Dear Editor

I have been following the debate about Basel II in The Banker with interest. To use an insurance analogy, moving from a flat-rate method of assessing motor premiums to one in which premiums depend on the driver’s accident history inevitably provokes opposition from learner drivers and those with poor accident records. But safe drivers are not treated fairly by a flat rate approach. The Basel Committee has been exceptionally transparent in the development of its proposals and this has manifested itself in the controversy reflected in your columns.

Now, though, the debate is moving on to implementation issues and The Banker in November raised the thorny question of cost. In recent months, several extensive surveys of the cost implications have been conducted by consulting firms, including Ernst & Young and Oliver Wyman. The results are relatively reassuring in relation to the benefits that Basel II will bring via improvements in risk management practices, more efficient allocation of resources and corporate governance incentives.

I was hence rather surprised that your leading comment column in the November issue quoted an estimate for Basel II compliance costs of $15,000bn, apparently achieved by taking a figure of $500m (which would in my judgment exceed the maximum cost even for a global bank that plans to adopt the most advanced approaches) and multiplying it by 30,000 banks. I assume your readers will not put any credence on that figure when informed estimates are suggesting around $100,000 for small banks adopting simple systems or five basis points of assets for others. Assessing what the likely total cost would be is, however, quite tricky. Much depends on how sophisticated a bank’s systems already are, and whether or not it chooses to adopt the more complex options available. In addition, it is difficult to disassociate Basel II compliance costs with investments in risk management that might take place even in the absence of Basel II. In the Ernst & Young survey, only 14% of respondents identified meeting the Basel II standards as the primary driver for their investments in credit risk management during the previous two years.

At the end of the day, basic economics will determine the amount of money that banks decide to spend on Basel II. If they see benefits in risk management supplemented by capital efficiency, they will invest. All the signs we are seeing are that more and more banks are indicating interest in the more sophisticated, and more expensive, options.

Charles Freeland Deputy Secretary General of the Basel Committee for Banking SupervisionBank for International Settlements

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