Implementation of Basel II—Implications for the World Bank and the IMF—Factual Update

Prepared by the Monetary and Financial Systems Department

October 20, 2005

This note provides factual updates on material recent developments with respect to the implementation of Basel II in member countries since the circulation of the paper prepared by Fund and World Bank staff on "Implementation of Basel II—Implications for the World Bank and the IMF.


  1. Summary of Staff Papers
  2. Factual Update of Material Developments

I. Summary of Staff Papers

1. The New Capital Adequacy Framework (Basel II) proposes a significant refinement of regulatory and supervisory practice and encourages increased attention to risk management practices in supervisory agencies and financial institutions. Many countries have expressed an interest in adopting Basel II for their banking systems, and staff believe that this interest may be leveraged to upgrade the quality of their banking supervision. At the same time, adoption of Basel II by member countries will affect the surveillance, technical assistance (TA) and financial sector development agendas of the Bank and the Fund. Meeting demands for Basel II -- oriented financial sector surveillance and technical assistance to member countries will require building of expertise within the Bank and the Fund and a greater reliance on cooperating supervisory agencies to provide Basel II experts. It will also be important to manage member country expectations in this regard.

II. Factual Update of Material Developments

2. With agreement having been reached on most outstanding issues, calibration of the new capital framework (i.e., adjusting the regulatory capital charges against the various assets and financial services provided by banks) will dominate the Basel II-related work agenda of the Basel Committee going forward. Data for the Fifth Quantitative Impact Study (QIS 5), will be collected for the fourth quarter of CY 2005 from banks in both BCBS member countries and other jurisdictions and will be available by Spring 2006 for any potential recalibration of the risk weights by the Committee.

3. European banks and investment firms are on track to implement Basel II in two stages starting from January 2007 in accordance with the June 2004 schedule announced by the Committee. The European Parliament passed the Capital Requirements Directive on September 28, 2005 thus paving the way for its adoption by the 25 European Union member countries. The Parliament also agreed to a clause that permits the European Commission (EC) to make amendments to the Directive without approval from the European Parliament, under the EC's "comitology powers" (which had earlier been suspended by the Parliament), for a further period of two years.

4. Adoption of Basel II in the U.S., however, has been delayed in response to two issues. The decision made several years ago in the U.S. to adopt only the advanced components of Basel II and to apply Basel II only to the largest international banks has been revisited because of a concern that keeping all other U.S. banks on Basel I may unintentionally place these smaller institutions at a competitive disadvantage. The U.S. banking agencies have also been concerned by the large drop in capital requirements for some large U.S. banks under Basel II that was projected by the fourth quantitative impact study (QIS 4).

5. As a result, on September 30, 2005, the U.S. agencies announced that they will adopt a more conservative approach to implementation of Basel II. The supervisors announced a plan that delays implementation of Basel II by one year, applies a more conservative floor on potential capital reductions (required by Basel II) in the transition period, commits to retention of a separate capital leverage ratio for all banks in the U.S., and proposes a modified approach to Basel I (a "Basel IA"), which would apply to all other banks in the United States.

6. The impact of a staggered implementation of Basel II across banks in member countries is unknown. Apprehensions have been expressed that U.S. banks could face a competitive disadvantage vis-à-vis their European competitors, which will be adopting Basel II ahead of them. However, these fears are predicated on the basis of Basel II resulting in significant reductions in bank capital levels. It is unclear whether market analysts and rating agencies will be sufficiently comfortable with Basel II at the outset to allow any banks to take full advantage of any reductions in required regulatory capital.

7. Finally, staff has begun to hold informal discussions with the Basel Committee on how to assess the quality of Basel II implementation by various countries. Given the systemic importance of the world's major commercial banks, it will be important that Basel II is properly implemented by national authorities and that it meets the objective of reducing risk in the banking system. Given the complexity of some parts of Basel II and the dearth of Basel II experts, it will be a challenge to assess the quality of implementation of Basel II, particularly if many countries choose to implement the new framework at the same time.