Capital Requirements, Capital Adequacy and Risk Management
22 Pages Posted: 7 Mar 2015
Date Written: August 11, 2000
The Basle Committee is seeking to amend the 1988 Accord by introducing a new capital adequacy framework for credit institutions. The proposals, put forward in a consultative paper issued in June 1999 (A New Adequacy Framework), have been submitted for comments to the international banking industry. This consultation has been closed by the end of last March. The proposed future regulatory regime is of paramount importance to all financial institutions as it lays the basis for a level playing field in which to operate.
This document aims at contributing to the round of discussions, in order to try and find an optimal solution for all practitioners. After reviewing the main pitfalls of the current Accord, we examine the content of the Basle proposal, focusing attention on the first of the three pillars referred to in the Basle paper, i.e. the Minimum Capital Requirements.
We call attention on the need to pursue an integrated approach, taking into account that regulatory issues will affect banking, financial and other institutions on a global scale. Credit risk is in fact just one of the component of the risks undertaken by financial institutions, albeit often the most relevant. The internal ratings-based approach which the Basle Committee is proposing to introduce as an alternative to a modified standard approach should be integrated with the identification of credit spreads applicable to the different categories of counterparts. These credit variables may be treated as analogous to market variables (typically interest rates) in order to quantify the overall market and credit exposure, both in the banking book and trading book. Following this approach it is possible to arrive at an integrated VAR for the calculation of the overall regulatory capital charges. More specifically, the Basle Committee should allow large and complex financial institutions to follow a more advanced approach, based on their own internal models, rather than only on internal ratings.
Keywords: Capital Requirements, Capital Adequacy, Risk Management
JEL Classification: G13, G21
Suggested Citation: Suggested Citation