Basel II: Principles of Avoiding Regulatory Failure

In this chapter I focus on the risk of regulatory failure in implementing the new Basel II requirements. It would be fair to say that whilst the intention of Basel II is to detect, manage and control the risk of capital inadequacy at the individual bank level, a large uncertainty looms over its successful implementation on a global basis. I shall draw attention to a range of possible unintended effects, to anticipate solutions which may be implemented by a variety of small and medium-sized financial institutions, especially in the emerging markets. The chapter is divided into three main sections: the private and public justification of the Basel II design; a theoretical model of regulatory design; and the major types of regulatory failure.