Such buffers enhance the ability of banks to readily absorb losses while remaining compliant with minimum ratios. An appropriate structure for capital buffers will be an important issue for the Review. 2. Capital requirements should be set in relation to the risk of bank exposures Regulatory capital requirements must reflect the underlying risk of exposures in order to avoid distorting banks’ risk-return decisions.
Critics of the Basel framework maintain that ever-increasing risk granularity has led to a spurious sense of sophistication and that the pendulum should swing back to simpler, more objective measures of risk.14 In particular, the use of internal models to determine capital requirements has been shown in practice to lead to excessively wide estimates of risk for what is the same underlying exposure.15 The Basel Committee has agreed that a simplification of the framework and a reduction in model-based variation in capital requirements is desirable.