Although we don't know the regulatory changes that will be
agreed at international level over the next few months, we can
form a surprisingly good idea of their effect. Increased
capital requirements, higher risk capital charges and the
tightening of trading book requirements will all increase the
capital banks will require to operate.
Interestingly, this increase will be cumulative with
another. The Basel II regime, which applies to almost all major
banks, determines capital requirements by looking at historic
loss data. For technical reasons it proved impossible to build
old data into these models, meaning that the data feeding the
risk models consisted entirely of the low default experience of
the last (nice) decade. This translated into low risk
assessments and low capital requirements.
However, the defaults and losses beginning to pile up will
soon feed into the Basel risk models, pushing up the capital.
This plus regulatory...