THE European Union upped the ante in its battle with the US over changes to global bank-capital rules, calling for a key plank of the reforms to be scrapped.

The EU, home to nearly half of the world’s biggest banks, opposes the introduction of capital floors, a restriction on firms’ use of their own statistical models to measure asset risk that would drive up their capital requirements, an EU official said. The US, by contrast, has said regulators should consider discarding the internal-model approach altogether because it creates the potential for banks to game the rules.

“It used to be Europe that criticised the US for failing to implement the Basel accords properly, but now the positions seem to have flipped,” said Martien Lubberink, an associate professor at Victoria University of Wellington. “In one instance after another we’ve seen Europe trying to backtrack on capital requirements. The argument now seems to be to let the banks take on risk to boost earnings and build up capital.”

The Basel Committee is racing to finish work on the post-crisis capital framework known as Basel III by the end of the year, and it’s under instructions not to increase overall capital requirements significantly in the process. That promise, first made in January, left open the possibility that individual countries or banks could face a marked increase.

The debate in Basel pits bank regulators from Tokyo to Frankfurt against a US-backed push for stiffer standards, which take effect when they’re implemented by national governments. Regulators from countries including Germany and Italy told the Basel Committee in recent meetings that the proposed changes to how banks assess credit, market and operational risks must be scaled back and slowed down, according to two people with knowledge of the matter.

Stefan Ingves, chairman of the Basel Committee, downplayed the dispute over risk-weighted capital rules.

“This process has been going for about eight years,” he told reporters in Frankfurt on Friday.”By now all the issues are well understood. That’s not a problem in itself. Right now we’re working very hard to finalise this, and I hope that we’ll be able to do so toward the end of the year.”

Finding a compromise on capital floors, which would cap the benefit banks can gain by measuring asset risk using their own statistical models instead of a standardised formula set by regulators, may prove challenging.

For about the past decade, lenders have been allowed to use sophisticated models with supervisory approval. In theory, this should give them an incentive to invest in less risky assets and price them in line with risk. Yet supervisors’ practical experience and empirical research have fed suspicions that banks misuse it to understate risks and manage down their capital requirements. Floors would limit their ability to do so.

Bloomberg-The Washington Post Service

Published in Dawn September 25th, 2016