Managing Bank Capital: Capital Allocation and Performance Measurement, 2nd Edition

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Current Problems and Future Developments: Towards an Internal-Models Based Approach?

This chapter takes a look at some of the shortcomings of the Basel Accord, and the consequences thereof. It also looks at some of the possible alternatives, and the direction which capital adequacy regulations might take over the coming five years or so. Of course, these regulations are constantly changing, and although this chapter is as up-to-date as possible at the time of going to print, the reader is advised to monitor the announcements made by the Basel Committee and individual regulators to ensure that developments are not overlooked. An appendix to this chapter reviews the latest consultative paper issued by the Basel Committee.

REGULATORY CAPITAL ARBITRAGE

A key issue with the existing framework is “regulatory capital arbitrage”, and any examination of the current and possible future framework for capital adequacy needs to start with this concept. Regulatory capital arbitrage was always possible under the Basel Accord, but the term has only really come into use—and into the daily vocabulary of the regulators—as developments have picked up over the past few years. These developments have been driven by the increasing sophistication of the capital markets and the introduction of new instruments (such as credit derivatives).

Regulatory capital arbitrage is the process whereby a financial institution reduces its regulatory capital requirement with little or no corresponding reduction in ...