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

  • Edward Altman
  • Anthony Saunders
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    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.

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    Paper provided by New York University, Leonard N. Stern School of Business- in its series New York University, Leonard N. Stern School Finance Department Working Paper Seires with number 99-084.

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    Date of creation: Jan 2000
    Date of revision:
    Handle: RePEc:fth:nystfi:99-084
    Contact details of provider: Postal: U.S.A.; New York University, Leonard N. Stern School of Business, Department of Economics . 44 West 4th Street. New York, New York 10012-1126
    Phone: (212) 998-0100
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    1. Mark Carey, 1998. "Credit Risk in Private Debt Portfolios," Journal of Finance, American Finance Association, vol. 53(4), pages 1363-1387, 08.
    2. Altman, Edward I, 1989. " Measuring Corporate Bond Mortality and Performance," Journal of Finance, American Finance Association, vol. 44(4), pages 909-22, September.
    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.
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