Basel Committee Sets Out Assessment Methodology for Global Systemically Important Banks

in Commercial Banks, International Financial Regulation, Prudential Regulation, Systemic Risk Management

by Peter King

As regulators seek to avoid a repeat of the 2008 financial crisis, attention is focused on a small group of financial institutions whose operations are so international and so significant that their collapse could adversely affect all financial markets. The Basel Committee on Banking Supervision has been at the forefront of attempts to agree global standards in this area. Following on from its papers on the so-called Basel III framework, it has now published a paper on how regulators should determine what are global systemically important banks or G-SIBs.

The paper should be seen against the background of other international efforts. Under the Dodd-Frank Act, the US Financial Stability Oversight Council has power to designate certain institutions as systemically important. The criteria it will use in this context have yet to be developed fully in implementing rules. The UK’s Independent Banking Commission has proposed that capital requirements for certain of the UK’s largest retail banks should be more stringent than the Basel III requirements.

Scoring methodology

The Basel Committee paper follows a scoring methodology to determine whether a bank should be seen as a G-SIB. There is a series of five categories with several indicators in each category (12 indicators in all). The indicators are then given a weighting to establish an overall score for each bank tested, which will be a number between 0 and 5.

The scoring approach is underpinned by the exercise of supervisory judgment. But the Basel Committee states that the scoring approach should only be overridden by supervisors in exceptional cases, and this should be done more on the basis of quantitative rather than qualitative information.

The “buckets”

On the basis of this approach, the Basel Committee has looked at 73 of the largest banks in the world and concluded that 28 of them are likely to be G-SIBs.

The most widely publicized aspect of these proposals has been the decision to split the 28 banks into five “buckets,” depending on the scores produced by the tests referred to above. For each bucket there is an additional capital requirement, ranging from 3.5% of risk-weighted assets for the highest scoring group (currently there are no banks expected to be in this group) to 1% for the lowest scoring group. The Basel Committee suggests strongly that common Tier 1 equity is the right way to meet this additional requirement, and sees a number of disadvantages in using contingent capital instruments.

Timing

This system is intended to be implemented by 1 January 2016. There is much to do before then, particularly in determining how these requirements will interact with other national and supra-national requirements. For example, UK banks are likely to have to find additional capital to meet the Basel G-SIB requirements and additional capital to meet the capital requirements for their retail operations imposed by the IBC. It is unclear whether the same capital can serve both purposes. In addition the consequences of failure to maintain the necessary additional capital are unclear.

Shortly after the Basel Committee’s paper was published, the European Commission published its proposals for a new Capital Requirements Directive (CRD4) to implement other Basel proposals, including Basel III. These complex and overlapping requirements are likely to make planning for capital requirements difficult for banks for a number of years, particularly for those with cross-border operations. At the same time they will create opportunities for those who see potential profit in providing additional funding to the financial services industry.

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