An Analysis and Critique of the Bis Proposal on Capital Adequacy and Ratings

32 Pages Posted: 11 Nov 2008

See all articles by Edward I. Altman

Edward I. Altman

New York University (NYU) - Salomon Center; New York University (NYU) - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: November 1999

Abstract

This paper has examined two specific aspects of stage 1 of the (BIS's) Bank for International Settlement's proposed reforms to the 8% risk-based capital ratio. We argue that relying on "traditional" agency ratings could produce cyclically lagging rather leading capital requirements, resulting in an enhanced rather than reduced degree of instability in the banking and financial system. Despite this possible shortcoming, we believe that sensible risk based weighting of capital requirements is a step in the right direction. The current risk based bucketing proposal, which is tied to external agency ratings, or possibly to internal bank ratings, however, lacks a sufficient degree of granularity. In particular, lumping A and BBB (investment grade corporate borrowers) together with BB and B (below investment grade borrowers) severely misprices risk within that bucket and calls, at a minimum, for that bucket to be split into two. We examine the default loss experience on corporate bonds for the period 1981-1999 and propose a revised weighting system which more closely resembles the actual loss experience on credit assets.

Suggested Citation

Altman, Edward I., An Analysis and Critique of the Bis Proposal on Capital Adequacy and Ratings (November 1999). NYU Working Paper No. FIN-99-084, Available at SSRN: https://ssrn.com/abstract=1299456

Edward I. Altman (Contact Author)

New York University (NYU) - Salomon Center ( email )

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New York University (NYU) - Department of Finance ( email )

Stern School of Business
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