Financial Sector Development in Africa: Opportunities ... - World Bank

162 Fuchs, Losse-Mueller, and Witte
capital adequacy ratio of 8 percent, but supervisors were encouraged to
set higher ratios, as was the case in most African jurisdictions.
In 2004, the Basel II reforms introduced additional risk-sensitive
options in the calculation of capital requirements based on the greater
use of risk assessments provided by banks’ internal credit and market risk
systems. Most important, the intention of the reforms under Basel II—to
allow banks to use capital more efficiently and broaden the framework’s
scope by including operational risks—resulted in lower capital requirements
for most credit risk classes, which are the predominant form of risk
for African banks. Against the background of the strategic development
dilemma of the need to maintain high capital as a stability anchor versus
the need to leverage capital to mobilize funding resources, it is important
to note that Basel II did not lower capital requirements per se, but instead
increased the risk sensitivity of capital requirements. This provided for a
more efficient use of capital, assuming, of course, that banks have the
necessary capacity to manage risk according to the more sophisticated
approaches of Basel II and also that supervisors are able to monitor banks’
risk management capacity.
According to the Results of the Fifth Quantitative Impact Study (BCBS
2006), banks that used the new option of the advanced internal ratingsbased
approach (IRB) reduced their minimum required capital by up to
30 percent more than banks using Basel I. IRB-based capital reductions
were especially strong for retail mortgages (82 percent), small and
medium retail loans (72 percent), and corporate loans (27 percent). Basel
II predicates these reduced capital requirements on a significant increase
in supervisory requirements—and therefore demands on supervisory
capacity—including the need for supervisors to assess individual bank risk
management systems. It requires supervisors to exercise considerable
judgment in reviewing and evaluating a bank’s internal risk management
practices, its exposure to risks, its funding structure, and its overall risk
profile.
Figure 5.4 illustrates the relation between overall regulatory capacity
and capital adequacy under the three different frameworks. Today most
African countries operate under Basel I, which—in comparison with the
more recent revisions—is characterized by higher capital and less-defined
demands on supervisory capacity. Most African frameworks are characterized
by an even higher reliance on capital and lower levels of supervisory
capacity than implied by the full observance of the BCPs, which complemented
Basel I. A potential move to Basel II is a formidable challenge for
any regulator. It requires a significant step-change in supervisory capacity,