Whether basel II could have mitigated the global financial crisis and what next

Abstract

International Economic Agreements have always been negotiated based on the spirit ofbrinkmanship. Each country negotiates keeping in mind its own constituents interests whilepushing for concessions and the opening up of the global economy and other countries. How isBasel Accord different? This is an Accord which has been signed by the countries to harmonizeinternational regulatory convergence for the banking sector. The Accord is based on the broadprinciples of arrangement for supervisory cooperation and substantive convergence among thenational financial regulators. The Accord is unique as it is not binding on countries nor does ithave any formal dispute settlement mechanism. Yet it envisions a mechanism for managing aglobal financial system in a world of nation states. At the heart of the regulations, is the intentionof the participating countries to ensure that while their regulators impose regulations on theircountry s financial sector, it does not render the institutions uncompetitive in the globallandscape.The global financial meltdown following the US subprime crisis clearly bears out the closeintegration of the global financial systems. The crisis also raised the debate on whether a fullyimplemented Basel II would have mitigated the subprime crisis. While the regulations have beendeveloped keeping in mind the systemic risks that can affect the banking sector besidesjeopardizing economic growth of the countries, the control mechanism through capital adequacymodel had proved to be inadequate. Drawing lessons from the crisis, the regulators have goneback to the drawing board and have proposal new set of Basel III guidelines which theybelieve would close the loopholes in the earlier regulations. The New Basel guidelines havedrawn up stringent regulations on capital, liquidity and leverage including tighter regulations ofSIFIs (systemically important financial institutions). More importantly the regulations haveintroduced macro prudential dimension to managing the systemic risks. This involves setting upof an early warning system, resolution through automatic interventions and more importantlycoordination between central banks to ensure that the effect of the financial contagion isminimized. The proposal envisages the offsetting of the pro-cyclicality of Basel II with countercyclicalprovisions in a new economic cycle reserve. The impact is likely to be momentous onthe way banking business will be undertaken, once the guidelines are fully implemented by 2019.Many conventional banking products would have to be redesigned and there might be aparadigm shift in the banking sector.In my final analysis, I have raised some of the issues that may hinder the functioning of Basel IIIto its optimal potential. Basel III is still under negotiation and some of the concerns raised in thisproject paper may get addressed going forward. In view of the dynamic nature of financialsector, the banking regulations are in a constant state of evolution to keep up with financialinnovations and economic developments. Nevertheless, the Basel regulations will go a long wayto ensure the safety and soundness of the banking systems.