Basel Ii : A Case for Recalibration

Objectives for Basel II include the promulgation of a sound standard for risk measurement and risk-based minimum capital regulation. The AIRB approach, which may be mandatory for large U.S. banks, will give rise to large reductions in regulatory capital. This paper assess whether the reductions in minimum capital are justified by improvements in the accuracy of risk measurement under Basel II. Review of credit loss data and analysis of the economics of capital allocation methods identify important shortcomings in the AIRB framework that lead to undercapitalization of bank credit risks