BASEL II and Europe - Assignment Example

BASEL II and Europe Introduction The advent of BASEL II is the turning point in the field of Banking as it demands complete transparency and rational approach towards making banking more risk sensitive. BASEL II prompted me to look for this new and exciting avenue of Financial Risk Management as it not only involved a more prudent approach towards banking but it also demands a transparent and flexible banking structure to be in place to effectively manage the interests of various stakeholders in the banking sector. The principals of risk management suggest that the credit providing institutions must maintain a minimum level of financial capital in order to sustain the various risk shocks to which they are exposed to. The basic aim of this approach is to ensure that the banks and financial institutions must maintain financial soundness and retain the consumer confidence in order to ensure the stability of the financial system and protect the interests of the deposit holders. With these perspectives in mind, Bank of International Settlement formed a Basel Committee on Banking Supervision in 1974 to provide a comprehensive forum for dealing with banking matters of such magnitude. The Basel Committee is made up of senior officials responsible for banking supervision or financial stability issues in central banks and other authorities in charge of the prudential supervision of banking businesses. Members of the Basel Committee come from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the UK and the US. This essay will discuss the implementation process of Basel II in Europe besides discussing some of the challenges and aspects that may raise tensions while implementing the accord in Europe. However, before exploring the issue of the implementation of the BASEL II accord, we will be discussing some of the key issues and points raised by BASEL II in order to implement it in true spirit. BASEL II and Europe Before discussing the BASEL II and its implementation in Europe, it is necessary that a view must be taken in order to provide a historical account of the process of BASEL II implementation in Europe and rest of the world. Bank of international Settlements was established in Basel, Switzerland in 1930 and is considered as the world’s oldest international financial institution. It remains the principal center of international central bank corporations around the world. The BIS was formed as a result of the treaty of Versailles which ended the First World War and BIS was basically established for repatriation of funds from the Germany to allied forces. However after the Breton Woods Agreement the scope of BIS was greatly increased as a result of the growing emphasis being placed on the role of central banks in managing the financial system of the banks and a need for a regulating the internationally active banks were felt. It was because of this reason that a Basel Committee on Banking Supervision was first established in 1974 as the committee for banking regulations and supervisory practices. This committee was established by the central bank governors of the G210 countries mainly due to the failure of the Herstatt Bank. The first serious effort towards developing the Capital accords took place in 1980s and resulted in the implementation of minimum capital standards of 8% was implemented by the end of 1992. However as the process evolved over the period of time, The Basel Committee issued a proposal for a new framework to replace the 1988 accord and after lengthy discussions, a new capital accord was introduced in June 2004 known as BASEL II. The new BASEL II accord was aimed at being implemented in G10 countries and was released also to Spain and Luxemburg besides the G10 countries to adapt the new accord by their own individual rule making process. The European Union will adopt the new accord through a centralized legislative process and steps are being taken to implement the accord uniformly across all the member states of the Union and in order to achieve this objective, a committee of European Banking Supervisors has also been established. The new accord of BASEL II therefore will be implemented in European Union through Capital Requirements Directive (CRD).(Compliance LLC,2006). The implementation process of BASEL II in EU is different from that of other countries including United States of America. The new capital accord of BASEL II is going to be adopted by all the banks and credit institutions across the whole block of European Union. What is also different for EU is the fact it will also be applied to investment firms authorized under the Investment Services Directive. In addition, as discussed above, the accord will be incorporated into a new Capital Requirements Directives. The draft for CRD has already been approved and differs slightly from the original accord itself. The CRD also needed to be submitted to the European Union Parliament to get its approval. The issuance of CRD was also subject to the comitology process which resulted from the Lamfaslussy Report.(GARP,2006). This process therefore divided CRD into two types of articles: 1) The so called Strand I or the principle and core rules which can only changed as a result of full legislative process including the approval from the EU Parliament. 2) The Strand II will outline he detailed implementing rules and requirement which can be subject to a change process involving the designated committees. Subjecting CRD to the process of Comitology required that it is being implemented to thousands of institutions across the Europe as EU is the only block of countries which is implementing the accord in all the institutions regardless of their size and legal structure. However sensing the difficulties in implementing the uniform rules and procedures across the EU, a third strand is also in process of preparation which will promote the convergence of the existing rules and regulations according to the Basel Capital Accord. When we discuss the implementation of Basel Capital Accord within the context of European Union, we must understand that there is a marked difference in the approach with which the accord is being viewed. Other countries including US view the capital accord to be implemented in International active banks only whereas EU conceive it for the implementation in all credit institutions. It is because of such broad scope within the EU that there are very tough challenges and issues to be met which might cause the friction while implementing the accord on the EU level. Challenges and other aspects Probably the greatest challenge of implementing BASEL II in European Union is the potentially enormous challenging of finding a common ground for the regulations to be implemented. Since monetary policy is being managed and exercised independently in each EU country and Central Banks of all the member countries are also subject to the local rules and regulations therefore finding a balance between the local regulations and the CRD may be touch difficult. Since Basel II allow the member countries to find a fit between the accord and the local regulations however since the EU is adopting a whole new approach of implementing it therefore it may be difficult to reconcile the CRD with the local laws as the question always remain as to whether the local regulations will altogether be abolished to accommodate the CRD or a fit may be found to implement CRD alongside the regular regulations of the country.( Holmquist,2007) Callum McCarthy, Chairman FSA in his speech delivered in Singapore during 2006 discussed the difficulties in implementing the Pillar II because of its unique nature, supervisors are finding it hard to find a one size fit for all approach to implement the Pillar II within the EU therefore this is also a significant challenge to the implementation of the accord in the European Union besides ensuring that its implementation provide a consistent outcome.(McCarthy,2006). However what is interesting is the fact that implementation of BASEL II is really a costly process and requires not only specialized skill sets but also the systems and technological support to validate and draw different models to calculate the Risk based capital however what is worrisome is the fact that due to its broadened focus, credit institutions within EU may find themselves in difficult waters to sum up resources for potentially non productive assets and given the soundness of the overall financial system across the Europe, banks may be ready to take a bet in becoming non-serious towards their approach in implementing the BASEL II since regulations and banking practices similar to the BASEL II may already being adopted by at least bigger banking and credit institutions as their own stand alone effort to bring in best practices in the institutions to increase their robustness and flexibility. Conclusion The implementation of BASEL II in Europe is quite broad and complex issue involving many complexities which need to be taken into consideration while implementing it across the whole Europe. However what is important is the fact that the process has already been started and efforts are being made to prepare a uniform directive to be implemented in all member states. References 1. Compliance LLC. (2006). BASEL II. Available: http://www.capital-requirements-directive-training.com/Title2.htm. Last accessed 06 April 2008. 2. GARP. (2006). BASEL II and the International Regulations of Banks. In: GARP Banking Risks- Measurements, Supervision and Disclosure. New Jersey: GARP. P37-40. 3. Holmquist, Jörgen. (2007). Implementation of BASEL II- Challenges and Opportunities. Available: http://ec.europa.eu/internal_market/speeches/docs/2007/jh05032007.pdf.. Last accessed 06 April 2008. 4. McCarthy, Callum. (2006). the Challenge of Basel II for Regulators. Available: http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2006/0918_cm.shtml. Last accessed 06 April 2008. Read More