Dec 10, 2008

World - Tightening banking norms

The strategy of the Basel Committee on Banking Supervision (BCBS) to enhance risk management practices in the wake of the global credit and liquidity crisis is part of ongoing interventions to ensure stability in the increasingly open financial and money markets. While the recent string of state-backed initiatives to rescue banks and other financial institutions may have addressed the question of public confidence, the larger question of safeguards against adverse scenarios owing to exposure to innovations in the markets still remains. The latest BCBS strategy seeks to raise capital requirements — in particular the risk capital of banks vis-a-vis counterparties — enhance their resilience to shocks, and strengthen the risk sensitivity in relation to trade in securities. These measures, together with the proposals made in September, bring into sharp focus the Basel II framework, which, critics allege, allows banks to operate with lower reserves of capital, notwithstanding its objective to the contrary.

Under the Basel I (1988) version, banks were required to maintain a standard reserve of capital, equivalent to eight per cent of assets weighted to risk linked to credit — a later amendment incorporated the risks associated with the market. In addition to the standard rules, Basel II allows — subject to certain explicit supervisory approvals — some banks to deploy their own internal measurements of credit risk to determine the adequacy of capital. The complexities in international cooperation on the implementation of the Basel II framework, finalised in 2005 by 13 top industrialised countries, are borne out by the differing time-table for its adoption — from 2008 in the European Union and from 2009 in the United States. More formidable, though, are issues of convergence on the interpretation of Basel II among national banking regulators and supervisors which could prove critical to its effective enforcement. Given the global nature of operations in the banking and financial markets, the need for coordinated regulation on an international scale is of utmost urgency. The rationale for emerging economies to embrace Basel II in this overall context is evident enough and they should expedite the process of creating institutional mechanisms.

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