International Economics Update July 2001 Copyright (C) 2001 The International Economics Network http://www.internationaleconomics.net Marginal notes. Basel Blues Recent critique [1] of the new Basel Capital Accord has centred on several key issues. The first of these is concerned with the adequacy of the suggested risk model in capturing risk, especially the systemic risk present in a financial crisis - the very form of risk that the new framework seeks to address. Risk is meant to be an endogenous process, and sadly, the employment of a uniform risk assessment model does not capture this fact; indeed, by requiring that market participants utilise a common model, there is an inadvertent flattening that increases the homogeneity of risk profiles in players. The second set of concerns involves the utilisation of the Value at Risk (VaR) methodology. VaR requires that certain restrictive assumptions - such as the elliptical (normal) distribution of returns - be fulfilled in order to work, and unfortunately, credit and market risks do not satisfy this pre-requisite. Also, the incorporation of the somewhat arbitrary estimates of ratings agencies. Besides the well-known rule of thumb among Wall Street suits that discounts agency ratings by a notch or two, their inconsistent and unregulated forecasts are also likely to lag real time, since there are inherent forces - such as the reliance on accounting data and preferred non-volatility - that guarantee a certain degree of inertia in their recommendations. Fourth, the incorporation of operational risk into the general model does not seem to be justified, as operational risk is often idiosyncratic, and hence immune to contagion. Furthermore, measurement problems plague the ability to accurately quantify this concept. Last, these proposals lead to a major problem: that, in sum, the proposals would also serve to accentuate and not mute the procyclicality of regulation and the susceptibility of the financial system to systemic crises. This is a genuine fear, and if the Accord is eventually implemented, one dreads the day when it is inevitably tested. References Basel Committee on Banking Supervision. The New Basel Capital Accord. Geneva: BIS, 2001. Danielsson, J., P. Embrechts, C. Goodhart, C. Keating, F. Muennich, O. Renault & H.S. Shin. An Academic Response to Basel II. Financial Markets Group Special Paper No. 130. London: FMG, 2001. Endnotes 1. See, for example, the paper by Danielsson et al (2001). Website Additions. 1. In view of the burgeoning literature on financial crises, a page dedicated to work on financial crises has been set up. Previously, research in this field was found under Research Papers: International Finance. The link to the new page is still accessible from there, or you may wish to try the direct URL: http://www.internationaleconomics.net/crisis.html Interesting Readings. 1. Biotech Blues: Frances Moore Lappe argues that democracy is the solution to hunger, not biotechnology ('Biotechnology Isn't the Key to Feeding the World', http://www.iht.com/articles/25037.html). An interesting perspective from a visiting scholar at MIT. 2. Euro Neuro: The Bank of England has just released its report on 'Practical Issues Arising From the Euro' (http://www.bankofengland.co.uk/euro/euroiss0106.htm). The Euro 2002 Information Campaign began on the 20th June. Full text of the speech at the launch is available here: http://www.ecb.int/key/01/sp010620.htm. 3. Finance & Development: The latest issue of F&D, June 2001, is out. See http://www.imf.org/external/pubs/ft/fandd/2001/06/index.htm. 4. International Capital Markets: An advanced copy of the 2001 International Capital Markets Report is now available on the IMF website (http://www.imf.org/external/pubs/ft/icm/2001/01/eng/index.htm). Particularly interesting are the sections on the 'Changing Structure of the Major Government Securities Markets', 'Financial Sector Consolidation in Emerging Markets' and the Annex on the 'Ongoing Weaknesses in Japan's Corporate and Financial Sectors'. 5. Money Money Money: As the global economy seems headed for recession, everyone is getting on the boat of expansionary monetary policy. The U.S. ('Greenspan Says Continued Weakness May Require More Fed Interest Rate Cuts', http://quote.bloomberg.com/fgcgi.cgi?ptitle=Economies&s1=blk&tp=ad_topright_econ&T=markets_bfgcgi_content99.ht&s2=ad_right1_economies&bt=ad_position1_economies&middle=ad_frame2_economies&s=AO1XyrxUvR3JlZW5z), the E.U. ('European Inflation Slows in June, Putting Rate Reduction Back on Agenda', http://quote.bloomberg.com/fgcgi.cgi?ptitle=Economies&s1=blk&tp=ad_topright_econ&T=markets_bfgcgi_content99.ht&s2=ad_right1_economies&bt=ad_position1_economies&middle=ad_frame2_economies&s=AO1WQBhZ0RXVyb3Bl) and deflationary Japan ('BOJ's Okina Proposes Buying Forex Assets to Lift Money Supply', http://quote.bloomberg.com/fgcgi.cgi?ptitle=Economies&s1=blk&tp=ad_topright_econ&T=markets_bfgcgi_content99.ht&s2=ad_right1_economies&bt=ad_position1_economies&middle=ad_frame2_economies&s=AO1YN7RXOQk9KJ3Mg). The Economist advises caution with tinkering with the money supply ('Greenspan's balancing act', http://www.economist.com/agenda/displayStory.cfm?Story_ID=699102). 6. Dollar Debates: Is the U.S. dollar overvalued? Opinions from the press tend to advocate a free-market approach ('Letting the Dollar Alone', http://www.nytimes.com/2001/07/30/opinion/30MON2.html). Hans-Werner Sinn and Frank Westermann, from the University of Munich, offer a novel explanation to the puzzle and debunks the traditional press arguments ('Why Has the Euro Been Falling? An Investigation into the Determinants of the Exchange Rate', http://papers.nber.org/papers/W8352). Endnotes. This update is sent by request to subscribers. If you wish to join the mailing list, please click on: http://www.internationaleconomics.net/contact.html And enter your email address on the form there. You will receive a verification message confirming your subscription to the International Economics Update mailing list. Please feel free to forward this mailing on to colleagues and friends who might be interested in the subject matter. The usual disclaimers apply. This mail is not spam. You have received this mailing only because you are on the International Economics Update mailing list, for which it is believed that you have voluntarily subscribed to. 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