What executives need to know about Basel II

Crashes of major commercial banks in the 1970s led to the setting up of a committee for the supervision of banking in Basel, Switzerland, at the Bank for International Settlement (BIZ). This committee is made up of representatives from central banks or supervisory institutions of Belgium, Germany, France, Italy, Japan, Canada, Luxembourg, the Netherlands, Sweden, Switzerland, Spain, the United States and Great Britain. The committee had identified the commercial banks´credit risk as an important factor to deal with, particularly in times of a bank crisis. The result of this awareness was the agreement on equity capital reached in 1988, better known under „Basel I”.

The strong growth of the capital market and new kinds of financing led to a new version of the „Basel I” agreement in 1999 and culminated in the publication of the new Basel instructions on equity capital in 2004. In the meantime, these new “Basel II” rules have been cast in binding law in Germany and will determine the granting of loans by German banks from 2006 onwards.

In future, the risk for the creditor, the bank, will not solely be calculated from the financial statements of the debtor as was done in the past, but this calculation will also involve the anticipation of future returns as well as the calculation of internal and external risks. Rating reflects the anticipated financial situation of a company much more precisely than the assessment methods hitherto applied and therefore enable a much more balanced interest structuring. The same applies to a bank´s adequate equity capital ratio which in future has to be between 1.6 and 12 percent. In other words: Loans granted to highly rated companies will become less expensive, whereas a low rating will amount to a more expensive loan, if it is granted at all.

For that reason Basel II will lead to additional costs but also new possibilities for SME. What conclusions, however, the banks will draw from all that to their own future strategies remains still to be seen. GERMAN