US joins the Basel II party

The Federal Reserve, Federal Deposit Insurance Corp. and other US financial institutions issued a joint statement on July 20th saying that they would join Basel II, a key global accord of financial regulatory bodies that has been hammered out in the Swiss city of Basel.

Various sticking points prevented the US from coming to the table, despite the fact that European and Asian economies had signed up more than a year ago.

At the core of Basel II is a promise from Banks to put aside capital reserves as protection from serious loses. The accord has been drawn up against a backdrop of financial deregulation over the past 15 years, and is seen by many as a critical guard against a global financial meltdown.

Basel II features a cocktail of complex methods for calculating the value of bank reserve assets, including novel methods to assess the riskiness of the reserve assets themselves. The complexity of these methods have created much hand-wringing debate. It was the techie, quantitative side of Basel II that drew my own interest.

Early on, the financial community feared that Basel II would bloat capital requirements and threaten bank competitiveness. Interestingly, one of the final sticking points for US participation was that the capital reserves would actually be lower under Basel II.

Thus, it was the Federal Deposit Insurance Corp. that threatened a veto, because Basel II would allow banks to hold lower reserve assets than those stipulated by existing US Bank lending rules.

The 12 large banking institutions in the US that will now comply with Basel II will also remain bound by the so called leverage ratio, a government imposed lower limit to the proportion of assets that banks are entitled to lend. With an agreement on this additional claus came the final settlement for US membership.

Earlier in the month, Middle East financial institutions made an announcement about their own progress with Basel II. A roundtable discussion involving financial representatives of the United Arab Emirates highlighted vulnerabilities in operational risk, i.e. risks associated with failures in systems, processes and people. A press release issued by the roundtable explained that regulators in emerging economies "lack credible, quality data" with which to evaluate their financial risk.

Basel II, the UAE roundtable argued, could be a source of competitive advantage for emerging economies by increasing banking efficiency and productivity. All of which is good news for those at the Bank of International Settlements in Basel, who can now count all major European economies, Japan and now the US at the Basel II table.