Norges Bank


Response to the proposed treatment of expected and unexpected losses

Kredittilsynet Norges Bank

Kredittilsynet and Norges Bank welcome the proposal on the treatment of expected and unexpected losses. Generally we believe that a capital requirement covering unexpected loss is conceptually more correct than the approach underlying CP3. We do however have some reservations regarding the proposal to adjust Tier 2 capital depending on the level of provisions compared to expected loss. We would also like to emphasise that it is not possible to have a firm view on the proposal as long as the outcome on the Basel Committees` calculation exercise is unknown at this stage.

Conceptual issues
Ideally, Kredittilsynet and Norges Bank would like to see a clear separation of accounting rules and capital adequacy rules. We do recognise that different national accounting practices may give rise to an unlevel playing field in a capital adequacy perspective. In our view, such differences should primarily be solved through harmonisation of international accounting standards. Further, in the opinion of Kredittilsynet and Norges Bank there is need for an overall discussion about whether provisions should be included in capital or not.

Kredittilsynet and Norges Bank would like to draw the attention to the current work on harmonising international accounting standards (IAS 39) which is expected to be finalised year end 2003/beginning of 2004. Although there is uncertainty regarding the outcome, the IASB presented a possible "incurred loss model" in May 2003. The new accounting standards, which will be adopted in the EEA-area from 2005, are expected to reduce the differences in provisioning practices among the countries. We would also draw the attention to the fact that it might be conceptual differences between a possible incurred loss model and expected loss calculated under the IRB approach were the latter not necessarily will be comparable with the level of provisions under the new accounting regulation.

Specific comments
The new proposal penalises banks with primarily tier one capital as excess provisions for inclusion in Tier 2 capital is calculated according to the level of Tier 2 capital (maximum 20% of Tier 2). Further, there is an incentive for institutions to switch capital from Tier 1 to Tier 2, given that provisions exceeds EL. A possible solution could be to set the limit on both Tier 1 and Tier 2 capital. However, the limit on 20 per cent would have to be reduced to ensure that the sum of eligible excess provision will not be substantially altered.

The proposed framework treats provisions, as a capital element, differently in the standardised approach and the IRB approach respectively. In effect, permitting general provisions up to 1.25 percent of risk weighted assets under the standardised approach would for many banks amount to more than the 20 percent limit under the IRB approach. We believe this issue should be considered under the forthcoming calibration to minimise the possible incentive for banks to stay under the standardised approach when the IRB approaches would be more suitable.

Total provisioning in Norwegian banks constitutes on average about 70 percent of total Tier 2 capital. It is reason to believe that Norwegian banks will hit the 20 percent ceiling for excess provisions in Tier 2 capital. Although the 20 percent limit will contribute to reduce the capital relief, further calibration of risk weighted assets should pay attention to the overriding goal of maintaining the total level of capital in the banking system. This should also be seen in relation to the QIS3 results where the capital requirements for the Norwegian banks were significantly reduced. We invite the commission to consider these issues in the calibration process.

Published 30 December 2003 10:27