The 1980s saw an international banking revolution take place spawned by a globalization of America's financial reconstructing amid the continuing global debt crisis. This led to adoption of a set of international safeguards by the 12 leading Western banking countries, known as the Basle Agreement. While the agreement has its weak points, its general thrust is to improve the banks' creditworthiness and ability to cope with increased risks.
Global deregulation has sharpened competition among all types and nationalities of financial institutions leading to accelerated innovation as financial firms try to maintain and increase their market share with "high-tech" products such as interest rate swaps and currency options. Unfortunately, the intensification of financial change is taking place against the backdrop of the global debt crisis, with many Latin American, East European, and African countries in substantial arrears on their debt payments.
Central banks in major countries are naturally concerned about the viability of the banking systems they supervise, particularly the inadequate capital (stockholders' equity) relative to the credit (default) risks and interest rate risks their wards face. This is due not only to the global debt crisis but also to the financial industry's new products. These often involve large, poorly understood risks. For example, Merrill Lynch lost $325 million in its new and very risky interest only/principal only stripped mortgage securities' dealings.
International coordination of the major countries' central banks' supervisory responsibilities has traditionally taken place at the monthly plenary meetings and in specialized committees at the Bank for International Settlements (BIS) in Basle, Switzerland. In fact, its circular $150 million skyscraper headquarters, with its panoramic views of the Rhine River, France, and West Germany, has come to be known as the "central bank of central banks."
In 1975, the major central banks signed the famous Concordat (modified in 1983), defining central banks' responsibilities in an age of proliferating banking branches, subsidiaries, and joint ventures, and amid major bankruptcies, such as those of Franklin National Bank in the United States, Bankhaus Herstatt in Germany, and Bank Ambrosiano Holding in Luxembourg. Thirteen years later, in July 1988, the Group of Ten countries (Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom, and the United States) plus Switzerland and Luxembourg signed the Basle Agreement to provide uniform 8 percent, risk-adjusted capital asset ratios for banks in the signatory nations. Essentially, the riskier the asset, the greater the amount of capital that has to stand behind it, with a standard $100 asset requiring $8 in bank capital backup.
The vice chairman of the U.S. Federal Reserve System, Manuel Johnson, signed the agreement on behalf of the Federal Reserve System, and it was subsequently approved in August 1988 by the Fed's Board of Governors by a 5 to 1 vote.
The catalyst for the Basle Agreement was the Fed's concerns over the inadequacy of America's capital asset ratio requirements, both from the viewpoints of being too low and not being risk-adjusted. The basic regulation had been that American banks must have capital equal to 6 percent of assets, of which 5.5 percent must be
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