Swiss banks are bracing for a wave of new regulations that will govern the way bankers measure and cover their financial risks.
Critics warn that an international "gentlemen's agreement", known as Basel II, will push up the cost of lending and could increase banks' exposure during financial crises.
Banking regulators say the new rules will bolster the stability of the global financial system and encourage transparency.
Basel II will determine how much capital - or reserves - internationally active banks such as Switzerland’s UBS and Credit Suisse should set aside.
The Basel-based Bank for International Settlements (BIS) hopes to finalise details of Basel II by mid-year, giving banks until early 2007 to comply.
Considered by some experts to be the “greatest challenge facing the financial services industry in a generation”, supporters say Basel II will give customers and investors greater insight into how banks manage risks.
Daniel Sigrist, the head of risk management at the Federal Banking Commission, told swissinfo that Basel II was designed to reflect modern banking.
"International banking is very interlinked," he said. "There is always the potential that a problem in one country can spread immediately through the financial system."
Basel II will replace a 1988 agreement that set a crude minimum.
The current rate is around eight per cent, although Swiss law requires banks to maintain a notably higher buffer.
The new rules are designed to replace the current “one-size-fits all” system, with one that better aligns a bank's reserves to the risks inherent in its chosen business.
A bank taking bigger bets, or trading more risky forms of credit, would therefore need to have greater reserves than one selling mortgages.
The new system will have a three-pillar structure. The first sets minimum capital requirements for credit and market risks, as well as operational risks, which are not considered under Basel I.
The second pillar builds in greater supervision, putting the onus on regulators to watch banks more closely.
And the final pillar, which is also new, will force banks to reveal more information about the risks they are taking.
Finding the black sheep
Sigrist said the third element of Basel II was crucial as it would encourage a system of peer pressure among banks.
"You always have black sheep," Sigrist said. "And if a bank had decided not to invest in risk management in the past, they will have to do it now," he said.
Although Basel II will not be legally binding, it imposes a straightjacket on any bank operating internationally.
"Every country has a right to ignore it, but then their banks will have a huge problem and will suffer from a pariah status among other banks," Sigrist said. "There is no alternative.”
Costly, unfair and risky
Because of the complexity of Basel II, some warn that the new rules will be costly to implement.
Many banks are likely to spend more on "Basel compliancy" than they did on the "Y2K" problem.
Some may also be moving too slowly. Last week, a global survey by the accounting firm, KPMG, found only ten per cent of the world's banks had set up Basel-implementation teams.
In Germany, there has been a widespread debate about whether the new rules could lead to a credit crunch for small and medium enterprises (SMEs).
In addition, there are concerns that by imposing tougher regulations on banks at times of crisis, some could be pushed into even deeper waters.
Swiss banks ready
Sigrist, however, said most of these problems had been over-emphasised, largely for political reasons.
"One criticism of Basel II is that it leads to enormous costs for small and large banks.
"But from my point of view, just to remain competitive a bank must invest in compliance. It’s not a question of whether Basel II itself induces this, but of whether the bank wants to remain competitive."
He also said the German debate had led to a built-in SME discount, which would ensure credit for small business was less expensive than it is today.
Sigrist added that most Swiss banks, especially the two biggest, Credit Suisse and UBS, are well prepared for Basel II because of the higher levels of regulatory capital already required under Swiss banking law.
"Imagine if one of these internationally active banks should fail. The Swiss economy would suffer severely from such an event.
“This is why we ask our banks for higher capital requirements than other countries do, such as the United States."
swissinfo, Jacob Greber in Zurich
Basel II will establish new rules for how much capital internationally active banks should set aside as a buffer against financial risk.
The new accord will replace a 1988 agreement that set a crude minimum by imposing a system designed to match a bank's reserves to its inherent business risk.
It will also require banks to reveal more detail about the risks they are taking.
Basel II is being coordinated by the Basel-based Bank for International Settlements, also known as the "bankers' bank".
Founded in 1930, the BIS aims to boost the stability of the global banking system.
Details of Basel II are due to be finalised by mid-year, giving banks until 2006 or early 2007 to comply.
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