Implications of the New Basel Capital Accord for European Banks

On January 1, 2007 the New Basel Capital Accord (Basel II), which will influence many financial institutions around the world, came into force. Czech banks and investment firms will be affected as well, because the European Union (EU) has accepted these new regulatory rules with a few minor exceptions. The aim of this paper is to provide the historical background, key features, and impacts of Basel II on economic subjects. The overall objective of Basel II is to increase the safety and soundness of the international financial system. Basel II is based upon three main pillars: Pillar I deals with the minimum capital requirements for credit, market, and operational risk, Pillar II focuses on the supervisory review process and finally Pillar III promotes market discipline through enhanced disclosure requirements for banks. The new accord is expected to have three main economic consequences: higher cyclical fluctuations, an increased level of investments, and higher economies of scale. However, there have been numerous criticisms concerning Basel II. These encompass four principal elements: higher procyclity, an excessive use of external ratings, an excessive prescription of the Basel II document, and finally the difficulty to quantify operational risk. In terms of quantitative results of Basel II, an additional small rise of Gross Domestic Product in the European Union is anticipated.