financial products that emerged during Basel II’s implementation stage—namely CDOs, re-securitizations and securitization liquidity facilities, all of which indirectly led to the 2008 crisis.

The new International Regulatory Framework for Banks (Basel III) is the response engineered by the BCBS to avoid the repeat of a similar crisis in the future. Basel III builds on a refurbished Basel II – enhanced in July 2009 with amendments to its three pillars – which is complemented with bold reforms, including: a global liquidity standard, a framework for neutralizing externalities imposed by SIFIs and a countercyclical capital framework.

Basel III will impose challenges to regulators and supervisors. This is even relevant to those that are not Basel Committee member countries and will not adopt it, such as the case with host supervisors of banks whose home supervisor adopts Basel III. It represents a change to traditional supervision techniques. In addition to the ordinary on-site and off-site supervisory processes, under Pillar 2 supervisors are responsible for revising banks validation of their internal rating systems and their assessment of their risk profile and capital adequacy.

- **Impact studies** . It is important that, prior to migrating to a Basel III-based prudential framework, regulators and supervisors simulate the likely effects of its implementation. Impact studies are useful to anticipate possible undesired outcomes from Basel III, such as its ability to tilt the playing field in financial systems when competing banks adopt different approaches to portfolios with a similar risk profile.<sup>28</sup>

In the run-up to the publication of Basel II, and now to calibrate and refine many of the enhancements in Basel III, the BCBS has conducted Quantitative Impact Studies (QIS) in member jurisdictions. These exercises have been performed bottom-up (i.e. by the banks themselves) and their outcomes have been quite detailed. However, it is unclear as to what extent the results between financial institutions are totally comparable. The possibility that authorities can perform the impact studies themselves (top-down approach) should not be discarded as a means to obtaining a readily and consistent, although perhaps rough, estimate of the impact of Basel III.

Banks typically report to PCRs their borrowers risk classification, produced either by the rules issued by the central bank or bank superintendency, or by their own rating system. If further basic information is available such as the type of borrower and credit, outstanding debt, residual maturity, type of mitigation securing each credit, simulating the impact of adopting Basel III is straightforward.<sup>29</sup>

> 28 Exposures that under Basel I carry an 8% capital requirement, under the IRB approach in Pillar 1 may experience dramatic shifts in their capital charge. This situation may tilt the playing field between Basel I and Basel III banks by shifting the incentives to assign capital to different types of credits. Bank regulators should carefully assess the effect on competition in the credit market and on the availability of credit.

> 29 Bank of Spain conducted several impact assessment exercises with its PCR information. Saurina and Trucharte (2004) analyze the impact of Basel II on lending to SMEs, while Saurina and Trucharte (2007) assess the effect procyclicality in mortgage portfolios. Repullo, Saurina and Trucharte (2009) analyze the procyclicality of Point-in-Time (PIT) and Through-the-Cycle (TTC) rating systems. A study on the stability of TTC ratings systems with PCR data of the Central Bank of Argentina can be found in Valles (2006).

11