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Texto para discussão 02/2005

Basel II: a critical assessment
Fernando José Cardim de Carvalho*

After a protracted discussion process, that ended up taking much longer than expected, the Basel Committee on BS has finally approved a new version for the 1988 Agreement (known as the Basel Agreement) to serve as a common international set of rules for banking regulation and supervision. Despite all the effort that was invested in the preparation of the new agreement, the reception was lukewarm at best. Many critics, including even some financial regulators, raised reservations about the new rules, related in particular to its complexity and the costs for compliance that could raise the cost of capital for borrowers beyond what could be considered reasonable. Official documents of the BCBS, and other institutions, such as the IMF, present the New Agreement as an evolution over the 1988 version. The relation between the two documents, however, is much more complex. In fact, even the scope of each agreement was different: the 1988 agreement was directed at leveling the playing field for the competition between internationally active banks in terms of costs of regulatory compliance. It was an attempt to regulate competition among banks subject to different regulation regimes trying to eliminate the cost advantages of banks constituted in countries with more lenient regulations. Financial stability was a secondary consideration in the 1988 text. In contrast, stability is the core of the new agreement. To some extent, the change in focus is just the ex post acceptance of the fact that an unexpectedly large of countries adopted the 1988 text as a guide to prudential regulation, even if this was not the original intention of its authors. But to define rules for prudential regulation that could be imposed on all banks of practically any country in the world is a completely different task than setting rules to equalize competitive conditions for a restricted set of largely similar banks. It is one of the contentions of this paper that it is precisely this change in focus that may be the root of the most important difficulties created by the new text. The main criticism raised here is precisely that the simplicity of Basel I was not a mistake, but, quite the opposite, its main strength. It is the attempt to transform it into a detailed road map for prudential regulation that may be an impossible task, if not in theory, at least in practice. No claim to originality is made for any of the arguments presented in this paper. Many, if not most, of the points raised here are already familiar of those who work with, or are interested at, problems of banking regulation and supervision. This is not a survey, however, of the already vast literature on Basel II, and for that reason, I had no preoccupation in checking and acknowledging precedence in any of the arguments advanced in the paper. The author’s intention is to intervene in an ongoing policy debate. To do it, in section II we try to address what was identified above as the main point of the paper, the fact that Basel II does not spring out of Basel I, but, on the contrary, represents a major change in scope for the proposed rules. To discuss the question, a brief summary is offered both of Basel I and II, ending the section with a comparison between the two documents. Section III is devoted to Basel II itself and its limitations. Section IV concludes the paper.

* Instituto de Economia/Universidade Federal do Rio de Janeiro.

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