Basel abandons plans for Pillar 1 rates risk charge

No standard charge for banking books, but souped-up Pillar 2 still worries critics

Basel Committee: no Pillar 1 charge for banking books

International regulators are believed to have scrapped plans to impose a standardised charge for interest rate risks in bank deposit and loan books, following more than three years of work on a so-called Pillar 1 approach – a step being cautiously welcomed by bank lobbyists.

Attention has switched to the current Pillar 2 approach, which gives national supervisors the flexibility to impose charges where they are deemed necessary. This could now be enhanced with standardised elements, such as a set methodology for measuring risk, guidance for supervisors on what actions to take, and a brand-new disclosure regime in which standardised capital numbers would be reported to supervisors and the public.

Lobbyists claim the decision to ditch Pillar 1 came last month at a meeting of the Basel Committee on Banking Supervision, which is confirmed by a regulator with knowledge of the process. The committee declined to comment.

Hugh Carney, vice-president of capital policy at the American Bankers Association (ABA), welcomes the change: "We fully support the abandonment of Pillar 1. The ABA has been opposed to a standardised Pillar 1 capital requirement for interest rate risk since the beginning. Our hope now is that a Pillar 2 approach will not include standardised elements as well."

An enhanced Pillar 2 approach was sketched out by the Basel Committee in its June 2015 consultation on interest rate risk in the banking book (IRRBB). It was also unpopular with the industry.

"The question is to what extent are they going to revise the proposed enhanced Pillar 2 approach because that was also criticised as being a 'disguised Pillar 1' due to its use of the Pillar 1 standardised calculations," says Denisa Mularova, a senior policy adviser at the European Banking Federation (EBF).

From the start, the IRRBB project has been ambitious and controversial. Deposit and lending products remain the heart of the business for most banks, but actual products and markets vary considerably between countries. There are also competing ways to measure the resulting risk – one based on economic value and the other on net interest income. And the project contains some big challenges, such as how best to forecast the term for so-called non-maturing deposits (NMDs) where a depositor can withdraw funds at any point in time.

The ABA has been opposed to a standardised Pillar 1 capital requirement for interest rate risk since the beginning. Our hope now is that a Pillar 2 approach will not include standardised elements – Hugh Carney, ABA

The Basel Committee convened a working group in 2012, but last year's long-awaited consultation paper was its first set of proposals and the two-pronged approach – either Pillar 1 or an enhanced version of Pillar 2 – came after lobbyists and regulators claimed the group was finding it hard to agree on either one. European authorities were said to be fans of Pillar 1, with Japan and the US on the other side of the debate.

It is not clear which, if any, standardised elements will be incorporated into Pillar 2, but the committee's proposals could produce a regime that is, in practice, not far removed from full-blown Pillar 1. In theory, banks could still be required to calculate and report a standardised capital number for banking book rates risk, with supervisors then being subject to guidelines that impel them to take action if the standardised and internally modelled numbers diverge significantly. The consultation paper mentions "a strong presumption for capital consequences" in such cases.

Even without the capital stick, the idea of standardised reporting worries some.

"We are not against reporting in principle, but the Pillar 2 approach from last June included a reporting requirement based on a standardised calculation that overshadows a lot, because we believe any standardised calculation could be misleading," says the ABA's Carney.

Specifically, industry critics worry the reports might overstate the risk a bank is facing. They also fear disclosure of an apples-to-apples number might result in it becoming the standard by which analysts and investors judge banking book exposure – whether it captures the risk correctly for a given bank or not.

Banks also do not know how much room they will have to continue using their own models. Restrictions could be imposed on NMD modelling, for example, in the same way some European banks have been required to apply floors to mortgage loss forecasts.

A senior treasury manager with one North American bank says: "It felt like a win that after 18 months of lobbying we are finally back on Pillar 2, but it's unknown and unclear yet how much of a move to Pillar 2 it is."