-The German Zentarler Kreditausschuss (ZKA) published its comments on the Basel Committee’s Consultative Document of 16 January 2001 on a New Capital Adequacy Framework for Banks criticizing some main aspects of the Basel II Accord. The main points of criticism of the
ZKA are as follows:
Scope of application/consolidation
We welcome the extension of the scope of application of the New Capital Accord. However, there is still the fundamental difference that the EU rules also include securities firms in the scope of consolidation, while Basel II only applies to banks. To allow full harmonization of the coverage of supervisory rules, we suggest that the scope of consolidation provided for in Basel II be brought completely into line with the rules applying in the European Union.
Mutual recognition of supervisory decisions
Insofar as the Basel Consultative Document allows national supervisors discretion in implementation of certain requirements1, the required transparency on the extent to which supervisors make use of this discretion should be created for market participants so as to ensure a common level playing field. The approval and supervision of internal systems for measuring credit risk, but also other risk, is to fall under Pillar 2 (Supervisory Review Process) of the future Basel Capital Accord. Home-country supervisors should be put in charge of group-wide recognition of internal systems. This principle of home-country control has proved successful within the European Union.
Internal ratings-based approach
As far as the requirements for use of the IRB approach are concerned, we feel that considerable modifications are still required. The key criticism of the Basel Committee’s internal rating requirements is that the risk weights in the IRB approach are much too high. These high risk weights are due in our opinion mainly to the fact that the Committee requires banks to cover not only their actual credit risk (the so called unexpected loss) with capital but also the risk which banks have already covered via the risk premiums included in interest rates (the so-called expected loss). Moreover, the numerous safety cushions, haircuts and floors imply that all potential crisis scenarios, errors and catastrophes will occur simultaneously with full force. This is, however, totally unlikely. All in all, it is to be feared that capital requirements for corporate exposures will increase on average, resulting in poorer loan terms.
To the surprise of the German banking industry, the Basel Committee’s Second Consultative Document provides for the inclusion of exposure maturity in the IRB approach. This means that, all other things being equal, a long-term exposure will require up to six times as much capital as a one-year exposure. Because of established corporate financing structures, the percentage of long-term loans in Germany is much higher than, for example, in the USA or the UK. Capital add-ons for long-term loans would therefore seriously affect the international competitiveness of the German banking industry and result in higher interest rates for borrowers that would not be justified by the risk exposure. We therefore reject such capital add-ons.
Recognition of collateral
The scope of eligible collateral is confined mainly to so-called financial instruments. This means, however, that the Committee’s proposals only reflect current practice as regards the use of collateral extremely inadequately. The scope of eligible security should be extended to include all collateral “customary in banking business”, such as collateral in the form of movable property and real estate liens.
The introduction of a 'w factor” as an extra risk buffer alongside collateral haircuts that are planned in any case in connection with the recognition of collateral to capture “residual risks” is not an adequate instrument. This is particularly true because the risks that the Basel Committee believes should be covered by the “w factor” are operational risks. If the Basel Committee were to stick to its intention of introducing a separate capital charge for operational risks, the application of the “w factor” would result in these risks being captured twice.
Operational risk
The methods proposed by the Basel Committee for determining the capital requirement for so called operational risk (e.g. IT risks, fraud, or the like) are inadequate. They are based on indicators that have got nothing to do with the actual operational risk. In this way, wrong risk management incentives would be set. The proposed so-called Basic Indicator Approach, based on banks’ “gross income” would mean, absurdly, that earning additional income would be punished by an increased capital charge for operational risk.
The further discussion of the future treatment of operational risk must focus on achieving more risk-sensitive solutions and avoiding a general increase in overall capital. It must at any rate be ensured that the methods for covering operational risk with capital do not create any wrong risk management incentives for banks. It is vital that the rules in the area of operational risk are worded “openly” enough. Progress in operational risk management methods made on the basis of more accurate loss data should be eligible for inclusion in the New Basel Capital Accord even after it has been adopted.
Market discipline
The Basel Committee is exceeding its original mandate by unilaterally pressing for banking disclosure that is already being pushed by market participants themselves and international organizations (IASC, IOSCO). There must be no division of disclosure for banks based on supervisory requirements on the one hand and capital-market-oriented requirements on the other.
The disclosure of confidential customer data and sensitive business information to outside third parties negates the practice whereby supervisors are informed fully on a regular basis about the development of a bank’s business and about its credit risk, market risk, liquidity risk and operational risk. The amount and depth of individual data lead to an “information overkill” at the expense of transparency for most addressees. It is no longer ensured that information is clear and relevant. This makes it impossible even for expert third parties to evaluate information quickly.
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© ZKA - Zentraler Kreditausschuss
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