Critical Evaluation of Basel III as Prudential Regulation and its Consequences in Developing Countries’ Credit Needs

This paper seeks to critically evaluate the nature and motivation for the regulatory frame sought in the Basel III norms and its consequences on the credit needs of developing countries. After the failure of previous two Basel accords (I and II), to act as the effective prudential regulation of large financial institutions operating on global scale, the new Basel III accord is hailed as the new regulatory rule which has successfully taken into consideration of all the lacunas of earlier accord. But structurally all Basel accords are market mediated regulation, which tries to contain systemic crisis of financial institution by imposing better liquidity and capital requirements on financial institutions. It was unable to deal with strong elements of regulatory capture, which virtually makes it ineffective. All Basel accords at best tries to stop bank insolvency issues during crisis period but it does not prevent the crisis from occurring altogether (like Glass Steagall act, at 1933 in US). Not only it is micro prudential in nature, it also ignores endogenous evolution of risk of underlying assets of financial institutions. Also non-binding character and ‘one size fit for all’ approach of the recommendation makes it very hard to implement. And for developing nations new Basel III has the potential to make flow of credit more volatile and pro-cyclical and additionally it raises the cost of financing and reduces the level of credit available for developmental purposes. It is unable to deal with the issue of regulatory arbitrage and consequent rise of shadow banking activities in developing countries which are raising serious concern of systemic risk in financial system of these countries.