Basel II: A Post-Crisis Post-Mortem

Author:Jeffery Atik
Position:Professor of Law and Sayre Macneil Fellow, Loyola Law School
Pages:731-759
Basel II: A Post-Crisis Post-Mortem
Jeffery Atik*
I. INTRODUCTION ......................................................................................... 731
II. THE MISPLACED HOPES OF BASEL II ...................................................... 735
A. Introduction ....................................................................................... 735
B. Why National Capital Adequacy Standards? ................................. 737
C. Why Harmonize Capital Adequacy Standards? .............................. 740
D. Competitiveness (Level Playing Field) Concerns ............................. 743
III. DIAGNOSTICS ......................................................................................... 746
IV. BASEL II WEAKNESSES .......................................................................... 748
A. False Sense of Security ..................................................................... 748
B. Reliance on Rating Agencies............................................................. 750
C. Cyclicality .......................................................................................... 751
V. FUTURE ROLE OF HARMONIZED CAPITAL ADEQUACY STANDARDS ......... 754
A. A Return to Basel .............................................................................. 754
B. Parallel Responses ............................................................................ 757
VI. CONCLUSION .......................................................................................... 758
I. INTRODUCTION
The outbreak of the Global Financial Cr isis (“Crisis”) coincided with
the programmed phase-in of the second-generation Basel1
* Professor of Law and Sayre Macneil Fellow, Loyola Law School, Los Angeles. This article was
developed for the Global Financial Crisis symposium sponsored by TRANSNATIONAL LAW AND
CONTEMPORARY PROBLEMS, held on Feb. 20, 2009, at the University o f Iowa College of Law. An
earlier version of this Article was presented at International Law Weekend, sponsored by the
American Branch of the International Law Association held in New York City, on Oct. 17, 2008. I
am grateful for the helpful comments of Timothy Canova, Michael Guttentag, Heidi Mandanis
Schooner, Lauren Willis and David Zaring and for the contributions of reference librarian Laura
Cadra, and research assistants Lawrence Keller and Michael Boardman.
internationally
1 Basel, Switzerland is home of the Bank for International Settlements [BIS], which has served
as the central forum for international cooperation in banking regulation. The 1988 Basel Accord
was the first effort to systematically harmonize bank capital requirements. Weaknesses and
gaps in the 1988 Basel Accord lead to the promulgation of Basel II. The BIS ho sts the Basel
Committee on Banking Supervision, the body that drafts and supervises Basel II.
732 TRANSNATIONAL LAW & CONTEMPORARY PR OBLEMS [Vol. 19:731
harmonized capital adequacy regime (“Basel I I”). The Basel II framework2
built upon the 1988 Basel Accord rules but gr eatly increased their complexity
and, it was hoped, their accuracy.3 The Basel Accord provided a unitary
capital requirement for each ide ntified asset classsuch as commercial
loans, mortgages, and sovereign debt.4 In contrast, Basel II rules generate a
range of values for regulatory capital depending on the credit worthiness of
the borrower, among other factors.5 For the most sophisticated cla ss of banks,
Basel II permits a customized assessment o f a bank’s capital for holding
particular assets based on that ban k’s own assessment of the riskine ss of
these assets.6 B asel II thus replaces a set of values of mandated capital
(expressed as a percentage of the value of an asset under the 1988 Basel
Accord) with a range of permitted methodologies for determining the amount
of required capital. Basel II also deepens harmo nized regulation by extending
capital requirements to additional financial products, such as complex
derivatives and off-balance sheet items, and br oadens regulation by imposing
new operational and transparency requirements on banks.7 Basel II
transformed the 1988 Basel Accord’s pr imitive capital adequacy rules into a
more general risk management regime. In so do ing, it largely abandoned the
one-size-fits-all rule for more elastic, institution-specific requirements.8
2 BASEL COMM. ON BANKING SUPERVISION, INTERNATIONAL CONVERGENCE OF CAPITAL
MEASUREMENT AND CAPITAL STANDARDS: A REVISED FRAMEWORK, COMPREHENSIVE VERS ION
(2006) [hereinafter BASEL COMM. ON BANKING SUPERVISION, INTERNATIONAL CONVERGENCE OF
CAPITAL MEASUREMENT, COMPREHENSIVE VERSION], available at
http://www.bis.org/publ/bcbs128.pdf?noframes=1. The Basel II Framework includes the Jun e
2004 Basel II Framework, unrevised elements of the 1988 Basel Accord, the 1996 Amendment to
the Capital Accord to incorporate market risks, and the July 2005 paper on the application of
Basel II to trading activities and the treatment of double default effects. Id.
3 David Zaring notes that “the contrast between the first Basel Accord on capital adequacy,
which was concluded in secret by the Basel Committee in 1988 and released in a twelve-page
document, and Basel II, which was put through most of a decade’ s worth of comment by
hundreds of interested individuals and institutions and resulted in a correspondingly long and
detailed regulatory product.” David Zaring, Three Challenges for Regulatory Net works, 43 INTL
LAW. 211, 212 (2009) (citing David Zaring, Informal Procedure, Hard and Soft, in International
Administration, 5 CHI. J. INTL L. 547, 57280 (2005)).
4 BASEL COMM. ON BANKING SUPERVISION, INTERNATIONAL CONVERGENCE OF CAPITAL
MEASUREMENT AND CAPITAL STANDARDS 1718 (1998).
5 See, e.g., BASEL COMM. ON BAN KING SUPERVISION, INTERNATIONAL CONVERGENCE OF CAPITAL
MEASUREMENT, COMPREHENSIVE VERSION, supra note 2, at 19 (weighting sovereign debt
according to credit worthiness as opposed to a fla t rate assigned under Basel I); Susan Burhouse
et al., Basel and the Evolution of Capital Regulation: Moving Fo rward, Looking Back, FED.
DEPOSIT INS. CORP. (Jan. 14, 2003), http://www.fdic.gov/bank/analytical/fyi/2003/011403fyi.html.
6 BASEL COMM. ON BANKING SUPERVISION, INTERNATIONAL CONVERGENCE OF CAPITAL
MEASUREMENT, COMPREHENSIVE VERSION, supra note 2, at 52.
7 Id. at 14.
8 Under the 1988 Basel Accord, the general level of required capital was 8 percent. Thus, a
portfolio of $100 million in commercial loans would require the maintenance of $8 million of
regulatory capital. The capital requirement was not sensitive to the credit worthiness of the
borrowers, nor to the concentration or granularity of risk. Under Basel II’s methodologies, banks
would take these factors into account either by weighing capital according to the credit ratings of

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