Author: Tom Bailey
9 Jun 2015
The Basel Committee on Banking Supervision has released a consultative paper urging banks to raise their minimum capital requirements. The committee intends for the paper to expand upon and replace the Basel Committee’s 2004 Principles for the management and supervision of interest rate risk.
The paper aims to ensure banks have enough capital reserves to weather any potentially damaging results from rate rises
After years of low interest rates, many central banks are expected to begin raising rates soon as the recovery takes hold. There has long been speculation that the Federal Reserve will hike rates after a decade of cheap credit, although new data showing a sluggish US economic performance in 2015 has staved off any rise for now.
The Basel Committee is concerned about the impact this inevitable rise will have on the bottom line of banks. Interest rate changes, the paper claims, could impact “the present value and timing of future cash flows change,” which will alter “the underlying value of a bank’s assets, liabilities and off-balance sheet instruments and hence its economic value.” Interest rate sensitive income and expenses will also be impacted, possibly affecting the bank’s net income. Ultimately, the committee concludes, if the coming rise in rates is not handled properly, it may “impact on profitability and shareholder value” and “pose a significant threat to a bank’s current capital base and/or future earnings.”
The paper aims to ensure banks have enough capital reserves to weather any potentially damaging results from rate rises. The committee writes that banks must “have appropriate capital to cover potential losses from exposures to changes in interest rates.”
It proposes two potential ways to ensure this. The first option is to take a blanket approach in which all banks heed to a mandatory minimum capital requirement. This will, they claim, provide greater transparency, consistency and comparability. Alternatively, a more varied approach could be taken whereby each bank is allowed to calculate its own exposure to the interest rate rise and decide upon its capital requirements accordingly. The committee will decide which approach to take later in the year.