Uncertainty Slows Preparation for Basel II

At congressional hearings earlier this year, regulators indicated that it might be wise to have Basel II capital requirements only apply to the top 10 banks in the United States; a fact that has some questioning whether the accord will still have the major impact on the financial-services industry -- and its technology vendors -- that had once been predicted.

Basel II, anticipated to come into force between 2006 and 2007, sets out a detailed scoring process for risk assessment which will be based on aggregate data collected by banks. The aim of Basel II is to introduce a more risk-sensitive capital framework and incentives to bring about the implementation of advanced risk-management practices.

David Koenig, chairman of the Professional Risk Managers' International Association (PRMIA), says that the announcement "threw the approach to Basel II into a spin." He says that the idea that only the top 10 banks would be required to participate and the rest would have to apply for inclusion (eventually receiving some type of Basel II seal of approval) is "good in theory except that people would have to have a reason to get in."

The hearing featured testimony from the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corporation.

Some firms had complained that while they would be subject to keeping additional cash in reserve to comply with Basel II, their competition (such as hedge funds) would remain exempt from the accord and thus gain a competitive advantage.

Koenig says that firms, especially banks, are naturally averse to change and would most likely not adopt the standard were it not mandated.

He describes the accord as "an attempt to incent banks to adopt more sophisticated risk-capital calculations, so that banks that are internationally active can use sophisticated approaches to ensure they have enough capital."

While Koenig says that Basel II is a good step for the industry, he says a negative result could be "pro cyclicality," which is the downward spiral created when depressed economic times cause banks to keep more cash on reserve and lend less. That, in turn, causes the economic climate to worsen, and on it goes.

Koenig says that one reason banks may not be preparing for Basel II as proactively as they might is that regulators have not provided enough concrete information that would allow firms to start spending. "People need more certainty about what they are preparing for from regulators in the U.S. They need to understand what the regulators are going to do."

He adds that relegating the requirements to the top 10 or so banks means that implementation of the accord will probably not have the stimulating effect on technology vendors that some anticipated. "If it's only the top 10 banks, it won't really affect things from the technology side," says Koenig. "There was potential for this to be a big event in terms of the vendors that sell software and technology, but if you take away the requirement that everyone adopt it then that chops off a big segment of the market."