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Basel's reaction to the crisis

Written by Mukul Pareek

A brief article that explains what is going on with the Basel framework, new proposals, and what is currently being called 'Basel 3'.

The BCBS
Basel II is not a law or statute that banks anywhere in the world have to automatically comply with.  The Basel Committee on Banking Supervision (BCBS) is one of the committees of the Bank for International Settlements (BIS).  The BIS itself is a body of central bankers all over the world.  The BCBS is one of the committees of BIS, and has as its members the central bankers of about 27 or so countries, which represent nearly all important economies of the world, including of course the countries in the western hemisphere, the ‘BRICs’, countries from southeast Asia and the middle East.  The BCBS was formed in the '70s after the breakdown of the ERM.
 
The nature of BCBS pronouncements
The BCBS comes up with recommendations in the form of papers that are publicly available on its website at www.bis.org.  When they are first issued as proposals, they are called ‘consultative documents’.  They stay as consultative for a few months, during which the BCBS invites comments and reactions.  Once the consultation period is over, the BCBS goes through the feedback received, and issues a final document.  Often, different documents address different aspects of capital adequacy, and from time to time combined documents that put together older documents may be issued. 
 
When the Basel II framework was finalized in June 2004, the document issued did not include the elements of the 1988 accord (Basel I) that were left unchanged, and also the 1996 amendments that addressed market risk.  A subsequent paper was also issued in 2005, which provided additional requirements relating to trading activities and double default effects.    So anyone wanting to get to a “complete” version of the framework had to put all of these different documents together.  In July 2006, the BCBS issued such a combined compilation of all these different documents as a “comprehensive version”, issued ‘solely as a matter of convenience to the readers’ (their words, not mine).
 
How Basel gets applied to different countries
Banks in each country are bound by the regulatory and legal framework in their countries of domicile.  For the Basel recommendations to be effective, the local legislative process in each country needs to make laws to implement the recommendations of the Basel Framework.  For example, if the BCBS makes a pronouncement (through the issue of a final document), that will not have any effect on say, banks in India, South Africa or the United States, till the banking regulators issue the document locally under their authority and require banks under their supervision to comply with them. 
 
Each country can take a different approach to implementing the recommendations of Basel II based upon the maturity and state of preparedness of their banks, and the implications for their local economy.  Where the BCBS permits multiple approaches to a particular issue, the local regulator may choose to offer only one to the banks under its supervision.  They may implement things piece meal, or delay things to suit their needs.  The point I am making is that there is no single “implementation date” for all countries.  In India, Basel II became effective on March 31, 2009, coinciding with the local fiscal calendar.  In the US, Basel II became effective in 2008.  Generally, unlike other multilateral groups like the WTO, the BIS and BCBS have seen far more cooperation between the members.  The dates by which different member countries will implement recommendations of the committee are generally arrived at after a negotiation.  These negotiations generally tend to be long drawn.
 
Basel’s response to the crisis
After the crises, the BCBS came out with a number of documents.  Some of these make far reaching changes.  About two of them have been issued in final form, ie are available to members to implement right away, but the most important changes are still in ‘consultative’ status.  Lots of battles lie ahead.  Some of these changes are quite significant which is why people have started to refer to them as “Basel III”.  However, as of today, there is no official thing called Basel III, though it is entirely possible that the next set of recommendations may well be officially called Basel III. 
 
There have been calls that the new set of capital requirements be finalized as soon as the end of 2010, and implemented by the end of 2011.  I think that is just grandstanding, things don’t move so fast when so many countries are involved.  The BIS did a quantitative study and basically said that the impact of the proposals may be to reduce credit in member countries to an extent as to reduce GDP by as much as 0.5 – 1%!  Another study said that the impact on global GDP from the reduced credit resulting from higher capital requirements will be reduce it by as much as 6%.
 
The new liquidity ratios proposed have created some controversy, because while on the surface they appear to be quite sensible, when one gets to the implementation the definitions of what gets included in the numerator or denominator are quite murky.  Banks are baulking at the new proposed rules, which are rather draconian and could make many banks just uneconomical to operate as what could be invested in return earning assets will need to be tied up as capital or in near cash instruments that make no money.
 
So we will see how it goes.

All new papers - including the finalized and consultative ones - can be accessed on the BIS's website at the following URL:

http://www.bis.org/publ/bcbsca.htm.