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Abstract

Patricia Correa: Endless pages have been written on the potential flaws that could prevent Basel II from achieving the ultimate goal of increasing financial stability worldwide by improving bank risk management and making capital requirements more sensitive to risk. Criticisms, which are sometimes contradictory, can be grouped into five categories. First, the new accord offers alternative approaches for measuring capital requirements (two versions of the standardized approach and two of the internal ratingsbased, or IRB, approach), but it does not create proper incentives to use the most risk-sensitive approach, thereby opening the door for arbitrage. Second, in countries with little capital market and financial development, reliable external ratings are not available for most of the assets in the banks' credit portfolio; in such cases, the standardized approach will do little to link better capital to risk and would be, at best, a poor substitute to Basel I. Third, Basel II relies heavily on methodologies that lead to capital requirements that tend to accentuate the cycle, which can eventually increase, rather than diminish, financial instability. Whether this flaw can be attributed to the methodologies themselves or to the length of the databases employed to make the respective estimates is a controversial issue, but this topic is certainly an important one in the discussion. Fourth, the new framework will most probably increase the amount of minimum regulatory capital regardless of the measurement methodology chosen, and many banks, particularly in emerging economies, are simply not ready to meet the additional capital requirement. Finally, regulatory and supervisory bodies in most emerging economies are not prepared to meet the challenges posed under the second pillar of the accord, owing to lack of infrastructure, inadequate human capital, and so forth.Majnoni and Powell's paper represents an important contribution to the understanding of the potential impact of Basel II on emerging economies and sheds light on the validity or relevance of the aforementioned criticisms. The authors' contribution is particularly valuable in two aspects: it