GEORGE BAILEY IN THE TWENTY-FIRST CENTURY: ARE WE

MOVING TO THE POSTMODERN ERA IN INTERNATIONAL

FINANCIAL REGULATION WITH BASEL II?

W. RONALD GARD∗

INTRODUCTION

Jimmy Stewart in It’s a Wonderful Life1 plays small town George Bailey,
“honest, decent, generous to a fault.”2 It’s a Wonderful Life is an extremely well-
known film about how one life matters to the greater world. But the film also brings
home the instability of the financial world and how easily lives can be ruined or
saved. The most well-known example of this instability is when George is “driven to
the verge of suicide when his dotty uncle loses a wad of cash that he’s supposed to
deposit for the family savings and loan.”3 The villain is Mr. Potter (Lionel
Barrymore), “the avaricious local banker” out to buy George’s family’s savings and
loan.4 In an earlier scene we see the goodness of George, when he uses money saved
for his honeymoon trip to forestall a run on the savings and loan. The film portrays
a simpler time when one’s small personal savings could avert a bank crisis. When
George finds himself years later facing another bank crisis, but this time with no
similar capital reserve, the townspeople, remembering George’s kindness from years
past, “begin to empty their pockets into a large basket, thousands of dollars, in
gratitude for what [George] and his company have done in enriching their lives.”5
Kindness repaid averts the second banking crisis.

∗
J.D., The University of Arizona James E. Rogers College of Law, 2005; M.A. in English, California
State University, Northridge, 1998; Ph.D. in English Literature and Theory, The University of
Arizona, expected May 2007. Thank you to Boris Kozolchyk, David Gantz, and Robert Hershey.

1 IT’S A WONDERFUL LIFE (Liberty Films 1946).

2 Bob Thomas, Christmas Classic had an Unpromising Start, THE ASSOCIATED PRESS, July 3, 1997,
http://www.reelclassics.com/Movies/Wonlife/wonlife-article.htm (last visited Nov. 9, 2006).

3 Id.

4 Roger Ebert, It’s a Wonderful Life (1946), Jan. 1, 1999,

http://rogerebert.suntimes.com/apps/pbcs.dll/article?AID=/19990101/REVIEWS08/401010376/1
023 (last visited Nov. 9, 2006).

5 It’s a Wonderful Life, http://www149.pair.com/marilynn/IAWL.htm (last visited Nov. 9, 2006).

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Today, the small-town savings and loan pitted against the evil small-town
banker has been replaced by sophisticated global market economies of a scale
unfathomable to George Bailey and Mr. Potter. However, the same concerns and
risks—albeit on a much larger scale—exist today: how does a financial institution
survive when mistakes, runs on banks, or fraud occurs? The modern, and now
postmodern, solution came in the form of the Basel agreements. The 1988 Basel
Accord (“Basel I”) established 8%6 of regulatory capital as the minimum
international standard in order to prevent panics on a global scale like those seen in
It’s a Wonderful Life.7 Basel II, the latest version being debated and possibly
implemented in the coming years, carries those concerns and potential solutions into
the twenty-first century.

The Basel Accords have had, and will continue to have, a tremendous
influence on the world’s financial and banking interests, as they rewrite the rules of
banking.8 These agreements are promulgated, not by governments, but by a small
committee of elite bankers from high-powered central banks.9 In fact, no national
legislatures voted to approve Basel I.10 In spite of this, banks all over the world, both
large and small, in developing and developed countries, have adopted the Basel
Accords. It is hardly an overstatement to say that the financial world is under the
power of Basel. As Professor John Eatwell writes, “An important part of Britain's
economic future is being determined by a committee sitting in Basel, Switzerland.”11
This statement could easily be expanded to encompass the world. To date, over a

6 Riskglossary.com, Basel Committee on Banking Supervision,

http://www.riskglossary.com/articles/basle_committee.htm (last visited Nov. 9, 2006) [hereinafter
Basel Committee on Banking Supervision].

7 In many ways, It’s a Wonderful Life harkens back to the bank closures of the 1920s, where annually in

the U.S. there were about 500 bank closures due to bank failure. Many of the failed banks were
similar to Bailey’s bank, a small, rural one-unit bank. See MILTON FRIEDMAN & ANNA JACOBSON
SCHWARTZ, A MONETARY HISTORY OF THE UNITED STATES 1857–1960, at 249 (1963) [hereinafter
FRIEDMAN & SCHWARTZ].

8 See John Eatwell, Basel II: The Regulators Strike Back, THE OBSERVER, June 9, 2002, available at
http://observer.guardian.co.uk/business/story/0,,729690,00.html [hereinafter Eatwell, Basel II].

9 Id.

10 See id.

11 Id.
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hundred countries have adopted the Basel Accord, now referred to as Basel I,12 and a
similar situation is expected with Basel II.

This Article explores the development of these banking regulations as a

measure of our increasingly globalized world. The Basel Committee is a window
into our history and our future. Basel I sought a solution to the kinds of problems
George Bailey was facing, although on an international scale, as the local gave way to
the international. Even so, in a relatively short time, Basel I was outgrown. As a
response, Basel II will institutionalize and legalize a two-tiered banking system, at
least in the United States. Such a solution moves us even further from the cultural
conditions and crises depicted in It’s a Wonderful Life.13 A handful of large
international banks will follow the new Basel II, while smaller U.S. banks will
continue to follow Basel I.14 In addition, Basel II will extend beyond banks to reach
other financial institutions, including the International Monetary Fund (“IMF”).15

Experts and scholars are asking whether Basel II will lead to greater harmony
and universality within the international banking world.16 Will Basel II bring greater
stability or, as some predict, new uncertainty? This Article adds to the dialogue by
viewing the question through a slightly different lens: that of a world changing from
a modernist to postmodernist social paradigm. Just as George Bailey represents the
simple, pre-modern banking world, Basel I can be read as a modern text on

12L. Jacabo Rodríguez, International Banking Regulation: Where’s the Market Discipline in Basel II?, POL’Y
ANALYSIS, Oct. 15, 2002, at 1, available at http://www.cato.org/pubs/pas/pa455.pdf [hereinafter
Rodríguez].

13 See Testimony of Roger W. Ferguson, Jr. before the Committee on Banking, Housing, and Urban
Affairs, U.S. Senate, June 18, 2003,
http://www.federalreserve.gov/boarddocs/testimony/2003/20030618/default.htm (last visited Nov.
9, 2006).

14 See id.

15 Eatwell, Basel II, supra note 8.

16 See, e.g., Daniel K. Tarullo, Testimony before the U.S. Senate Committee on Banking, Housing, and

Urban Affairs, Sept. 26, 2006, available at 2006 WLNR 16671335; Analysis: A very traditional approach to
financial innovation, FT.COM, Sept. 26, 2006, http://www.ft.com/cms/s/1d36d3a0-4d72-11db-8704-
0000779e2340,dwp_uuid=824a0bea-4d72-11db-8704-0000779e2340.html (last visited Nov. 9, 2006);
Testimony of Susan Schmidt Bies before the Committee on Banking, Housing, and Urban Affairs,
U.S. Senate, September 26, 2006,
http://www.federalreserve.gov/boarddocs/testimony/2006/20060926/default.htm (last visited Nov.
9, 2006).
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international financial institutional markets, and Basel II as a postmodern text on a

more complex, globally-linked economic world. In adding this theoretical scope of
modernism/postmodernism, we read the evolution of the Basel Agreements as
reflective of a larger cultural shift, rather than merely as a response to the immediate
changing conditions.

Part I presents a brief history, beginning with the creation, development, and
collapse of Bretton Woods; the resulting 1973 banking crises; and the creation of the
Basel Committee in 1974. Part II looks at Basel I. Part III turns to Basel II,
including the current concerns and criticisms regarding its implementation. Part IV
concludes with a reading of the Basel agreements through modern and postmodern
theory, as a way to understand the shifts of our increasingly complex and globalized
village.

I. THE BIRTH OF THE MODERN ERA OF INTERNATIONAL FINANCIAL

REGULATION

The soon-to-be-implemented Basel II is a response to concerns that Basel I

is too outdated for our currently complex, international financial world.17 Basel II
grows out of the work of the Basel Committee, which seeks to standardize banking
regulation around the world and across jurisdictions.18 It is preceded by the 1975
Basel Concordat, the Revised Basel Concordat, Basel I, and the 1996 Amendment to
Basel I.19 All of these developments are fairly recent; this Section places them in
historical context.

17 Basel Committee on Banking Supervision, supra note 6.

18 Id.

19 See Patricia Jackson, International Financial Regulation and Stability, Fin. & Reg. Seminar Series at the
Judge Inst. of Mgmt., Mar. 8, 2002, at app. 1-3, available at
http://www.cerf.cam.ac.uk/publications/index.php?current=5.
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A. The Creation and Collapse of Bretton Woods

Seldom can there have been concentrated for the ordering of human affairs so comprehensive a
combination of economic and political vision, of administrative and technical expertise, of idealism
and interest. 20

- Lord Eric Roll, historian and

chairman of a London merchant bank

The collapse of the Bretton Woods system in the early 1970s21 encouraged
the development of the Basel Committee. It is important to understand this
economic transition in order to better understand the economic significance of Basel
I and Basel II within the socioeconomic cultural context.

World War II brought new extremes of rationalization to a series of

industries that had been developing in the preceding decades, including “[c]ars,
shipbuilding, and transport equipment, steel, petrochemicals, rubber, consumer
electrical goods, and construction.”22 These industries of production, utilizing
“interlinked financial centres—with the United States and [specifically] New York at
the apex of its hierarchy— . . . drew in massive supplies of raw materials from”
around the world. 23 They produced goods that were in turn distributed to “an
increasingly homogenous mass world market.”24 This system depended on “state-
sponsored reconstruction of war-torn economies, suburbanization particularly in the
United States, urban renewal, geographical expansion of transport and
communications systems, and infrastructural development both within and outside
the advanced capitalist world.”25 It also required a tacit structural agreement between
the state, increasingly large and profitable corporations, and organized labor.26 The
20MICHAEL MOFFITT, THE WORLD’S MONEY: INTERNATIONAL BANKING FROM BRETTON WOODS
TO THE BRINK OF INSOLVENCY 14 (1983) [hereinafter MOFFITT].

21 See generally id. at 13-40 (describing the rise and fall of the Bretton Woods system).

22 DAVID HARVEY, THE CONDITION OF POSTMODERNITY 132 (1989) [hereinafter HARVEY].

23 Id.

24 Id.

25 Id.

26 See id. at 132-34.

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primary historical factors giving rise to this tacit agreement include expansive U.S.
industrial production coupled with the need to rebuild European and foreign
economies to absorb that production.27 For the U.S. to meet those demands, both
domestically and internationally, however, a new financial world system had to be
conceived.28 This new financial world came in the form of the Bretton Woods
system.29

In 1944, in the midst of World War II, more than 700 delegates from the
forty-four Allied countries met in Bretton Woods, New Hampshire to discuss the
creation of a set of international financial institutions.30 The delegates were
beginning to imagine and create what a post-war world would look like, even though
the war itself would last another full year.31 The Bretton Woods system created the
World Bank to provide reconstruction money for Europe, and the IMF to provide
short-term loans for national governments.32 The system also created rules
governing commercial and financial interactions with countries around the world.33
The Committee hoped that these measures would help stabilize currencies and avoid
restrictive exchange practices.34

Planning for postwar reconstruction had begun as early as 1942.35 The main
architects of those plans, John Maynard Keynes from Great Britain and Harry
Dexter White from the United States, oversaw the transformation of these plans into
an international agreement at the Bretton Woods conference.36 The principal goal of
27 Id. at 136-37.

28 Id. at 137.

29 Id.

30 MOFFITT, supra note 20, at 13.

31 Id.

32TED NACE, GANGS OF AMERICA: THE RISE OF CORPORATE POWER AND THE DISABLING OF
DEMOCRACY 189 (2003).

33SAMUEL ROSENBERG, AMERICAN ECONOMIC DEVELOPMENT SINCE 1945: GROWTH, DECLINE

AND REJUVENATION 84 (2003) [hereinafter ROSENBERG].

34 See id.

35 MOFFITT, supra note 20, at 20.

36 Id. at 13.
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Bretton Woods was to stabilize the world’s economy for prosperous world trade.37
The U.S. sought a postwar economic arrangement that would give it access to
European and foreign markets as they were rebuilt, and that would allow U.S.
corporations to invest in those markets through the removal of restrictions on
international capital flows.38 While access to foreign markets significantly benefited
the U.S., it was viewed as simultaneously benefiting all nations involved because it
was believed that the U.S. “could act as an engine for global recovery.”39 In short,
the U.S. needed access to these rebuilt markets for its industrial surplus and for
overall growth; reciprocally, these markets needed U.S. resources in order to rebuild
and develop. Negotiated in just over three weeks of “marathon discussions,” the
Bretton Woods Accord established an international framework for what has been
recognized as “the greatest economic boom in history.”40

A key feature of Bretton Woods was the means by which it sought both
“stability and flexibility.”41 Prior to Bretton Woods, through the nineteenth and early
part of the twentieth centuries, nations by and large “tied their currencies to gold.”42
This correlation between currency and gold resulted in “the volume of currency in
circulation [being] limited by the nation’s gold supply.”43 Keynes and White, viewing
a traditional gold standard as overly restrictive on international economic growth and
development, sought an alternative; nevertheless, they were forced by practicality “to
mollify the powerful New York bankers who were staunchly progold.”44 The result
was a middle ground in which the U.S. dollar was tied to gold, with the U.S. Treasury
pledging “to redeem foreign dollar holdings in gold at the 1934 price of $35 per
ounce,”45 while the values of other world currencies were tied to the U.S. dollar.46
37 Id. at 20.

38See id. (“The aim was to establish new trading rules the major trading companies could live with and
entrust a new international agency with the authority to enforce them.”).

39 Id. at 16.

40 Id. at 14.

41 Id. at 20.

42 Id.

43 Id.

44 Id. at 21.

45 Id.
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History had taught that a single stabilizer was needed,47 and because of U.S.
hegemonic dominance in the world, that role fell to the U.S. Further stability in the
international system was achieved by establishing “fixed exchange rates between
[world] currencies,” with changes in those rates requiring approval by the IMF.48

As planned at Bretton Woods, the U.S. dollar, following the end of World
War II, flooded into western nations, helping many of those nations rebuild and
develop vibrant industrial economies.49 For more than a decade, the strength of the
U.S. dollar fostered an unparalleled economic boom, with the U.S. benefiting above
all others.50 What was unforeseen, however, was how quickly a U.S. dollar
overhang—the excess of U.S. dollars in circulation beyond what U.S. gold reserves
could satisfy—would emerge in the international arena. What was unimaginable at
the close of World War II appeared as a stark reality by 1958: the number of U.S.
dollars circulating worldwide and guaranteed by the U.S. as exchangeable for gold at
$35 an ounce threatened, in short order, to exceed the U.S. gold supply should
foreign nations suddenly choose to cash them in.51 By 1960, a number of foreign
governments began to fear a devaluation of the U.S. dollar and began converting a
portion of their U.S. currency holdings; the feared projection became a reality.52

The U.S. was able to sustain the Bretton Woods system for more than a
decade beyond this point.53 However, throughout the 1960s and into the 1970s the
system experienced increasing strain from many different sources, most importantly
the U.S. balance of payments crisis that emerged in the late 1950s and continued to
worsen.54 The shortage of U.S. dollars that made them so valuable following World
46 ROSENBERG, supra note 33, at 86.

47 MOFFITT, supra note 20, at 19.

48 Id. at 21.

49 See ROSENBERG, supra note 33, at 97, 93 (“European economies . . . experienced[d] a great
economic boom in the 1950s and 1960s.”).

50 MOFFITT, supra note 20, at 14.

51 ROSENBERG, supra note 33, at 97.

52 Id. at 97-98.

53See id. at 179 (“[B]y August 1971, the Nixon Administration had concluded that the Bretton Woods
system had outlived its usefulness for the United States.”).

54 See id. at 103-04.

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War II had become a glut by the early 1970s.55 This growing glut threatened a forced
devaluation and, ultimately—because the U.S. dollar underpinned the system of
exchange and value—an unraveling of the entire Bretton Woods structure.
Ironically, when this did finally occur in the early 1970s, U.S. banks and corporations
were at the fore in bringing about its demise.56

U.S. banks experienced a slow international expansion through the 1950s and
into the 1960s as they followed U.S. corporations abroad in pursuit of foreign direct
investment and market opportunities.57 Following 1965, however, international
banking began to come into its own.58 This coincided with the rise of the Eurodollar
market.59 Operating “as a kind of dollar market in exile,”60 the Eurodollar market
provided a structure and means for U.S. banks and corporations to transact beyond
U.S. regulatory oversight.61 With this structure in place, and as the U.S. dollar
became increasingly vulnerable at the end of the 1960s and early 1970s, the
Eurodollar market functioned as the platform from which banks (U.S. and
otherwise) could attack and further devalue the U.S. dollar.62 As one commentator
notes, this was nothing short of “a struggle between governments and the private
banks for control over the international monetary system.”63

In the early 1970s, with the U.S. dollar already demonstrably weak,
“corporations and banks, anticipating a devaluation, sold dollars on Europe’s money
markets in order to reduce their cash exposure in dollars.”64 The U.S., after

55 See MOFFITT, supra note 20, at 34.

56 See id. at 77.

57 Id. at 42-44.

58 Id. at 50.

59 See id. at 46-48.

60 Id. at 46.

61 See id. at 66 (“Being transnational, the Euromarket is virtually free of all government regulation.”).

62 See id. at 74-75, 77.

63 Id. at 71.

64 Id. at 77.
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repeatedly failing in its efforts to prop up the value of the dollar, finally succumbed
to economic pressures.65 In March 1973, in an effort to halt the U.S. dollar’s decline
in value, the foreign currency markets were closed (for the second time); when they
reopened two and a half weeks later, currency values were allowed to float.66
Although initially intended to be a temporary condition, the continued speculation
against the U.S. dollar, which further devalued it, made the economic reality quickly
apparent: the Bretton Woods system was no more.67

The 1970s saw the dissolution of many of the fundamental economic

structural tenets that were put in place as part of the Bretton Woods agreement
established at the end of World War II. With its collapse, longstanding financial
controls were abolished, including exchange controls, quantitative controls on credit,
and domestic restrictions.68 By the end of the Bretton Woods era, new modern
banking had come into existence;69 within a few years, the need for modern banking
regulations would be manifestly apparent.70 Just as Bretton Woods helped expand
and stabilize a post-war world, new agreements were needed to keep the banking and
financial worlds stable. Because so many banks were now linked internationally,
bank failure in one part of the world could trigger economic disaster in another part
of the world. This possibility was brought home in 1974.

B. The Herstatt Debacle

A number of reasons are given for the need to regulate financial and banking
markets, namely the protection of customers from lack of transparency, monopoly
power of a few banks operating within a particular market, and criminal activities by
banks and others.71 As the world becomes more global, the need for international

65See id. at 73-75.

66 Id. at 75.

67 Id.

68 Eatwell, Basel II, supra note 8.

69 See MOFFITT, supra note 20, at 44-55.

70 SHELAGH HEFFERNAN, MODERN BANKING 361 (2005) [hereinafter HEFFERNAN].

71 Id. at 173-74.
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regulation increases.72 This need could not have been demonstrated better than it
was in the summer of 1974.

Two bank failures in 1974 spurred the creation of the Basel Committee. One
of these failures has come to be known as the Herstatt Debacle, a banking crisis that
was initiated in Germany, but proceeded to spread around the world. On June 26,
1974, Bank Herstatt, a German bank, was forced into liquidation by German
regulators.73 The bank had run up huge “losses from foreign exchange trading,
which were originally estimated at £83 million but rose to £200 million.”74 In that
instance “a number of banks had released payment of DEM to Herstatt in Frankfurt
in exchange for USD . . .to be delivered in New York. Because of the time-zone
differences, Herstatt ceased operations between . . . respective payments. The
counterparty banks did not receive their USD payments.”75 As Heffernan explains,

The bank’s failure is famous because it exposed a weakness in the

system related to liquidity risk. Bankhaus Herstatt was due to settle
the purchase of Deutsche marks (DMs, in exchange for dollars) on
26 June. On that day, the German correspondent banks, on
instruction from the American banks, debited their German accounts
and deposited the DMs in the Landes Central bank (which was acting
as a clearing house). The American banks expected to be repaid in
dollars, but Bankhaus Herstatt was closed at 4 p.m., German time. It
was only 10 a.m. on the US east coast, causing these banks to lose
out because they were caught in the middle of a transaction. The US
payments system was put under severe strain. The risk associated
with the failure to meet interbank payment obligations has since
become known as Herstatt risk. In February 1984, the chairman of
the bank was convicted of fraudulently concealing foreign exchange
losses of DM 100 million in the bank’s 1973 accounts.76

72 Eatwell, Basel II, supra note 8.

73 Basel Committee on Banking Supervision, supra note 6.

74 HEFFERNAN, supra note 70, at 361.

75 Basel Committee on Banking Supervision, supra note 6.

76 HEFFERNAN, supra note 70, at 361.

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The Hertstatt bank was considered a failed bank.77 But Herstatt was not the
only bank failure that year. A month before, Franklin National Bank (“FNB”) in the
U.S. also faced serious problems. This bank was the twentieth largest in the U.S.,
with deposits of close to $3 billion.78 It too “suffered very large foreign exchange
losses and could not pay its quarterly dividend. It transpired that in addition to these
losses, the bank had made a large volume of unsound loans, as part of a rapid growth
strategy.”79 These revelations led large depositors to withdraw their money; it was
later discovered that its largest shareholder, Michele Sindona, had used the bank to
“channel funds illegally around the world.”80

The Herstatt Debacle and FNB’s problems ultimately led to the creation of
the Basel Committee.81 But this was far from the first instance of a bank failure or
mismanagement. As many have noted, international and global banking began with
the first instances of trade hundreds of years ago,82 and banks have been subject to
regulations concerned with safety and soundness of the banking system since at least
the 1930s, following the stock market crash.83 Why, then, was there considered a
need for a new banking accord in the 1980s, and again for the twenty-first century?
Why do banks need to be regulated on a global scale?

77 A bank is deemed to have “failed” if it is liquidated; merged with a healthy bank under central

government supervision or pressure; or rescued with state financial support. See HEFFERNAN, supra
note 70, at 352.

78 Id. at 361.

79 Id.

80 Id. at 362. Heffernan writes, “In March 1985 [Michele Sindona] died from poisoning, a few days
after being sentenced to life imprisonment in Italy for arranging the murder of an investigator of his
banking empire.” Id.

See Basel Committee, History of the Basel Committee and Its Membership, March 2001, at 1, available at
81

www.bis.org/publ/bcbsc101.pdf.

82Jaime Caruana, Chairman, Basel Comm. on Banking Supervision,

What Next for Basel? (Oct. 9, 2003), available at http://www.bde.es/prensa/intervenpub/archivo/
caruana/091003e.pdf#search=%22Remarks%20of%20Governor%20Jaime%20Caruana%2C%20Cha
irman%20of%20the%20Basel%20Committee%20on%20Banking%20Supervision“What%20Next%2
0for%20Basel%3F”%22.

83 See Kenneth E. Scott, The Patchwork Quilt: State and Federal Roles in Bank Regulation, 32 STAN. L. REV.

687, 696 (1980).

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Part of the answer lies in the fact that in the 1970s and 1980s, as Harper and
Chan note, “banking systems around the world were substantially deregulated,
reflecting a prevailing view that regulation had become a distorting influence on the
industry, no longer serving its original public policy goals.”84 What changed is how
regulatory systems are seen. Previously, “[r]egulation of banks has usually come in
the form of entry restrictions, limits on activities, geographical restrictions, reserve
requirements, and capital requirements.”85 Governments feared finance wars, and
therefore began regulating interest rates and other activities.86 Now, regulation tends
to be seen as a means to “safety and soundness” in banking on a larger, global
scale.87 Both Basel I and Basel II address this view: international regulation
requirements keep banks stable and the markets less vulnerable to bank failures.88
The focus on how to prevent more Herstatt crises, the Basel Committee believes, is a
focus on risk-weighted capital adequacy regulations.89

What happened with Herstatt is known as contagion, when the spread of one
bank’s problems infect other banks and the banking system as a whole. 90 This
creates systemic risk, which can cause problems across the entire global

financial system, leading to widespread bank runs by wholesale and

retail depositors, and possibly, collapse of the banking system. An
extensive collapse will result in the loss of intermediation, money
transmission and liquidity services offered by banks which, in turn,

84Ian R. Harper & Tom C.H. Chan, The Future of Banking: A Global Perspective, in THE FUTURE OF
BANKING 30, 37 (Benton E. Gup ed., 2003) [hereinafter Harper & Chan].

85 See GEORGE J. BENSTON, REGULATING FINANCIAL MARKETS: A CRITIQUE AND SOME PROPOSALS

80-84 (1998); Randall S. Kroszner, Financial Regulation, in THE ELGAR COMPANION TO AUSTRIAN
ECONOMICS 419, 421 (Peter J. Boettke ed., 1994) [hereinafter Kroszner]; Edward J. Kane, Ethical
Foundations of Financial Regulations, 12 J. OF FIN. SERVICES RES. 51, 51-52 (1997); CHARLES GOODHART
ET AL., FINANCIAL REGULATION: WHY, HOW AND WHERE NOW? 189-202 (1998).

86 See Kroszner, supra note 85, at 420; Harper & Chan, supra note 84, at 37.

87 Harper & Chan, supra note 84, at 37.

88 Basel Committee on Banking Supervision, supra note 6.

89 Id.

90 HEFFERNAN, supra note 70, at 175. See generally Charles W. Calomiris & Joseph R. Mason, Contagion

and Bank Failures During the Great Depression: The June 1932 Chicago Bank Panic, 87 AM. ECON. REV. 863
(1997) (discussing the “social costs of asymmetric-information induced bank panics in an
environment without government deposit insurance”).
174 TRANSACTIONS: THE TENNESSEE JOURNAL OF BUSINESS LAW [Vol. 8

will cause an inefficient allocation of resources in the economy. In

the extreme, the economy could revert to barter exchange.91

But in regulating and protecting banks, society also runs into a moral hazard
problem: when the government determines that one sector of society is too
important to fail (and thus is given insurance), it gives that sector latitude to
misbehave or participate in riskier ventures.92

To prevent such catastrophic losses, both in the local and global arena,
national banking systems created special regulations for banks—so-called “prudential
regulation”—which sought to minimize the social costs of bank failures.93 Most of
these regulations were on the micro level, including Basel I and Basel II.94 They set
requirements of what banks must do to keep from being in the precarious position
of failing.95 But some scholars, including Claudio Borio, believe we should be
looking at the macro level as well.96 Borio argues that banks should be seen as a
collective whole, all engaged in similar activities; therefore, problems can arise that
affect them simultaneously.97

Prudential regulation, however, has become key in the global banking

environment, mainly in order to prevent another Herstatt.98 Prudential regulation

91 HEFFERNAN, supra note 70, at 175.

92 Id. at 176.

93 Id.

94 See id. (“As this chapter proceeds, it will become apparent that prudential regulation focuses on

bank regulation at the micro level, i.e. ensuring that each bank behaves in a prudent manner, to
prevent systemic failure arising from contagion if one bank fails.”).

95 See id.

96 HEFFERNAN, supra note 70, at 176; Claudio Borio, Towards a Macroprudential Framework for Financial

Supervision and Regulation?, 49 CESIFO ECON. STUD. 181, 182 (2003), available at
http://cesifo.oxfordjournals.org/cgi/reprint/49/2/181.

97 HEFFERNAN, supra note 70, at 176.

98 Boris Kozolchyk explains,

The notion of prudential regulation is central to an understan[d]ing of what is being

attempted, especially by Basle II [sic]. Central bankers differ in their understanding
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takes the form of deposit insurance, capital requirements, licensing and examination
of banks, and intervention when banks get into trouble.99 It is designed to ensure the
stability of banking, without banks taking advantage of their position.100 Compliance
costs go down if all international banks are required to meet the same standards.101
The knowledge that specific standards are in place builds confidence in both
domestic and foreign banks, and provides stability from bank failure.102 And,
prudential regulation levels the playing field, allowing smaller banks to compete in a
global market. This Article looks specifically at the capital requirements established
in Basel I, the 1998 revisions, and Basel II.

C. Basel(s) and the Need for Global/International Regulation of Risk-

Weighted Capital Adequacy in Banks, or the Birth of the Modern Era

The Committee on Banking Regulations and Supervisory Practices (the

“Basel Committee”) is credited with starting the modern era in banking regulation.103
When the 1974 crises occurred, “[t]he failure of that German firm had seriously
threatened the American banking system, an eventuality that neither German nor US

of this type of regulation. To some, practically anything goes under the heading of
“prudential”, they tend to read language such as the one in your paper (referring to
a combination of deposit insurance, margins, reserves, inspections[,] etc) as
amounting to prudential regulation. Others, more correctly, I believe, see
prudential regulation as a providing some upper and lower of limits for various
measurements of liquidity, safety and soundness rules and then allowing banks to
operate within those limits.

Email from Boris Kozolchyk to W. Ronald Gard (Dec. 7, 2005) (on file with author).

99 See id.

100 HEFFERNAN, supra note 70, at 176.

101 Id.

102 Patricia Jackson, William Perraudin & Victoria Saporta, Regulatory and ‘Economic’ Solvency Standards for

Internationally Active Banks 9, at 11 (Bank of England, Working Paper No. 1368-5562, 2001), available at
www.bis.org/bcbs/events/b2eajps.pdf.

103 The Federal Reserve, Capital Standards for Banks: The Evolving Basel Accord, available at

http://www.federalreserve.gov/pubs/bulletin/2003/0903lead.pdf [hereinafter FRB Capital Standards

for Banks].
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regulators were, at that time, properly equipped to tackle.”104 The Basel Committee
was formed as a response “to the cross-jurisdictional implications of the Herstatt
debacle” as well as the problems with FNB the same year .105 The Committee was
supposed to coordinate and establish regulatory conditions among banks to prevent
a similar debacle.106 The Committee is comprised of individuals from central banks
and regulatory authorities from the G-10 countries, which include Belgium, Canada,
France, Germany, Luxembourg, Italy, Japan, the Netherlands, Sweden, the United
Kingdom, and the United States.107 While not having legislative or any other formal
authority, the Basel Committee does require its member countries to implement its
recommendations, although with flexibility, of course. 108 The Committee meets
every three months in Basel at the Bank for International Settlements.109

The Committee was formed to look at regulatory practices and issues of

international banks in member countries, and “to use concordats and agreements to
prevent any international banking operation from escaping effective supervision.”110
In short, it seeks to prevent another Herstatt. The Committee pursues three primary
objectives: “[1] define roles of regulators in cross-jurisdictional situations; [2] ensure
that international banks or bank holding companies do not escape comprehensive
supervision by a ‘home’ regulatory authority; [and 3] promote uniform capital
requirements so banks from different countries may compete with one another on a
‘level playing field.’”111 Throughout its history, Basel has expanded its scope and

104 John Eatwell, The New International Financial Architecture: Promise or Threat?, available at
http://www.cerf.cam.ac.uk/publications/files/Cambridge-MIT%20lecture%2022.5.pdf.

105 Basel Committee on Banking Supervision, supra note 6.

106 Id.

107 Id.

108 Id.

109 The Bank for International Settlements (“BIS”) provides revenue for the permanent secretariat,
and is owned by the central banks. It plays no role in policy-making. Formed in 1930, the BIS is one
of the oldest international financial institutions. It is actively involved in securing and maintaining
international central banks cooperation. See Bank for International Settlements, BIS History –
Overview, http://www.bis.org/about/history.htm (last visited Nov. 9, 2006).

110 HEFFERNAN, supra note 70, at 180.

111 Basel Committee on Banking Supervision, supra note 6.

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depth of sophistication. The first Basel Agreement came in 1975, where home and
host countries were given specific supervisory responsibility in particular areas, such
as liquidity and solvency.112

D. Further Crises in 1982

Each new edition seeks to fill gaps. The Revised Basel Concordat in 1983,
for example, did just that, after another series of bank failures, including the failures
of Banco Ambrosiano and its subsidiary in 1982.113 “As a result . . . the Concordat
was revised so that home and host supervisors now have joint responsibility for
solvency problems of subsidiaries and liquidity problems from either a subsidiary or
branch.”114 In addition, a second event put pressure on the Basel Committee to
maintain stability in the international financial markets; in August 1982, Mexico
announced that it was

unable to roll over its debt to private creditors and would therefore
be forced to suspend principal payments. Soon after, other
developing countries such as Argentina, Brazil, and Venezuela,
among others, found themselves in financial difficulties. U.S. banks,
which had lent recklessly to Latin American countries in the 1970s
and early 1980s, faced huge losses. Indeed, the nine largest U.S.
banks had loans outstanding to the most indebted countries that were
equivalent to almost twice their capital at the end of 1982. Those
banks had also lent 140 percent of their capital to Mexico, Brazil, and
Argentina. Although U.S. banks curtailed substantially their lending
to developing nations after Mexico’s announcement, they still faced
the possibility of becoming insolvent if the debtor countries

112See generally Banks for International Settlements, Principles for the Supervision of Banks’ Foreign
Establishments (May 1983), http://www.bis.org/publ/bcbsc312.pdf (describing “the responsibilities
of banking supervisory authorities for monitoring the prudential conduct and soundness of the
business of banks’ foreign establishments”).

113 HEFFERNAN, supra note 70, at 180-81. The bank failed “after its Chairman, Roberto Calvo, was
found hanging from Blackfriars Bridge in London. Depositors panicked upon hearing the news; a
lifeboat rescue was launched by the Bank of Italy ($325 million), but the bank was declared bankrupt
in late August 1982.” Id.

114 Id. at 181.

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defaulted. It was at this stage that the U.S. government orchestrated

a resolution to the crisis.115

The U.S. gave loans to Mexico, and instructed the IMF to give rescue packages to
the other countries.116 The U.S. Congress made efforts to provide additional loans to
developing countries caught in the crisis, but only in exchange for new regulations in
the banking industry, “including higher capital requirements.”117

The idea of new regulations concerned the U.S. banking community; in

particular, U.S. banks feared they would be less competitive with Japanese and
German banks, so there was a great push to make the new regulations
international.118 The first step towards international regulations came in 1986 when
the U.S. and the U.K. signed a bilateral treaty agreeing to minimum capital
standards.119 With these two powerhouses behind international regulations, the G-10
(Basel) Committee was presented with a proposal. The U.S. also threatened to apply
the new minimum capital regulation standards to international banks operating
within the U.S.120 In 1987, the Basel Committee began discussions, with the U.S. and
the U.K. on one side of the table, and Japan on the other.121

II. THE 1988 BASEL ACCORD

The Basel Accord was released in 1988; it “proposed a set of minimum

capital requirements for banks.”122 These requirements became law in 1992 in the G-
10 countries, with Japanese banks requiring an extended period to comply.123 The

115 Rodríguez, supra note 12, at 6.

116 Id.

117 Id.

118 Id. at 6-7.

119 Id. at 7.

120 Id.

121 Id.

122 Basel Committee on Banking Supervision, supra note 6.

123 Id.
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goal of the Basel Accord was to gain greater stability for international banks.124 This
was done by focusing on the supervision of banking operations. “The 1988 Basel
Accord established a single set of capital adequacy standards for international banks
of participating countries from January 1993.”125 Now known as Basel I, it required
“all international banks to set aside capital based on the (Basel) risk assets ratio”:
capital/weighted risk assets.126

The Basel Accord applies only to banks; it does not apply to securities firms
(investment banks or broker-dealers).127 The U.S., the U.K., and Japan distinguish
between the two, while the other G-10 countries have “a tradition of universal
banking.”128 “Banking” in this sense is the act of “deposit taking and lending,”
which are the activities that constitute commercial banking under U.S. law.129 The
primary issue addressed by the Basel Accord is credit risk.130

A. Framework for Measuring Risk

The 1988 Basel Accord created a four-part “framework for measuring capital
adequacy in relation to credit risk”: 1) defining what is capital; 2) determining risk-
weighing rates for types of assets; 3) determining the ratio of capital required for
each risk-weighed assets; and 4) determining the conversion of off-balance sheet
assets to risk-weighed assets.131

See Carl Felsenfeld & Genci Bilali, A Speculation on the Future of the Bank for International Settlements, 18
124

TRANSNAT'L LAW. 231, 236 (2005).

125 HEFFERNAN, supra note 70, at 182.

126 Id.

127 Basel Committee on Banking Supervision, supra note 6.

128 Id.

129 Id.

130 Id.

131 Rodríguez, supra note 12, at 7.

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1. Determining Capital: Tiers 1 and 2

Basel I divided a bank’s capital into two tiers.132 Tier 1 was comprised of
“core capital,” which included “common equity shares, disclosed reserves, non-
cumulative preferred stock, other hybrid equity instruments, retained earnings,
minority interests in consolidated subsidiaries, less goodwill and other deductions.”133
Tier 2 was comprised of “supplementary capital,” which included “(1) upper tier 2-
capital such as cumulative perpetual preferred stock, loan loss allowances,
undisclosed reserves, revaluation reserves (discounted by 55%) such as equity or
property where the value changes, general loan loss reserves, hybrid debt instruments
. . . and (2) lower tier 2-subordinated debt . . . .”134

Basel I also defined the amount of each type of capital a bank could hold.135
Tier 2 capital was limited to a maximum equivalent of Tier 1 capital.136
“Subordinated debt [was] limited to a maximum of 50 percent of Tier 1 capital.
General loan-loss reserves are limited to a maximum of 25 percent of Tier 2
capital.”137

2. Five Risk Rates

Currently, there are five risks rates under Basel I: 0%, 10%, 20%, 50%, and
100%, which are applied to various risk categories.138 These rates apply to both tiers
of capital.139 One of the greatest complaints against the system is that qualitative

132 See HEFFERNAN, supra note 70, at 182.

133 Id.

134 Id.

135Rodríguez, supra note 12, at 7-8.

136 Id.

137 Id. at 8.

138 FRB Capital Standards for Banks, supra note 103, at 396 n.2.

139 Gary A. Goodman & Robert W. Becker, The New Basel II Capital Accord: Business and Legal Challenges
for Real Estate Lenders, 120 BANKING L.J. 309, 310 (2003) (“Capital is defined as consisting of Tier 1
and Tier 2.”).
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differences in the risk categories are not taken into consideration.140 For instance, in
the U.S., all commercial loans are weighted at 100% and all residential loans at
50%.141 This is one of the motivating factors for Basel II’s revised system, which
accounts for the qualitative differences with great force.142

Basel I assigned risk weights to each category, with a lower rating indicating
the more credit-worthy and lower risk.143 Zero percent risk weight included cash,
gold, and bonds issued by OECD governments.144 Twenty percent risk weight
included bonds issued by agencies of the OECD governments, local governments,
and insured mortgages.145 Fifty percent risk weight included uninsured mortgages.146
One hundred percent risk weight included all corporate loans and claims by non-
OECD banks, and government debt, equity, and property.147 Key to this Article,
“[o]ff-balance sheet instruments (e.g. letters of credit, futures, swaps, forex
arrangements) were converted into ‘credit risk equivalents’, and weighted by the type
of counterparty to a given claim. Again, OECD government counterparties receive a
0% weight; 20% for OECD banks and public sector agencies.”148

3. Eight Percent Capital Requirement

The Basel Accord subjects banks to an 8% capital requirement, which

requires the capital divided by the credit risk to measure greater than 8%.149 This
140 See, e.g., FRB Capital Standards for Banks, supra note 103, at 396 (“As implemented in the United

States, [Basel I] specifies only four levels of risk, even though loans assigned the same risk weight (for
example, 100 percent for commercial loans) can vary greatly in credit quality.”).

141 Id.

142 See Dwight C. Smith III, Basel II: An Update, BANK ACCT. & FIN., Feb. 1, 2004, at 27.

143 HEFFERNAN, supra note 70, at 182.

144 Id.

145 Id.

146 Id.

147 Id.

148 Id. (emphasis added).

149 Basel Committee on Banking Supervision, supra note 6.

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requirement represents an indicator of a bank’s financial strength, and many

institutions exceed this minimum. Of that 8%, a minimum of 4% must be from Tier
I capital. 150

For example, “if a bank has assets in the form of U.S. Treasury bonds worth
$100, the capital charge required for those assets is zero.”151 This is because
government bonds are given a risk weight of 0%.152 “If, alternatively, a bank has
assets in the form of corporate bonds worth $100, the capital charge required is
equal to $8, of which at least $4 must be in Tier 1 capital.”153 This is because
corporate loans and bonds are weighted at 100%;154 therefore, one must calculate the
8% requirement from the full amount of the bond, in this case $100. So, $8 is
required to be held as a capital charge, $4 of which must come from Tier 1 capital.
The Basel system is based on the idea that having reserve capital requirements will
lessen the likelihood of panic, contagion, and bank failure.

4. Off-balance Sheet Items

Off-balance sheet items include letters of credit and other transactions that
banks carry on as part of their daily business.155 These are given the risk-weights of
“100 percent for instruments that substitute for loans, such as standby letters of
credit; 50 percent for transaction-related contingencies, such as standby letters of
credit for a particular transaction; and 20 percent for short-term, self-liquidating
trade-related contingent liabilities, such as commercial letters of credit.”156 So, a
commercial letter of credit worth $100 is a 20% risk-weighted asset. Eight percent
of $20, or $1.60, is the capital charge required. A stand-by letter of credit for $100

150 Rodríguez, supra note 12, at 8.

151 Id.

152 See id. at 8, tbl. 1.

153 Id. at 8-9.

154 See id. at 8, tbl. 1.

155 See Wikipedia, Off-balance-sheet, http://en.wikipedia.org/wiki/Off-balance-sheet (last visited

Nov. 9, 2006) (“Off balance sheet usually means an asset or debt or financing activity not on the
company’s balance sheet. It could involve . . . a contingent liability such as a letter of credit.”).

156 Rodríguez, supra note 12, at 8 tbl. 1.

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would have a risk-weight of 50%, so the capital charge would be eight percent of
$50.

B. Evening the Playing Field

Through Basel I, the Basel Committee sought to bring greater stability to the
financial world.157 It also hoped to provide a more even playing field.158 The benefit
of a system like Basel I is that it is easy to figure out the rates. The capital charge of
a stand-by letter of credit is a known quantity; that will not necessarily be the case
under Basel II.

C. Basel Amendment 1996: The Addition of Market Risks

The 1996 amendment to Basel I added market risks to the equation. A

market risk is defined as the risks (a) “in the trading book of debt and equity
instruments and related off-balance-sheet contracts and (b) foreign exchange and
commodities risks.”159 The amendment “introduced a more direct treatment of off-
balance sheet items rather than converting them into credit risk equivalents, as was
done in the original Basel I.”160 A Tier 3 capital was also added, which was defined
as “short-term subordinated debt (with a maturity of less than 2 years), which meets
a number of conditions stipulated in the agreement, including a requirement that
neither the interest nor principal can be repaid if it results in the bank falling below
its minimum capital requirement.”161 A bank could adopt either an internal model or

157Abhijit Ghosh, Solution Framework for Credit Risk Under BASEL II, BUS. CREDIT, Mar. 1, 2004, at 56.
This is the same justification of Basel II as well. See, e.g., Susan Schmidt Bies Delivers Remarks on
Current Banking Issues at The British Bankers’ Association 10th Annual Supervision Conference,
FDCH CAPITAL TRANSCRIPTS, Oct. 11, 2006, available at 2006 WLNR 17587348 (“Basel II is intended
to promote the stability of the U.S. financial system by ensuring the safety of and soundness of the
largest U.S. banks.”); Ben Bernanke Delivers Remarks On Basel II at The Federal Reserve Bank Of
Chicago’s 42nd Annual Conference on Bank Structure and Competition, FDCH CAPITAL
TRANSCRIPTS, May 18, 2006, available at 2006 WLNR 8540694 (“It is important to keep in mind,
however, that the core goal of Basel II is to promote the stability of the U.S. financial system by
ensuring the safety and soundness of U.S. banks.”).

158 Rodríguez, supra note 12, at 1.

159 Basel Committee on Banking Supervision, Amendment to the Capital Accord to Incorporate

Market Risks 1 n.2 (Jan. 1996), available at www.bis.org/publ/bcbs24.pdf.

160 HEFFERNAN, supra note 70, at 186.

161 Id. at 187.

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standardized model for determining its capital charge and market risk.162 Under the
current Basel rules, more sophisticated banks may employ their own advanced risk
models if the country regulator approves.163

III. BASEL II

A. The Growing Need for Basel II

1. The Asian Financial Crisis

The Asian Crisis “in the Fall of 1998 was the first post-World War II crisis in
which events in emerging market economies seriously threatened the financial
stability of the West, and where the origins of the crisis were clearly to be found in
the workings of liberalised markets and private sector institutions.” 164 Lord Eatwell
explains,

The spark was the financial crisis that overwhelmed many of the
Asian economies in 1997, and spread to Russia in 1998. But the
centre of the conflagration was the near failure of the hedge fund
Long Term Capital Management. More than any of the other
problems in the Fall of 1998, the threats that LTCM’s difficulties
posed to financial stability throughout the world illustrated
beyond all reasonable doubt that the international financial
system had entered a new era. This was not a problem of
sovereign debt, or macroeconomic imbalance, or even a foreign
exchange crisis. Instead it was the manifestation of the systemic
risk created by the market driven decisions of a private firm.165

162 Id.

163 Id.

164 John Eatwell, The New International Financial Architecture: Promise or Threat?, May 22, 2002, at 6,

available at http://www.cerf.cam.ac.uk/publications/files/Cambridge-MIT%20lecture%2022.5.pdf.

165 Id.
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Some believe that the Asian crisis occurred in part because of Basel I.166
Basel I encouraged short-term loans to other banks because it assigned a 20% risk-
weight to short-term loans to banks, instead of the 100% risk-weight assigned to
loans to non-banks.167 This choice is believed to have contributed to the crisis, as
Asian banks took advantage of the increased borrowing opportunities and the rest of
the world took advantage of lending to banks.168 “Sixty percent of the $380 billion in
international bank lending to Asia at the end of 1997 had a maturity of one year or
less” because loans under a year in length required no capital need regulations. 169

2. Circumventing Basel I: Regulatory Arbitrage

The Asian financial crisis of 1998 is credited, in part, with creating the need
for a revised Basel accord.170 The fixed risk-weight scheme under Basel I also led to
another consequence: banks began engaging in regulatory arbitrage.171 Regulatory
arbitrage is defined as “using a financial instrument or transaction to reduce capital
requirements without a corresponding reduction in the risk incurred.”172 The Asian
bank crisis could be seen as an example of regulatory arbitrage.173 William
McDonough, president and CEO of the Federal Reserve Bank of New York and
chairman of the Basel Committee on Banking Supervision explained, “One
significant weakness is that the Accord’s broad brush structure may provide banks
with an unintended incentive to take on higher risk exposures without requiring

See, e.g., Rudi Bonte et al., Supervisory Lessons to be Drawn from the Asian Crisis 26-33 (Basel Comm. on
166

Banking Supervision, Working Paper No. 2, 1999), available at http://www.bis.org/publ/bcbs_wp2.

htm.

167 Rodríguez, supra note 12, at 11.

168 See id.

169 Id.

170 See Lee Hsien Loong, Post Crisis Asia – The Way Forward, ASIAN BANKER J., Oct. 4, 2000, available
at http://www.emeap.org/review/0011/sg2109.htm.

171See Patricia A. McCoy, Musings on the Seeming Inevitability of Global Convergence in Banking Law, 7 CONN.
INS. L.J. 433, 450 (2001); Bothersome Basel, ECONOMIST, Apr. 17, 2004, at 5-8.

172 HEFFERNAN, supra note 70, at 185.

173 Another example is called “cherry picking,” which “involves the holding of riskier assets within a

given category.” Rodríguez, supra note 12, at 10.

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them to hold a commensurate amount of capital.”174 Basel II is supposed to end

regulatory arbitrage because riskiness will be included as a factor in measuring the
need of capital reserve, but some are not so sure.175 Again, economists cite Basel I’s
preference of equity over debt.176 One economist concludes, “For a given perceived
differential between the cost of equity and the cost of debt financing, incentives to
take RCA [Regulatory Capital Arbitrage], therefore, are related negatively to the
associated structuring costs, and positively to the extent to which RCA permits debt to
be substituted for equity.”177

3. Different Needs for Large International Financial Institutions

The U.S. Federal Reserve Board believes that Basel I works very well for
most financial institutions.178 It believes, however, that a new Basel accord is needed
for more complex, large, financial institutions; it is to those institutions that Basel II
is directed.179 Because the art of risk management has evolved, Basel I’s crude
system of four categories of risk-weighing should be replaced with a more
sophisticated, more qualitative determination.180 As the banking community has
become increasingly concentrated, Basel I started seeming outdated.181 Big

174William J. McDonough, President and Chief Executive Officer, Fed. Reserve Bank of New York,
The Impact of Today’s Technology on Banking and the Financial Markets (Sept. 20, 2000), available at
http://www.ny.frb.org/newsevents/speeches/2000/mcdon000920.html.

175 Rodríguez, supra note 12, at 15 (“As the Shadow Financial Regulatory Committee, a group of

publicly recognized, independent experts on financial issues, stated in its comment on the New Basel
Accord: ‘Although the task of computing the correct economic capital for a bank is very difficult and
complex, bank capital regulation need not be. Indeed, greater complexity in bank regulation reduces
transparency and may increase the scope for regulatory arbitrage and regulatory forbearance.’”)
(quoting Statement of the Shadow Financial Regulatory Committee on The Basel Committee’s
Revised Capital Accord Proposal 1-2 (Feb. 26, 2001), available at
http://www.bis.org/bcbs/ca/shfirect.pdf).

176 See, e.g., id. at 10.

177Id. (citing David Jones, Emerging Problems with the Basel Capital Accord: Regulatory Capital Arbitrage
Related Issues, 24 J. OF BANKING & FIN. 39 (2000)).

178 See FRB Capital Standards for Banks, supra note 103, at 396.

179 Id.

180 Id.

181 Id.
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international banks want to use their own risk-management software and calculations
to include riskier credit and other factors not used in Basel I.182

B. The Imminent Arrival of Basel II

With the Asian financial crisis, the spread of regulatory arbitrage, and the
development of sophisticated risk-management systems in large international banks,
critics began to feel that Basel I was becoming outmoded. In 2001, a new proposal
was introduced in the Basel Committee.183 Comments from outside the elite group
of the Basil Committee were encouraged, and the committee received over 250
responses.184 The Basel Committee conducted three impact statements as well.185
More changes were made to the agreement, and a new agreement was reached in
May 2004.186

Basel II significantly revises the concept of regulatory capital. “Future capital

requirements are to be far more flexible, and more closely aligned to free market
forces.”187 Moreover, the one-size-fits-all approach of Basel I has been replaced with
a more complex mix-and-match system. There is great criticism of Basel II from a
myriad of camps.188 This Section tries to understand just what Basel II will do when
it is finally implemented in 2007.

Whereas Basel I had a three-tiered system focused on capital, Basel II will

have a three-pillar system, and although the change in name does not make it
obvious, the ordering of Basel II is something distinctly new from the more

182 Id. at 397.

183 Bank for International Settlements, Update on the New Basel Capital Accord, June 25, 2001,

http://www.bis.org/press/p010625.htm (last visited Nov. 9, 2006).

184 Id.

185 Bank for International Settlements, Basel II: International Convergence of Capital Measurement
and Capital Standards: a Revised Framework, June 2004, http://www.bis.org/publ/bcbs107.htm (last
visited Nov. 9, 2006).

186 Bank for International Settlements, Consensus achieved on Basel II proposals, May 2004,
http://www.bis.org/press/p040511.htm (last visited Nov. 9, 2006).

187 Eatwell, Basel II, supra note 8.

188 See, e.g., Rodríguez, supra note 12, at 14-17.

188 TRANSACTIONS: THE TENNESSEE JOURNAL OF BUSINESS LAW [Vol. 8

simplified Basel I agreement.189 Minimum capital requirements continue to be the

focus of Basel II, but their determination and monitoring is much more complex.190

Basel II is different from Basel I in that it focuses on specific variables, rather

than broad categories for determining credit risk.191 Just as the 1998 amendment
expanded the formula to include market risks, Basel II goes significantly further in
that direction. “The core idea of Basel II is that market disciplines, whether direct or
mediated through banks’ own risk-modelling, should be placed at the heart of
financial regulation.” 192

Does Basel II slide too close to the business of banks, rather than regulating
them? We have seen this trend in other areas, including laws protecting the
environment. When businesses that hurt the environment help write the regulations,
the environment may not be the first focus of protection. Similarly, many are
concerned that the regulations will not provide adequate protection in a banking
crisis.193 As Eatwell explains,

But the reason regulators exist is that markets don't always work
efficiently to achieve society's goals. Just as the environmental
watchdog is there because the market encourages polluting behaviour
(imposing costs on society as a whole rather than the polluter), so the
financial regulator is there because financial risk takers expose society
to far greater losses than they might suffer themselves. 194

Pillar One concerns the core element of Basel I, namely determining how
much regulatory capital a bank must have on hand.195 The Tier 1 and 2 system
189 Wikipedia, Basel II, http://en.wikipedia.org/wiki/Basel_II (last visited Nov. 9, 2006).

190 Rodríguez, supra note 12, at 11.

191 Eatwell, Basel II, supra note 8; ICBA, Summary of Proposed Revisions to Basel I,

http://www.icba.org/advocacy/index.cfm?ItemNumber=16587&sn.ItemNumber=1710 (last visited

Nov. 9, 2006).

192 Eatwell, Basel II, supra note 8.

193 See, e.g., Statement of L. William Seidman, Basel II, November 10, 2005, at 4, available at
http://www.senate.gov/~banking/_files/seidman.pdf.

194 Eatwell, Basel II, supra note 8.

195 FRB Capital Standards for Banks, supra note 103, at 398.
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TO THE POSTMODERN ERA IN INTERNATIONAL FINANCIAL REGULATION WITH BASEL II?

continues in Basel II, as does the 8% capital requirement.196 The significant change
comes in how to calculate the risk-weight for individual assets.197 This will be based
on a more complex calculation than anything seen in Basel I, even the 1998
amendment.

Under Basel II, there would be three options for measuring credit risk: one
standardized approach and two internal-ratings-based approaches (“IRBs”).198 The
standardized approach continues with fixed risk-weighing categories (adding more
categories), but adds a qualitative component through external credit ratings “to
evaluate corporate risk exposures.”199 The IRBs focus their analysis on the
qualitative elements in greater proportion, and can be determined by the banks
themselves.200 The more simplified IRB focuses on the probability of loan default,
whereas in the more complex version, the bank would determine all of the risks
associated with the particular transaction.201

The benefit of the new system is that it will give weight to the qualitative
differences in banks’ choices, rather than treating types of finance as blanket
categories.202 This is known as the IRB compliance, and is far more complicated
than the Basel I formulas.203 For those who see this as a positive step,

[t]hese investments enable banks to realise more consistent profits

and reduced volatility of credit losses by taking a structured and
consistent view of risk management. Also, banks may actually realise

196 Rodríguez, supra note 12, at 11.

197 FRB Capital Standards for Banks, supra note 103, at 398.

198 Id.

199 Id.

200 Id.

201 Id.

202 See id.

203 See id.

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an increase in profits in the form of lower provisions, consistent risk

spreading, more effective deployment of capital and loss avoidance.204

Some believe that this will lead to better decisions on the day-to-day level of
the bank, because the new system rewards quality, rather than merely quantity:
“differentiating risk on an asset-by-asset level adds transparency to the credit
decision-making process and empowers better economic decision making.”205 On a
second level, some see Basel II as leading to greater consistency within a bank’s
internal risk systems.206

There is also a new charge for operational risk that is factored into the
former 8% capital requirement.207 Operational risk is “defined as ‘the risk of loss
resulting from inadequate or failed internal processes, people and systems or from
external events.’”208 The new formula includes credit risk + market risk +
operational risk.209 The measurements for market risk remain the same as under the
1998 amendment.210

Even the most enthusiastic recognize that Pillar One places new burdens on
data acquisition and management when it is figured on a less standardized system.211

Jason Kofman, Basel II: Laying the Groundwork, THE BANKER, July 1, 2004, at 165 [hereinafter
204

Kofman].

205 Id.

206 Id.

207 See Patrick de Fontnouvelle et al., The Potential Impact of Explicit Basel II Operational Risk

Capital Charges on the Competitive Environment of Processing Banks in the United States 23 (Fed.
Reserve Bank of Boston, Jan. 12, 2005), available at
http://www.federalreserve.gov/generalinfo/basel2/docs2005/opriskjan05.pdf.

208Rodríguez, supra note 12, at 11; see also Mamiko Yokoi-Arai, The Evolving Concept of Operational Risk
and Its Regulatory Treatment, 9 L. & BUS. REV. AM. 105, 107 (2003) (“[Operational risk] is generally
defined as ‘the risk of losses resulting from inadequate systems, controls or human error.’”) (quoting
Group of Thirty, Global Derivatives: Practices and Principles (July 1993)) [hereinafter Yokoi-Arai].

209 Yokoi-Arai, supra note 208, at 107.

210 Id.

211 See Kofman, supra note 204, at 165.

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TO THE POSTMODERN ERA IN INTERNATIONAL FINANCIAL REGULATION WITH BASEL II?

In part, this is probably why the Basel Committee felt the need to add two additional
pillars.

Pillar Two concerns banking supervision, which sets out “four key
supervisory principles.”212 The supervisors are supposed to encourage development
of internal methods of assessing capital and control methods.213 Supervisors are also
supposed to intervene as soon as possible if bank levels of capital dip below the 8%
capital requirement.214 There are no specific directions given on how supervisors are
supposed to accomplish these tasks.215

Pillar Three focuses on “market discipline enforced by greater disclosure of

banks’ financial status and their internal risk management procedures.”216 Banks
must disclose risk exposure, capital adequacy, methods for computing capital
requirements, and any additional material information.217 Disclosure is to take place
twice a year, and quarterly if there is risk exposure, particularly if the bank is involved
in global activities.218

C. The Practical Impact of Basel II: A Two-Tiered System Replaces a Level

Playing Field

Basel I created a system whereby large and small international banks all
configured their capital on the same scale.219 Some, including the Basel Committee,

212 Rodríguez, supra note 12, at 14.

213 See id.

214 Id.

215 Id.

216 Eatwell, Basel II, supra note 8.

217See generally Bank for International Settlements, Part 4: The Third Pillar – Market Discipline, in THE
NEW BASEL CAPITAL ACCORD 154 (2003) (describing the disclosure requirements under Basel II),
available at http://www.bis.org/bcbs/cp3part4.pdf.

218 HEFFERNAN, supra note 70, at 203.

219 Some have called Basel a regulatory “imperialism” because a group of bankers created a standard,

which was then adopted by the G-10 countries, whose banks then all followed the requirements. See,
e.g., Michael S. Barr & Geoffrey P. Miller, Global Administrative Law: The View from Basel, 17 EUROPEAN
J. OF INT’L L. 15, 20 (2006) (“While the Basel standards were intended only to apply to internationally
192 TRANSACTIONS: THE TENNESSEE JOURNAL OF BUSINESS LAW [Vol. 8

believed this would help create a more level playing field.220 Basel II does away with
this notion entirely.221 Moreover, unlike Basel I, not everyone is poised to adopt the
new standards. In fact, the U.S. has decided that only its top ten international banks
will be required to adopt Basel II, with an additional ten having the option to choose
between Basel I and Basel II.222 As the Federal Reserve explained,

Basel I was a major step forward in capital regulation. Indeed, for

most banks in this country, Basel I is now—and for the foreseeable
future will be—more than adequate as a capital framework. . . . Basel
I is too simplistic to adequately address the activities of our most
complex banking institutions.223

But Basel II does not come without concern. Some worry Basel II creates a
complicated system that brings a false sense of security.224 Alan Greenspan worried
that foreign banks would claim they have proper risk management systems in place,

active banks in the G-10, the 1988 Accord was quickly applied to all banks in the G-10, and over 100
other countries ‘voluntarily’ adopted the accord.”); see also Testimony of Jim Garnett on Behalf of the
American Bankers Association before the Committee on Banking, Housing and Urban Affairs of the
United States Senate, September 26, 2006, at 5, available at http://www.aba.com/NR/rdonlyres/
222CE044-577A-11D5-AB84-00508B95258D/44460/GarnettSenateTestimonyfinalSept262006.pdf.
He concludes his testimony, “The initiative to improve existing capital rules could impose burdens
that far outweigh its benefits.” Id. at 8. But he is also not advocating a one-size fits all system: “It is
important that risk and capital be appropriately linked for all banks regardless of their size, and in such
a way as to avoid creating competitive disparities.” Id.

220See Remarks by Roger W. Ferguson, Jr. at the ICBI Risk Management 2003 Conference, Geneva,
Switzerland, December 2, 2003, http://www.federalreserve.gov/BoardDocs/Speeches/
2003/20031202/default.htm (last visited Nov. 9, 2006).

221 Testimony by James H. McKillop, U.S. House of Representatives Committee on Financial

Services, A Review of Regulatory Proposals on Basel Capital and Commercial Real Estate, September
14, 2006, at 13, available at http://www.icba.org/files/ICBASites/PDFs/test091406.pdf.

222 See Testimony of Vice Chairman Roger W. Ferguson, Jr., U.S. House of Representatives, Basel II,

before the Subcommittee on Domestic and International Monetary Policy, Trade, and Technology,
Committee on Financial Services, February 27, 2003, http://www.federalreserve.gov/boarddocs/
testimony/2003/200302272/default.htm (last visited Nov. 9, 2006).

223 Id.

224Credit Suisse Group, The New Basel Capital Accord, Consultative Paper of Jan. 16, 2001, at 5
(May 30, 2001), available at http://www.bis.org/bcbs/ca/cresuigro.pdf [hereinafter The New Basel
Capital Accord].
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TO THE POSTMODERN ERA IN INTERNATIONAL FINANCIAL REGULATION WITH BASEL II?

when in actuality they too were far from prepared.225 This is particularly worrisome,
since the IRB systems help determine the capital charges themselves.

1. The IMF and the World Bank

The IMF increasingly views itself as a financial regulator.226 After the

1997/1998 financial crisis, the IMF and the World Bank set up a new worldwide
Financial Sector Assessment Program (“FSAP”).227 Moreover, the IMF has plans for
implementing Basel II around the world.228 One commentator worries, “Handing
financial regulation back to ‘market discipline’ will nullify the progress that has been
made to create a system of international regulation.” 229

2. Benefits May Fall Short

Some commentators think that while the measuring of regulatory capital will
be far more complex, the new system does not necessarily promise to be any more
accurate.230 For developing countries, some believe Basel II will detrimentally affect
lending “as a consequence of . . . lending to lower rated borrowers.”231 Others
predict that those who do adopt Basel II will spend an enormous amount figuring
out the capital requirements, reducing any benefit Basel II might have brought

225 See Remarks by Chairman Alan Greenspan at the Conference on Bank Structure and Competition,

Federal Reserve Bank of Chicago, Chicago, Illinois, May 10, 2002, http://www.federalreserve.gov/
boarddocs/speeches/2002/20020510/default.htm.

226 See Eatwell, Basel II, supra note 8.

227 Id.

228 Id.

229 Id.

230 See, e.g., Stephany Griffith-Jones, Miguel Angel Segoviano & Stephen Spratt, Basel II and
Developing Countries: Diversification and Portfolio Effects 11 (Dec. 2002), available at
http://www.stephanygj.com/_documents/Basel_II_and_Developing_CountriesDiversification_and_
Portfolio_Effects.pdf.

231 Id.
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them.232 “Indeed, the Credit Suisse Group estimates compliance costs at an average
of $15 million per bank for about 30,000 banks worldwide.”233

The hope is that the IRB model will result in lower capital charges, but at
what price? Moreover, Basel II requires that the regulatory capital cannot be
decreased very rapidly from the Basel I requirements. A bank must keep the current
minimum of at least 90% of the Basel I standard for the first year and 80% for the
second year.234 This is in contrast to the extensive costs associated with
implementing the new system. Basel II also requires greater supervision and
regulatory oversight, something that was not as necessary with the Basel I system.235

3. And What About in a Crisis?

Many are predicting that Basel II will work just fine in day-to-day operations,
but once a crisis hits, the new regulatory system will only increase risks, losses, and
panic, rather than stabilizing the financial and social environment.236 One person
predicting danger with Basel II is Lord John Eatwell, Director of the Cambridge
Endowment for Research in Finance.237 He sees three problems with Basel II and its
creation of a more risky world.238 He explains that this is because the internal risk
management systems of individual firms are extremely sensitive to changes in the
market.239 Eatwell explains and predicts,

232See, e.g., Ernst & Young, Global Basel II Survey: Basel II: The Business Impact 7 (2006), available at
http://www.ey.com/global/download.nsf/Ireland/Basel_II_Survey/$file/Basel%20II%20Survey.pdf
; The Economist Intelligence Unit, Weighing Risk: Basel II and the challenge for mid-tier banks 13
(2004), available at http://www.oracle.com/industries/campaigns/finsrv/oracle_eiu_baselii.pdf.

233 Rodríguez, supra note 12, at 3 (citing The New Basel Capital Accord, supra note 224, at 7).

234 Id. at 16.

235 Id. at 15.

236 See, e.g., Eatwell, Basel II, supra note 8.

237 See Cambridge Endowment for Research in Finance, Professor Lord Eatwell,
http://www.cerf.cam.ac.uk/staff/index.php?current=3&staff_id=5 (last visited Nov. 9, 2006).

238 See Eatwell, Basel II, supra note 8.

239 Id. For more on Lord Eatwell, please see www.cerf.cam.ac.uk.

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TO THE POSTMODERN ERA IN INTERNATIONAL FINANCIAL REGULATION WITH BASEL II?

Good risk managers hold a portfolio of assets that are not volatile
and the prices of which are not highly correlated—not correlated in
normal times that is. But in a crisis the volatility of a given asset may
rise sharply. The models will tell all firms to sell. As all try to sell,
liquidity dries up. As liquidity dries up, volatility spreads from one
asset to another. Previously uncorrelated assets are now correlated in
the general sell-off, pumped up by the model driven behaviour of
other institutions caught in the contagion. So whilst in normal times
models may encompass a wide range of behaviour, in extreme
circumstances they will encourage firms to act as a herd, charging
toward the cliff edge together. 240

Eatwell further explains,

[T]he emphasis on disclosure reduces the diversity of information

that has in the past created diversity of action. Today, information is
ever more readily available, and disclosure of price sensitive
information is legally required. Insider dealing on private
information is, rightly, characterised as market abuse. But the
attainment of equal information is bought at a cost - increased
likelihood of herd behaviour as all react in the same way to the same
news.241

Eatwell also believes that a herding mentality will act in the wrong way during a
crisis: “So, in extremis, when regulation really matters, it will work the wrong way,
reinforcing destabilising behaviour.”242

IV. ARE WE ENTERING THE POSTMODERN ERA OF INTERNATIONAL

FINANCIAL REGULATION?

Basel II is typically viewed as reflecting the increasing complexity within the

global financial markets. Because of the Asian Crisis and its aftermath in 1997 and
1998, and increased regulatory arbitraging, a more complex agreement was needed
than Basel I and the 1998 amendments. Is it possible to place this shift in need and

240 Eatwell, Basel II, supra note 8.

241 Id.

242 Id.
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response within a larger theoretical context?243 Might we see these developments as a

movement from a modern to a postmodern system of banking?

A. The Differences between Pre-modernism, Modernism, and

Postmodernism

This Article began with a reference to George Bailey’s bank-related troubles

in It’s a Wonderful Life. The banking system represented in that film can be seen as
something of a precursor to the modern banking world, which is to say a precursor
to Basel I. This Section explores Bailey’s pre-modern bank, and what Bailey’s world
would look like in a modern Basel I and a postmodern Basel II context, to better
understand just what changes are occurring on a socio-cultural scale. This Section
argues that Basel II, while commonly viewed as reflecting an increasingly complex
globalized financial world, can also be seen as reflecting a postmodern socio-cultural
condition. And if we understand the cultural milieu that we inhabit, we can better
confront the shortcomings and praise the inventiveness of the era. In short, how
should we culturally conceptualize the development of Basel I and Basel II in the late
twentieth and early twenty-first centuries?

It is notable that the crisis that George faces is entirely local. In fact, it is the
local nature of the crisis that provides the dramatic foundation for the film’s pathos.
George believes himself to be alone, facing off against an opponent with far greater
economic resources than George could hope to muster. It is the town, his friends
and neighbors, that ultimately comes to his rescue. In the end, George is “the richest
man in town” because his immediate social relations provide a means for combating
the financial threat that he faces. In this manner, his social relations take on greater
significance than his financial standing.

George’s experience, and the lesson he takes away from it, is only possible
within a pre-modern banking system. Mr. Potter’s attempt to foreclose and take
over George’s savings and loan affects only the two individual institutions and those
with deposits in George’s savings and loan. While this may impact those individuals
who invested in George’s savings and loan, there is no suggestion that such an
occurrence would translate into any sort of crisis touching other financial
institutions. The condition of financial affairs has changed radically over the course
of the twentieth century as banking and financial practices have grown increasingly
national and international in character.

243For others working on the subject of Basel from a more theoretical perspective, see, e.g, Ethan B.
Kapstein, Supervising International Banks: Origins and Implications of the Basle Accord, ESSAYS IN INT’L FIN.,
no. 185, (1991); Thomas Oatley & Robert Nabors, Redistributive Cooperation: Market Failure, Wealth
Transfers, and the Basle Accord, 52 INT’L ORG. 35 (1998).
2006] GEORGE BAILEY IN THE TWENTY-FIRST CENTURY: ARE WE MOVING 197
TO THE POSTMODERN ERA IN INTERNATIONAL FINANCIAL REGULATION WITH BASEL II?

As noted above, the profound changes in the organization of production,

distribution, and consumption through the course of and following World War II
can be seen, in retrospect, as the culmination of “Fordist” practices (named after the
automobile giant Henry Ford) dating back to innovations initiated in the early
periods of the twentieth century.244 Only with institutionalization, through the post-
World War II Bretton Woods system, could a stable version of these financial
arrangements be propagated on a global scale. With the U.S. domination of the
West, financially and otherwise, following World War II, this financial regime held
for several decades, bringing along with it a maturation of the international banking
system. Ironically, the very developments bringing it to maturation also sowed the
seeds of the Bretton Woods system’s collapse in the early years of the 1970s. The
modern banking system had become truly global by this time and, as other elements
fatally fractured the overall financial global system that was in place, the first
instances of bank failures threatening to swamp interconnected institutions with
similar crises was experienced.

Basel I, conceptualized as operating within a modern configuration of

international banking, reflects a modernist approach to solving problems within and
among financial institutions. Bretton Woods sought global stability through the
institutionalization of international financial controls underpinned by U.S.
hegemonic dominance. In spite of the increasingly complex global financial
conditions appearing in the aftermath of the Bretton Woods collapse, the approach
Basel I took in response to this crisis proved similarly modernist in perspective. Like
Bretton Woods, Basel I embraces a modernist belief that greatest stability can be
achieved through a centralized authority deploying a controlled solution throughout
the system. Even more significant than centralization, however, is the belief under
Basel I, originated in the attempt to prevent the occurrence of another Herstatt
Debacle, that a universal, one-size-fits-all system could be formulated that would
adequately regulate all of the international banks in the same manner.

In contrast, Basel II moves beyond a modernist paradigm in a number of

ways. Though its formulation has been centrally organized, Basel II is a complex,
convoluted, individualized system that may or may not work to achieve its goals of
capital stability. There is not the same confidence in the plan. Moreover, even the
design of the agreement reflects a postmodern multivalent chorus of interests and
concerns, with over 250 comments from outside of the committee dramatically
altering the final product. The mix-and-match approach to determining a bank’s
regulatory capital also reflects a postmodern consciousness. There is no attempt to
fit all banks into a universal system; many banks will not even opt into Basel II. It
244 See HARVEY, supra note 22, at 124.
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reflects our world today, wherein one agreement to fit the problem is no longer
recognized as a viable goal.

And where does this lead us in looking at Basel I and Basel II? These
documents are a reflection of our times, demonstrating not only the needs of
banking institutions to ward off crises, but also how we conceive the structure of the
world. Neither Basel I nor Basel II would have been structured as a solution to
George Bailey’s problems. And what of George Bailey in the twenty-first century?
If his small savings and loan still existed and had not been consolidated into a larger,
international banking institution, he would not have to implement Basel II. But he
might be worried that the large international banks would now have an even greater
advantage with IRBs instead of a standardized method of determining regulatory
capital. And his foe, his contemporary Mr. Potter, likely would cast a far wider
shadow, now in the form of the international bank. George also might worry that
the uneven playing field would become insurmountable under Basel II. He might be
grateful that his system of determining the 8% capital requirement is still relatively
easy and not too costly, since he would still be operating under Basel I. But he also
would know that in some way he was being left behind, as the world moved from a
straightforward, modernist framework—fearful of the world coming apart—to a
postmodern framework—embracing differences, chaos, and even potential failure in
favor of individuality, potential profit, and the greater complexities that comprise our
postmodern world.