BANKING - Another reason for banks to make friends of credit-worthy

Son of Basle is coming to a bank near you. Ten years after the Basle Capital Adequacy Accord came into force, requiring banks to hold a minimum level of capital against their core base, the supervisors have gone back to the drawing board to design an updated version of the framework for international banks. Under the first set of Basle rules, banks were required to hold a minimum of 4% Tier 1 capital and 8% total capital to risk-weighted assets. These rules are not legally binding but they are enforced by each country’s regulator. The new BIS proposals, named after the Bank for International Settlements (BIS), which provided the venue for the original 1988 Basle Committee meetings, address themselves to credit risk and, to a more limited extent, operational and legal risk. The new document is in a consultation period due to last until March 2000. But nobody doubts it will be adopted by international regulators more or less in its current form. For Patrick Fell, a director at PricewaterhouseCoopers, the critical point of the document is its proposal for credit ratings, as these will determine the weightings banks have to take for accepting bonds issued by corporates. “The old regime was crude, as it treated all risk on the same basis,” says Fell. “For every £100 of loans, you had to have £8 of capital, regardless of ratings applied to corporate issues, except for sovereigns, banks and so forth. Under the new proposals banks can use a credit rating-based regime. The better the rating the lower the credit charge, and hence the lower the issuing costs for corporates.” The Basle proposals in their draft form rely on commercial agencies’ credit ratings and internal bank risk ratings to measure risk, but this throws up the obvious questions of their reliability as regulatory tools. This may appear to be a move towards rationalising risk weights, but essentially the proposals retain the crude additive approach to measuring the risk of a loan portfolio. The losers will be those banks that are unable to obtain ratings of at least AA- with S&P or Aa3 (Moody’s), as they will be at risk of disadvantageous terms of business in their dealings with other banks and corporate clients. It is important for corporate customers to understand the new proposals and their impact on banks, says Philip Middleton, head of banking strategy at KPMG. “If a bank has a sophisticated risk measurement model it may provide some competitive and even some funding advantages,” he says. “For financial directors of non-financial institutions, hopefully it means they will be dealing with soundly managed banks.” The basic shortcoming of the 1988 Accord was the crudeness of the risk weightings of assets. Under the system currently in force, loans to IBM and to the corner newsagent are assigned the same degree of risk. But although the proposals attempt to address this flaw, they have their own drawbacks. Under the new rules, lending to an AAA-rate corporate will attract a 20% capital charge. Below B-minus will mean a 150% charge. From a corporate’s point of view this would imply that it is worthwhile getting a credit rating. But an unrated corporate is weighted at 100%, so in fact it might make sense for a company not to seek a credit rating at all, as the company would be likely to obtain better borrowing terms than if it were to attract a rating of B-minus or below. “The idea of using credit ratings and internal ratings is certain to change the way banks look at credit,” says PwC’s Fell. “There are no incentives to go into the lower grade corporate market.” For companies themselves, the rules will become important in two or three years, if they borrow or issue debt that is likely to be around at that time. This could be a significant factor in determining re-financing terms, for instance, as banks start to think about their portfolio from a different perspective. At present, if an AA-rated corporate and another rated BBB have ten-year facilities with a given bank, they both require the same capital usage. However, this will change once the new proposals come into force, and it will have an effect on a bank’s decision about how to grow its corporate loan book. Analyst Simon Samuels at Salomon Smith Barney says the three key areas where the new BIS proposals are likely to have a significant impact are in this adoption of external credit ratings, the elimination of the OECD/non-OECD distinction, and a large potential reduction in capital requirements for lending to AAA- and AA-rated corporates. “Perhaps most significant is the BIS proposal that ‘sophisticated’ banks be allowed to calculate their own internal risk assessment,” says Samuels. He reasons that a bank that is advanced in developing this approach, such as Barclays, could see its capital base reduced by almost 20%. “In general, we have identified the likely winners as being large, sophisticated banks with high credit ratings,” he says. Jules Stewart is a freelance journalist.