LyrArc Article Gist
Basel 2 got its start in 1999 in the midst of the Asian banking crisis. By 2004 financial regulators had come up with a set of rules for Basel 2. The idea was to make banking safer and reduce unsafe lending. It makes lending safer by requiring banks to match the size of their capital cushion to the riskiness of their loans and securities. Because banks are in such a precarious state with amny risky loans and securities the implementation of Basel 2 in the USA in 2009 would mean that the banks have to set aside an even bigger capital cushion and this would mean an even lower lending for capital needs of business than otherwise in a lending environment that is already constrained, thus making the economic conditions worsen. Critics point to this to show their concern that this would be a good thing but at the wrong time leading to a bad result. But Basel 2 is so far along that its likely to be implemented especially since the current crisis is partly a result of extensive leveraging and not enough capital has been set aside to account for higher risk for loans and securities. Basel 2's plus point is that it requires more shareholder capital for riskier loans a bank makes, and its shareholders who are first on the hook in a default protecting depositors and tapayers and creating an incentive to lend with due diligence and carefully. In the current situation though once a credit crisis has started its extremely difficult to get more money from shareholders. European countries have implemented Basel 2 starting in January 2008 and no adverse effects on credit have been seen. But the US credit crisis much worse and is expected to worsen in 2009 so the timing for Basel 2 is sure to cause concern. Regulators can ease up on implementation of Basel 2 if this is the case. Note that these regulatory rulebooks are always a work in progress as for instance Basel 1. Under Basel 1 financial firms were not required to have capital backing up lines of credit if they were for less than 1 year, so banks decided to game the system by issuing short term lines of credit and rolling them over. And banks learned to get the loans off their books so they were not required to have capital to back these loans by securitizing the loans. Basel 2 also uses mark to market acccounting which would put more pressure on securties prices in times of distress. But Stefan Walter of the Federal reserve Bank of New York who is secretary general of the Basel Committee on Banking Supervision says theree are built in stabilizers such as letting banks estimate their risks on average using historical data and lets national regulators use their own judgement as to what is acceptable. Note that a research paper by greenlaw of Morgan stanley Hatzius of Goldman Sachs , Kashyap of the University of Chicago, and Song Shin of Princeton Unicersity, 4 leading economists, released feb 29, states that highly leveraged financial institutions reduce their lending by $10 for every $1 of capital they lose. by this estimate bank lending could be down by as much as $900 billlion from the $90 billion in mortgage loans losses that have been seen.