Basel II accord: is it the answer to ineffective risk management frameworks?

Abstract

Given the current global financial crisis and turbulence, the importance of having an efficient and effective regulatory framework to regulate the functioning of financial institutions across the world cannot be overstated. Basel II, the second of the Basel accords was first introduced in 2004 to rectify some of the obvious errors in Basel I. Since then Basel II has undergone several modifications to ensure that it can achieve its purpose of creating an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face. While Basel II is without doubt an improvement over Basel I, it is not without its critics who argue that Basel II has several fundamental errors which render it ineffective. The ongoing financial turmoil has given further strength to these voices. Through this Contemporary Concerns Study we aim to study the origin, evolution, possible shortcomings and improvements if any possible in Basel II. The authors have developed a series of case-lets which cover some of the major financial happenings in recent years and analyze the impact of Basel II on them. These have been used to draw relevant conclusions. The first section of this report studies the origin and main features of Basel II. Following this the methodology followed in the CCS is described. After this the impact of Basel II on financial institutions is studied through the help of several case-lets. Subsequently some of the shortcomings of Basel II as demonstrated by the case-lets are discussed. The authors then explore the realm of possible solutions to remove these anomalies and build an effective risk management regulatory framework. Finally the authors conclude with their learning from the study.