ISDA answers Basel

The International Swaps and Derivatives Association (ISDA) has called on the Basel Committee on Banking Supervision to provide greater detail of the “conceptual framework” behind its goal that banks should hold capital against a broad range of risks. Although it strongly welcomed the proposal that banks should use internal ratings when setting their capital requirements, ISDA also commented that the parameters of the minimum capital requirements are not clearly specified and that the rationale for the division of risks between the Three Pillars (minimum capital standards; supervisory review and market discipline) needs to be better defined. ISDA has come up with its own suggested amendments. The Basel Committee is concerned that the new structure should, as a minimum, preserve the existing level of capital in the system but ISDA contends that this aim conflicts with the goal of greater risk sensitivity in international capital rules. It is keen that regulators should reflect on whether minimum capital requirements are a suitable mechanism for control of all forms of risk when only credit risk commands a minimum capital charge in the banking book. The Association does not think that a capital charge offers appropriate safeguards against operational risk since it could lead to arbitrage with the negligence of more effective systems and controls. In addition, tests by a small number of ISDA members have shown that the risk weights proposed by the Basel Committee would create a significant discrepancy between banks’ regulatory and economic capital. There are fears that they would perpetuate a bias in favour of lower grade assets. ISDA has proposed an alternative index table (default probability along one axis and maturity along the other) that contains capital requirements for benchmark assets against which regulatory capital can be calculated.