If banking regulators follow through with proposals to curb the use of internal models for certain portfolios, this should reduce variation in banks’ capital ratios and enhance investor confidence, says Fitch Ratings in a report published on Monday.
The New York-City based-rating agency reports that the Basel Committee on Banking Supervision has proposed reducing the use of banks’ internal models by eliminating their use for low-default portfolios that are difficult to model because data is limited, and by imposing new constraints on the use of these models in other areas.
Under the proposals, the standardized approach “will become far more important” than the internal approach for determining capital requirements, the Fitch report says.
The proposals, which are out for consultation until June 24, should, if adopted, “reduce variation in capital adequacy ratios across banks,” the report says. “Reducing banks’ reliance on internal models could boost public confidence in regulatory capital ratios, and enable creditors to make better informed decisions,” it adds.
Although the regulators aren’t trying to increase capital requirements with these proposals, according to the report, they could lead to an increase in capital requirements for low-risk weight portfolios.
At the same time, Fitch also expects the banks to lobby hard to preserve their internal models. Failing that, the rating agency suggests that regulators must develop a more risk-sensitive standardized approach for calculating capital requirements.