THE BASEL COMMITTEE´S PROPOSALS FOR REVISED CAPITAL STANDARDS: MARK 2 AND THE STATE OF PLAY

Abstract

The Basel Committee´s Proposals for Revised Capital Standards: Mark 2 and the State of Play. The new 500-page consultative document on capital standards of the Basel Committee on Banking Supervision (BCBS), “The New Basel Capital Accord”, gives what is likely to prove a reasonable idea of the eventual shape of the new capital accord. However, many detailed issues remain to be resolved before completion of the drafting process in 2002. The scale and duration of this process reflects both the increasing complexity of banking operations and the role of the BCBS as the institution responsible for globally applicable standards for banking regulation and supervision. The basic structure of the 2001 consultative document follows that of the June 1999 proposals, in particular three Pillars treating the calculation of capital requirements, supervisory review, and the disclosure necessary for effective market discipline. But the 2001 proposals are much more concrete and detailed. In their present form the proposals of the New Accord raise several concerns likely to apply to all countries but in some respects particularly to developing ones. One set of concerns relates to the New Accord’s impact on supervisory divergences among countries, cross-border competition between banks, and cooperation between national supervisors. The New Accord has been crafted to accommodate banks of very different levels of sophistication. Yet this may compromise its basic objective of enhancing competitive equality by actually creating regulatory divergences in some areas of banking practice both within and between different countries. As a result the difficulties of achieving effective cross-border cooperation amongst supervisors may well increase. A second set of concerns involves the relation of the New Accord to ongoing exercises involving codes and standards. Here the key standard is the BCBS’s Core Principles for Effective Banking Supervision for which the capital adequacy requirements of the Basle Capital Accord provide the principal benchmark. The New Accord will represent a quantum increase in the complexity of supervisors’ responsibilities in most countries, and the resulting administrative burden will be aggravated by its in corporation in assessment exercises regarding compliance with the key standards. Furthermore, the link between the New Accord and key standards for financial systems also implies that implementation will become a subject for IMF Article IV surveillance and part of the conditionality associated with the IMF’s new CCL facility. A further set of issues involves possible effects on regulatory arbitrage, since the comprehensiveness and detailed character of the rules of the New Accord will almost inevitably be a source of new opportunities for such arbitrage. Finally, there are concerns as to the effects of the New Accord on economic activity and international capital flows. The proposed risk weights of the IRB approach would lead to substantial rises in interest rates for lending to borrowers with low credit ratings both within countries and internationally – rises likely to affect borrowers from several developing countries. Moreover, owing to their links to the ratings of credit rating agencies and to observed default rates, the risk weights proposed in the New Accord are capable of contributing to the pro-cyclical character of bank lending both within countries and across borders, since they would be likely to translate higher credit risks in more difficult times into increased capital requirements (and thus more restrictive lending policies). Prudential rules which would minimize such dangers can be sketched but would nonetheless be difficult to incorporate in the design of regulatory systems.