The New Basel Capital Accord: Making it Effective with Stronger Market Discipline

Abstract

In January 2001 the Basel Committee on Banking Supervision proposed a new capital adequacy framework to respond to deficiencies in the 1988 Capital Accord on credit risk. The main elements or "pillars" of the proposal are capital requirements based on the internal risk-ratings of individual banks, expanded and active supervision, and information disclosure requirements to enhance market discipline. We discuss the incentive effects of the proposed regulation. In particular, we argue that it provides incentives for banks to develop new ways to evade the intended consequences of the proposed regulation. Supervision alone cannot prevent banks from "gaming and manipulation" of risk-weights based on internal ratings. Furthermore, the proposed third pillar to enhance market discipline o f banks' risk-taking is too weak to achieve its objective. Market discipline can be strengthened by a requirement that banks issue subordinated debt. We propose a first phase for introducing a requirement for large banks to issue subordinated debt as part of the capital requirement.

Origins and Resolution of Financial Crises: Lessons from the Current and Northern European Crises

“…See Benink and Wihlborg, 2002. Legal, regulatory and political institutional factors are not linked one to one to the listed factors but a specific institutional characteristic of a country can influence friction in financial markets as well Most of the assets that fell in value after the bursting of the IT bubble were traded in active markets for equity and contractual relations for allocating the losses were uncomplicated since the assets were relatively simple claims on corporate assets. Furthermore, there were few layers of financial firms wherein losses had to be recognized.…”

Can International Capital Standards Strengthen Banks In Emerging Markets?

“…20. This issue is further discussed in Benink and Wihlborg (2001) The potential weakening in supervisory practices in industrial countries would have adverse consequences for banks in emerging markets. First, regulatory forbearance in industrial countries may exacerbate the volatility of capital flows to emerging markets-interbank lending in particular.…”

An International Comparison and Assessment of the Structure of Bank Supervision

“…For instance, most analysts would expect supervisory independence to have a positive long-term effect on banking safety and soundness and financial stability since independent supervisors would be more immune to short-term political pressures (Claessens et al 2002;Quintyn and Taylor 2002). Most analysts also recognize the complementary roles played by government supervision and private monitoring of banking systems (Benink and Wihlborg 2002;Llewellyn 2002). However, for all three measures, the effects (and the expected sign) could be ambiguous.…”