Rethinking capital adequacy: The Basle Accord and the New Framework

When the Basle Committee on Banking Supervision promulgated its Basle Capital Accord of 1988, the face and scope of international banking regulation changed forever. Designed to protect bank insolvency by encouraging uniform capital ratios for commercial lending institutions, the Accord's implementation caused major complications throughout the global economy. More than a decade after the Basle Accord, the Basle Committee produced A New, Capital Adequacy Framework to largely replace the existing regime. Although the new rules will mitigate some of the current flaws in capital adequacy regulation, they will unfortunately fail to ameliorate the bulk of the "sins" committed in 1988, and with their new emphasis on rating agencies and internal models, introduce further dilemmas as well. Instead, regulators should consider allowing the market to force banks to make prudent lending decisions rather than mandating rigid standards that encourage banks to engage in imprudent regulatory arbitrage.