Alert March 04, 2008

Standard & Poor’s Introduces New Capital Benchmark

Standard & Poor’s (“S&P”) introduced a new capital benchmark, the Basel II Adjusted Ratio (“BAR”), which will be used in the firm’s public credit ratings.  The BAR is meant to complement the Basel II regulatory ratios and to add an extra perspective on the adequacy of bank capital as foreign and large U.S. banks transition from the 1988 Basel I standards to the Basel II Capital Accord, which S&P says is likely to take several years.  While acknowledging that Basel II has many advantages over Basel I, S&P highlights inconsistency related to banks’ choices between the so-called standard approach methodology and the internal ratings-based approach as one of its main concerns with Basel II.

S&P discusses the BAR in detail in a report (the “Report”) entitled “Transition to Basel II Creates a Need for a Consistent, Comparable Measure of Bank Capital.”  In the Report, S&P states that Basel II’s greater alignment with economic reality “will reduce banks’ ability and willingness to window‑dress their published regulatory ratios.”  S&P also notes that many of the risk measurement systems of Basel II were developed during a more settled economic environment, and that Basel II’s calculations may be put to the test during this time of relatively unfavorable economic conditions. 

In the Report, S&P describes the BAR as “a refinement of our existing approach that takes into account Basel II and adjusts for its resulting inconsistencies.”  The goal of the benchmark is to neutralize the impact of Basel II options, national discretions, and differences in banks’ internal assessments.  S&P stated that it did not expect ratings to change as a result.

S&P will ask for comments on the proposed BAR over the next two months.  It will make banks’ actual ratios public as soon as banks that have adopted Basel II publish market data required under the new accord.  Federal banking regulations implementing the U.S. version of Basel II are scheduled to take effect on April 1, 2008.