International risk-based capital requirements for banks are under review again. Under current Basel III capital standards, large banking organizations, with regulatory approval, can use their sophisticated internal risk models to determine the risk weight of their assets and smaller institutions could use an updated revision of the standardized risk-based capital calculations that had replaced the original ones issued in 1988. However, the Basel Committee, which develops international capital standards, has become concerned that there is a large variability in how asset risk weights are being calculated by banks and is proposing revisions to various aspects of the risk-weighted capital ratio structure. On Dec. 22, 2014, the Basel Committee proposed changes to the standardized approach for credit risk.1 This month’s column discusses the highlights of the proposal. Comments are due by March 27, 2015.
In the Beginning
Capital is the engine that causes a banking organization to be able to exist. The 1988 Basel Capital Accord established the first international standards on regulatory capital. Under Basel I, as it is now known, specified categories of assets were assigned a risk weight against which capital must be preserved. The riskier the asset, the more capital that must be preserved. For example, cash was considered to be of zero risk, and corporate loans would be considered to be 100 percent risk weight. This is referred to as a standardized approach.
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