Risk-based capital requirements and their impact upon the banking industry: Basel II and CAD III

Journal of Financial Regulation and Compliance

Volumn 12, Issue 3, 2004, Pages 225-239

  Lastra, Rosa Maria ^a  

^a QUEEN MARY UNIVERSITY OF LONDON   (United Kingdom)

Author keywords

Bank capital regulation; Basel II; CAD III

Indexed keywords

EID: 35348914507     PISSN: 13581988     EISSN: 17400279     Source Type: Journal    
DOI: 10.1108/13581980410810803     Document Type: Article

References (43)

1. Bagehot, W. (1873) ‘Lombard Street’, p. 21.
2. See Kaufman, G. (2000) ‘Banking and currency crises and systemic risk: A taxonomy’, Financial Markets, Institutions and Instruments, Vol. 9, pp. 69-131.
3. ‘The most important aspect of a bank’s balance sheet, the quality of the asset portfolio is difficult to assess at any given time. Perhaps, in recognition of those limitations, federal regulators are increasing capital requirements.' See Litan, R. (1986) ‘Taking the dangers out of bank deregulation’, The Brookings Review, Fall.
4. FDICIA provides especially severe treatment for critically undercapitalised depository institutions (those whose leverage ratio is less than 2 per cent of total assets) as opposed to depository institutions that are merely undercapitalised.
5. Modigliani and Miller argued in their seminal contribution that the value of any corporation, including a bank, is the present discounted value of its expected future earnings stream. How claims on this earnings stream are divided between debt and equity does not matter. See Modigliani, F. and Merton M. (1958) ‘The cost of capital, corporate finance and the theory of investment’, The American Economic Review, Vol. 48, No. 3, pp. 261-297.
6. HM Treasury (UK) (2003) ‘The New Capital Adequacy Directive, CAD 3: The transposition of the new Basel Accord into EU legislation’, Consultation Document, December, available at www.hm-treasury.gov.uk.
7. On the one hand, subordinated term debt carries a repayment obligation that is just as real as an uninsured deposit, so it is not actually a permanent source of funds. On the other hand, debt which is legally subordinate to deposits is a source of funds that does not place an immediate repayment burden on the institution and thus offers a quasi permanence similar to equity capital. Subordinate debt holders serve as an important monitor of an institution because they stand to lose if a bank takes excessive risks.
8. Ferguson, R. (2003) ‘Testimony of the Vice Chairman of the Federal Reserve Board of Governors, before the Subcommittee on Domestic and International Monetary Policy, Trade and Technology of the Committee on Financial Services of the US House of Representatives,' 27th February, p. 2. If the market believes that the capital charge on residential mortgages (risk weight of 50 per cent) and on credit cards (risk weight of 100 per cent) is higher than the real risk, that facilitates the securitisation and sale of a large volume of such loans to other holders (capital arbitrage).
9. Lastra, R. (1996) ‘Central banking and banking regulation’, Financial Markets Group of the London School of Economics.
10. The reports of the Basel Committee are available at www.bis.org
11. HM Treasury (2003) The reports of the Basel Committee are available at www.bis.org
12. Litan (1986) The reports of the Basel Committee are available at www.bis.org
13. The statement of the US Shadow Financial Regulatory Committee are available at www.aei.org
14. John Hawke, US Comptroller of the Currency, 27th February, 2003.
15. As reported in the Financial Times of 2nd March, 2004, by Jane Croft and Charles Pretzlik, in an article entitled ‘Global red tape saddles HSBC with $400 million’, HSBC expects the burden (of complying with different regulatory regimes around the world) to rise further, as new regulations, such as the Basel II rules on bank capital come into force. The FT noted that this was the first time a bank had given such a precise indication of the costs of regulation.
16. Bischofberger, A. and Rybach, M. (2003) ‘Basel II implications for banks and banking markets’, Credit Suisse Economic and Policy Consulting, Zurich, p. 11, available at http://research.credit-suisse.ch/de/publications/spotlight/pdf/spotlight_20030730_ss_e.pdf
17. Gandy, T. (2003) ‘A risky business? A survey of industry preparations for Basel II’, The Financial World, September issue, special report, pp. 25-29. With regard to the results of the survey of industry preparations, Gandy writes: '90 per cent of the respondents already have a Basel coordinator and implementation team in place. Project sponsorship for Basel II tends to come from very senior sources. Project leadership can come from the finance director, chief risk officers, chief executive or deputy. With the Basel II programme costing anywhere between £6 million to 125 million to implement and with potential capital savings running into billion of pounds for some major institutions, senior leadership is essential to the success of a Basel II programme.'
18. See generally Huber, N. (2003) ‘Banks wake up to risk management challenge:Basel II’, Financial Times, 7th May, p. 10.
19. See Rodriguez, J. L. (2002) ‘International banking regulation: Where’s the market discipline in Basel II?', Cato Institute Policy Analysis No. 455, pp. 1-27, 15th October, available at http://www.cato. org/pubs/pas/pa455.pdf. ‘For all the added complexity, it is not yet clear that even the best-managed banks with the most sophisticated risk-management models will have lower capital charges. For banks, the incentive to adopt those costly models is that, insofar as they provide a more accurate picture of the risks taken, they could lead to lower capital charges.'
20. In its 2003 Annual Report, HSBC states:‘It is HSBC’s policy to maintain a strong capital base to support the developments of its business. HSBC seeks to maintain a prudent balance between the different components of its capital. (…) Capital generated in excess of planned requirements is paid up to HSBC holdings normally by way of dividends (…) HSBC recognizes the impact on shareholder returns of the level of capital employed within HSBC and seeks to maintain a prudent balance between the advantages and flexibility afforded by a strong capital base and the higher returns on equity possible with higher leverage. In the current environment HSBC uses a benchmark tier 1 capital ratio of 8.25 per cent in considering its long-term capital planning.' See HSBC Holdings plc (2004) ‘Annual Report and Accounts: 2003', HSBC, London, available at http://a248.e.akamai. net/7/248/3622/a88d726492b742/www.img.ghq.hsbc.com/public/groupsite/assets/investor/hsbc2003ara0.pdf
21. See generally Suiter, J. (2003) ‘Overhaul of banking rules could cost up to euro 200m’, Financial Times, 11th May.
22. See ref. 17 above.
23. See ref. 17 above at p. 10: ‘Banks specializing in areas such as asset management and custodial services will be among the main losers of the New Accord, whereas banks focusing on retail and lending to SMEs are likely to benefit the most’.
24. See ref. 17 above., pp. 9 and 10. The use of ratings by eligible external credit assessment institutions for setting capital charges for asset securitisation is introduced in Basel II. The proposal primarily addresses transactions that result in a special purpose vehicle (SPV) issuing paper secured on a pool of assets. The Committee proposes that securitisation tranches be risk weighted at 20 per cent, 50 per cent, 100 per cent, 150 per cent depending on the rating by an ECAI.
25. US banking agencies must publish notice and seek comments from all interested parties on any proposed regulation, and must fully consider those comments before adopting it in final form, according to the Administrative Procedure Act (APA), 5 USC 551 et seq.
26. See Statement No. 2 of the Latin America Shadow Financial Regulatory Committee, available at www.aei.org.
27. See ref. 17 above, p. 12.
28. See Fuller, J. (2004) ‘Credit rating groups need greater scrutiny’, Financial Times, 13th April.
29. See Hawke, J. (2003) ‘Testimony of the Comptroller of the Currency before the Subcommittee on Domestic and International Monetary Policy, Trade and Technology of the Committee on Financial Services of the US House of Representatives’, 27th February.
30. See statement No. 16 of the European Shadow Financial Regulatory Committee (ESFRC) of 12th May, 2003, at www.ceps.be
31. See ref. 17 above, pp. 10, 12 and 23.
32. The Banco de Espana introduced a new solvency provision in December 1999, the so-called statistical or dynamic provisioning, which started to be applied in July 2000. See www.bde.es
33. On 1st July, 2003, the European Commission (Internal Market DG) published its third consultation paper on the ‘Review of capital requirements for banks and investment firms’, www.europa.eu.int. The European Commission has also published its own Quantitative Impact Studies (QISs) available also at www.europa. eu.int
34. Lastra, R. (2003) ‘The governance structure for financial supervision and regulation in Europe’, Columbia Journal of European Law, Vol. 10, No. 1 Basel Committee on Banking Supervision (1988) ‘International convergence of capital measurement and capital standards’, July, available at http://www.bis. org/bcbs.
35. Basel Committee on Banking Supervision (1999, 2001, 2003) ‘The New Basel Capital Accord,' consultative documents, available at http://www.bis.org/bcbs.
36. Basel Committee on Banking Supervision (2003) ‘Quantitative Impact Study 3. Overview of global results’, http://www.bis.org/bcbs/qis/qis3results.pdf.
37. Citigroup (2003) ‘Response to the consultative document The New Basel Capital Accord’, 31st July, available at http://www.bis.org/bcbs/cp3/citigroup.pdf.
38. Commission of the European Communities (2004) ‘Review of capital requirements for banks and investment firms-Commission services’, Third Consultation Paper, feedback on responses received, 15th March, http://www.europa.eu.int/comm/internal_market/regcapital/docs/cp3/200403-feedback/feedbackdoc_ en.pdf.
39. Croft, J. (2004) ‘FSA plans to charge banks for work on new rules’ Financial Times, 26th February.
40. Croft, J. (2003) ‘Capital rules to cost banks up to euros 200m’, Financial Times, 5th June.
41. Van Rixten, A., Alexopoulou, I. and Harada K. (2003) ‘The New Basel Capital Accord and its impact on Japanese banking: A qualitative analysis’, Center for Economic Institutions Working Paper, Tokyo, p. 27, available at http://cei.ier.hit-u.ac.jp/working/2003/2003WorkingPapers/wp2003-25.pdf.
42. Vernon, M. (2004) ‘Regulation aimed at curbing the excesses of the 1990s’, Financial Times, 16th January.
43. Wallison, P. (1990) ‘Destroying the banks to save them’, Wall Street Journal, 28th September.