The Basel Accords: The Implementation of II and the Modification of I

Publication Date: February 2006

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Banking and finance

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Abstract:

Even though much has been clarified about the implementation of Basel II, the new international capital standards for the U.S. banking system, uncertainty still remains about how U.S. bank regulators will activate these more efficient capital standards that the European Union (EU) is already implementing. On September 30, 2005, U.S. bank regulators announced they were revising plans for implementing the Basel II framework for a small number of large banks in a notice of proposed rulemaking (NPR). At the same time, and more important due to its potential impact on the vast majority of U.S. banks, U.S. regulators published for comments an advance notice of proposed rulemaking (ANPR) that would amend the existing Basel I regulatory capital rules. The purpose of these modifications to Basel I is to address the competitive inequalities that could have emerged from the implementation of Basel II rules for large banks while smaller banks were operating under Basel I. The ANPR addresses some research findings that suggest that Basel II could significantly lower the regulatory capital of the 10-20 larger Basel II banks, whereas smaller banks would be operating under the higher capital requirements of Basel I.

The Basel II NPR and the Basel I ANPR are of interest to Congress for several reasons. They would change the safety and soundness standards for U.S. banks, and they may be the subject of legislation as well as require new regulatory oversight. Moreover, they have serious implications for the world's financial system in ways that would affect the U.S. economy. For such reasons, the United States Financial Policy Committee for Fair Capital Standards Act (H.R. 1226) was introduced in Congress on March 10, 2005. It would establish a mechanism for developing U.S. positions on Basel Committee issues. U.S. banking regulators are now receiving comments on the ANPR. Since the implementation of Basel II is at a more advanced stage of the rulemaking process than modifications of Basel I, the changes to Basel I are expected to occur after the Basel II capital rules are made applicable to the large international banks.

This report provides the basic information needed to understand the issues surrounding the proposed implementation of Basel II and the pending proposed modifications of Basel I in the United States. First, it gives a basic background on capital standards and how capital assessments were made before these accords. Second, it briefly explains how Basel I works. Third, it addresses the major problem with Basel I and the modifications being considered. Fourth, it describes the Basel II framework the United States may implement and the framework the EU is already implementing. The report concludes with a section on Congress and the Basel Accords.

This report will be updated as developments warrant.