewing in the lead-up to the financial crash of 2007-09.

As early as 2010, the Financial Stability Board, a global standard-setter, said it did not want banks anywhere to “mechanistically” rely on ratings when assessing creditworthiness.

The Basel Committee said on Monday that it was considering replacing references to external ratings in the so-called “standardised approach” banks can use to measure risk-weighted assets.

For example, exposures to corporate customers would no longer be risk-weighted by reference to the borrower’s credit rating, but would instead be based on the firm’s revenue and indebtedness.

The move comes alongside a range of other changes aimed at tightening measurement of risks under the standardised approach.

Regulators consider the outsourcing of credit assessments to external agencies to be an “unacceptable weakening of market discipline”, said Paul Sharma, a former UK regulator now at consultants Alvarez & Marsal.

“Dodd Frank in the US already prevents banks there from relying on credit ratings when they assess risk-weighted assets, and the Basel Committee is now saying the rest of the world should take a step closer to the US approach,” he said.

In addition, the Basel Committee is introducing a new capital “floor” that will reduce banks’ ability to use their own models to reduce the amount of capital they have to hold.

“The committee’s proposed floor would ensure that the level of capital across the banking system does not fall below a certain level,” it said. “It would also enhance the comparability of capital outcomes across banks.”

The level of the floor has yet to be set, however.

Mr Podobnik at Deutsche added: “Up until now banks globally have invested heavily in internal models. The introduction of capital floors could be a significant shift in the way banks and the market think about RWA calculations.

“What is truly interesting is that both concepts — capital floors and the potential elimination of credit ratings in RWA calculation — have been somewhat pioneered by the US in the Dodd Frank framework.”

David Strachan, a partner at Deloitte, said: “The Basel Committee’s consultation illustrates the challenge that it faces when moving away from a relatively simple standardised approach to one that is more risk-sensitive and, because of that, inevitably more complex in some areas.”

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