It’s become fashionable to make fun of the Basel risk-based capital rules for being overly complicated and subject to gamesmanship. “Why should we risk-weight assets at all?” people ask, for some reason. “Just look at simple leverage and assume that all assets are equally risky!” Sure okay. The problems with treating all risks the same seem too self-evident to be worth discussing (though wehave!) but on the other hand I challenge you to read Friday’s Basel Regulatory Consistency Assessment Programme report on the “Analysis of risk-weighted assets for credit risk in the banking book” without feeling a bit of sympathy for the simple-leverage crowd.
Not because the report is complicated, particularly? It’s actually pretty straightforward in concept. Basel II and III allow big banks to use the internal ratings-based approach to credit risk, in which the risk-weighting of a bank’s loans,1 and thus the bank’s capital requirements, are determined by the bank applying its own internal models to determine the credit risk of its borrowers. So to calibrate that system, the Baselisks went out and asked a bunch of banks to give them the probability of default that they assigned to a bunch of sovereign, financial, and corporate borrowers. Lo and behold some banks assigned different probabilities of default to some borrowers than others did and so you get somewhat head-scratching charts like this one: Read more »
Some analysts at the Bank for International Settlements have found a new way to unwind too-big-to-fail banks painlessly, which I guess is newsworthy; here is a good summary, and here is the actual paper. The basic idea is to resolve a bank over the weekend by writing down its debt by some regulator-chosen amount X, giving it X more capital, which is held by a new temporary holding company. Then the bank reopens for business on Monday with more equity and less debt. The holding company eventually sells its equity in the bank to the market, and distributes the proceeds “to [the old bank’s] creditors and shareholders strictly according to the hierarchy of their claim.” Here are some blue boxes:
The main attraction of this, besides speed, is that it provides a market mechanism for determining how much senior creditors lose: regulators decide how much of the bank’s senior liabilities are converted into holdco liabilities, but those holdco liabilities retain their seniority over subordinated liabilities and equity, and ultimately the amount of writedowns suffered by the senior (and junior for that matter) debtholders depends on how much the bank’s equity is ultimately worth when the holdco sells it.
A key insight from the enhanced BIS credit derivatives data is that non-rated multi-name credit risk sourced from multiple sectors has been transferred from derivatives dealers to IFGCs, SPVs and OFCs.
Yeah! Wh … what?
It’s from the quarterly review of the Bank for International Settlements, which is a delightful hodgepodge of hard-to-read charts, hard-to-read sentences, and general oblique glances at the guts of the global financial system. It is both glancing and gutsy. There are reams of tables. Give it a read.
The quote above is about this:
Everything clear now?
I love charts and all but I mostly think in stories, and I’m trying to parse together the story for these facts because they seem somehow important. It seems to go like this. Read more »
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