Basel II: An Example of 'Smart' Regulation

Abstract

In contrast to Basel I, Basel II features with three-pillar framework which has been acknowledged as superior both by academics and industry. Fundamentally, the three-pillar framework reflects a major shift from simple risk measurement under Basel I to comprehensive risk management under Basel II. However, this obvious aspect of superiority is not a sufficient explanation for the likely success of Basel II as a regulatory system designed for maintaining financial stability. Basel II embraces certain features of third-way regulatory strategies which are positioned mid-way between direct government command and self-regulation. This paper will draw on two of those middle-path concepts to evaluate Basel II; one of these is reflexivity as explicated by Aalders and Wilthagen (1997), another is responsive as developed by John Braithwaite and his co-researchers (Ayres & Braithwaite, 1992). This paper will examine the congruence between Basel II and these two concepts of third-way regulation to evaluate the likely effectiveness of prudential controls under Basel II.