As a consequence, the Basel Committee has come up with a new proposal known as Basel II. This proposal is intended to be more risk sensitive than the 1988 Accord, in order to provide a better alignment and calibration of regulatory capital and capital adequacy with the underlying economic risks that banks face. Categorizing debtors into a fewer risk ‘buckets’ was certainly a progress in 1988, but it open the gap between the regulatory risk measurement of any given transaction and its actual economic risk. This favours high risk loans over the low risk ones, given the 100% risk weight charged, irrespective of the risk profile of firms receiving the loan. Consequently, it adversely affects the accuracy of assessing capital requirements and allocation. The most concerning side-effect has been the distortion of financial decision-making which is, loans and investments made on basis of regulatory constraints rather than genuine economic opportunities. The new Basle II accord tries to improve on these issues by encouraging banks to become more sophisticated in their risk assessment and aligning more rigorously regulatory requirements with internal risk measurement methodologies. It is important to recognize that the application of the New Accord is principally intended for large international banks, which are complex institutions usually operating in developed countries. Therefore, Basel II has often been questioned about its implications and appropriateness for banking in emerging market economies, and it is on this point that I would like to focus my remarks.
The recent competitive environment has actually fostered the gradual transformation of banking activities, with a greater emphasis on the "originate and distribute" business model. With this model, credit institutions arrange financings but quickly offload a substantial portion of their risks, for example through securitisation, and take payment – much more so than in the past – in the form of fees and commissions. But although activity in new products such as LBOs is helping to boost French banks' revenues and earnings, it is also a source of vulnerability. First, in terms of remuneration, fierce competition among credit institutions is not only exerting downward pressure on margins; it is encouraging "covenant-lite" deals – a worrying trend. These complex transactions are also beginning to generate new risks. On this point, there is a tendency towards longer underwriting periods, during which banks bear the bulk of the risk. Banks should also pay attention to the fact that counterparties such as hedge funds are becoming increasingly involved in this type of deals. Allow me two brief asides, if you will. First, with regard to LBOs, let me refer you to the study appended to the Annual Report. On the topic of hedge funds, I would remind you that the Banque de France devoted a special issue of its financial stability review to this subject and that the Commission Bancaire pays close attention to banks' involvement with this type of counterparty.