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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

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    1. Altman, Edward I, 1989. " Measuring Corporate Bond Mortality and Performance," Journal of Finance, American Finance Association, vol. 44(4), pages 909-922, September.
    2. 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.
    3. Mark Carey, 1998. "Credit Risk in Private Debt Portfolios," Journal of Finance, American Finance Association, vol. 53(4), pages 1363-1387, August.
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    Cited by:

    1. Gropp, Reint & Vesala, Jukka & Vulpes, Giuseppe, 2006. "Equity and Bond Market Signals as Leading Indicators of Bank Fragility," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(2), pages 399-428, March.
    2. Dziawgo Danuta, 2012. "Present and Future Position of Credit Rating," Folia Oeconomica Stetinensia, De Gruyter Open, vol. 12(2), pages 160-174, December.

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