The Swing Away from Models

The Basel Committee on Banking Supervision has a busy few months ahead if it’s to achieve the ambition of global policy-makers to finish the latest round of measures before the end of 2016. This includes finishing a review of the leverage ratio and credit valuation adjustment (CVA) rules, as well as an initiative to address variability in risk-weighted assets.

The latter project includes the potential removal of internal model approaches for certain risks, and the design and calibration of capital floors. And this, says the Group of Central Bank Governors and Heads of Supervision (the body that oversees the Basel Committee), should be done without significantly increasing capital requirements.

The Basel Committee has announced a number of initiatives in response. It has proposed removing the advanced measurement approach from the operational risk framework, ruled there’s no place for internal models in the calculation of CVA capital, and consulted on restrictions on the use of internal models for credit risk-weighted assets.

But there’s plenty of anxiety about this raft of measures – and scepticism about the ability to restrict the use of internal models without increasing capital requirements. Standardised approaches tend to be relatively blunt and more conservative than internal models, which is likely to result in more capital, bankers argue. More broadly, widespread use of standardised models means the capital charge for holding a particular asset may not reflect its risk, leading to the possibility of a misallocation of capital.

This issue of IQ: ISDA Quarterly explores these issues from a variety of angles. The first article looks at the proposed changes to the use of internal models, and considers the potential impact (see Internal Model Pushback). This issue also includes an article on the Fundamental Review of the Trading Book (FRTB), which features analysis on the capital impact of moving from internal models to standardised approaches. Given a lack of clarity in the process for obtaining model approval under the FRTB, some banks have raised concerns about the eventual impact on certain business lines (see Market at Risk).

Not everyone shares the concern about internal models, though. For some, the Basel Committee could go further in restricting their use for regulatory capital purposes. In an interview with IQ: ISDA Quarterly, Thomas Hoenig, vice-chairman of the Federal Deposit Insurance Corporation, gives his views about models and the leverage ratio and its impact on clearing (see Interview: Thomas Hoenig, FDIC).