Banking and securities regulators may end up revising capital adequacy rules and forcing banks to change their risk management models. The moves are on the agenda as part of a review of market risk in illiquid financial instruments. The variety of risk assessment approaches means there will likely be changes and costs for some banks. Darryll Hendricks, senior v.p. at the Federal Reserve Bank of New York, said, "It's probably not going to be feasible to have a rule that's costless for everyone to implement."
The illiquid instrument analysis is being carried out by a Basel Committee on Banking Supervision and the International Organization on Securities Commissioners joint working group, which aims to publish a comment paper by March.
Bankers fear the group might introduce rules that are too conservative or not sufficiently sensitive to the real risks involved, said market officials.
Firms have a variety of approaches for trying to address the risk inherent in illiquid positions in place already, such as a stress testing approach or a way of performing specific modifications of value-at-risk calculations. Modifying systems for calculating risk would inevitably land banks with a large IT bill.
Any rule change may also alter the capital requirements on activities involving illiquid positions, Hendricks said. The implications of this are hard to predict because these activities may already attract more capital internally if the firm regards them as riskier than the regulatory capital they are required to hold, he noted. If firms do find it necessary to boost regulatory capital, however, the rule change may act as a disincentive to undertake activities involving illiquid position.
Tanya Azarchs, a managing director at Standard & Poor's in New York, said a rule change would bring better disclosure, adding current rules do not factor in enough risk for illiquid positions. "We have always tried to adjust that," she said.
