Industry Practices in Credit Risk Modeling and Internal Capital Allocations: Implications for a Models-Based Regulatory Capital Standard: Summary of Presentation

Abstract

The authors provide examples by which information from internal credit risk models might be usefully incorporated into regulatory or supervisory capital policies. In view of the modeling concerns described, incorporating internal credit risk measurement and capital allocation systems into the supervisory and/or regulatory framework will occur neither quickly nor without significant difficulties. Nevertheless, supervisors should not be dissuaded from embarking on such an endeavor. The current one-size-fits-all system of risk-based capital requirements increasingly is inadequate to the task of measuring large bank soundness. Moreover, the process of patching regulatory capital leaks as they occur appears to be less and less effective in dealing with the challenges posed by ongoing financial innovation and regulatory capital arbitrage. Finally, despite difficulties with an internal models approach to bank capital, no alternative long-term solutions have yet emerged.