A Capital Accord for Emerging Economies?

Abstract

The Basel 1988 Capital Accord is arguably the most successful of all recent financial 'standards.' Although it was designed for internationally active banks in G10 countries, more than 100 countries claim to adhere to it and many apply the Accord to all banks. Significant changes to this Accord are currently under discussion and a final version is to be published in 2002 for implementation by 2005. The first section of this paper reviews the current proposals (published in January, 2001) from the standpoint of an emerging market. The question of how implementation in G10 countries will affect the cost of capital to emerging economies is then addressed. The new proposals make considerable advances in linking risk and regulatory capital for internationally active banks especially for their corporate loan book. However, the corporate-calibrated IRB approach leads to significant changes to capital requirements and spreads for banks that lend to emerging countries. It is proposed that for sovereign lending, banks should develop internal ratings according to an S&P or Moody's scale and capital charges be levied at the corresponding weights given by the standardized approach. In a third section, it is argued that the more detailed and specific are the proposals for G10 internationally active banks, then the proposals will necessarily be less relevant for non-G10 countries that wish to implement the new Accord for all banks. Indeed, many emerging countries will implement the 'standardized' approach in which case, given the limited universe of rated risks, little will change. Or, emerging countries will attempt to implement an IRB approach but with significant problems of implementation and in calibrating the parameters - or this will result in the use of inappropriate G10 calibrations. At the same time, banks in emerging economies remain the most important vehicle for financial intermediation and the appropriate regulation of bank capital one of the most important issues for financial sectors. It is then suggested that additional alternatives should be included or, failing that, the time may have come specifically for an Accord for emerging economies.

This paper - a product of the Financial Sector Strategy and Policy Department - is part of a larger effort in the department to study the impact of financial regulation on economic development. The author may be contacted at [e-mail].