An analysis and critique of the BIS proposal on capital adequacy and ratings ¬リニ

This paper examines two speci®c aspects of stage 1 of the Bank for International SettlementÕs (BISÕs) proposed reforms to the 8% risk-based capital ratio. We argue that relying on ``traditional'' agency ratings could produce cyclically lagging rather leading capital requirements, resulting in an enhanced rather than reduced degree of instability in the banking and ®nancial system. Despite this possible shortcoming, we believe that sensible risk based weighting of capital requirements is a step in the right direction. The current risk based bucketing proposal, which is tied to external agency ratings, or possibly to internal bank ratings, however, lacks a sucient degree of granularity. In particular, lumping A and BBB (investment grade corporate borrowers) together with BB and B (below investment grade borrowers) severely misprices risk within that bucket and calls, at a minimum, for that bucket to be split into two. We examine the default loss experience on corporate bonds for the period 1981±1999 and propose a revised weighting system which more closely resembles the actual loss experience on credit assets. Ó 2001 Elsevier Science B.V. All rights reserved. Journal of Banking & Finance 25 (2001) 25±46 www.elsevier.com/locate/econbase