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ISDA Applauds Basel II, Sort Of

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NEW YORK (–The International Swaps and Derivatives Association gave a mostly enthusiastic thumbs-up to the Bank for International Settlements’ revised framework for capital measurement and standards, with a few caveats.

The “International Convergence of Capital Measurement and Capital Standards: A Revised Framework,” commonly known as Basel II after the Swiss town where the Bank for International Settlements is located, provides a more up-to-date framework for determining how much capital banks should have on hand to withstand losses and loan to consumers and businesses.

Overall, ISDA officials applauded the so-called Basel II accord, saying its approach to credit risk worked better with banks’ internal risk management structures than the current capital accord, originally devised in 1988 and updated in 1996. They also gave the Basel Committee on Banking Supervision, which has been responsible for drafting the new accord, high marks for crafting operational risk standards that are flexible enough to accommodate banks’ own internal risk measurement and management standards.

And ISDA officials said they welcomed improved recognition of credit risk mitigation, especially provisions that expand the range of financial collateral considered eligible to offset risks, recognition of commodity capital and adoption of a portfolio approach to measuring counterparty risk against securities financing transactions, according to a statement from ISDA.

Some problems remain, however. ISDA officials said the Basel committee needs to reduce the discretion each country has in implementing the new accord, so as to make standards more consistent from country to country. Also, the committee needs to address how to treat the double default risk of buying unfunded credit protection, as well as counterparty risk from derivatives transactions.

Basel committee officials have said they plan to make the framework available by the end of 2006 and the most advanced risk measurement approaches available a year later.

Governors of the European central bank, as well as heads of bank supervisory authorities in the Group of 10, the consortium of 11 countries comprising the most industrialized nations in the world, on June 26 endorsed publication of the new Basel II accord.

ISDA and other groups previously have offered comments on the Basel II accord, some of which was reflected in the latest document.

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Contact Robert F. Keane with questions or comments at: [email protected].