The New Basel Capital Accord was meant to create a level playing field but that now looks like a distant dream.
A camel, the saying goes, is a racehorse designed by a committee. The New Basel Capital Accord set out to be the new sleek, sophisticated capital adequacy framework that would replace the clunking, crude 1988 version. But after four years and the biggest banking committee exercise in history the question is whether Basel II is a true thoroughbred or something quite different.
Finding a capital framework that would satisfy regulators and a variety of banks and financial institutions worldwide was bound to be complex and a difficult compromise. This third and final consultative paper (CP3), which is now unlikely to be altered significantly before implementation at year-end 2006, is exceedingly complex. But, as the results of the quantitative impact study (QIS3) announced in May demonstrate, the capital benefits and costs are potentially huge and critical for banks. The capital requirements for some G10 banks could decline by as much as 36% and increase by up to 84% depending on the choice of approach to credit risk. Smaller banks face even larger potential variances.
The banks have managed to lobby hard and gain concessions but while CP3 looks close to the final outcome much still depends on how the Accord is applied or not applied by individual regulators.
The US authorities dropped a bombshell earlier this year by saying that Basel II would only apply to around 10 internationally active banks. The EU plans to issue a paper this month on how its capital adequate directive (CAD III) will incorporate CP3 and apply it (under force of law) to all banks and investment firms in the EU. Experts expect the EU regime to mirror Basel but a lot can happen before 2006. How Asian banks and others will react to the US and EU positions remains to be seen.
The concept of creating a level playing field may have been envisaged but now looks like a distant dream. Other issues are worrying. If the QIS3 results imply a significant average reduction in capital is this outcome not contrary to the Basel Committee’s objectives and what are the consequences for the stability of the banking system of significantly lower capital held by banks?
Basel II is a highly ambitious project in its final phase but its future application is in doubt. The high cost of implementation has made many wary but banks are likely to be sucked in over time as market forces and the rating agencies flex their muscles. Basel II is no thoroughbred, it is far too ungainly; the danger is that it could turn into another Concorde – built for speed but only used by the very sophisticated, not relevant to most and destined for mothballs.
