In an effort to address shadow banking risks, and concerns about leverage, global banking regulators are proposing revisions to the way banks’ equity stakes in investment funds are treated under the new capital adequacy regime.
The Basel Committee on Banking Supervision Friday published a set of proposals that would revise the prudential treatment of banks’ equity investments in funds in order to ensure that the risks associated with these sorts of investments are properly captured by the capital rules. The regulators says their goal in revising this part of the rules is “to develop an appropriately risk sensitive and consistently applied risk-based capital regime.”
The committee says that the existing standard needs to be clearer in some areas. It also aims to to “more appropriately reflect the risk of a fund’s underlying investments and its leverage”; noting that the existing rules do not require banks to reflect a fund’s leverage when determining their capital requirements, “even though leverage is an important risk driver.”
Additionally, the committee says that the revised standard will also help address risks associated with banks’ interactions with shadow banking entities, contributing to the broader effort by the Financial Stability Board (FSB) to strengthen the oversight and regulation of shadow banking.
“The committee’s proposal is based on the general principle that banks should apply a look-through approach to identify the underlying assets whenever investing in schemes with underlying exposures such as investment funds,” it says. Recognizing that this may not always be feasible, the committee notes that the proposed policy framework consists of three approaches, with varying degrees of risk sensitivity. “To ensure that banks have appropriate incentives to enhance the risk management of their exposures, the degree of conservatism increases with each successive approach (as risk sensitivity decreases),” it says.
Comments on the proposals are due by October 4.