University of Arkansas, Fayetteville
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Abstract

Basel II, a major international regulatory capital revision, was supposed to have been implemented in the U.S. by 2004, but delays pushed it back more than five years. Basel II could have lowered minimum capital standards and made the largest banks even more vulnerable to the subprime financial crisis and economic downturn had it been adopted before its onset in 2007. Consequently, the procrastination in implementing Basel II made the banking industry more stable as it entered the financial crisis. In this study, the assets of the 11 largest bank holding companies at year-end 2006 were separated into broad asset classes with similar default characteristics as set forth under the second Basel Accord. The hypothetical capital to be held by the BHCs against their loans and leases was computed as required under Basel II and compared with the actual capital the banks held at year-end 2006. Based on these computations, it appears that Basel II would have made banks even more vulnerable to the financial crisis had it been adopted earlier. Consequently, the procrastination in implementing Basel II benefited both the banking industry and the federal government. Among the 11 bank holding companies, total capital could have decreased by more than $170 billion under Basel II compared to the actual capital being held. The change would have amounted to a 29.7% decrease in total capital and a 52.9% drop in capital held against loans and leases, both on a weighted-average basis. Without question, Basel II needs to be adjusted to be more conservative.

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