Banks should delay Basle compliance, says research

UK banks could make substantial savings by delaying compliance with controversial and costly international regulations set out in the final version of the Basle II Accord, research shows.

The FSA is allowing UK banks to choose whether they adopt basic or more advanced levels of compliance to Pillar 1 of the regulations when it is implemented in 2007. They can choose between standardised capital allowances for credit risk, broadly similar to those in the old 1988 accord, or capital allowances based on their own internal ratings of risks.

Research into the cost benefits of the two levels of compliance by senior finance lecturer at Cass Business School Dr Alistair Milne and Tim Giles of consultants Charles River Associates has shown banks could save substantial amounts of money by setting their own slower timetable for advanced compliance.

The recently released finalised accord, which has been created by the Basle-based International Committee on Banking Supervision and Regulation, has taken five years to fine tune. The accord sets new international standards for prudential bank regulation, protecting bank customers and the wider economy against the risks of bank failure. It will be implemented in European law through a new capital adequacy directive.

Dr Milne says: “Contrary to the advice being given by many consultants, we advise banks to spend shareholder money cautiously when achieving advanced compliance. Eventually all banks will want to do this but it is more important to do it properly and our research has shown there may be a significant cost saving by delaying until 2009 or 2010.

“Advanced compliance requires big system changes and with many banks rushing to achieve full compliance in the next two years, pressure of demand is pushing up the costs of implementation. Expenditure on data collection, changes to systems, and training for staff will all far outstrip any short-term gains from lower regulatory capital.”

He adds that instead of worrying excessively about advanced compliance, the realpriority is for banks to focus on their response to Pillars 2 and 3 of the new accord, ensuring that their systems of risk-management are sufficiently robust to withstand close regulatory scrutiny and that they have appropriate policies on disclosure of risk-exposures and capital adequacy.