Basel Committee Proposes New Measures For Derivatives

The Basel Committee on Banking Supervision has made proposals to revise the method of assessing exposure of banks to derivatives. If implemented, this could help the banks reduce the amount of capital that they need to maintain to ensure that the leverage ratio remain within healthy limits, as required by regulations.

The committee comprises of the Federal Reserve, the European Central Bank and a number of other financial regulators. This review of existing norms indicates a relaxation in the regulation of banks which have been heavily controlled after the financial crisis of 2008-09.

The committee has said that it intends to modify the leverage rule which fixes the capital requirement according to the assets held by banks. Currently banks are required to add up their entire exposure to derivatives while estimating their capital requirement.

According to banks this method omits the fact that large portions of derivative contracts go through a third-party for its completion. This process requires the customer to provide a margin to cover any losses. Banks want this margin to be reduced from their overall derivatives exposure, which would bring down the capital requirement.

The committee has however said that it needs to collect more evidence before it makes a decision and brings about the change.

Basel has also proposed to replace the current system with a new framework called the standardized approach for estimating counterparty risk. This would allow banks to complete net trade settlements which would also help them to reduce the capital requirements and their exposure.

Industry members have said that the proposed measures are still not extensive enough to change things significantly. The FIA, a derivatives industry body said that it was disappointed that Basel had yet to approve these changes which include customer margins while calculating exposures involving clearing houses.

The Basel Committee has commenced work to assess how a higher leverage ratio could be imposed on the critical 30 global banks. Some of these banks include the likes of HSBC, Goldman Sachs, Societe Generale and Morgan Stanley. Many might be required to comply with a leverage ratio of 3 percent but regulators are looking at having a higher ratio for larger banks.

According to the Basel Committee, the leverage ratio could be a fixed number for all banks or differ as the current capital surcharge does. Most of the bigger banks already maintain a ratio of 4 percent or above to reassure regulators. The easing of regulations regarding derivative exposure would go a long way in reducing the pressure on banks to maintain large capital amounts.

Charlie Harrison

More articles by Charlie Harrison