Rapaport Magazine

Banking Pillars

New banking standards intended to reduce the risk of bankruptcies by financial institutions have ramifications for Antwerp’s diamond industry.

By Marc Goldstein
RAPAPORT... If you gather ten diamantaires and ask them to define Basel II, you would be lucky to get one explanation of what it is and to what extent it is important to the trade. But other sources in Antwerp say the industry should educate itself on Basel II because it has potential implications for credit availability and loan collateral.

The seeds for Basel II were planted some 20 years ago, in 1988, when the Bank for International Settlements, located in Basel, joined with central bankers from around the world in hosting a round of deliberations that resulted in a set of minimal capital requirements for banks. Known as the Basel Accords, or Basel I, the primary focus was to assess and limit credit risk. Bank assets were classified and grouped into five categories according to credit risk, ranging from 0 percent, such as a national sovereign debt, to 10, 20, 50 and up to 100 percent, the category applying to most corporate debt.

Basel I provided that any bank with an international presence would henceforth be required to hold a minimum capital equal to 8 percent of its risk-weighted assets. Over the past two decades, the Basel I framework has been progressively introduced in more than 100 countries, including Belgium, Canada, France, Germany, Italy, Japan, Luxemburg, Netherlands, Spain, Sweden, Switzerland, United Kingdom and the United States. Obviously, the efficiency with which the standards are enforced varies. Over time, most noticeably since 2003, Basel I has been replaced in increments by a more comprehensive set of guidelines, known as Basel II.

Protecting Against Risk
The purpose of Basel II is the same as it was for Basel I: to improve the way banks match their capital reserves to the risks they take. The goal was to help protect the international financial system from the consequences of a collapse of a major bank or series of banks by giving banks guidelines as to how much capital reserves are appropriate to the risk they expose themselves to through their credit and investment practices. The greater the risk to which the bank is exposed, the greater the amount of capital the bank will have to hold so as not to jeopardize its solvency and overall economic stability.

Basel II is described as a three-pillar concept. The first pillar, minimum capital requirements, is comparable to requirements in Basel I, but gives banks greater flexibility to adapt credit reserves based on the types of their specific risks. Pillar two gives regulators new tools for assessing and measuring a wide variety of risk factors. And pillar three increases the information disclosures banks must make to provide greater transparency of the industry.

So what does this mean for diamantaires?
Jeremy Sulzbacher of the Diamond Finance newsletter explains that “In 1988, the first Basel Capital Accord set minimum capital and equity requirements for banks, which in turn set capital requirements for their customers. The Basel II framework is intended to promote a more forward-looking approach to capital supervision, one that encourages banks to identify the risks they may face. It means that they have to match the return on equity to their customers’ risk profiles. To diamond and jewelry companies, it can mean higher rates of interest and higher equity requirements.”

“Basel II is forcing not only banks, but also companies, to understand and identify all of their risks and manage them more effectively,” adds Bart Baesens, professor on the Faculty of Economics and Applied Economics at the Catholic University of Leuven, Belgium. “This will mean ensuring equity to cushion them against adverse conditions. We have a Basel II review package to help diamond companies stay one step ahead of their banks.”

Impact on Interest Rates

“The direct consequence,” says Sulzbacher, “is that in practice, besides banks requiring more equity from their ‘risky’ customers, they may also charge them higher rates of interest.” On the other hand, Freddy Hanard, managing director of the Antwerp World Diamond Centre (AWDC) and a former banker himself, suggests that “Basel II could indeed have an influence on interest rates, but those that are currently applied to the Antwerp diamond industry already encompass substantial risk premiums. That tends to suggest that instead of rates increasing for the less-efficient companies, the interest rates could instead diminish for the better-performing ones. Moreover, those that don’t manage to become Basel II-compliant might end up being too risky and find no further credit at all.”

The head of an Antwerp diamond bank branch urges customers everywhere “not to underestimate the importance of strengthening their balance sheets today, before they close 2007.”

It’s also understood that under Basel II, banks would not be able to rely on personal guarantees or flimsy collateral or, as Sulzbacher puts it, “lunch with the branch manager will not be enough to ‘sort out the problems.’”

An ABN AMRO representative explains that, “At the end of the day, the very purpose of the Basel Accords is the protection of the depositors.” Philip Claes, AWDC spokesman, concludes, “If it becomes necessary, AWDC is prepared to help anyone in need of further assistance as far as Basel II compliance is concerned.”

Article from the Rapaport Magazine - December 2007. To subscribe click here.

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