Basle 2 Is Overcomplicated And An Unnecessary Replacement For The 1988 Basle Agreement On Capital Adequacy - Agreement Essay Example

Basel committee with its goal of harmonizing the banking industries through redefining the risk of capital measurement is now in the process of regulating the existing Basel Accord, 1988 - Basle 2 Is Overcomplicated And An Unnecessary Replacement For The 1988 Basle Agreement On Capital Adequacy introduction. Basel committee in the process of redefining the existing standards, propose to eliminate the threat and to enhance the security and reliability of the financial systems of the banks. Basel committee plans to achieve this by focusing on banks internal risk models, supervisory review of capital competence and market regulation. This new rule has its own merits and built-in dangers too.

This paper discusses in detail the impacts of Basel II implementation in banking sectors and other financial sectors. Basel II too complicated strategy Basel committee an international body for banking based settlements after introduction of Basel II is facing numerous criticisms from bankers who feels that implementation of the new standards would involve more complication and higher cost. “Basel II has to be revised thoroughly before its implementation to deliver maximum benefit from its operation and to reduce the risk- sensitivity”, says the Institute of International Finance, the leading player of internationally active banks.

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Basel II codes have to be approved by political bodies of United Nation, Europe and other countries before its implementations. Apart from all of this, Basel II is facing criticisms form other countries as well. IFF is more concerned about the cost and complications in implementing the new standards, which would result in replication of validation measures, duplication of information and contradictory information. Both, IFF and American Bankers Association insist the committee to eradicate the country-to-country variation in rules.

They feel implementing similar rules in all world banks would improve the efficiency of the transactional banks, but with the existing rules they should report to every national regulator using diverse codes. Moreover, according to IFF new standards over operational risk would encourage terrorism, computer threat, illegal activities etc, says IFF. Basel II – a challenging revolution in banking industries According to Manila Bulletin, 2004 “Banks based on its present risk practice, volume of its organization, portfolio, customers and market would need to face various outcomes on implementation of Basel II. The major four factors involved in these outcomes are i) Regulators, ii) Customers, iii) Capital Market, and iv) Rating Agency. The existing Basel Accord allows banks to operate with 8% risk weighting capital but the new system would supersede the existing Basel Accord by calculating its risk weighting using internal credit assessments for all customers, instead of relying on external ones.

Thus, the New Basel Accord insists the banks to maintain sufficient capital to cover operational risk. Banks, which would be covered under Basel II and the banks, which are planning to adopt Basel II, should make efforts to reinforce their risk management capabilities and should rework on their business strategies. Banks under Basel II by its successful implementation of risk management would be benefited with lower capital requirements. ” On the other hand, large banks would be facing more challenges in handling management information system, work process, clientele, international capital market, excluding the financial functions and regulatory procedures.

In addition, the new Basel accord has divided the world into two and applies the risk weightings between the Organization of Economic Corporation and Development (OECD) and non-OECD countries. In a bank, loan supply and funding costs are decided using risk weights. Risk weight generally guides the bankers in deciding how much loan they must cover in capital, as bank has to obtain an equivalent amount of capital with respect to their risk-weighted assets. “The new Basel Accord allows the OECD and the central banks to sustain Zero risk weighting, whereas private banks obtains a 20% capital weighting.

However, non-OECD countries countenance a huge 100% capital weighting, though, private banks gain a 20% weighting on short-term loans. ” (Reisen, H. 2000). However, shifting in to the new settlement will be a challenging task for few banks than the rest, because those would need to adapt to the new strategies from current risk practices, operational functions, portfolio, market applications, etc. Transformation of the process in the institution while running the business is the challenging part.

Effects of Basel II on developing countries Global banks and renowned international banks are concerned about the restoration of the existing rules in banks to the new Basel standards, since it would reduce their opportunity in involving in the upcoming market economies and in underdeveloped countries. Stanley Fischer, Vice Chairman, Citigroup of the U. S has also stated “Basel II standards lower the progress of the banks by de-motivating them in entering into the emerging market economies. “In spite of all these presumptions and fears the committee will get prepared and continue to review all the technical issue”, says Jaime Caruana, Chairman of the Basel Committee. The IRB based risk assessment approaches do not completely allow the banks to diversify their loan lending process across the developed, developing and underdeveloped countries. This seems to be the challenging technical issue for most of the banks. However, regulators show positive hope for the weakness faced by the new accord, as it would overcome these shortcomings in due course of time after its implementation of the new Basel Accord.

However, the Institute of International Finance, Washington claims, “that capital requirements needed for risk securities would badly reflect on loan process and on diversification. ” Another welfare organization (not named), which works for underdeveloped countries, is concerned about the Base II lending procedure. “It argues that holding huge capital against risk possibilities would increase the loan cost for underdeveloped countries thus reducing the possibilities of lending loans to these countries. ”

Impact of Basel II – in lending procedure Banks in general consider lending procedure as riskier because they presume lending to economically stable countries would be beneficial than the emerging economies and underdeveloped economies. “According to Organization of Economic Corporation and Development (OECD), there are nearly 55 and more emerging economic countries existing in the globe. Henceforth, restriction in the lending procedure to these countries would considerably affect the profitability of banks financial system. (Bielski, Lauren. 2003. ) Fischer, former Managing Director International Monetary Fund (IMF) has acclaimed the Basel Committees dedication; “he feels that implementation of Basel II standards would lead to increase of risk burden on emerging economies than the present system”. “Economic position of a country is directly involved with banks efficiency hence countries with low economy and emerging economy would be less profitable than countries with developed economy”, says critics.

But supporters argue that, “focus in particular economy may be riskier than diversification, as when lending producers is widely spread among the various countries could yield better profit than with one single economy”, this is agreed by Caruana, Chairman of the Basel Committee. He also state that, “Basel II will not affect the banks present lending procedure and also will not alter the risk policies for investments in developing economy”. “However, implementation of Basel II would result in various changes in the internal systems of the banking industries, which in turn lead to increased cost,” says D.

Opiokello’s. “They include regeneration of IT system or total change in the IT system, increased cost especially for training the staffs for the new process, to engage extra workers for covering the committee needs, restricted lending capacity, and complicated transaction procedures, increased cost for risk assessment and cost” says Tanmoy Bhattacharjee, Consultant, Banking Products Division, I-Flex Solutions, 2004. Basel II standard – as a best practice will take time Basel II as a ‘Best Practice’ in banking industries would definitely take time.

As Basel II has introduced its draft in June 2006 and the member countries has started implementing the simpler procedures of Basel II from the end of 2006. In later part of 2007, banks are to implement the sophisticated standards. Nearly 50 – 60 countries are in position to implement Basel II standards when compared to the 100 countries in the Basel Committees list which are at present following the Basel I standards, according to the survey performed by Benton Group. They also states that nearly 20-25 countries out of 50 countries fall under developed and underdeveloped economy. Developing countries like Russia, Brazil, and India etc. re grouped under emerging economy and countries like Botswana, Bissau etc. falls under poor economy. According to Caruana, “Not all countries could adopt Basel II at initial stage. It can be done only in systematic process. Initially countries planning to adopt Basel II should reinforce their managerial infrastructure, later apply the pillars of new accord, and slowly encourage the changes of the new accord from the present practice.

He also says that ascertaining a strong foundation in legal standards, supervisory process and financial management are the vital elements of the first stage. The three step approach ease the process of implementation and assessment and helps in improving the quality of the management. “The countries should decide on the possibility of adapting Basel II based on the banking structure, market condition, and their supervisory practices,” says Basel committee. Moreover, IMF and World Bank says that in future the evaluation of risk management would not be applicable for all the banks which has adopted Basel II, instead the evaluation process depends on the nations performance in relation to the standards of the committee.

Conclusion Thus, the risk management procedure under the New Accord is likely to yield momentous changes in the core business of an individual bank as well as in its organizational structure. Under Basel II, the banks can allocate capital to various activities and transactions based on risk factor. Further, the new capital requirements will also result in resource needs, IT System architecture and processes. Thus, under the New Accord, the bank top management is entrusted with broad challenges, new risk management and responsibilities for reporting.

Thus, the bank top management is obliged to integrate the Basel II compliance with those other compliances to enhance the corporate governance. To escape from the liability of higher capital reserve requirements, which would bring disadvantages to market position, banks are obliged to ensure that they have a detailed implementation approach in place. Further, they also inquire into how Basel II challenges and opportunities could influence their business and their customer relationship’s overtime.

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