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Your stock could rise after Basle II


When seeing the term Basle II, it’s understandable if readers’ eyes glaze over and they quickly turn the page to read about matters more pertinent to their day-to-day business.

But sooner or later we will all have to understand the basics of Basle II as it applies to UK financial institutions – probably by December 2006 although this date may be moved back pending demand from some signatory countries for simplification of the draft rules.

Two main questions apply to Basle II – what is it and why should I know about it?

Answering the first of these, Basle II is an international initiative that requires financial services companies to have a more risk sensitive framework for the assessment of how much capital they need to hold in relation to their trading activity with the public. This regulatory capital reserve is seen as a vital way the interests of consumers can be safeguarded, should the company run into trouble and be in danger of failing to meet its obligations to customers. The Basle Accord – named after the city in Switzerland where the committee meets – was an initiative of the then G7 group of the world’s most economically powerful nations which developed into the International Committee on Banking Supervision. This committee discusses supervisory issues relating to the Organisation for Economic Co-operation and Development banks, representing 30 countries.

The first Basel Accord in 1988 specified that 8% of assets should be held in reserve by member institutions and 4% for residential mortgage assets. The Basle accords are overseen by each country’s regulator – in our case, the Financial Services Authority.

Basle II develops the original idea by proposing the proportion of capital reserves held by each financial institution should be determined by the level of risk in its business dealings. This is not necessarily about the customers’ credit risk profile but is much more to do with how the institutions collect and record customer data and build it into their risk management systems. As such, it can be seen in the context of improving corporate governance. For example, in the US, the Sarbanes-Oxley Act – often mentioned in connection with Basle II – imposed auditing rules in the wake of the collapses of companies such as Enron and WorldCom. Closer to our own sector, FSA regulation means a greater emphasis on corporate governance in all regulated firms through which consumers’ interests are safeguarded.

Why should mortgage adviser firms be interested? One reason is that the FSA’s training and competence rules state continuous staff development must take into account any changes in the market and recent developments in products.

The implementation of Basle II is likely to have substantial repercussions in the UK mortgage market. It could also affect product pricing and structure as institutions will be obliged to pass on at least some of the cost of administration and higher capital reserves in the cost of mortgages.

This could lead to an interesting scenario with the premium rates traditionally charged for sub-prime falling to levels much closer to prime rates. This is because sub-prime lenders have developed highly sophisticated customer data management and risk evaluation systems, already used in structuring and pricing their products. In doing this, these lenders are aiming both for competitive pricing and best possible loan performance, vital in securing a good price for mortgage assets when they are securitised. This high level of risk monitoring and analysis should earn these lenders a lower ratio for capital reserves than will be on offer to mainstream lenders who haven’t had such sophisticated risk management systems in place.

If it comes down to putting a higher value on customer knowledge, Basle II could also raise the perceived value of brokers and packagers in mortgage distribution and help halt the slide toward automation that could be seen as a threat to the intermediary sector. Knowledge of the marketplace will be our best tool in taking advantage of these changes so taking notice of what’s happening with Basle II rather than turning over the page is highly recommended.


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