Capital requirements for banks' equity investments in funds

The Basel Committee on Banking Supervision today published a set of proposals that would revise the prudential treatment of banks' equity investments in funds. The Basel II framework outlines the current treatment of banks' equity investments in funds under the Standardised Approach and the Internal Ratings-Based (IRB) approaches for credit risk and the Committee believes that the existing standard would benefit from further clarity in some areas. In addition, it does not require banks to reflect a fund's leverage when determining capital requirements associated with their investments in a fund, even though leverage is an important risk driver. In reviewing the existing Basel II standard for banks' equity investments in funds, the Committee's objective was to develop an appropriately risk sensitive and consistently applied risk-based capital regime. The Committee believes the revised standard will more appropriately reflect the risk of a fund's underlying investments and its leverage.

The revised standard will also help address risks associated with banks' interactions with shadow banking entities. The work of the Basel Committee therefore contributes to the broader effort by the Financial Stability Board to strengthen the oversight and regulation of shadow banking.

The Committee's proposal is based on the general principle that banks should apply a look-through approach to identify the underlying assets whenever investing in schemes with underlying exposures such as investment funds. The Committee recognises that a full look-through approach may not always be feasible and that a staged approach based on different degrees of granularity of the look-through is warranted. The proposed risk weighting framework therefore enables the application of a consistent risk-sensitive capital framework which provides incentives for improved risk management practices.

Following this principle, the proposed policy framework consists of three approaches, with varying degrees of risk sensitivity: the "look-through approach" (LTA), the "mandate-based approach" (MBA), and the "fall-back approach" (FBA). To ensure that banks have appropriate incentives to enhance the risk management of their exposures, the degree of conservatism increases with each successive approach (as risk sensitivity decreases).

The Committee welcomes comments on this consultative document. Comments on the proposals should be submitted by Friday 4 October 2013 by e-mail to baselcommittee@bis.org. Alternatively, comments may be sent by post to: Secretariat of the Basel Committee on Banking Supervision, Bank for International Settlements, CH-4002 Basel, Switzerland. All comments may be published on the website of the Bank for International Settlements unless a respondent explicitly requests confidential treatment.