(The authors are Reuters Breakingviews columnists. The opinions
expressed are their own)
By Peter Thal Larsen and George Hay
HONG KONG/LONDON, May 10 (Reuters Breakingviews) - Britain’s
principled approach to banks’ holdings of sovereign debt could
have a perverse outcome. The watchdog has taken the sensible
step of demanding that lenders expect big losses if government
bonds default. That helps fix one of the biggest flaws in
measuring bank capital. But pan-European rules mean that risky
euro zone debt is excluded from the precautions.
The proposals, outlined by the Bank of England’s Prudential
Regulation Authority in March, aim to fix one of the most
contentious areas of measuring bank capital: the treatment of
government bonds. For years, regulators treated all sovereign
debt as if it was all low-risk. The euro zone crisis has exposed
the folly of that approach.
But even new Basel III capital rules don’t fully address the
problem. That’s because big banks calculate risk on the basis of
past experience, and sovereign defaults are still rare. The
danger is that government bonds will continue to receive lenient
treatment. That would further confirm investors’ suspicions that
bank capital ratios cannot be trusted.
So the PRA has stepped in. It says banks should assume that
sovereign bonds will lose at least 45 percent of their value in
a default. Plugging this figure into risk models will raise RWAs
and reduce capital ratios. HSBC’s RWAs were $19 billion higher
at the end of the first quarter as a result of the shift.
The problem is that the PRA’s approach is at odds with the
European Union’s interpretation of Basel, which states that all
bonds issued by European Economic Area governments in their
local currency should receive a zero risk weighting. Under the
EU’s "maximum harmonisation" provisions, Britain is not allowed
to toughen up the rules by itself.
It’s not the first time Britain has run into this problem:
the UK government’s plans to make banks hold bigger capital
buffers has also met with resistance from Brussels. Unless
Britain can persuade its European partners to adopt its
approach, risky sovereigns like Portugal, Spain and Italy are
excluded from the PRA’s new rules, while U.S. Treasury bonds
aren’t. That gives UK banks an incentive to hold more euro zone
debt, and penalises those lenders with large operations in other
parts of the world. A sensible policy looks to be creating a
SIGN UP FOR BREAKINGVIEWS EMAIL ALERTS:
- HSBC on March 7 reported that risk-weighted assets
increased by $19 billion bin the first quarter of 2013 as a
result of changes to risk models imposed by UK regulators.
- The changes affect the way banks calculate the riskiness
of sovereign debt they hold. The Bank of England’s Prudential
Regulation Authority said in a consultation document published
in March that it wanted banks to assume government bonds would
lose at least 45 percent of their value in the event of a
- Imposing a higher Loss Given Default increases the
risk-weighting that banks apply to holdings of government bonds.
This raises their risk-weighted assets (RWAs) – a key part of
the measure of bank capital – and makes capital ratios appear
lower than under the previous approach.
- However, the PRA’s approach clashes with the European
Union’s Capital Requirements Directive, which states that bonds
issued by governments in the European Economic Area should carry
a zero risk weighting.
- Under a provision known as "maximum harmonization", member
states are prevented from adding their own extra safety to EU
- HSBC’s total risk-weighted assets at the end of March were
$1,098 billion, down from $1,124 billion at the end of December.
- Standard Chartered said in its 2012 annual report that the
changes increased its RWAs by $3.5 billion by December 2012.
- HSBC first quarter results: link.reuters.com/gyf97t
- UK Prudential Regulation Authority consultation paper: link.reuters.com/fyf97t
- For previous columns by the author, Reuters customers can
click on [LARSEN/]
(Editing by George Hay and David Evans)
Keywords: BREAKINGVIEWS DEBT/
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