An Analysis and Critique of the Bis Proposal on Capital Adequacy and Ratings
32 Pages Posted: 3 Nov 2008
Date Written: January 2000
This paper has examined two specific aspects of stage 1 of the (BISâ¬"s) Bank for International Settlementâ¬"s proposed reforms to the 8% risk-based capital ratio. We arguethat relying on â¬Straditionalâ¬? agency ratings could produce cyclically lagging rather leading capital requirements, resulting in an enhanced rather than reduced degree of instability in the banking and financial system. Despite this possible shortcoming, we believe that sensible risk based weighting of capital requirements is a step in the right direction. The current risk based bucketing proposal, which is tied to external agency ratings, or possibly to internal bank ratings, however, lacks a sufficient degree of granularity. In particular, lumping A and BBB (investment grade corporate borrowers) together with BB and B (below investment grade borrowers) severely misprices risk within that bucket and calls, at a minimum, for that bucket to be split into two. We examine the default loss experience oncorporate bonds for the period 1981-1999 and propose a revised weighting system whichmore closely resembles the actual loss experience on credit assets.
Suggested Citation: Suggested Citation