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The New Basle Accord, Internal Ratings, and the Incentives of Banks

  • Kirstein, Roland

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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Paper provided by Saarland University, CSLE - Center for the Study of Law and Economics in its series CSLE Discussion Paper Series with number 2000-06.

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Date of creation: 2000
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Handle: RePEc:zbw:csledp:200006
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  1. João A. C. Santos, 2000. "Bank capital regulation in contemporary banking theory: a review of the literature," BIS Working Papers 90, Bank for International Settlements.
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