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Manipulating an IRB model: considerations about the Basel II framework

Manipulating an IRB model: considerations about the Basel II framework Purpose – The purpose of this paper is to contribute to the debate on the current economic crisis and to highlight the importance of the counter‐party credit risk, which was surprisingly neglected by the Basel Committee on Banking Supervision in its proposed enhancements to the Basel II framework. The paper supports the proposition that there is an incentive for synergy between bank management, corporate management and auditors as long as all these parties' remuneration schemes are based on the same principles. Design/methodology/approach – In this paper an advanced IRB corporate credit‐rating system is constructed in accordance with the Basel II framework and the current literature. The impact of common creative accounting and banking practices on the manipulation of that system is explored. Findings – The paper shows how creative accounting and banking practices can be used in manipulating an advanced IRB corporate credit‐rating system, and thus presenting a high‐risk corporation as a highly attractive (low‐risk) bank customer. Practical implications – The regulatory authorities should take into consideration the inability of rating agencies to ascertain the risk associated with the US sub‐prime mortgage market and the decline of auditors' independence. Originality/value – The contribution of the paper is the propositions made to the Basel Committee on Banking Supervision in order to enhance the Basel II framework, and avoid repetition of the current economic crisis in the future. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png EuroMed Journal of Business Emerald Publishing

Manipulating an IRB model: considerations about the Basel II framework

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Publisher
Emerald Publishing
Copyright
Copyright © 2011 Emerald Group Publishing Limited. All rights reserved.
ISSN
1450-2194
DOI
10.1108/14502191111151250
Publisher site
See Article on Publisher Site

Abstract

Purpose – The purpose of this paper is to contribute to the debate on the current economic crisis and to highlight the importance of the counter‐party credit risk, which was surprisingly neglected by the Basel Committee on Banking Supervision in its proposed enhancements to the Basel II framework. The paper supports the proposition that there is an incentive for synergy between bank management, corporate management and auditors as long as all these parties' remuneration schemes are based on the same principles. Design/methodology/approach – In this paper an advanced IRB corporate credit‐rating system is constructed in accordance with the Basel II framework and the current literature. The impact of common creative accounting and banking practices on the manipulation of that system is explored. Findings – The paper shows how creative accounting and banking practices can be used in manipulating an advanced IRB corporate credit‐rating system, and thus presenting a high‐risk corporation as a highly attractive (low‐risk) bank customer. Practical implications – The regulatory authorities should take into consideration the inability of rating agencies to ascertain the risk associated with the US sub‐prime mortgage market and the decline of auditors' independence. Originality/value – The contribution of the paper is the propositions made to the Basel Committee on Banking Supervision in order to enhance the Basel II framework, and avoid repetition of the current economic crisis in the future.

Journal

EuroMed Journal of BusinessEmerald Publishing

Published: Jul 18, 2011

Keywords: Creative accounting; Basel II; IRB credit rating; Credit management; Credit rating; Accounting systems; Banking; Investments; International standards; Laws and legislation

References