Basel III and Credit Risk Measurement: Variations Among G20 Countries

Most countries require banks to hold extra capital to protect against unforeseen financial calamities; banks with riskier loans must hold more capital than those with safer loans. Basel II, a set of international banking standards, allows banks to measure a loan’s risk in different ways: some banks make their own judgments; others use outside agencies. The recent mortgage crisis prompted banks to reevaluate these methods, in part due to banks having failed to perceive the high level of risk inherent in securitized mortgages. The international community’s response was Basel III, an updated version of its previous standards. This Comment will look at how Basel III’s implementation will change the way banks measure the credit risk of their loans. Part I of this comment will examine how credit risk measurement fits into the overall Basel scheme; Part II will analyze Basel II’s options for estimating credit risk; Part III will illustrate how inaccurate credit risk estimations contributed to the mortgage crisis; Part IV will explain the new Basel III rules; and Parts IV and V will examine problems with the Basel III rules and propose some solutions