Still Tweaking
The Basel Committee itself does not actually have any authority to impose capital-reserve requirements on the world's banks; instead, it formulates broad supervisory standards and recommends best practices, which it then turns over to regulatory authorities in its 13 member countries for implementation. Many nonmember countries also seek to comply with its recommendations. In the United States, the Federal Reserve has indicated that only the 10 largest and most-complex U.S. banks will be required to comply with Basel II, although it won't say exactly which banks meet those criteria. The Fed also expects the next 10 largest banks to opt in, partly for competitive reasons and partly because Basel II is expected to offer a better, more-sophisticated methodology than Basel I. In Europe, by contrast, the European Union Commission has decided to apply the capital-adequacy directive to all financial institutions, including brokerages and broker-dealers.
Basel II compliance also will require changes to banks' public disclosures and the regulatory review of their capital adequacy. With banks set to gain more control over how they assess their risks and reserve for them, the Basel Committee wants to make sure that regulators' judgments of risk and capital adequacy are based on more than an assessment of whether a bank complies with minimum capital requirements. Under Basel II, banks will subject themselves to stress tests of their own design. Regulators will then evaluate the tests and recommend changes if banks are not holding a sufficient capital buffer. The committee also has stressed it will be more important than ever for banks to provide key information about their risk profiles and capitalization levels to market participants.
Until the remaining details of Basel II are hammered out and implementation is under way, it is difficult to say exactly how prices might change for different types of corporate credit. "We have a good idea of what the framework of Basel II looks like, but the various elements of it are still being tweaked," says Fanger. "So it's not exactly clear how much impact there will be on pricing, or how the market's competitive dynamic will factor into the equation."
At a minimum, Basel II should result in a broader array of funding sources. "I think some of the lending activities that got forced out of the banking system are going to become economical again for banks," says Aboaf.
That, of course, is good news not only for banks, but also for companies. More financing choices are always better than fewer.
Randy Myers is a contributing editor of CFO.
Accord Discord
The Basel Committee on Banking Supervision includes representatives of central banks and banking regulators from 13 developed countries (see below). Although it began working toward a second Basel accord in 1999, reaching a consensus on the myriad details — the latest draft numbers 226 pages — has been a slow process. As recently as October, German bank regulators warned that Basel II could collapse because of demands by their U.S. counterparts that only unexpected loan losses — not expected losses, as proposed by Basel II — be backed by capital reserves. Bankers in the United States complained that expected losses are already covered either by a loan's pricing, an insurance policy, or income. At the time, some banking regulators suggested the scheduled implementation of the new accord, originally slated for year-end 2006, would be pushed back to year-end 2007.
The accord was rescued, for the time being, at a meeting in Madrid later that month, when the committee capitulated to the demand to excuse expected losses from the capital requirements, and also announced that it would drop a controversial and complex "supervisory formula" for determining capital backing for securitized assets that they admitted was too difficult to understand.
There remain some sticking points. As currently written, Basel II proposes unused lines of credit on credit cards be treated like actual outstanding balances on those cards, raising howls of protest from credit-card issuers. "The reality is that credit-card lines aren't contractually committed; banks can cancel or re-price them at any time," says Todd Thomson, CFO of Citigroup, the largest credit-card provider in the world. Many bankers also have pushed the Basel Committee to reduce capital charges on assets for which lenders have purchased insurance, and require lower reserves for banks whose loan portfolios are broadly diversified, rather than concentrated among a few types of borrowers or industries. If the Basel Committee and banking regulators become comfortable with the methods that sophisticated banks use to quantify risk mitigated through credit-risk insurance, corporate borrowers are likely to benefit, since banks would be more willing to make loans to riskier borrowers and more willing to make larger loans to smaller borrowers.
Following the October meeting in Madrid, the Basel Committee, chaired by Jaime Caruana, governor of the Bank of Spain, announced that the committee will revisit the credit-card and credit-insurance issues, among others. He also said the committee expects to have all outstanding issues resolved by midyear 2004, with implementation of the new accord still targeted for year-end 2006. —R.M.
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