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An Analysis and Critique of the BIS Proposal on Capital Adequacy and Ratings

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  • Edward Altman
  • Anthony Saunders

Abstract

This paper has examined two specific aspects of stage 1 of the (BIS's) Bank for International Settlement's 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 financial 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 sufficient 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.

Suggested Citation

  • Edward Altman & Anthony Saunders, 2000. "An Analysis and Critique of the BIS Proposal on Capital Adequacy and Ratings," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-084, New York University, Leonard N. Stern School of Business-.
    • Handle: RePEc:fth:nystfi:99-084
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    File URL: http://www.stern.nyu.edu/fin/workpapers/papers99/wpa99084.pdf
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    References listed on IDEAS

    as
    1. Edward I. Altman & Diane Cooke & Vellore Kishore, 1999. "Defaults & Returns on High Yield Bonds: Analysis Through 1998 and Default Outlook for 1999-2001," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-005, New York University, Leonard N. Stern School of Business-.
    2. repec:bla:jfinan:v:44:y:1989:i:4:p:909-22 is not listed on IDEAS
    3. Altman, Edward I. & Saunders, Anthony, 1997. "Credit risk measurement: Developments over the last 20 years," Journal of Banking & Finance, Elsevier, vol. 21(11-12), pages 1721-1742, December.
    4. Morgan, Anthony W., 1997. "Removing College Price Barriers. By Michael Mumper. Albany: State University of New York Press, 1995. 304p. $24.95," American Political Science Review, Cambridge University Press, vol. 91(2), pages 464-465, June.
    5. Treacy, William F. & Carey, Mark, 2000. "Credit risk rating systems at large US banks," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 167-201, January.
    6. repec:bla:jfinan:v:53:y:1998:i:4:p:1363-1387 is not listed on IDEAS
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