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The cornerstone of Basel II, the New Basel Accord, is one that says that a regulated organisation’s minimum capital requirements shall be 8% of risk-weighted capital – in the words of the 1988 Basel I agreement, still operative, “the target standard ratio of capital to weighted risk assets should be set at 8%”. To date, Basel II participants’ energies have been applied to defining and reducing risk-weighted capital - to the extent that insurance instruments were created with the sole purpose of reducing risk-weighted assets. But could this change?
The US difficulties with Basel II all focused on the possibility of clever financial engineering reducing the risk-weighted assets to unacceptable levels. Commentators, including ourselves, referred to the US folk memories of the 1929 Crash and its then under-capitalised banks. This 79 year-old crisis has now re-emerged as our current credit and liquidity crisis and one must believe that there is no possibility of US banks being allowed to continue with the current levels of Basel II-compliant capitalisation.
Last month a report (“Risk-Based Capital - New Basel II Rules Reduced Certain Competitive Concerns, but Bank Regulators Should Address Remaining Uncertainties”) from the US’s Government Accountability Office (GAO) called on the US regulator to clarify how they would apply capital rules to US banks. This report preceded the current peak (or at least upward slopes if the peak is still to come) of the crisis but has set the scene for US changes to Basel II. Most of Basel II has passed into US regulatory rules (although there is still a proposed rulemaking on the standardised approach which closes for comment on October 27th) but that will not stop the US government making changes to the way risk-weighted assets are calculated and to what constitutes regulatory capital.
But is it time to revise the right-hand side of the equation – the 8% figure? Yesterday the Indian Finance Minister, Palaniappan Chidambaram, announced that India would be raising the bar to 12%. The finance minister did not give dates or details but said that “No <Indian> bank has a capital adequacy of less than 10%, yet we are raising it”. This is seen as a move to increase depositor confidence and Chidambaram pointed out that India already has a 9% level and that few of its banks were below the 10%.
This is the first of the emerging economies to increase capital levels in the current crisis – a more suitable move for them as most banks in these regions use the basic and standardised approaches so there is less flexibility in changing advanced calculation methods.
Where the emerging economies have gone, will the governments of Europe and the Americas be tempted?
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