Basel II does not need to be overhauled – it is adaptable to rapid financial innovation and moreover, is designed to help steer banks through extreme market conditions, says Nout Wellink.
Possibly the greatest challenge in banking regulation is to ensure that fundamental changes in the structure of financial markets are accompanied by upgrades in risk management, regulation and supervision. Basel I served us well for many years but ultimately failed to keep pace with an increasingly complex financial environment. Basel II takes a major step towards setting the right incentives. Its minimum capital requirements are more risk sensitive, it better captures all different types of risk, encourages sound risk management practices and enhances market discipline. And, it is able to adapt to rapid financial innovation over time.
The minimum capital requirements under pillar 1 have received considerable attention in the past few years. However, minimum regulatory capital requirements will never completely keep up with changing financial markets. It is therefore important to focus on the supervisory review of pillar 2. The primary objective is for banks to understand their risk profiles. All risks should be considered, including traditional types relating to concentration, liquidity and interest rates.
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