If everything goes according to plan, Greek banks will know in a relatively short period of time what they will have to do to comply with the new international standards in banking regulation, known as the Basel II Accord. Its impact is likely to make the life of some banks and corporations easier and others more difficult, providing more impetus for merger and acquisition (M&A) activity. Up to this point, banks were required to have enough capital reserves to account for the market and credit risk they carried on their books. However, the new Basel II Accord has introduced important changes, including the calculation of a new type of risk and different methods of calculating capital requirements which affect different banks and their corporate clients in different ways. It should be noted the Basel II Accord is the second set of recommendations about how much capital banks have to set aside to guard against different types of risk in lending and investing issued by the relevant committee of the Bank for International Settlements (BIS) over the last 20 years. Back in 1988, the big industrialized countries asked BIS to come up with a comprehensive set of rules to regulate the international banking system with the goal of making it more stable and transparent. As the years passed, the landscape in banking in particular and financial services in general became more complicated, making the prudent rules of Basel I, as the first accord was called, look increasingly less and less capable of coping with the new situation. The large countries and banking regulators understood that the one-size-fits-all approach of Basel I had to be overhauled and the new accord, Basel II, was its offspring, coming into effect this year. Credit crisis The issue of banks properly managing risks and holding enough capital reserves for lending and investment purposes came to the forefront last year, following the ongoing credit crisis, and continues to dominate the headlines. Although Basel II brings in a new set of rules, the new major element is the introduction of a new type of risk, the operational risk, for which no capital had to be set aside in the first accord. Operational risk has a very broad definition and includes tax evasion, theft of information, hacking damage, forgery, bribery, data entry errors, intentional mismarking of positions, bribery, discrimination and workers’ compensation. It also engulfs natural disasters, such as earthquakes and terrorism. Banks have been called upon to set aside enough capital to account for this type of risk and this increases their capital needs. Although we are well into 2008, it is not clear how each Greek bank and its clients will be affected, since relevant reporting by commercial banks and its evaluation by the central bank are not yet completed. Still, it is understood that banks with larger operational risks and smaller mortgage portfolios will be hit harder, meaning they will be called upon to put up more capital to shore up their capital adequacy ratio and continue to loan out. On the other hand, banks with larger mortgage portfolios and highly rated corporate clients will benefit because they will be required to hold lees of capital for the loans and other risk weighted assets. For example, banks were required to put aside -80,000 or 8 percent for each corporate loan worth -1 million. Under Basel II, the capital reserve for the same loan will be less than -80,000, provided the corporation is rated, meaning it can make more loans for the same amount of capital. Less for mortgages Also, banks will have to reserve less capital for mortgage loans when loans account for 75 percent of the market value of the real estate property. Bankers say 4,000 euros or half of 8 percent of a -100,000 euro mortgage loan was put aside under Basel I but this will fall to -2,800 under the new accord. However, banks will no longer accept checks by small and medium-sized (SME) firms or professionals as a form of guarantee for giving out loans. This will lead to higher capital requirements for this type of loan because they were deducted from the amount of the balance when calculating capital reserves in the past. Given the widespread use of this form of guarantee in revolving credit facilities by SME in Greece, it will undoubtedly have a negative impact. If bankers are right, the new set of rules will most likely favor large over small banks and clients with good credit standing over others with a weaker one. This will add to pressure on small banks to boost their capital base and make un-rated clients pay a higher interest rate on their loans, increasing the burden of servicing them. An argument in favor of large banks, although not everything, is that they are more prepared to use the more sophisticated methods, the approach based on internal risk appraisal systems (IRS) which allows more leniency in pricing risks than the less sophisticated approach. The latter, so-called standardized approach, will be used by the majority of Greek banks and certainly all the smaller ones, and will call for capital to be set aside to satisfy the requirements under Basel II. All in all, banks and their clients will have to cope with the new reality of pricing risk under Basel II. Although its is not clear at this time which banks will gain the most and which will lose from the new international regulatory regime, it is safe to add it will put more pressure on the weaker players, banks and firms alike, to change their policies and seek a partner.