Time running out

Basel II will be implemented across much of Europe and Asia in just six months' time, yet there's still plenty of uncertainty about how national supervisors will implement the framework.

In Europe, regulators are working to interpret the capital requirements directive (CRD) - EU legislation that paves the way for the implementation of Basel II across the 25 member states - and apply that into national law ahead of the January 1, 2007 start date. However, there's concern about how this legislation is being applied by individual regulators, complaints over ambiguity in the national rulebooks, and fears that the framework will be applied inconsistently.

This is demonstrated most vividly in the responses to the UK Financial Services Authority's (FSA) most recent consultation paper on its implementation of the CRD, published in February. In a joint response released in May by several industry bodies, including the International Swaps and Derivatives Association and the British Bankers' Association, the associations raise concerns about the clarity of the FSA's rulebook, and note the language is confused, imprecise and unnecessarily legalistic (page 11).

As large chunks of the FSA's paper are taken directly from the CRD - a piece of jargon-heavy EU legislation meant for government lawyers, not for everyday reference by bank risk managers - greater guidance and explanation is needed, the associations say. Without this guidance, there's a good chance of inconsistent implementation, not only between various jurisdictions, but also between banks in the UK. The FSA also needs to ensure it has the resources to provide individual guidance to any bank unsure about its interpretation of the rulebook - particularly if the regulator intends to punish firms for breaching the rules, the associations say.

Putting those extra resources in place to provide greater explanation and individual guidance may just about be possible for the FSA, but is likely to be more problematic for other, less well-resourced supervisors. There's already a heavy burden on regulators to put a framework in place to assess and validate banks' internal models under Pillar I. Throw in Pillar II, which requires regulators to review and evaluate banks' internal capital adequacy assessments, and the home-host issue, which will entail lengthy and ongoing negotiation with countless other regulators to ensure there's no duplication of effort in model validation, and it's difficult to see how many supervisors will cope with the workload. Given that few regulators are able to match investment bank wages, it won't be easy for those looking to bolster resources to attract the necessary expertise.

As we head towards the start date, and both banks and regulators get down to the nitty-gritty of implementation, it's becoming increasingly clear what a gargantuan beast Basel II really is. With just six months to go, banks and regulators will have to pull out all the stops to avoid just muddling through.

Nick Sawyer, Editor.