Application of risk-based capital rules

Regulators have not yet settled on the most appropriate application of risk-based
capital rules for credit derivatives, and banks trying to use them to reduce credit risk
may find that current regulatory interpretations serve as disincentives.5 Generally,
the current rules do not require capital based upon economic risk. For example,
capital rules neither differentiate between high- and low-quality assets nor do they
recognize diversification efforts. Transactions that pose the same economic risk may
involve quite different regulatory capital requirements. While the Basel Committee
has made the review of capital requirements for credit derivatives a priority, the
current uncertainty of the application of capital requirements has made it difficult
for banks to measure fully the costs of hedging credit risk.6