Resources for Basel II Capital Accord (Basel II)

Basel II capital adequacy framework is not adequate

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Says Harald Benink and George Kaufman, Professors of Finance and chair and co-chair of the Shadow Financial Regulatory Committees in Europe and the US respectively, highlighting the weaknesses of the Basel II capital adequacy framework in today’s FT.

The credit squeeze has focused eyes on the design of financial regulation, including the new Basel II capital adequacy framework for banks.

Basel II aims to address weaknesses in the Basel I capital adequacy framework for banks by incorporating more detailed calibration of credit risk and by requiring the pricing of other forms of risk.

The Basel II accord allows large banks to determine their regulatory capital requirements based on their own risk assessment models, which is fundamentally problematic as it invites an optimistic attitude toward risk exposure if you want to maximise return on equity.

The implementation of Basel II coincides with massive losses reported by some of the world’s largest banks, requiring large-scale recapitalisations. The risk models that anchor Basel II are basically the same as the ones many of these banks have been using in recent years says Benink and Kaufman. To some extent, this reflects the difficulties of accounting for low-probability but large events.

“Bank capital-asset rations are near historically low levels, typically at about 7 per cent of total assets (on a a non risk-weighted basis).” Several quantitative impact studies show that implementation of Basel II will actually reduce bank capital requirements.

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