Why Simple, When it Can Be Difficult?

Abstract

One of the major innovations in the New Basel Capital Accord (Basel II) is represented by the Internal Ratings Based (IRB) Approach. It can be considered as a conceptually new approach to capital rules, since the IRB risk weight function is derived from a simple portfolio model. A careful analysis of the underlying model reveals, that it is based on a quite complex theoretical background and depends on some critical assumptions. Beside this inherent vagueness of model-based results, the committee shows a politically determined will to calibrate the parameters of the model so as to obtain an economy-wide average of 8% - implying an unchanged level of regulatory capital requirements on average.

Taken together, this suggests that the model-driven approach is more like a pretext to disguise politically determined decisions, and pretend, an accurateness, that is not given. We argue, that if it is the committees aim to provide risk-sensitive capital rules, together with some target level of average capital requirements, this can be achieved much easier. (JEL G21, G28)