Basel III in Chile: Advantages, Disadvantages and Challenges for Implementing the New Bank Capital Standard

Abstract

La version espanola de este articulo se puede encontrar en: http://ssrn.com/abstract=2609031Even though a growing number of emerging countries are implementing the Basel III recommendations on bank capital, this is not yet the case in Chile, a financially sound economy that has not undergone a banking crisis since the 1980s. This paper analyzes the relevance, advantages and challenges that the Chilean financial system would face if the new international standard were implemented. One conclusion is that there are two substantial reasons to implement Basel III: (a) the need to avoid major regulatory discrepancies between domestic and foreign banks, considering that the parent companies of European banks operating in Chile are already implementing Basel III, and (b) the need for tools, such as the Basel III countercyclical capital buffer, to prevent credit booms.A second conclusion, based on simulation exercises, is that if Basel III were implemented, Chilean banks at an aggregate level would comply with the Basel III recommendations regarding total capital ratios, but would have a moderate capital deficit to comply with the Tier I Capital Ratio (which includes only higher quality capital). This leads to the recommendation for a more detailed analysis at the level of individual banks. A third conclusion is the need for gradual implementation of the new standard, in the current context of a less favorable international environment affecting Chile and other emerging countries in the short and medium term.Finally, further analysis is recommended to determine which Basel III recommendations should be adapted (rather than adopted) to the Chilean context. One example is that it would not be appropriate to use the reference indicator suggested by Basel III (deviations of the credit/GDP ratio from its trend) in order to activate (or deactivate) the countercyclical capital buffer since it could lead to an increased pro-cyclicality of capital requirements — precisely the opposite of what Basel III intends.