Global banking regulators are proposing new measures that aim to prevent regulatory arbitrage by banks through the use of credit default swaps (CDS).
The Basel Committee on Banking Supervision published a proposal Friday that it says would strengthen capital requirements when banks engage in certain high-cost credit protection transactions.
The committee notes that it has concerns about potential regulatory capital arbitrage through credit protection transactions, and so it’s now decided it’s necessary to impose a more comprehensive capital treatment in order to address those concerns.
The committee says that, while it recognizes that the purchase of credit protection can be an effective risk management tool, “the proposed changes are intended to ensure that the costs, and not just the benefits, of purchased credit protection are appropriately recognized in regulatory capital.”
It does this by requiring that banks, under certain circumstances, calculate the present value of premia paid for credit protection and that this be assigned a 1,250% risk weight in their capital calculations.
Comments on the proposals are due by June 21.