The Basel Capital Adequacy and Regulatory Framework: Balancing Risk Sensitivity, Simplicity and Comparability

Abstract

As well as highlighting the importance of cost benefit analyses in decision-making processes where (expected) outcomes are very difficult to predict – given the degree of prevailing and potential risks and uncertainties, as well as the unquantifiable nature of such risks and uncertainties, this paper also illustrates the importance of complementary measures in the current Basel risk based capital adequacy framework.

As technological advances and societal changes contribute towards the generation of certain levels of risks – some of which were previously not in existence, it is increasingly becoming evident that risks certainly have a dual nature. Institutional risks comprise of risks which are not only attributable to the firm or organisation where models (such as internal controls) or techniques are operated, namely internal control risks, but also the risks involved in managing those risks.

In view of such uncertainties, and the continual evolution of risks, it becomes immediately apparent that certain outcomes cannot be predicted with high accuracy and certainty – hence the need to weigh the investment of high expenditure in such unpredictable outcomes. Is the desire to achieve comparability, as well as simplicity, greater than the need to attain accurate, reliable and more relevant results through investment in more complex techniques? Such techniques involving not only initially high outlays but also costs (as well as risks) involved in managing such techniques? These constitute some of the questions which this paper attempts to address.

Keywords: comparability, simplicity, risk based capital adequacy framework, bank stress testing, risks, risk theories, Basel leverage ratios, liquidity standards