The New Capital Adequacy Framework and the Need for Consistent Risk Measures for Financial Institutions

In banking capital structure matters more than in other industries because of the importance of confidence to banks. Regulators want to make sure that banks are well enough capitalized to avoid any 'systemic effect' whereby a bank failure would propagate to the rest of the financial system. In this chapter we review the evolution of the risk-based capital adequacy standards. The foundations were laid out in the initial Accord (BIS 88). They were further modified in the 1996 Amendment (BIS 98) which required banks to hold capital to cover their exposure to market risks in the trading book. The new BIS 2000+ Accord, currently under discussion, will replace the old BIS 88 Accord for the banking book and should constitute a more comprehensive approach to risks that eliminates the criticisms ofthe 1988 Accord.