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Basle II prompts strategic rethinks

Extensive revisions to capital requirements under Basle II will force structural changes in the financial services industry, offering advantages to some institutions and hindering others.

THE BASLE II ACCORD is expected to be implemented in 2007 as the basis for global bank regulation, directly affecting the capital required to support an estimated $50 trillion of global credit exposures. Like Basle I in 1988, Basle II will have consequences for a wide range of banking activities, and has already led to extensive political lobbying and pre-emptive strategic positioning.

We estimate that banks will spend around $25 billion (five basis points of assets) preparing for implementation, with the largest banks typically investing $50 million to $200 million over five years. Investments in credit risk measurement and management (which have the strongest impact on risk-weighted assets - RWAs) and supporting IT will be the most significant. Maximizing value from these expenditures should be a key element in any bank's strategy, and is increasingly being given priority at the highest levels in leading banks.

The changes in capital requirements that are likely to result from the better alignment of regulatory capital with banks' risk profiles - the core purpose of Basle II - along with the impact of the apparently softer Pillars 2 and 3 will drive structural changes in the financial services industry. The relative changes in capital costs will alter the perceived attractiveness of individual products, countries and businesses, leading to strategic and tactical shifts as players respond to the new environment.

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