Moody's: Basel modeling proposals will broadly impact risk-weighted assets for large banks

The Basel Committee on Banking Supervision's (BCBS) recent proposals regarding the use of models in calculating risk-weighted capital ratios among medium to large-sized banks would help make minimum capital requirements more consistent across banks, Moody's Investors Service says in a report.

The report "Banks -- Global: Basel Proposals Restricting Models Broadly Impact GSIBs' Risk-Weighted Assets," focuses on the impact that the reforms would have on so-called global systemically important banks, both in the US and Europe.

The new rules would largely replace internal modeling with a standardized approach to calculating capital. BCBS has proposed removing models completely as a tool for measuring operational risk, significantly restricting internal model use in a large number of credit risk portfolios and using floors in cases where models are still used.

"Greater consistency in reported capital ratios is a positive development," says Meredith Roscoe, a Vice President and Senior Research Analyst at Moody's.

The proposed changes are likely to have the greatest impact on risk-weighted asset calculations for the large US banks and banks in Europe, given the current prevalence of modeled approaches across risk areas for these banks.

These banks are most likely to use advanced (model-based) approaches to calculating capital and are the main lenders to low-default large corporate borrowers and financial counterparties, who are the largest consumers of counterparty, market and operational risk.

If the proposals were to be implemented in their current form, capital requirements could increase for many banks. However, as authorities have said the intention of these changes is not to increase capital requirements overall, but rather to reduce variability in risk-weighted assets for similar exposures across banks, the final rules might include offsets or changes from what has been proposed to date.

Recent comments from European Union officials suggest that the proposals will not be adopted by European authorities unless they are modified, while reports suggest that US and Swiss officials are more supportive of the current proposals. Moody's view is that a breakdown of the international agreement on capital rules would be credit negative as it could lead to further fragmentation of capital standards.

Moody's also highlights that the proposed changes to the calculation of risk weights should be viewed in context of Basel III's entire capital framework and the importance of additional capital adequacy metrics outside of the risk-weighted capital ratio, which are equally as binding. This includes the unweighted leverage ratio requirement and annual stress testing in the US, UK and Europe for the largest banks.

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