An Analysis and Critique of the BIS Proposal on Capital Adequacy and Ratings
January, 2000
Edward I. Altman and 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 oncorporate bonds for the period 1981-1999
and propose a revised weighting system which more closely resembles the actual loss experience on credit assets.
Subject: Banking
Edward I. Altman
Institution: Stern School of Business, New York University
Email: ealtman@stern.nyu.edu
Telephone: (212) 998-0709
Home Page: http://www.stern.nyu.edu/~ealtman
Anthony Saunders
Institution: Stern School of Business, New York University
Email: asaunder@stern.nyu.edu
Telephone: (212) 998-0711
Home Page: http://www.stern.nyu.edu/~asaunder
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