A Review of Credit Registers and their Use for Basel II
The Basel Committee on Banking Supervision (BCBS) has been working on the design of a new capital adequacy framework under which bank regulatory capital requirements will be linked more closely to the actual level of risk incurred. The 1988 Capital Accord (Basel I) was a giant step forward in the international consistency of capital standards for banking organisations. However, technological and financial innovation, improvements in credit risk management systems (identification and control, measurement, and broader application of risk reducing techniques), and the practice of regulatory capital arbitrage have made revisions to Basel I necessary.
The simplicity of the 1988 Accord does not allow sufficient discrimination in capital requirements on the basis of the risk exposure to each borrower: for example, a loan to a nonfinancial corporation with the highest rating requires the same capital allocation as a loan to a firm with a rating one step above default. Within the Organisation for Economic Co-operation and Development (OECD) there are countries with a rating, and thus a likelihood of default on their credit obligations, substantially better than that of other OECD members. Nevertheless, the capital allocation of a loan to any OECD county is, in principle, the same. This has detracted from the information content and the disciplinary effect of the capital ratios maintained by credit institutions and has led the BCBS to undertake the current reform of the 1988 Accord, commonly known as Basel II.
Basel II poses a major challenge for both banks and their supervisors. Why? For the former, because it is the first time they will be allowed to use their own credit and operational risk models to determine their minimum regulatory capital requirements. For the latter because, whether they are from industrialised countries or emerging market economies, they will be confronted by a new and hitherto unknown operating and organisational framework, in contrast to the traditional supervision techniques. It will be essential for supervisory authorities to adapt their available resources to that environment and, in short, to develop and use whatever techniques and tools are needed to meet the new challenges and objectives established in the current reform of the 1988 Capital Accord. In particular, they will have to face the challenge posed by the task of validating the internal models developed by banks and, moreover, establish each credit institution's risk profile and assess whether the capital required of it is appropriate for that profile.
The more precise alignment of regulatory capital with the underlying risks in banks' loan portfolios will stimulate them to better allocate the funds attracted and to improve the quality of their management. In the medium term, this will also have implications for the stability of countries' financial systems by reinforcing their soundness, ultimately with the resulting favourable impact on social welfare.2
In view of the foregoing, this essay aims to highlight the enormous potential that credit registers (CRs) possess as a key tool in the hands of supervisory authorities, and to demonstrate the as-yet untapped possibilities that will allow bank supervisors to face, with sufficient assurance of success, the new environment and challenges that will accompany the implementation of Basel II.
Moreover, the extensive use of the information contained in CRs, whether public or private, will enable credit institutions to improve the identification and control of their banking risks and, ultimately, provide conditions conducive to the greater stability of the financial system. At the same time, in certain countries the supervisors, by improving and modernising their inspection practices and thus adapting them to the new credit risk assessment and measurement techniques, can help their supervised institutions enormously in the progressive adoption of the more advanced approaches advocated by Basel II. The possibilities offered by the information included in CRs probably constitute one of the most important available mechanisms to address and eventually resolve certain validation and benchmarking issues that Basel II has recently been posing for banking supervisors.
Part 1 of the essay briefly reviews the main uses of CRs, the current literature on them and their key characteristics. Part 2 then explains the special features of Spain's Central Credit Register and its utilisation by the Spanish supervisor. Finally, Part 3 looks in detail at how to focus the use of CRs to make for more efficient monitoring and, ultimately, implementation of Basel II by the supervisory authority.
1 The opinions expressed in this essay are the responsibility of the author and do not necessarily represent those of the Banco de España.
2 Bank bankruptcies have a high cost in both fiscal terms and forgone potential production (Hoggarth and Saporta (2001)).