I. Summary of Staff Papers
1. The New Capital Adequacy Framework (Basel II) proposes a significant
refinement of regulatory and supervisory practice and encourages increased
attention to
risk management practices in supervisory agencies and financial institutions. Many countries have expressed an interest in adopting Basel II for their banking
systems, and staff believe that this interest may be leveraged to upgrade the
quality of their banking supervision. At the same time, adoption of Basel II
by member countries will affect the surveillance, technical assistance (TA)
and financial sector development agendas of the Bank and the Fund. Meeting
demands for Basel II -- oriented financial sector surveillance and technical assistance
to member countries will require building of expertise within the Bank and
the Fund and a greater reliance on cooperating supervisory agencies to provide
Basel II experts. It will also be important to manage member country expectations
in this regard.
II. Factual Update of Material Developments
2. With agreement having been reached on most outstanding issues,
calibration of the new capital framework (i.e., adjusting the regulatory
capital charges
against the various assets and financial services provided by banks) will dominate
the Basel II-related work agenda of the Basel Committee going forward. Data
for the Fifth Quantitative Impact Study (QIS 5), will be collected for the
fourth quarter of CY 2005 from banks in both BCBS member countries and other
jurisdictions and will be available by Spring 2006 for any potential recalibration
of the risk weights by the Committee.
3. European banks and investment firms
are on track to implement Basel II in two stages starting from January 2007
in accordance with the June 2004 schedule
announced by the Committee. The European Parliament passed the Capital
Requirements Directive on September 28, 2005 thus paving the way for its
adoption by the
25 European Union member countries. The Parliament also agreed to a clause
that permits the European Commission (EC) to make amendments to the Directive
without approval from the European Parliament, under the EC's "comitology
powers" (which had earlier been suspended by the Parliament), for a
further period of two years.
4. Adoption of Basel II in the U.S., however,
has been delayed in response
to two issues. The decision made several years ago in the U.S. to adopt
only the advanced components of Basel II and to apply Basel II only to the
largest
international banks has been revisited because of a concern that keeping
all other U.S. banks on Basel I may unintentionally place these smaller
institutions at a competitive disadvantage. The U.S. banking agencies have
also been concerned
by the large drop in capital requirements for some large U.S. banks under
Basel
II that was projected by the fourth quantitative impact study (QIS 4).
5. As a result, on September 30, 2005, the U.S. agencies announced
that they will adopt a more conservative approach to implementation of Basel
II. The
supervisors announced a plan that delays implementation of Basel II by
one year, applies a more conservative floor on potential capital reductions
(required
by Basel II) in the transition period, commits to retention of a separate
capital leverage ratio for all banks in the U.S., and proposes a modified
approach
to Basel I (a "Basel IA"), which would apply to all other
banks in the United States.
6. The impact of a staggered implementation
of Basel II across banks
in member countries is unknown. Apprehensions have been expressed that
U.S.
banks could
face a competitive disadvantage vis-à-vis their European competitors,
which will be adopting Basel II ahead of them. However, these fears
are predicated on the basis of Basel II resulting in significant reductions
in bank capital
levels. It is unclear whether market analysts and rating agencies will
be sufficiently comfortable with Basel II at the outset to allow any
banks to take full advantage
of any reductions in required regulatory capital.
7. Finally, staff
has begun to hold informal discussions with the Basel
Committee on how to assess the quality of Basel II implementation by
various countries. Given the systemic importance of the world's major commercial
banks, it will be important that Basel II is properly implemented by
national authorities
and that it meets the objective of reducing risk in the banking system.
Given the complexity of some parts of Basel II and the dearth of Basel
II experts,
it will be a challenge to assess the quality of implementation of Basel
II, particularly if many countries choose to implement the new framework
at the
same time.
