Banks' internal capital modelling needs to be more transparent

The internal models that banks use to assess their capital requirements need to be more transparent and consistent, according to Deloitte's risk and regulatory leader, Kevin Nixon.

Nixon served as managing director for regulatory affairs at the Institute of International Finance in Washington from 2012 until recently. He spoke with Banking Day last week to preview financial regulation topics that may feature in this week's G20 meeting in Brisbane.

"There's a degree of discomfort in the official sector," Nixon said.

"Basel announced work to increase the transparency of internal modelling and to reduce the variability of banks' internal modelling and in turn to reduce the variability internationally of model outputs.

"It's not hard to find divisive commentary on bank's internal models," he said.

"There's nothing more scrutinised by the regulators than a bank's internal model, but there's a credibility issue.

"There's two camps. One says lets throw out the internal models and go for a high, hard leverage ratio. That gets you to 20 per cent."

Nixon said he anticipated "more transparency and steps to reduce the variability, constraining parameters or modelling choices."

One topic attracting interest, he said, was that "there is no consistent definition of default in the world, so things inside the model can be tightened up.

"I do not believe we will throw out internal models and move to a leverage ratio [alone]. There will be change."

Nixon said: "There's a fair sense of what's going to happen, at least on the regulatory front," at the G20.

"They want to say, six years after [the failure of] Lehman Brothers, 'we looked at the crisis, we came up with a plan. At a policy level, we've done what we needed to do'."

Nixon said "I'd be surprised if there are big surprises. The surprises may be in the detail.

"On the banking front, three big things that will be discussed and announced. One is Basel III, with revisions to capital and the conservation buffer and the counter cyclical buffer.

"Then the liquidity ratios and the NSFR, just published. We've seen the final liquidity ratios put in place.

"The leverage ratio will be put at three per cent."

Nixon voiced doubts about  speculation fanned by a recent Bloomberg article on the Financial Stability Board's G20 recommendation which said one FSB working document it obtained showed the basic requirement for the leverage ratio would be set at 16 per cent to 20 per cent of risk-weighted assets, but could swell to 21 to 25 per cent with additional buffers for the biggest banks.

"There have always been people out there who push for very high leverage rations as a way of work through this," he said. "I do not see it anywhere near that."

Nixon backed a consensus view that the leverage ratio would settle at four per cent in most markets, below the six per cent favoured in the US for most banks.

"Looking at the bail-in rules [on wholesale debt] you get double the leverage ratio. I would be surprised with anything in the double digit leverage ratio.

"On the capital front [they have] got it about where they need to have it.

"The total loss absorbing capital ratio - that's what everyone is focusing on. It's not decided what counts as TLAC."