Banks Brace for Implementation of New Basel Capital Accord

The Korean banking sector is bracing for the New Basel Capital Accord (Basel II), which will be implemented at the end of 2006.

Under the new accord, the creditworthiness of bank customers will be considered when assessing the soundness of banks. In that case, the credit rating of banks will fall as the Bank of International Settlements’s (BIS) capital-equity ratio goes down.

The Bank of International Settlements presented an international standard of bank capital adequacy in 1988 in order to enhance financial soundness and stability around the world. Under the accord, banks are obliged to maintain their capital-adequacy ratio at eight percent.

The Basel Committee is planning to implement a new international capital standard at the end of 2006 after reaching an agreement among member nations in July of this year.

The New Basel Capital Accord requires that when banks evaluate risk-adjusted assets, they have to consider the personal credit ratings of customers to whom they lend. When the accord is implemented, the BIS capital-adequacy ratio of Korean banks will fall. The domestic banks have just managed to maintain the BIS ratio since the financial crisis. Banks will face disadvantages in terms of bank withdrawals and mergers when the BIS ratio falls.

Banks are busily coming up with measures, such as setting up taskforce teams or getting accounting services, to cope.

“When the Basel II is implemented, the BIS ratio will fall about 20 percent,” said one bank manager. “We are pushed for time in securing several trillion won in capital.”

Some point out that the introduction of the Basel II accord will be a new challenge to the Korean economy.

The Bank of Korea warned in its report Wednesday that the implementation of the New Basel Accord will sway the Korean economy further.

During the economic slowdown, banks may cut their lending to customers whose credit rating is high risk in order to prevent the fall of the BIS ratio, causing a worsening of the economic slowdown. During the economic boom, in contrast, excessive lending can lead to an overheated economy.

Medium and small sized companies, or individuals who have low credit ratings, are likely to face difficulties getting loans.

“The implementation of Basel II may negatively affect the economy, such as the contraction of lending to companies with low credit ratings,” said Financial Supervisory Commissioner Lee Jeong-jae.

Joong-Hyun Park Keuk-In Bae sanjuck@donga.com bae2150@donga.com