Abstract
The accounting-based capital requirement mandated by the Bank for International Settlements (the BIS) allows for some spectacular cases of regulatory arbitrage. The most blatant one is the banks’ preference for short over longer-term loan commitments or more precisely, the preference for those with an initial term to maturity up to one year, over those with an original term to maturity over one year. The banks’ reasoning is simple: 364-day credit commitments are not subject to any capital constraint whereas the risk-weighted, positive balance of longer-term commitments is used to compute the banks’ regulatory capital requirement. Yet, this artificial dichotomy in commitment maturity.ould be eliminated if the commitment potential risk is linked accurately to the regulatory capital charged. This observation raises two questions: 1) What is the fair value of credit line (CL) commitments? and 2) Do banks incur any (even notional) liability when offering loan commitments, and if so, how is their credit-risk exposure computed?
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