In most cases, there will be “colleges of supervisors” and it is hoped that the home supervisor will play the role of lead supervisor, although that will depend on the agreement of the other supervisors. While the general jurisdictional lines between home and host supervisors have been defined, details of their respective roles are still being debated.
“The more discrepancies there are between jurisdictions, the more critical supervisory co-operation and flexibility will be, as international groups try to implement what was supposed to be a global accord across borders,” says Mr Bouton.
Mr Baker believes that home-host issues “could be potentially the Achilles heel of the whole system”. He adds: “I am not quite sure how it will work but it will require an awful lot of co-operation between national regulators, especially outside the EU.”
Richard Herring, professor of international banking at The Wharton School, University of Pennsylvania, writes in Financial Markets, Institutions and Instruments journal: “It is clear that differing approaches to the implementation of Basel II will prove costly to banks that are active in more than one market. Some of these problems are the consequence of the sharing of supervisory and regulatory responsibilities. While these tensions between the home and host country are present under the Basel I regime, they are likely to be greatly exacerbated by several features of Basel II.”
Susan Schmidt Bies, a Federal Reserve Board governor, said in a speech in December: “Understandably, internationally active organisations may worry that cross-border implementation will be complicated by the timing differences between the US and other Basel member countries.” US banking agencies were working with institutions and foreign supervisors “to minimise the difficulties in cross-border implementation”, she said. “We can work to harmonise differences but it is probably not practical to try to eliminate them entirely.”
Jaime Caruana, chairman of the Basel Committee and governor of the Bank of Spain, also writing in the latest issue of Financial Markets, Institutions and Instruments journal, accepts that the issue of “consistency of implementation across jurisdictions” will be difficult to resolve. “While I am confident that we will adequately address this issue over time, at the moment I have more questions than answers.
“For example, how will supervisors approve and monitor advanced Pillar 1 approaches in a consistent manner for banks operating in multiple jurisdictions? How will supervisors recognise external credit rating agencies in different jurisdictions? How will Pillar 2 be made operational for a bank with foreign subsidiaries? How can Basel II be implemented in an effective and efficient way that minimises the regulatory burden on internationally active banking organisations so that they can focus their energies on managing risks rather than managing regulatory relationships? How can this be done in a way that maintains a safe and sound banking system and respects the legal responsibilities and legitimate prudential concerns of both home and host supervisors?”
If Mr Caruana does not have the answers to these questions, who does? To be fair, the Accord Implementation Group (AIG), set up by the Basel Committee in 2003, is working hard to come up with answers to these and other inconsistencies. “The AIG discusses home-host issues, promotes consistency in application of Basel II and convergence of supervisory practices where possible,” writes Mr Caruana. But he emphasises that “neither the Basel Committee nor the AIG intend to create perfect harmonisation across all jurisdictions”.
Emerging markets
Although emerging markets are being encouraged to adopt Basel II eventually, the timetable does not apply to them and in practice most will use the less sophisticated Basel II approaches or stay on Basel I indefinitely. “We believe more needs to be done to encourage emerging markets in general to move toward Basel II and modern risk management,” says Mr Bouton. The IIF is concerned that banks in those countries could lose out.
Professor Herring writes that though many of the largest emerging economies intend to implement the advanced internal ratings-based versions of Basel II so they can benefit from appropriate data, infrastructure, institutions and supervisory independence, the attempt to adopt the advanced versions of Basel II is likely to be harmful. Not only does it divert scarce resources from more fundamental ways of improving the safety and soundness of the financial system, the approach also ignores the most important risks in most emerging economies.”
The EU directive
The CRD contains a number of national discretions that allow each state to have slightly different rules when implementing the directive. It also allows differences in the application of identical rules. The effect will be “disruptive”, believes the CBFA’s Mr Swyngedouw.
Mr Hills of the BBA says this state of affairs “introduces the possibility of differential implementation and level playing field issues” throughout Europe. “We are not sure what [each country’s] rules and guidance will look like until they have gone through the legislative process,” he says.
“The Committee of European Banking Supervisors (CEBS) plans to put on its website a matrix listing these national discretions and how each of the 25 EU countries is going to apply them. I do not think it will be live until 2007. We would like it populated as soon as possible.”
Professor Herring says the EU and its CRD provide “a striking example” of how a single set of rules will be applied differently across 25 countries. “Even within the EU single market for financial services, an internationally active bank may face considerable regulatory and supervisory complexity arising from differences in implementation alone.”
Reality check
Despite the problems of inconsistent implementation, bankers generally support Basel II because they believe it will bring great advantages. Caitríona O’Kelly, banking supervision adviser at the European Banking Federation, says her members are concerned about inconsistencies in the EU but acknowledges that they are to be expected in a union of 25 states. The federation will continue to push for the CEBS to gradually iron them out, she says.
The same applies to the rest of the world, says Ms O’Kelly. “You cannot expect to have full consistency on a global basis because, while it is called an accord it is really a ‘gentlemen’s agreement’ between G-10 countries.
“The big concern on inconsistency is what the US is going to do. That is where the threat lies. We already know it is on a different timetable but the question is whether the US will take elements of the accord back to the Basel Committee for amendments. That would leave the EU in a difficult position because we are tied to a directive that is difficult to change.”
Ms Schmidt Bies told The Banker that everyone knew from the outset that there would be national differences. “That is why a couple of years ago the Basel Committee created the AIG, which has been focusing on home-host issues,” she says. “The most important thing that bankers can do is to talk regularly with their primary supervisor in all the countries in which they operate, because the sooner they can raise specific issues of concern, the smoother the transition is going to be.”
Making progress
Mr Caruana thinks there is no major cause for concern. He says: “The implementation of Basel II is a very important issue and we are making a lot of progress in this area.”
He accepts that he has raised many difficult questions about home-host relationships. “There is still work to do but, if you look back, we have made tremendous progress,” he says. Home-host issues have “existed for a long time” and “Basel II is a good opportunity” for supervisors to deal with them.
As for each country adopting its own version of the accord, Mr Caruana says that was the intention. “Having different options and being so flexible is not the problem, it is the solution. It is the only solution to the real diversity that exists in the world’s banking systems,” he says.
The US timetable delay is more of a problem. “Staggered implementation of Basel II, in my view, is an additional difficulty,” he admits. “But it is a quite manageable difficulty.”
The Federal Reserve and the Basel Committee may be justified in taking a less alarmist view. However, others are not so sanguine. If the IIF cautions that inconsistent versions of the accord could “undermine” Basel’s basic fabric and “create serious level playing field issues”, if the former US Comptroller of the Currency warns that “a chaotic situation will arise” if Basel is implemented in the rest of the world before it is implemented in the US, and if Lloyds TSB’s Basel guru regards home-host issues as “potentially the Achilles heel of the whole system”, then there is only one conclusion: Basel, we have a problem.