UPDATE 2-Banking regulators propose tougher rules on trading books
* Basel proposes standardised risk approach for all banks
* Basel to study impact of a capital 'floor'
* Standardised and internal risk models to be more rigorous
By Huw Jones
LONDON, Oct 31 (Reuters) - Global regulators proposed fundamental changes on Thursday to how banks price risk on their trading books in a move lawyers said would prompt some lenders to exit or cut back activities.
The Basel Committee of banking supervisors from nearly 30 countries published a second, more detailed 127-page proposal on reforming how risks on trading books are calculated after finding wide discrepancies among banks.
In reviewing the causes of the financial crisis, regulators have accused banks of having underestimated the risk levels for their trading books, which are meant to house tradeable, market-related assets and are valued differently from the banking book containing a bank's other assets, which are not actively traded.
Policymakers in the United States and those in Britain, such as the Bank of England's director of financial stability Andrew Haldane, say Basel's current system of allowing the use of in-house models to assign weightings to risky assets to determine capital levels is too complicated and easily gamed.
Faced with such pressure, the committee has proposed a backstop for in-house models used by the biggest banks.
"This is achieved by establishing a closer calibration of the two approaches, requiring mandatory calculation of the standardised approach by all banks, and requiring mandatory public disclosure of standardised capital charges by all banks, on a desk-by-desk basis," the committee said in a statement.
The standardised approach involves measuring credit risks on assets by using credit ratings from agencies such as Moody's and Standard & Poor's. In-house models use a bank's own estimates of risks, subject to regulatory vetting.
Patrick Fell, a director of financial services at PwC consultancy, said investors would challenge banks when they publish figures showing risks are lower under in-house models.
"Some banks may have a hard time in the public arena," Fell said.
Basel has yet to decide when the changes would be introduced but the committee will take into account other banking reforms now being phased in, including its own Basel III accord.
BACK DOOR VOLCKER
The standardised approach itself would be revised so that it is "sufficiently risk-sensitive to act as a credible fall-back to internal models". Bespoke or internal models would also undergo a more rigorous vetting process by regulators.
Basel is also considering the merits of introducing the standardised approach to require an absolute amount of capital as a buffer against trading losses, irrespective of the risk calculated using an in-house model.
"However, it will only make a final decision on this issue following a comprehensive quantitative impact study, after assessing the impact and interactions of the revised standardised and models-based approaches," the committee said.
Simon Hills of the British Bankers' Association said the introduction of any floor must be carefully considered.
The committee introduced a quick fix in 2009, known as Basel 2.5, following the 2007-09 financial crisis which revealed banks to be under-capitalised, but felt more needed to be done.
"The tenor of the paper is a conservative approach," said Thomas Huertas, a former UK regulator and Basel Committee member, now on EY consultancy's regulatory team.
Banks had to hold far more capital against trading books under Basel 2.5 but the latest reform would be more incremental in impact, Huertas added.
Simon Gleeson, a financial services lawyer at Clifford Chance, said the tougher rules would make banks wonder if it was worth running a trading book.
"This is Haldane-ism rampant. It's back-door Volcker stuff," Gleeson said, referring to a new U.S. rule to prevent banks from risky trades using their own capital.
The latest paper also sets out how to make the boundary between a bank's trading book and its core banking book "less permeable" to reduce the incentives for regulatory arbitrage.
Policymakers found that, in the run-up to the crisis, banks had been shifting assets that might have been kept on the banking book to trading books and as a result had reduced the capital requirement, due to the difference in how the assets were valued.
The proposal states which instruments must be parked on trading books and gives supervisors powers to force a bank to shift assets from the banking to the trading book or vice versa.