Just under two weeks before the Basel Committee meets in Santiago to negotiate new international rules for the regulation of banks, Bundesbank Executive Board member Andreas Dombret has outlined the Bundesbank's demands. He has said that he will advocate that banks retain internal models to calculate their credit risk. Large banks in particular use such models to determine how much capital they need to put aside for loans and other business transactions. 

Banks and savings banks obliged to apply conservative value calculations

During a speech he delivered in Frankfurt, Dombret cited property loans to illustrate his demand. He pointed out that in Germany and other countries, banks and savings banks are obliged to apply conservative value calculations when valuing real estate. These, he explained, are more cautious and less volatile than valuations based only on the market value of a property, for example. "Market prices are, of course, prone to overvaluations and price bubbles," Dombret said, but added that less restrictive valuation standards are often used in other countries than in Germany. However, he pointed out that the Basel rules make no distinction between them and the valuation methods that German banks are penalised for using, as they incur lower risk yet are subject to the same capital requirements. "We, as the German supervisory authority, will be objecting to this," said Dombret. He further remarked that, in his view, this approach would distort global and regional competition. Dombret commented that each institution would, moreover, feel penalised for contributing to a more cautious management of the financial risks resulting from property finance. "In the case of real estate loans, we want the Basel framework to take due account of reliable data series on low loss ratios, like those obtained from conservative valuation methods in Germany," Dombret noted. Andreas Dombret expressed his belief that maintaining internal models would mean a risk-sensitive regulatory approach under which the capital requirements reflect an institution's actual risks as accurately as possible.

Moreover, the Bundesbank Executive Board member said that he is opposed to an initiative in support of imposing an output floor on capital requirements that a bank itself calculates. An output floor would come into play if a bank with its own risk models calculates lower capital requirements than banks using standardised approaches. According to the Basel Committee's proposals, the maximum reduction in capital requirements should in future be either 20 per cent or 40 per cent compared with the standard model. The aim here is to limit the advantage accruing to banks that use internal models. Dombret said he believes that, in theory, the output floor acts as a way of putting a stop to the frivolous calculation exercises associated with internal models. "In practice, however, it works against the focus on risk," he said. In addition, the Bundesbank Executive Board member recommended that the new rules should not be used in the case of small and medium-sized institutions. "These rules," he remarked, "are intended for large, international institutions."

No agreement at any price

Dombret concluded his speech by emphasising the importance of international agreements such as Basel III, saying that effective international standards beyond the regional level are in everyone's interests. In this way, he continued, Basel sets the standard for effective international cooperation. "Currently, we are seeing many citizens calling our globalised world into question, with more and more looking for answers in separation or regionalisation," said Dombret. He expressed the strong hope that the cooperation on the Basel Committee will continue under the new administration in the United States on the basis of mutual trust. Andreas Dombret stressed, however, that "the Bundesbank is not prepared to reach an agreement at any price".