International Financial Co-Operation

Bryce Quillin

• Publisher: Routledge
• Year: 2008
• ISBN:
  9781135979591
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: Business allgemein

The Basel Accord - now commonly referred to as "Basel I" - has exerted a profound influence on international financial politics and domestic prudential financial sector regulatory policy yet great controversy has always surrounded the Accords impact on the safety and competitiveness of the worlds largest financial institutions and the evolution o

1
Introduction

Book overview

In 1988, the G-10 states agreed to a series of prudential capital adequacy guidelines for the credit risks of their internationally active commercial banking institutions. These rules, called the Basel Accord, endeavored to increase the soundness and stability of their largest financial intermediaries and ameliorate the competitive regulatory advantages conferred by some G-10 regulators to their domestic banks.¹

Though, by the late 1990s, a major international effort was initiated to fundamentally amend the agreement, the original Basel Accord ostensibly produced a highly successful international regime. Initially created by a small group of industrialized states, the Basel Accord (“Accord”) has become the worldwide prudential standard, or benchmark, for the commercial banking industry. The Accord was negotiated by an informal organization of G-10 central bank governors and financial services regulators, now known as the Basel Committee on Banking Supervision (BCBS).² The ambitions of the Committee were to create a common definition of bank regulatory capital, formulae for weighing the relative credit risks of banks’ assets, and to enforce uniform capital-to-assets minima. The agreement was concluded in 1988 and was to be fully implemented in the G-10 economies by 1992. Yet, the goal of the Committee was to extend the Accord’s influence beyond the G-10 and the Accord was “circulated to supervisory authorities worldwide with a view to encouraging adoption of [the] framework in countries outside the G-10 in respect of banks conducting significant international business.”³ This ambition was fully realized as the Accord was adopted by the European Community (EC), Australia, Ghana, Hong Kong, New Zealand, Norway, Saudi Arabia, and Singapore during the late 1980s and early 1990s.⁴ Over the next decade, this number increased exponentially so that over 100 states had unilaterally committed to the Basel standards by 1999.⁵

This global diffusion of the Basel rules has been accompanied by an enormous production of research by political scientists, international lawyers, and financial economists eager to examine the political origins and economic impacts of the Accord. Tomes of research have been dedicated to understanding the effects of the Accord on the banking sector and broader economies of implementing countries. Economists have questioned whether the Accord increased, or indeed decreased, the safety and soundness of country banking systems, influenced the long-run competitiveness of multinational banks, or contributed to downturns in macroeconomic growth during the 1990s.⁶ Scholars of international relations and law have similarly produced much research to understand how such a successful inter-state regime could have emerged in an issue area – financial services – in which very little international cooperation had occurred before the 1990s.⁷

Yet, before academic attention shifts away from the 1988 Basel Accord to its successor Basel II Accord, there are several important dimensions of the 1988 Accord that have yet to be systematically investigated and which, ex ante, appear to have ramifications for a full evaluation of the Accord’s significance.⁸ Such research could have crucial implications for the results of previous findings on the politics of the Accord’s negotiation and its micro- and macroeconomic effects. This research could also contribute to a broader understanding of the implementation of international financial regulatory regimes and the process of transnational policy convergence and divergence.

In particular, little empirical evidence has been produced that illustrates how the Accord was implemented in some or all of the 100 adhering states. Minimal academic attention has been given to understanding how domestic political actors interpreted the Basel Accord rules when creating the regulatory guidelines and legislation that implemented the Accord. This is a critical handicap to bear when gauging the political economic effects of the agreement. Though a key goal of the 1988 Accord was to level the regulatory playing field for banking risks, the agreement is an example of “soft law.” National regulators were given extensive discretionary powers for determining the exact manner in which the Accord was operationalized and enforced in their domestic banking space.⁹ This discretion was established, explicitly, by laying out a minimum regulatory baseline that national policymakers were invited to exceed in critical issue areas. Also, the Accord implicitly provides for high levels of discretionary policy by not seeking to harmonize cross-national tax and accounting standards and other prudential regulatory policies that are believed to bear upon the stringency of prudential banking regulation.¹⁰

The importance of understanding the implementation of the Basel rules was recognized in research by banking practitioners and economists during the first several years after the Accord’s negotiation. The results of these studies suggested that the Accord was implemented in widely different fashions by the core group of industrialized states in the G-10 and EC that adopted the agreement shortly after its completion.¹¹ Some states implemented very strict or “super-equivalent” interpretations of the Basel rules while others implemented loose, barely in compliance or non-compliant, interpretations. Econometric research has provided support for the view that these disparities matter as the domestic rule interpretations may have financially advantaged some banks at the expense of others.¹² In other words, the Accord may have failed in its objective to level elements of the banking regulatory playing field and allowed or exacerbated the problem of competitive regulation in the area of capital adequacy.

Yet, this book argues that previous research is not extensive enough to draw firm conclusions about the effects of the Basel Accord. The research on the Accord that has progressed over the last decade lacks attempts to operationalize its implementation in such a way that we can measure it across a wide range of cases over a period of time. Research has generally focused on implementation in two or three states and most of this work was completed with late 1980s data.

This book will address this empirical lacuna. Subsequent chapters analyze the Accord’s implementation with the preliminary aim of answering the question of how were the baseline Basel rules interpreted in the core implementing countries and how, if it all, did such interpretations change over time? In so doing, two specific questions will be addressed:

1 Did the Accord produce or contribute to transnational convergence or divergence in industrialized states’ capital adequacy policies shortly after the Accord’s negotiation?

2 Did the Accord produce or contribute to transnational convergence or divergence in industrialized states’ capital adequacy policies during a 12-year period (1988–2000) after the Accord’s negotiation. Put differently, did initial levels of convergence or divergence alter over time?

Addressing this set of questions permits a unique study of comparative political economy. Looking at the implementation of the Accord provides an opportunity to conduct a yardstick comparison of the way that states make bank regulatory policy in relation to a common, baseline standard. Before the Basel Accord, cross-sectional bank regulatory capital comparisons were almost impossible because of the distinctions in regulatory approach and vocabulary utilized among countries. It was common for academics to observe that if State A’s banks maintained an average capital adequacy ratio (CAR) of 7 percent and State B’s banks maintained a 5 percent ratio, then the latter were less sound and, by virtue of being less severely regulated, maintained a competitive advantage.¹³ Yet, such statements ignore the rules that underpin how banks are required to tabulate such ratios and thus ignore one of the key areas of cross-border regulatory advantage – or “non-market” advantage – that banks may compete for when interacting with their domestic supervisors. From a positive political economy perspective, the absence of a common regulatory approach and language made the detection of capital adequacy policy convergence and divergence very difficult and confounded efforts to learn if financial internationalization produced a global “race to the bottom” through the adoption of a common, lax regulatory standard or increased prudential oversight.

Two methodologies will be employed to address these questions. First, univariate statistical analysis will be employed to determine the degree of implementation severity that emerged in a large sample of industrialized states that committed to the Basel Accord in 1988. A quantitative index of implementation will be constructed to provide numerical comparisons of the degrees of implementation stringency for the sample states. This index is constructed from two under-utilized studies of Accord’s implementation produced by PriceWaterhouse (1991) and Murray-Jones and Gamble (1991) and documentation provided by G-10 and European Union (EU) regulators. In addition to presenting data for a cross-section of states, the index will provide implementation data across a period of time. It will thus be possible to judge whether there has been a convergence in Basel rule interpretations from 1988 to 2000, about the time that the Basel II discussions launched.

Qualitative case studies will accompany this quantitative analysis. These cases allow for a much more empirically detailed examination of rule implementation. This will be provided in a selection of focused, comparison case studies of the United States (Chapter 6), France and Germany (Chapter 7), and Japan (Chapter 8). Each case country study will provide data of the country’s pre-Basel Accord capital adequacy rules and their interpretations of the Accord from 1988 to 2000. Though the quantitative indicators seek to be exhaustive in capturing the empirical phenomena of rule implementation, there are several regulatory issue areas that are difficult to capture with quantitative measures. As will be made clear, the implementation of the Basel rules, and capital adequacy regulation more generally, is quite complex. Some elements that can affect the severity of capital regulation are difficult to directly observe. Moreover, as Tamura (2003a:2) observed, evaluating implementation “requires a considerable element of judgment about compliance – the degree to which national regulators adhere to the spirit of an international regulatory accord.” The case studies afford such a close “on the ground” inspection of some of the more complex elements of Basel rule implementation.

Beyond providing these descriptive data on the content of Basel rule interpretations, however, this book endeavors to address the question of why did some countries adopt strict interpretations of the Basel Accord while other countries adopted more lax approaches. Another way to address this question is why has there been convergence among some states’ capital adequacy regime rules over time but not others? Adding to the two questions posed above, the two questions addressed here are:

3 Why did states adopt loose or strict interpretations of the broad “soft law” provisions of the Accord?

4 What led states to increase or reduce the stringency of their initial interpretations of the Accord over a 12-year period of time (1988–2000)?

As before, quantitative and qualitative methodologies will be employed to address these questions. Econometric tests of a battery of hypotheses will be made in an effort to understand some explanations for the uneven amounts of implementation over the sample time period, 1988–2000. In these analyses, the implementation index, described above, will constitute the dependent variable and measures of statistical association will be generated between it and a number of explanatory variables generated by the hypotheses.

These “why” questions will also be investigated in the case studies of the United States, France, Germany, and Japan. Given the difficulties in determining the convergence of results from different research strategies in studies employing triangulation techniques, the case studies will not test the exact theories tested in the quantitative exercise but will use the regression re...