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The Future of Banking as We Know It with Basel II (May 30, 2007)

Location: New York
Author: Lenny Broytman
Date: Wednesday, May 30, 2007

Quite possibly the bible of the US banking world, Basel II has revolutionized banking regulation since its inception. Now, experts are saying that one unresolved aspect of the regulatory recommendations issued by the Basel Committee on Banking Supervision has the potential to become the biggest change in banking in 20 years.

David Rowe's risk management blog on Sungard's website explores some of the changes surrounding differing capital charges for low rated credit between Standardized Basel II banks and Internal Ratings-based Approach banks.

As Rowe explains, internal ratings-based analysis often results in much higher capital charges for low quality credits as opposed to using the standardized approach.

This often results in regulatory capital arbitrage in transferring such credits to banks using the standardized approach as opposed to using one of the internal ratings-based approaches. It is a phenomenon that stands to threaten assets in smaller, less sophisticated banks that are able to manage them effectively.

According to Alain Debuysscher of the, capital charges for market risk are not in danger and most likely, will not change. The April 2005 article did however predict that what would change would be capital charges for credit as well as operational risk.

Debuysscher writes that "In contrast to the situation under Basel I, credit risk capital charges will become much more risk-sensitive as they will be linked to credit ratings. Banks will either use public ratings published by rating agencies under the simplest approach or the standardized approach or they will use their own internal ratings under the more advanced internal ratings-based (IRB) approaches."

Experts do agree that Basel II will in fact revolutionize banking; only time will tell if they are right.

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