ability to absorb shocks arising from financial and eco-
nomic stress—hence mitigating spill over risks from the
financial sector to the real economy.
The Committee is also striving towards the improve-
ment of risk management and governance as well as
strengthen banks’ transparency and disclosures.”
II. Key elements of the Basel Committee’s proposals
The quality, consistency, and transparency of capital
base will be raised to ensure that large, internationally
active banks are in a better position to absorb losses
on both a going concern and gone concern basis. (For
example, under the current Basel Committee standard,
banks could hold as little as 2% common equity to risk-
based assets, before the application of key regulatory
adjustments).
—As well as recommending an increase in the quality,
consistency and transparency of capital base24, the Basel
Committees recognition of the fact that “insufficient
detail on the components of capital”25 render “accu-
rate assessment of its quality or a meaning comparison
with other banks difficult”, infers its acknowledgement
of the importance attributed to enhanced disclosures.
Furthermore, the increased importance attached to the
role of central counter parties in efforts aimed at reduc-
ing systemic risks should also facilitate the process of
achieving greater and more enhanced disclosures.
The risk coverage of the capital framework will
be strengthened. In addition to the trading book and
securitisation reforms announced in July 2009, the
Committee proposes the consolidation of the capital
requirements for counterparty credit risk exposures
arising from derivatives and securities financing activi-
ties. These enhancements are aimed at strengthening
the resilience of individual banking institutions and
reducing the risk of shocks being transmitted from
one institution to another through the derivatives and
financing channel. Consolidated counterparty capital
requirements should increase incentives to transfer
OTC derivative exposures to central counterparties and
exchanges.
However there is also a limit to what the capital
framework could address. As highlighted by the recent
crisis, capital requirements on their own, were insuf-
ficient in addressing liquidity and Rmding problems
which arose during the crisis. The importance of
enhanced disclosures is also reflected and embodied
within the Committee’s second objective in relation to
its proposal to strengthen the resilience of the banking
sector, that is, its endeavours “to improve risk man-
agement and governance as well as strengthen banks’
transparency and disclosures.”
As a result of the inability’ of bank capital adequacy
requirements, on their own, to address funding and
liquidity’ problems26, the need to focus on Pillar 3 of
Basel II, namely, market discipline, is becoming more
apparent. There is growing justification for greater
measures aimed at extending capital rules to the secu-
rities markets. This not only arises from increased
conglomeration and globalisation—which increases
risks attributed to systemic contagion, but also the fact
that “the globalisation of financial markets has made it
possible for investors and capital seeking companies to
switch to lightly regulated or completely unregulated
markets/*27 Furthermore, it is not only argued that „the
fact that many banks in a number of countries have
chosen to securitise assets is probably largely due to the
capital requirements imposed on them“, but also that
present rules do not „explicitly cover risks ocher than
credit and market risk.”28
The engagement of market participants in the
corporate reporting process, a process which would
consequently enhance market discipline, constitutes a
Rmdamental means whereby greater measures aimed at
facilitating prudential supervision, could be extended
to the securities markets. Through Pillar 3, market par-
ticipants like credit agencies can determine the levels
of capital retained by banks—hence their potential to
rectify or exacerbate pro cyclical effects resulting Rom
Pillars 1 and 2. The challenges encountered by Pillars 1
and 2 in addressing credit risk is reflected by problems
identified with pro cyclicality, which are attributed to
banks’ extremely sensitive internal credit risk models,
and the level of capital buffers which should be retained
under Pillar Two. Such issues justify the need to give
greater prominence to Pillar 3.
As a result of the influence and potential of market
participants in determining capital levels, such market
participants are able to assist regulators in managing
more effectively, the impact of systemic risks which
occur when lending criteria is tightened owing to Basel
28 ∙ Banking & Financial Services Policy Report
Volume 30 ∙ Number 9 ∙ SepternberlOII