Latest from APRA on Basel II – information in two areas.
Margin lending is where an institution lends you money to go trading in shares, secured by a claim on the shares you purchase and requiring that you have a certain proportion more value in the shares than they have advanced to you. The problem (at least as APRA see it) is that most of this type of lending is sufficiently secured that no capital would be needed to back it under the Basel II rules, rather than the full capital weight needed under Basel I (full weight being 8%).
In 2005 APRA flagged this up as an issue – essentially they said they disagree with no capital weight being applied. The reality is, of course, that in most cases no capital is needed – the chances of a loss are very low. As the experience of the last week has shown, though, that can change rapidly at times and, if liquidity is squeezed, getting more security to cover losses can be tricky.
After a good look at it APRA have done as expected here, cutting the capital required substantially – but not to zero. Their approach is that you can use either a risk weight of 20% (i.e. a 1.6% capital allocation) or a model for secured exposures. A simple outcome and an improvement from the current one.
One of the alphabet soup of acronyms that often intimidate newcomers to the Basel II space is “ECAI”. These are the External Credit Assessment Institutions – known in the real world as rating agencies. They appear throughout the accord, mostly in the standardised areas, and their ratings can be used to assess credit risk and therefore affect the capital numbers. Early on in the process (back in the dark days of pre-2003) there was a big debate about the use of these at all. Basing regulatory capital on a rating issued by an agency seemed dangerous. After the sub-prime problems (where even AAA rated bonds have suffered at least liquidity issues) this may have been a sensible debate.
Nevertheless, they are in the Accord, so every regulator has to come up with an acceptable list. With no domestic agencies of any real size APRA have taken the sensible course and (drum roll) used the list issued by the US SEC (guidelines here)- the “Nationally Recognized Statistical Rating Organizations” or NRSROs:
- Moody’s Investor Service
- Standard & Poor’s
- Fitch Ratings
- A. M. Best Company
- Dominion Bond Rating Service, Ltd
If you are dealing internationally you are also allowed to use those accredited by the host country supervisor.
This also looks like a sensible move – if you are confident that the SEC will not make a major blunder, and there are no domestic ones to add to the list, a good approach is to outsource responsibility. I just hope the SEC does not decide to change the acronym.