Capital accord for banks

The recent approval of the Basel II Accord by the central bank governors and monetary regulatory heads of the group of 10 most developed countries in Basel, Switzerland, means radical changes in how the capital adequacy of commercial banks is calculated. After the adoption of the final document of the Accord, the European Commission will now move to set out its specific proposals, as well as the timetable for the adaptation of banks to the new, global safety rules. Bank managers believe that these will be fully in place by 2006 or, at the latest, by 2007. The impression in the industry is that the new rules will benefit the largest banks, which are better placed to free capital by employing their risk-evaluation systems, operating with lower capital adequacy requirements and at the same time with higher safety «cushions.» By contrast, small and medium-sized banks, which may not be able to introduce risk evaluation or constant risk-monitoring systems, will follow standardized procedures laid out by the Basel II Accord, which is largely in line with their current operational environment. This means that smaller banks will have to reserve relatively large amounts of capital, in order to achieve congruence with the Basel II guidelines regarding capital adequacy, while larger ones will invest in technology and advanced internal control systems, which will help free up capital. One of the major changes brought about by the Basel II Accord concerns the inclusion of the operational risk factor in the calculation of the capital adequacy levels of banks. Speaking at the International Banking Summer School seminar which took place on the island of Kos last week, Christos Gortsos, the general secretary of the Hellenic Bank Association, described the Basel II Accord as a «major challenge for the banking system.» Yet he also stressed that the changes to come held no bad surprises for banks, since they are the result of long-term negotiations and public dialogue. Gortsos expressed confidence that Greek banks will benefit from the new regulatory framework. Local banks have moved toward adapting to the Basel II Accord regulations, and the largest ones are optimistic that they will be able to avoid having to follow the standardized procedures. Yet the considerable difference in size between the Greek banks and their European counterparts means that it will be difficult for them to get the full benefits of the new regulatory environment. A study by PricewaterhouseCoopers notes that if they do not put in place risk-evaluation systems as soon as possible, Greek banks will need additional capital in order to adapt to the new regulatory scheme. The same study notes that local banks have not made great progress toward the introduction of modern risk-evaluation systems, such as the Internal Rating Based Approach, meaning that they will presently have to try harder. Customers of Greek banks are also not expected to benefit from the Basel II Accord. The inadequacy of modern risk-evaluation systems, common to most Greek banks, means that they will have to raise their capital adequacy concerning risk management, with little or no chance left of lowering borrowing costs as well as the cost of other services offered. This explains why Greek banks lend with much higher interest differentials than their European counterparts. Their premiums amount to more than 3 percent, almost double that of the European average. The PricewaterhouseCoopers study says that the major hazard for Greek banks is operational risk. This is a new factor, which will be used, according to the Basel II Accord, for the calculation of capital adequacy levels of banks concerning risks due to inadequacies of the internal systems of banks, allowing for such hazards as may result from human error or faulty risk-monitoring systems. The Greek financial system is to face great challenges on this front during the next few years.