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AmericasNovember 7 2005

Basel II risks failure without the US on board

If the US and Europe cannot agree on a common capital adequacy system, the idea of a level playing field will become a vain hope.
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If Basel II is built on the fundamental principle of providing a level playing field of capital rules for banks competing internationally in a more sophisticated financial environment then the field looks rather rocky at present. With the EU recently approving its version of Basel II – known as the Capital Requirements Directive (CRD) – which applies to all banks in Europe, and the US authorities having serious concerns over implementation and seeking delays (see Basel II supplement, p93), Europe and the US appear to be on divergent paths and the Basel Committee is at pains to find common ground.

In attempting to simplify a series of complex issues, Europe has moved well ahead in Basel II terms and, following the Quantitative Impact Study 4, the US seems fearful of the volatility engendered and is reluctant to match the European timetable.

The question is, if the European and US positions continue to diverge – as seems possible – is the entire Basel II project in danger worldwide? As Jerry Hawke, former US Controller of the Currency, says in our supplement, it is “unthinkable” that banks inside and outside the US operate under different rules. Mr Hawke insists that Basel II must be implemented but that now seems difficult and an international financial dislocation seems possible.

With continuing divergence of systems competitive disadvantages emerge, especially in regard to European banks operating large networks in the US. Vastly different capital requirements create vastly different pricing structures for products such as mortgages. The large number of US small banks, which are outside the scope of Basel II, do not want to be at a disadvantage to large US or foreign banks operating on different capital structures.

US regulators have mooted that a so-called “Basel 1A” might be a suitable compromise, allowing some aspects of Basel II to be incorporated into the US approach. But “Basel 1A” is a long way off and the US is not yet satisfied that, even for its biggest banks, Basel II is a realistic way forward.

If the US, the world’s biggest financial player, is not genuinely involved in Basel II, it is hard to envisage how the accord could help to create a level playing field worldwide. This chaos over Basel II represents a major financial dislocation in the making. The key players must resolve the core issues – and fast.

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