Decision Indecision

Much of banking supervision that is exercised today is what was decided by Basel Accord developed in 1988 by the Bank of International Settlements. The accord was announced to control the risky banking services that are heavily prevalent and some way or the other affects all the economies of the world.

The entire cycle of boom and burst is a near fourteen year cycle which if properly analysed could be predicted before occurrence. The cycle completely relies of the numbers of defaulters that grow year after year up to the point when their number actually leads the economies into recession. This theoretic assumption has no buffer to define the mercenary attitude of banks or any such financial activities that have been the prime causes of recession. There is no account given to the messy governmental policies or the new instruments that companies tend to launch each year which one way or the other affect everyone. Interestingly these instruments make the effects of the scenario even more ramified and insoluble.

On going by the book the next big market crash is delayed up till 2014 if all goes well, but this is usually not the case. There are still situational faults attached. Who would have though once so regal Mortgage Based Securities would hamper the world economy so much that giants like AIG would have to settle as a public owned body? The end point of the situation is what comes around goes around. As a result in light of the market crashes since 1988 the bank of international Settlements has been framing rules to contain what little it can the reckless nature of the banks. Baking institutions however have always found a way to get through the situation, thus it goes with the saying that every time the rules are going to be broken and more or less the public end up suffering.

Beginning with the latest Basel Committee meeting that was organised by BIS at Switzerland, there economist from the G20 nations decided over the future of banking regulations. There were some very interesting clauses that were added to the accord. The banks do not hold the practice of holding large chunks of cash with themselves because cash in circulation can only bring returns. Stagnant cash is like money in vain. The amount of money held in liquid form by the bank is defined by the capital adequacy ratio.

Capital adequacy ratio is supposed to be the amount of cash that the banks own at any point of time divided by the entire amount of the risky assets. The definition of the money that banks own is defined by the types of ownership rights the share owners have on the bank. There are some shares that have ownership rights (tier I) i.e. you literally own some part of the bank and some that only pays you dividends (tier 2). When the bank is being foreclosed it is this capital that banks own is used to pay out the public who had invested.

Previously the definition of the capital adequacy definition was somewhat faulty. The definition was tightened by keeping the numerator restricted to only tier I and increasing it to 4.5% by 2015 and another 2.5% later to bring a total of 7%. Previously the calculation the ratio was carried out by considering both tier I and tier 2 assets. So when Basel II had decided to keep the sum of tier I + tier II at 8% due to banking instruments the ratio was a mere 1.6%. The banks had brought up a new instrument called credit default swap where betting on the securities they were selling helped them achieve a capital ratio of 8% by a mere holdings of 1.6%.

Apart from tightening the cash held by the banks provisions for countercyclic buffers have been initiated. The main objective of the countercyclic buffers is to neutralise whatever peaks the wavy nature of economic boom and burst takes. How we are able to control any further financial earthquakes it is difficult to predict. The Basel Committee has definitely tried to fill the void which has been one of the chief reasons for the wipe out of all the assets that banks previously controlled. Previously banks did not keep to themselves any money but put all in circulation. This was a very risky mal practice and the result is very much evident. However how the future banking functionalities turn out, let us wait and see. Human mind has seldom learnt anything from mistakes and it usually finds repenting much better than to try effectuating caution beforehand. Control is decisive when the control is welcome and not when it is forced upon.


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