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Banks call for Basel III rewrite as QIS exercise ends

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QIS spreadsheet depicting Operational riskThe industry hopes the impact study will lead to a rewrite of proposed new rules on capital, liquidity and leverage. Banks had until end of April 2010 to submit a 21-page, 3,000-row spreadsheet to the Basel Committee on Banking Supervision – and believe the results will cause a major rethink of rules the Committee proposed last December, or at least persuade it a fresh round of consultation is needed.

"Now we've got the results there's a conviction throughout the bank that the proposals don't make sense and will therefore have to change. The rules as they stand are so extreme this can't possibly be where they'll come out," says a senior New York-based risk manager with one large US bank.

The spreadsheets are part of an exercise called a Quantitative Impact Study (QIS) and ask banks to provide comprehensive information on how the Basel Committee's proposals on capital, liquidity and leverage would affect them. Bankers involved in the QIS say the calculations are spitting out unexpectedly large numbers, notably for the credit valuation adjustment (CVA) charge, which would require banks to hold capital to cover the market value of their counterparty exposures.

In the CVA worksheet of the QIS, bankers were required to compute four different scenarios, plugging in different factors for each scenario. The results vary by bank, from scary to horrifying. One French banker said the figures obtained would mean an additional capital charge almost as big as all the other proposed measures put together, and his findings are widely shared.

"Given the impact estimates, the CVA charge looks unworkable in its current form. The industry is certainly of the view that it has been poorly designed and mis-calibrated, and without material change will be disruptive to trading activities," says Andrew Cross, a managing director in the risk division at Credit Suisse in London.

Other banks say the QIS has highlighted problems with the proposed leverage ratio and liquidity rules. "Under the regulations, banks are going to leap from a leverage ratio of 15 or 20 to one, to a ratio of 50, 60, 70 to one – that's how they're going to look. But that is only because the proposal throws everything in on a gross basis, from derivatives to undrawn credit card lines. Those types of things really create – arithmetically – huge problems," says the US bank's risk manager.

Banks have already registered their criticisms during the comment period, which ended on April 16, but it is the QIS that will shape the final rules, says Credit Suisse's Cross. "There is a lot of disquiet in the industry about the current shape of the proposals, but the dialogue with regulators is important to make sure the right adjustments are made to the framework. I don't think some of the qualitative commentary made so far will be as influential as the QIS analysis, where problems should be sized more precisely and the root of real issues should be clearer."

Hitting the QIS deadline has been a Herculean task: dozens of staff have been involved since January, says the US bank's risk manager, putting in "hours upon hours upon hours – it's been a huge resource commitment". And regulators now face what looks – even to them – like an impossible mission. They have promised to use the QIS results to calibrate their proposals and hope to deliver a final package to leaders of the Group of 20 countries in November.

"One of the biggest issues is the time schedule for doing everything – there's quite a bit of supervisory fatigue because there's just so much that has to be done and the time schedule is so short. And the proposals are complicated, they have many implications and a lot of potential for adverse consequences," one US-based regulator and senior committee member tells Risk.

Given the numbers the QIS is expected to produce once it is collated, many bankers hope and believe the exercise will lead regulators to ask the G-20 to delay both the calibration and the implementation, allowing time to properly rework the proposals and submit them to a further round of consultation.

Below is a list of the main proposals that were up for consultation, and which may change before the formal list of rules is published at the end of this year.

Capital bases

The committee proposed to raise the “quality, consistency and transparency” of banks’ capital bases to ensure the industry is better equipped to deal with losses “on both a going concern and a gone concern basis”. This would mean, among other things, that banks would need to increase the amount of tier-one capital held on their books.

Setting aside for risk

Banks with large trading books and exposure to the derivatives, securities financing and repo markets, will need to bolster their capital frameworks to help lessen counterparty risk. The committee said in December that it hoped this would help push the murky over-the-counter markets onto exchanges and encourage participants to use central counterparties to further reduce risk. The committee also said it would require banks to take a harder look at the way they measure and manage risk.

Leverage ratios

The amount of leverage that banks held on their balance sheets in the run up to the financial crisis was blamed for exacerbating the problems they faced when markets tumbled. The committee has proposed that banks adopt, internationally, tighter leverage ratios to avoid a build-up of excessive debt in the banking system.

Make hay while the sun shines

Banks are being encouraged to set aside more money during boom years that will act as a buffer for their businesses when markets sour. By using such a countercyclical capital framework, the committee hopes that banks will be able to absorb the shock of a future crisis much more ably. It has also putting forward that banks adopt more “forward-looking provisioning based on expected losses”.

Liquidity standards

The committee wants to introduce a minimum 30-day liquidity coverage ratio for all internationally active banks, meaning that a bank will have to have enough set aside to meet short-term funding obligations for a 30-day period in the event it finds itself with a liquidity problem. This proposal comes after banks failed to anticipate the illiquidity that hit the markets during the worst of the crisis.

Separately in March, the Basel Committee set out principles for enhancing corporate governance in the financial sector and called for stronger risk management, better-trained board members and simpler corporate structures.

A consultation paper set out six key areas for focus. board practices, senior management, risk management, compensation, complex structures, and disclosure.

The closing date for responses to these proposals is June 15.

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