By Laurent Balthazar
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Additional info for From Basel 1 to Basel 3: The Integration of State-of-the-Art Risk Modeling in Banking Regulation
The bank lost 10 billion USD in CDs in two months. This posed an important systemic threat as 2,299 other banks had deposits at Continental (of which 179 might have followed it into bankruptcy if it had been declared insolvent following a FDIC study). 3 billion USD credit was granted by a group of twenty-four major US banks, and top management was laid off and replaced by people chosen by the government. 1 billion USD, not a lot considering the bank’s size, thanks to the effectiveness of the way the regulators had handled the case.
The main principle of the solvency rule was to assign to both on-balance and off-balance sheet items a weight that was a function of their estimated risk level, and to require a capital level equivalent to 8 percent of those weighted assets. Thus, the main innovations of this ratio compared to the others that had been tested earlier was that it differentiated the assets by function of their assumed risk and also incorporated requirements for off-balance sheet items that had grown signiﬁcantly in the 1980s with the development of derivatives instruments.
That is why, backstage, people are already speaking of a “Basel 3 Accord” that would fully recognize internal credit risk models. Numerous contacts had to be created between regulators and the sector through joint forums and consultations to set up Basel 2; this built precious communications structures that are expected to be maintained even after Basel 2’s implementation date to keep working on what will be the regulation for the 2010s. This evolution is even highlighted in the ﬁnal text itself: The Committee understands that the IRB [Internal Rating-Based] approach represents a point on the continuum between purely regulatory measures of credit risk and an approach that builds more fully on internal credit risk models.
From Basel 1 to Basel 3: The Integration of State-of-the-Art Risk Modeling in Banking Regulation by Laurent Balthazar