Why Are There So Many Banking Crises? The Politics and Policy of Bank Regulation

By Jean-Charles Rochet | Go to book overview

Chapter Nine

Rebalancing the Three Pillars of Basel II

Jean-Charles Rochet


9.1 Introduction

The ongoing reform of the Basel Accord is supposed to rely on three “pillars”: a new capital ratio, supervisory review, and market discipline. But even a cursory look at the proposals of the Basel Committee on Banking Supervision reveals a certain degree of imbalance between these three pillars. Indeed, the Basel Committee (2003) gives a lot of attention (132 pages) to the refinements of the risk weights in the new capital ratio, but it is much less precise about the other pillars (16 pages on pillar 2 and 15 pages on pillar 3).1

Even though the initial capital ratio (Basel Committee 1988) has been severely criticized for being too crude and opening the door to regulatory arbitrage,2 it seems strange to insist so much on the importance of supervisory review3 and market discipline as necessary complements to capital requirements while remaining silent on the precise ways4 this complementarity can work in practice. One possible reason for this imbalance is a gap in the theoretical literature. As far as I know, there is no tractable model that allows a simultaneous analysis of the impact of solvency regulations, supervisory action, and market discipline on the behavior of commercial banks.

This paper aims to nil that gap by providing a simple framework for analyzing the interactions between the three pillars of Basel II. We start by offering a critical assessment of the academic literature on the

1This imbalance is also reflected in the comments on Basel II; see Saidenberg and
Schuermann (2003) for an assessment.

2See, for example, Santos (1996) and Jones (2000). The allegedrole of risk-based capital
ratios in the “credit crunch” of the early 1990s is discussed in Bernanke and Lown (1991),
Berger and Udell (1994), Peek and Rosengren (1995), and Thakor (1996).

3For example, the Basel Committee (2003) insists on the need to “enable early super-
visory intervention if capital does not provide a sufficient buffer against risk.”

4In particular, despite the existence of very precise proposals by U.S. economists
(Calomiris 1998; Evanoff and Wall 2000; see also the discussion in Bliss 2001) for
mandatory subordinated debt, these proposals are not discussed in the Basel II project.

-258-

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