February 17, 2013 9:26 pm

Basel eyes set periods for banks’ risk models

Big banks would be barred from using one their most common tactics to reduce capital requirements under a proposal being considered by global regulators.

If adopted by the Basel Committee on Banking Supervision, the rule could force some banks to increase sharply the amount of capital they hold against trading assets, at least over the short term.

The committee, which sets global standards, is seeking to reassure investors that big banks have enough capital after its own study revealed last month that certain banks were holding one-eighth as much capital against the same assets as some of their peers.

It is taking aim at what it has called the “most important driver” of such a wide variation: banks use different historical time periods when calculating value at risk, which is the crucial component for determining trading book capital requirements. Some banks use one year of data, others look as far back as five years.

Currently, banks using longer time periods tend to have higher capital requirements because their models include wild market swings from the 2008 financial crisis. However, after big crashes, many banks prefer longer data sets to dilute the impact of those recent events.

Morgan Stanley provided a real-time example when it said last October that it had switched from a four year-weighted model to one that was geared to the past 12 months. The shift lowered the bank’s average VAR from $82m to $63m.

Regulators want to standardise the time period in banks’ models to somewhere between two and five years of data, although nothing has been finalised yet, said two people familiar with the deliberations.

The committee’s study said the “choice of look-back period and any weighting scheme applied to that period’s data are the most important driver of the variation” in VAR. It suggested it would look at additional standardisation as part of its larger review of trading book capital, which is expected by the end of the year.

Confining banks to a single time period for their risk models could have a huge impact, especially if regulators apply the principle to lending as well as trading assets. A study by Simon Samuels, Barclays banking analyst, found that some European banks used four years of data to measure the riskiness of residential mortgages while others used as many as 25 years.

“It’s not the concept of difference that is the problem, it is the degree,” Mr Samuels said, adding that he expected regulators to curb the variation. “The very high degree of discretion that banks currently have is slowly being eroded.”

Huw Van Stenis, Morgan Stanley analyst, praised the Basel Committee for reacting to the study. “I think the market expects some follow-through to get greater consistency, but not revolution . . . harmonising some inputs makes a lot of sense,” he said.

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