The aim of Basel II is to increase the stability of the banking system, promote a level playing field in the banking sector, and improve transparency. In light of the considerable developments made in bank-internal credit rating and risk management policies, a revision of the first Basel Accord (Basel I) from 1988 was inevitable. The key aspect of the Basel II is the orientation toward a more risk-oriented and more comprehensive structuring of minimum capital requirements. Harmonizing banking supervisory standards and disclosure requirements in the various countries are further aims. These combined measures will hopefully allow risk to be managed more efficiently, while maintaining the capital base in the banking system as a whole.

In the future, capital adequacy requirements for credit risks will largely be based on three factors: the borrower's rating and category (e.g. SMEs, private individuals, public institutions, banks), and the collateral put up. Banks have a number of approaches for the calculation of the minimum capital from which to choose: the standardized approach, IRB foundation approach, and IRB advanced approach (IRB: internal ratings-based). The more advanced a bank's risk management, the greater the potential alignment of the regulatory minimum capital requirement with the actual risks, and the greater the potential reduction of this requirement through the employment of credit risk minimizing methods (e.g. guarantees, credit derivatives). This then allows regulatory capital to be brought into line with the capital deemed necessary from an economic perspective.

Little impact on Swiss credit market

According to Credit Suisse economists, the impact of the new guidelines on private and corporate clients in Switzerland is not likely to be serious. Firstly, many Swiss financial institutions have further developed their credit risk management processes in the past ten years and have thus already anticipated many of the Basel II requirements. Secondly, the Swiss Finish resulting from Basel I bears a closer resemblance to the capital adequacy requirements of Basel II than is the case in many other countries.

Fears that small and medium-sized enterprises (SMEs) in particular would have greater difficulties in accessing capital, thus triggering a wave of bankruptcies, are unjustified. Firstly, most corporate clients have a medium credit rating - an area in which future regulatory capital requirements will be in line with current requirements. Secondly, (smaller) SME credits under Basel II will receive special treatment in comparison with other corporate credits.

Tougher competition for lower risks

Authors of the study believe that changes to the capital adequacy requirement are more likely to be felt by companies with good ratings and by private clients. In such cases, banks will generally not be required to underpin loans with as much equity capital, as capital adequacy regulations for relatively secure loans in the current accord tend to be too high. As a result, already intensive competition for low-risk business will increase even further and will force banks to continue to improve their efficiency. This could be achieved through targeted changes to processes and services or in the form of alliances.

As far as (new) borrowers who have little equity capital and are unable to put up collateral are concerned, Basel II will have little impact on access to bank loans. This also applies to borrowers from structurally weak sectors. In these cases too, banks will determine risk-appropriate credit conditions (e.g. higher credit interest rates). In order to allocate capital efficiently, it would make sense both from an operational and a overall economic point of view to base corporate and investment decisions on return and risk considerations.

Ratings becoming increasingly important

With Basel II, corporate client ratings will become even more important. As a result, companies will increasingly be assessed on their market viability and on their future prospects. Corporate financing will become more focused on risk and profitability. These rating processes offer borrowers a chance to complement their internal - and necessary - appraisals with external assessments.

Meanwhile, rating processes are noticeably becoming a vital success factor as banks seek to avoid being affected by increased capital adequacy requirements and avoid becoming a magnet for high-risk business.

Important milestone reached

Basel II is a milestone on the way toward internationally harmonized banking regulation and a more stable financial system. Major weak points in the Basel I will herewith be redressed. However, there are also some reservations regarding the new recommendations. For example, Credit Suisse economists find it problematic that Basel II does not apply to all financial market players and that national implementation is not totally consistent, the result being distortion of competition. It is already foreseeable that further changes to Basel II with regard to the regulation of financial institutions will be necessary in the future.

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