supervision is included in the BCP’s but the data on BCP compliance (BCP 20) indicate that it is an area where many countries fail<sup>13</sup> . Indeed BCP 20 has the highest percentage of countries in either non-compliance or material noncompliance than any other Basel Core Principle and this area is singled out for special mention in a recent paper by the World Bank and the IMF on concerns regarding the pattern of BCP compliance<sup>14</sup> .

If we extend consolidation to the cross-border variety (BCP number 23), then the picture becomes even more worrisome. Cross-border here might include an “offshore bank” owned by a national bank or a retail or other type of bank operating in another jurisdiction. In the case of developing countries, especially those with a history of capital flight, cross-border consolidation can be important. In Latin America in particular such institutions have been the source of serious problems and regulators frequently do not have the appropriate authority, enforcement powers or information<sup>15</sup> .

The aim of Basel II is that banking supervisors will consolidate from the holding company of a banking group down and not just traditional consolidation, i.e., down from the bank within a holding group. This change is understandable given the changing face of financial group structures in many countries, but as many developing countries do not have traditional consolidated supervision, it represents a huge challenge<sup>16</sup> .

> 13 The wording in the new Accord does allow for a national supervisor not to consolidate all entities within a group (paragraphs 7 and 8 of the CP3).  However, the spirit of the Accord is clearly towards a deeper level of consolidation and in those instances where an entity within a group is not consolidated a) it must be subject to other (appropriate) regulation, b) it remains imperative that banking supervisors still have sufficient information on those entities and c) all investment in those entities must be deducted from capital. As the paragraph on the BCP surveillance indicates, many countries fail on the current definition of consolidated supervision let alone the more ambitious Basel II version.

14 “Implementation of the Basel Core Principles for Effective Banking Supervision, Experiences, Influences and Perspectives”, World Bank and IMF, Sept 23 2002.

15 In the case of Argentina an essentially unregulated offshore operation caused the first bank to close during the Tequila crisis, in late 1994, and in Ecuador the offshore sector was a source of considerable problems and eventually was even granted a deposit guarantee in the banking crisis of 1999/2000.

16 On the other hand, Basel II is decidedly weak on investments in non-financial companies and on related lending. Basel II is the first time that the BCBS has introduced specific rules on something like related lending. The rule in the proposals is that any single investment above 15% of bank capital (and aggregate investments of this type over 60% of capital) would be deducted from bank capital. Moreover, below this limit the investment would attract a 100% risk weight under the standardized approach and at least that under the IRB approach. Many developing countries already have stricter rules including actual limits and not just deductions from capital over a given threshold. Ecuador has the strictest rules I am aware of where the limit is literally zero i.e.: a bank cannot lend to a “related” party. Related lending is covered in BCP 10.

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