Basle accord set to change banking landscape By James Mackintosh and Charles Pretzlik in London Published: July 8 2002 20:14 | Last Updated: July 8 2002 20:14
The small Swiss town of Basle will this week play host to what could go down in financial history as a momentous event: agreement in principle on new banking regulations. Neither the location - the Bank for International Settlements' cylindrical modern offices - nor the complex subject matter are likely to excite many. But the impact of the Basle II accord, as the agreement is known, will lead to a restructuring of the banking industry and, through changes in the cost of borrowing, will help shape the global economy. "Executives will be reshuffling the whole strategy of their banks and buying and selling bits and pieces [after the accord comes into effect]," said Dennis Ischenko, banks analyst at Schroder Salomon Smith Barney. The accord, to be agreed by central bankers and regulators from developed countries, governs how much capital banks must set aside to cover risks of default on loans or problems with operations. It is designed to prevent a financial meltdown by ensuring that banks have sufficient capital to survive difficult times - and enough to stop the sinking of one causing tidal waves that take out the rest of the banking system. But this has a big impact on the real world. Because banks have to set aside more reserves against some types of loans than others, it discourages higher-capital lending and cuts the price of lower-capital lending. Controversially, this has become a factor in the German election campaign. Chancellor Gerhard Schröder claimed a victory last week by negotiating changes to the accord that would protect the Mittelstand, the middle-sized companies at the heart of the German economy. Mr Schröder feared that forcing banks to set aside more capital against riskier loans would cause a credit crunch for the Mittelstand, which had been defined as riskier because of their size. As a result the German delegates to the committee demanded, and got, a compromise under which lending to companies with assets and turnover under ?500m ($490m) will need up to 10 per cent less capital than originally suggested. "There are lots of carefully crafted compromises," said one official close to the negotiations. "It is not quite as bad as the agriculture policy of the EU, but sometimes you wonder." The compromise means the German banks will be among the winners from the new accord, along with banks involved in mortgage lending, lending to large, low-risk companies, consumer lending, and secured lending. Simple banks will also benefit from a low charge for so-called "operational risk" - the danger of fraud or computer failure. The biggest, global banks will be rewarded with a cut of 3-4 per cent in their capital requirement if they develop sophisticated internal risk management measures of their own. Professor Avinash Persaud, global head of research at State Street, said: "The banking system will have less time for riskier assets, which is probably not a good thing for smaller companies and countries." "There is a grave danger of Basle being captured by the large international banks. They are the main beneficiaries. They get to use their [internal] models," he said. Some investment bankers have already started to prepare the ground for an expected boom in deals. They forecast that big banks will use the benefit of their lower capital requirements to buy small banks, producing what could be "self-financing deals" in some cases. Other banks are expected to sell parts of their businesses and bolster other parts through acquisitions in order to concentrate on low-risk areas and get rid of high-capital operations. However, the changes remain some way off. This week's announcement, following a formal meeting of central bankers tomorrow, will pave the way for a third and final test of the new rules by banks in October. A short consultation will follow next May, with the rules due to be finished by the end of next year and implemented from the end of 2006.
