Global regulators have proposed hefty charges to cancel out capital relief banks enjoy when buying pricey insurance to cover risky loans without acknowledging the cost in a timely way.
The Basel Committee on Friday published for consultation proposals to alter how banks recognize the high cost of buying credit protection to cover assets such as complex bonds.
The committee accepted that credit protection can be an effective risk-management tool, but the costs should be appropriately recognized in a bank’s capital buffer.
Under current rules, steps taken by a bank to cover risks help it to reduce how much capital it must hold.
It is the latest move by regulators to restore credibility to capital figures published by banks and to reassure investors that no hidden dangers lurk on or off balance sheets.
Under the proposals, banks would have to calculate “in an appropriately conservative manner” the current value of premiums paid on insurance that has not yet been recognized in earnings.
This figure would have to assigned a risk weighting of 1,250 percent to effectively cancel out any capital relief.
The aim is to prod banks into recognizing the cost of insurance upfront rather than later.
The consultation considers some exemptions from the charge, which supervisory bodies would grant at their own discretion.
Basel will continue to monitor capital relief trades and would consider imposing a “globally harmonised minimum capital requirement if necessary.”
Regulators suspect that the insurance does not really transfer risk to the seller and is merely a ploy to cut capital requirements while the cost of the insurance is not recognised for a long period.
The U.S. Federal Reserve and Britain’s Financial Services Authority (FSA) have also questioned the use of insurance in this way.
In 2010, the FSA told the Association for Financial Markets in Europe, a banking lobby, that companies should not be claiming capital relief where there is little or no risk transferred to the seller of insurance.