Caruana: 2006 implementation of Basel II still on target, despite difficulties

“The 1988 Accord was a blunt instrument that quickly fell behind the times,” said Caruana, speaking during a keynote address at Risk’s Credit Risk Summit USA 2003 in New York this morning. ”As many have pointed out [by way of complaint], the current proposals are much more sophisticated. But that’s the point,” he told conference delegates.

Most of the comment letters received during the recent consultation period focused on credit risk. In particular, the Basel Committee’s plan to include expected losses, in addition to unexpected losses, within the credit risk capital requirement became a flashpoint. “It was intended as a practical compromise to account for the differences in national accounting practice,” said Caruana. US banks in particular were sceptical. Some cautioned against the committee’s proposed approach, claiming it was too much of a departure from the traditional approach of managing expected losses via provisions.

Based on these comments, and its own research, the Basel Committee decided it would be preferable to calibrate regulatory capital on the basis of unexpected trading losses alone. The committee has invited comment on its revised approach through to the end of 2003.

The controversy about unexpected losses is an example of wider criticism that the Basel Committee’s proposals are too conservative. Caruana was keen to stress the committee’s flexibility. He said the committee is open to the possibility of reducing capital requirements, where it can be shown the Accord treats exposures too harshly relative to their inherent risk. He cited the example of retail exposures, where the committee found good economic evidence to support the case for significantly lower requirements compared with those included in earlier drafts. “It’s a critical concern of the committee that banks compete on a level playing field. Competition should be driven by banks’ strengths, not the regulatory environment,” said Caruana.

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