The Basel committee last Wednesday announced plans to enhance Basel II, a move that involves some extra steps to "strengthen the resilience of the banking system."

These steps include changes to the capital treatment of liquidity facilities, trading book credit exposures and complex structured credit products.

The Basel committee that drew up Basel II capital requirements for banks was already working on amendments before the credit crunch happened. However, the measures disclosed last week were a direct response to the blow-up.

"A resilient banking system is central to sound financial markets and growth," said Nout Wellink, chairman of the Basel committee and president of the Netherlands Bank. "Supervisors cannot predict the next crisis, but they can carry forward the lessons from recent events to promote a more resilient banking system that can weather shocks, whatever the source."

He said that the key building blocks to core bank resiliency are strong capital cushions, sound risk management and supervision, robust liquidity buffers and better market discipline through transparency.

According to Wellink, a market report claiming that the new accord failed to place adequate restrictions on bank trading are misdirected because, under Basel II, banks are not allowed to use the credit pricing models that have failed to perform. Instead, he said that the crisis highlighted the Basel I regime's inefficiency.

The committee is now looking to enhance various aspects of the Basel II framework, including the capital treatment of complex structured credit products, liquidity facilities to support ABCP conduits and credit exposures held in the trading book.

Specifically, they are looking to revise the framework to establish higher capital requirements for certain complex structured credit products, such as "resecuritizations" or CDOs of ABS, which have caused the majority of losses during the recent market turbulence. The committee is also looking to strengthen the capital treatment of liquidity facilities extended to support off-balance-sheet vehicles such as ABCP conduits.

"We take this to mean that structures with one level of securitization, i.e., CLOs, CSOs, RMBS, CMBS, etc., will not be affected," Royal Bank of Scotland analysts said. "Structures with two or more levels of securitization, like ABS CDOs and CDO squared, will therefore attract greater capital charges and will look increasingly unattractive, although events of the past nine months have likely killed this type of structure anyway."

Additionally, there are plans to strengthen the capital requirement for trading book exposures of structured credit and to move away from a value-risk-based system for these illiquid securities. To address this, there will be an "event risk" proposal released for consultation later this year.

No further information is given on the scale of capital increases or on the timing of such a move, although the committee noted the importance of the Basel II framework's prompt implementation, as it will help address a number of the shortcomings brought to light by the current financial market crisis.

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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