The Basel Committee on Banking Supervision (BCBS), the global regulator of banks, has proposed revisions to its framework for identifying and supervising the world’s biggest banks, in order to prevent them from window-dressing their capital rules. The revisions, which were published on Thursday, March 8, 2024, aim to constrain banks’ ability to lower their systemic risk scores through temporary adjustments of their balance sheets.
The systemic risk scores, which are calculated based on a range of indicators, such as size, interconnectedness, complexity, and cross-border activity, determine which bucket the banks are slotted into, and therefore how much extra capital they must hold. The extra capital, known as the capital surcharge, is intended to reflect the potential impact of the failure of a bank on the global financial system, and to reduce the likelihood of such a failure.
The BCBS, which comprises banking regulators from the world’s main financial centers, introduced the framework for identifying and supervising the globally systemic banks (G-SIBs) in 2011, after the global financial crisis of 2008-2009, which saw many banks being bailed out by taxpayers. Currently, there are 30 G-SIBs, such as JPMorgan, HSBC, BNP Paribas, and Morgan Stanley, which must hold between 1 percent and 3.5 percent of extra capital, depending on their bucket.
The revisions aim to stop regulatory arbitrage behavior by the banks
The BCBS said that it has observed “unacceptable” attempts by some banks to game the capital rules, by making their balance sheets appear smaller or less risky around the reference dates used for the reporting and public disclosure of their systemic risk scores. This practice, known as window-dressing, allows the banks to reduce their capital surcharge, and to gain a competitive advantage over their peers.
The BCBS said that this behavior undermines the credibility and effectiveness of the framework, and poses risks to the financial stability and market confidence. The BCBS also said that this behavior is inconsistent with the principle of prudence, which requires banks to maintain adequate capital at all times, and not just at certain points in time.
To address this issue, the BCBS has proposed revisions to the framework, which would require banks participating in the G-SIB assessment exercise to report and disclose most of the indicators based on an average of values over the reporting year, rather than year-end values. The BCBS said that this would reduce the incentives and opportunities for window-dressing, and ensure a more accurate and consistent measurement of the systemic risk scores.
The BCBS has also proposed to introduce a leverage ratio indicator, which would measure the ratio of a bank’s equity to its total assets, as an additional indicator in the size category. The BCBS said that this would complement the existing indicator, which measures the ratio of a bank’s total assets to the global GDP, and capture the potential impact of a bank’s failure on the financial system, regardless of its risk-weighted assets.
The BCBS has also proposed to revise the disclosure requirements for the banks, to enhance the transparency and comparability of the data. The BCBS said that this would include disclosing the values of the indicators for each quarter of the reporting year, as well as the year-end values and the average values. The BCBS also said that this would include disclosing the values of the indicators in both US dollars and the reporting currency, to account for the exchange rate fluctuations.
The revisions are open for public consultation until June 7, 2024
The BCBS said that the proposed revisions are open for public consultation until June 7, 2024, and that it welcomes feedback from all interested parties, including banks, regulators, investors, and academics. The BCBS said that it sees the benefits of a wide application of the revisions to all banks participating in the G-SIB assessment exercise, but that it is also seeking feedback on options that would apply the changes to a narrower set of banks, to reduce the reporting burden.
The BCBS said that it plans to finalize the revisions by the end of 2024, and to implement them by January 2027. The BCBS said that it expects the revisions to have a limited impact on the overall calibration of the framework, and on the distribution of the banks across the buckets. The BCBS also said that it will continue to monitor the implementation and effectiveness of the framework, and to review it periodically, to ensure that it remains fit for purpose.
The BCBS also published a study on Thursday, which analyzes how the implementation of the framework has evolved over the past decade, and how it has affected the behavior and performance of the G-SIBs. The study said that the framework has achieved its objectives of reducing the systemic risk posed by the G-SIBs, and of creating incentives for them to become less systemically important. The study also said that the framework has contributed to enhancing the resilience and resolvability of the G-SIBs, and to promoting a level playing field among them.
