Evaluating the Policy Implications of the Other Two Pillars of Basel II

This brief evaluates the supervisory-process and market-discipline pillars of the Basel II bank regulatory framework. It reviews and critiques their fundamental features and reaches three conclusions. First, the supervisory-process pillar provides too much scope for supervisory discretion and almost no support for a rules-based approach to regulation that arguably would be much more effective in promoting bank safety and soundness. Second, the market-discipline pillar’s information-disclosure guidelines represent a useful first step for many nations with less-developed banking systems, but these costly guidelines fail to promote attainment of other conditions required to enhance market discipline in any of Basel II’s participant nations. In light of these first two conclusions, the third conclusion is that these pillars of the Basel II framework require rethinking and reworking. In the longer term, global banking safety and soundness would more likely be enhanced by delaying implementation of Basel II until its framers replace the current supervisory-process pillar with a system of promptcorrective action rules and expand the market-discipline pillar to include more features that might actually enhance bank market discipline.