Since the Madrid meeting of the Basle
Committee on Banking Supervision in October, a new realization has
dawned on the senior managements of banks around Europe and the
rest of the world. The Basle II accord will go ahead - having
looked in doubt at various times this year - and the time is
fast approaching when banks must move beyond arguments over
complexity, pro-cyclicality and inappropriate incentives. They must
start implementation.
Everyone agrees that the original Basle
accord of 1988, with its very crude assessments of credit risks and
associated capital requirements, urgently needs updating. But
that's where agreement ends.
Many complain bitterly about the
complexity of the new rules and the danger that regulators will be
ill equipped to implement them. In March, US comptroller of the
currency John Hawke grumbled at the hundreds of pages of draft
regulations littered with mathematical formulae: "They're not
written by or for bankers - or for that matter by or for
conventional bank examiners," he said. "They're written by
mathematicians and economists for mathematicians and
economists."
Policymakers worry that banks will be
encouraged to lend too much in boom times when ratings are strong
and regulatory capital light, and cut back lending in a recession
as credit ratings fall. That is, just when borrowers most need bank
credit.
The implementation date for Basle II
has been put back twice. It is now due to come into effect in 2007,
a full eight years after the new capital framework was first
proposed in June 1999.
There have been times this year when
the whole project seemed to be in danger of falling apart. The
biggest bombshell came in the spring, when US regulators announced
that they would apply Basle II to only 10 or 12 very large
internationally active banks. This raised hackles in Europe, where
some 9,000 credit institutions will eventually become subject to
Basle II on the grounds that they can all now participate in each
other's national markets and are therefore internationally
active.
In the summer and autumn a crisis blew
up over the Basle Committee's plans to require capital to be set
aside against both expected losses on credit portfolios and
unexpected losses. Banks protested. The margins on loans provide
revenue to pay for the inevitable delinquents in a portfolio -
the expected losses. Capital should only be a cushion against
unforeseen events.
In fact, this proposal sprang out of
inconsistencies in national accounting treatment of provisions. But
when the Basle Committee backed down in Madrid and undertook to
adopt an approach based on unexpected losses, the whole Basle II
project regained its momentum. Now that banks realize it is going
to turn into reality, they see that time is running short. A last
consultation is under way and a final draft should appear in
mid-2004. Much then depends on the smoothness with which the rules
are adapted into European law.
Banks that haven't yet moved beyond
theoretical work - because the final shape of the accord was
still unclear - will have to spring into action.
PricewaterhouseCoopers believes that many small and mid-tier banks
have so far been mere spectators. Some larger banks have been
equally quiet while concentrating on lobbying for changes in the
draft proposal. Only a handful have made any substantive
progress.
Just about the only people celebrating
inside banks are the chief risk officers, who are about to become
hugely influential within their organizations. But others may be
quietly celebrating too. The Basle II accord may force a radical
restructuring of the tens of thousands of unrated, sometimes
privately owned small and medium-size companies that dominate the
European economy. For years European banks have subsidized them
with cheap credit. Now they will stop. When borrowers ask why,
banks will explain that under the new accord their credit attracts
a higher capital charge. If customers want cheaper credit they will
have to overhaul their capital structures and their
finances.
Europe's much touted corporate
restructuring may soon get an unexpected boost.