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The new Basle Accord, internal ratings, and the incentives of banks

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  • Kirstein, Roland

Abstract

The Basle Accord of 1988 regulates how much equity banks must set aside as a cushion against the default risk. In its 1999 proposal for a new Accord, the Basle Committee seeks to introduce different equity ratios for customers of different risk levels. The proposal strongly favors external ratings as a means of risk determination. German banks, on the other hand, demand acknowledgement of their internal ratings. This paper shows that, even if assumed that banks have better diagnosis skill than external rating agencies, external ratings are better able to implement the goals of the Basle Committee than internal ratings. This is due to a lack of incentives to truthfully reveal their diagnosis results. These incentives may be provided by supervision of internal ratings, even if imperfect and only occasional. However, this requires that a fine be imposed if the supervising authority comes to a result different from the internal rating assigned by the bank.
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  • Kirstein, Roland, 2002. "The new Basle Accord, internal ratings, and the incentives of banks," International Review of Law and Economics, Elsevier, vol. 21(4), pages 393-412, May.
  • Handle: RePEc:eee:irlaec:v:21:y:2002:i:4:p:393-412
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    Cited by:

    1. Kirstein, Roland, 2003. "Imperfect Monitoring of Monitoring Agents: One Reason Why Hierarchies Can Be Superior to "Lean" Organizations," CSLE Discussion Paper Series 2003-07, Saarland University, CSLE - Center for the Study of Law and Economics.
    2. Van Tassel, Eric, 2011. "Information disclosure in credit markets when banks' costs are endogenous," Journal of Banking & Finance, Elsevier, vol. 35(2), pages 490-497, February.
    3. Francesco Giuli & Marco Manzo, 2005. "Protecting Savings: Do We Need a Supervision Authority?," Working Papers 84, University of Rome La Sapienza, Department of Public Economics.
    4. Francesco Giuli & Marco Manzo, 2009. "Enhancing Bank Transparency: What Role for the Supervision Authority?," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 56(4), pages 1-58, December.
    5. Brana, Sophie & Lahet, Delphine, 2009. "Capital requirement and financial crisis: The case of Japan and the 1997 Asian crisis," Japan and the World Economy, Elsevier, vol. 21(1), pages 97-104, January.
    6. Bertrand Rime, 2003. "The New Basel Accord: Implications of the Co-existence between the Standardized Approach and the Internal Ratings-based Approach," Working Papers 03.05, Swiss National Bank, Study Center Gerzensee.
    7. Kirstein Roland, 2007. "Banken zwischen Wettbewerb, Selbstkontrolle und staatlicher Regulierung: Anmerkungen zum gleichnamigen Buch von Gerrit Fey," ORDO. Jahrbuch für die Ordnung von Wirtschaft und Gesellschaft, De Gruyter, vol. 58(1), pages 251-254, January.
    8. Bigus, Jochen & Prigge, Stefan, 2005. "When risk premiums decrease as the bank's risk increases--a caveat on the use of subordinated bonds as an instrument of banking supervision," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 15(4), pages 369-390, October.
    9. Eric Van Tassel, 2009. "Sharing credit information under endogenous costs," Working Papers 09004, Department of Economics, College of Business, Florida Atlantic University.
    10. Ali, Syed Babar, 2012. "Quality of Internal Risk Rating Frameworks at Commercial Banks in Pakistan," MPRA Paper 55117, University Library of Munich, Germany.

    More about this item

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • K00 - Law and Economics - - General - - - General (including Data Sources and Description)
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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