study suggests expense of Rushing to comply with finalised accord is not worth short-term gain
UK banks could make substantial savings by delaying compliance with controversial and costly new international regulations set out in the final version of the Basel II Accord, according to research by the Cass Business School, City of London.
Dr Alistair Milne, senior finance lecturer at Cass Business School, said: "Contrary to the advice being given by many consultants, we advise banks to spend shareholder money very 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."
The FSA is allowing UK banks to choose whether they adopt basic or more advanced levels of compliance to 'Pillar 1' of the new 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.
The recently released finalised accord, which has been created by the Basel-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.
The main reason many banks are rushing to achieve advanced compliance by 2007 is because it will lower their average regulatory capital requirement by one fifth, from 2.8% to 2.2% of their total assets.
Dr Milne said: "The shareholder value created by this reduction is not large, worth less than 0.4 basis points of total assets per annum. This saving is offset by the short-term implementation costs estimated to be up to $300m for medium/large-sized banks. It will take as much as 10 years for the reduced capital requirement to pay back the initial cost of advanced compliance.
"Advance 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.
"Instead of worrying excessively about advanced compliance, the real priority 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."
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Short-term noise or something sinister?