Sovereign shuffle

10 May 2013 By Peter Thal Larsen, George Hay Follow @Peter_TL

Britain’s financial watchdog wants lenders to expect big losses if government bonds default. That helps fix a flaw in how capital ratios are calculated. But EU rules mean European debt is excluded. The UK’s decision to push ahead on principle could have perverse consequences.

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HSBC on March 7 reported that risk-weighted assets increased by $19 billion bin the first quarter of 2013 as a result of changes to risk models imposed by UK regulators.
The changes affect the way banks calculate the riskiness of sovereign debt they hold. The Bank of England’s Prudential Regulation Authority said in a consultation document published in March that it wanted banks to assume government bonds would lose at least 45 percent of their value in the event of a default.
Imposing a higher Loss Given Default increases the risk-weighting that banks apply to holdings of government bonds. This raises their risk-weighted assets (RWAs) - a key part of the measure of bank capital - and makes capital ratios appear lower than under the previous approach.
However, the PRA’s approach clashes with the European Union’s Capital Requirements Directive, which states that bonds issued by governments in the European Economic Area should carry a zero risk weighting.
Under a provision known as “maximum harmonization”, member states are prevented from adding their own extra safety to EU rules.
HSBC’s total risk-weighted assets at the end of March were $1,098 billion, down from $1,124 billion at the end of December.
Standard Chartered said in its 2012 annual report that the changes increased its RWAs by $3.5 billion by December 2012.

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