He held several senior positions in the Clinton administration, ultimately as assistant to the president for international economic policy, responsible for coordinating the administration's international economic policy. He serves on the advisory editorial board of International Economics and the Advisory Committee of Transparency International.
Acknowledgments
The third ongoing activity of the Basel Committee is the formulation of capital adequacy standards. The Bank for International Settlements (BIS) is the institutional home of the Basel Committee on Banking Supervision.
Summary of Argument
Second is an assessment of the contribution of the specific international character of Basel II to the achievement of various national policy goals. The assessment of this interaction leads to the conclusion that the international character of Basel II does not compensate for the shortcomings of the IRB approach.
Outline of the Book
While the choice of regulatory model is crucial and the operation of the Basel Committee may be interesting, it is the interaction between the two that will determine the impact of Basel II. However, the combination of uncertainty about the optimal substantive approach for capital regulation and the institutional limitations of the Basel Committee suggest that a simpler and more eclectic international arrangement would be preferable to Basel II.
A Note on Timing
Third, the doubts raised during the negotiations and implementation of Basel II have only been strengthened by the circumstances surrounding the subprime mortgage crisis. Now, however, both trends have converged in the advanced internal assessment-based (A-IRB) approach of Basel II.
Rationale for Capital Regulation
In relation to deposit insurance, the government is an express guarantor of the bank's debt to insured depositors. Note first that the previous account emphasized the effect of the government safety net on the private parties' perceptions and incentives of the bank.
Evolving Role of Capital Regulation
Indeed, the capital ratios of smaller banks (less than $300 million in assets) actually increased significantly. As in the United States, the economic turmoil of the 1970s and early 1980s led to a deterioration in asset quality.
Conclusion
The development of capital adequacy regulation in the Basel Committee countries in the late 1970s and early 1980s reveals two points that are quite important in evaluating the Basel II approach as a substantive regulatory paradigm for international regulation. Second, there have been significant differences in the required levels of capital, the definition of capital, and other characteristics of the relationships between capital and risk-based assets.
Origins of the Accord
Equally striking was the growth in the share of assets of the world's largest banks, which was accounted for by Japanese institutions. In a sense, it also presages the United States' trade strategy in the early 1990s, when it was reactivated.
Elements of the Accord
䡲 the total number of elements of level 2 is limited to a maximum of 100 percent of the total value of elements of level 1. The inclusion of off-balance sheet items in the balance sheet total of the bank for the purposes of capital calculations is one of the permanent contributions of the agreement. However, like the discrete changes in risk categories, they did not represent any development in the Board's conceptual approach to capital regulation.
The committee described its April 1993 article as a "consultative proposal" and noted that this was the "primary purpose" of the consultation process.
Assessment of Basel I
Of course, the record of Basel I in its waning days was marred by the severity of the subprime crisis. Of course, within a few years of the implementation of Basel I, global concerns shifted from the possible competitive advantage of Japanese banks to the possible collapse of the Japanese banking system. The lending of the branches appears to be sensitive to the capital conditions of the Japanese parents.
The most basic forms of regulatory arbitrage arise from the highly arbitrary nature of many of Basel I's rules.
Launching the Review Process
Papers and speeches presented at the conference, "Financial Services at the Crossroads: Capital Regulation in the Twenty-First Century," are summarized in the October issue of the Federal Reserve Bank of New York's Economic Policy Review. In July, at its first meeting, chaired by McDonough, the committee agreed to a thorough revision of the Basel accord. The very creation of the Basel Committee was a result of the 1974 crisis in many G-10 banks.
Similarly, Basel I arose out of a series of events triggered by the Latin American debt crisis of the 1980s, and revisions to the Basel Concordat were made following the collapse of the Bank of Credit and Commerce International in 1990.
Curious Release of the First Consultative Paper
The ongoing work of the Basel Committee's Models Task Force (which included many participants at the London conference) was Table 4.1 External agency ratings and risk weights in the former. By the March 31, 2000 deadline for written comments to the Basel Committee, nearly 200 had been received. After the publication of the Basel Committee document on credit risk modelling, the IIF had asked some of its member banks to review that document.
The American members of the Basel Committee, especially the Federal Reserve, spoke more forcefully than ever before for a far-reaching shift to an IRB approach.
Shift to an Internal Ratings–Based Approach
The advanced approach allows the use of bank estimates of the probability of default, the exposure if default, the loss if a default occurs, and the maturity of the exposure. on default, the exposure at default, the loss given default and the maturity of the exposure are inputs. Under the A-IRB approach, banks could also use their own estimates of their exposure in the event of default, their losses if a default occurs, and the maturity of the exposure.
In order to qualify for the A-IRB approach, a bank would have to meet additional requirements that apply to the calculation of exposure given default, loss given default and exposure maturity.
Process of Continuous Revision
In February 2002, two members of the Basel Committee were cited, albeit anonymously, for precisely this purpose. Senator Richard Shelby (R-AL), chairman of the Senate Banking Committee, worried about the competitive effect on smaller banks that would not use an IRB approach, a concern that would later be echoed by his counterpart, Representative Michael Oxley (R-OH), chairman of the House Financial Services Committee. Immediately after the release of CP-3, the prospects for Basel II did not look better than before.
As they negotiated the international arrangement, European members of the Basel Committee awaited a revised European Union (EU) Capital Adequacy Directive (CAD).
Revised Framework
However, in the two years following the release of the revised framework, a mild backlash occurred. The agencies announced their agreement in the form of a press release, which was likely issued to quell speculation that the tradition of the four acting together on capital requirements had collapsed. During the transition years, the agencies will jointly issue annual reports on the effectiveness of the new framework.
The agencies apparently expect their disputes of recent years not to diminish during the transition period.
Responding to the Subprime Crisis
At first glance, the origins and severity of the subprime crisis seem to reflect very badly on Basel II. The main conclusion that emerges from this review is that the Basel II process was launched without a sufficiently developed set of objectives. A final point is that the revised framework was not the final word on the Basel II exercise.
As detailed in the previous section, the subprime crisis of 2007–2008 prompted a reconsideration of important elements of Basel II even before it was fully implemented.
Regulatory Model
Consideration of this possible compromise will come in Chapter 6, which examines the merits of Basel II as a specific international agreement. A related point is that a proponent of an IRB approach might respond to some of the criticisms of Basel II made in this chapter by asserting that the problems lie not in the concept of an IRB capital regulation model, but in its embodiment. specific to Basel II. For example, as suggested in the previous chapter, the dynamics of the Basel II process may have been such as to put downward pressure on the stringency of A-IRB rules.
Moreover, of course, Basel II is the only current case of an IRB approach that we need to consider.
Do Regulatory Capital Requirements Matter?
The extent to which the leverage ratio is practically binding can be illustrated by examining the positions of the 10 largest US banks at the end of 2003 towards the end of the Basel II negotiations (table 5.1). Despite the apparent unanimity among regulators, maintaining the leverage ratio has been far from an uncontested position. The argument against it is that the obtuseness of the leverage ratio is inconsistent with the risk-sensitive IRB method.
The dynamics of the Basel II negotiation process described in Chapter 4 made it possible for most large banks to welcome the final product.
Potential Benefits of the Advanced Internal Ratings–Based Model
But the test runs of the Basel II formulas - the quantitative impact studies - raised as many questions as they answered. It also did not say whether a scaling factor would be a temporary or indefinite feature of the A-IRB approach. The discussion of the consolidated results in the text focuses on the 56 "group 1" banks from Basel Committee countries.
Of course, even without a regulatory push, the big banks had developed or adopted internal credit risk models, which they pushed to the Basel Committee in the early stages of the Basel II process.
Potential Negative Effects of the Advanced Internal Ratings–Based Model
Mindful of this tendency and other criticisms of the A-IRB approach, some observers have only half-facetedly suggested that the objective of Basel II to get banks to spend more on risk management had been achieved, and thus there was no need to the revised framework. The concern about Basel II is that three features of the A-IRB approach may lead to more pronounced procyclical impacts.59 First, the very use of internal models is intended to lead to greater sensitivity to changes in the credit risk of a bank's assets. . Supervisors will monitor the procyclicality effects of Basel II as the new regime is implemented.
One suggestion is to use a different risk curve formula for capital requirements depending on the state of the economy (Kashyap and Stein 2004).
