Basel II, the new capital requirements regime is set to cost UK banks hundreds of millions of pounds. The major cost will development of IT systems for modelling credit risk.

Central to Basel II is a move to allow banks capital requirements to be based on their individual credit risk profile.

Across Europe, Basel II is to be effectively implemented through the European Capital Requirements directive. Yesterday UK financial regulator , the Financial Standards Authority (FSA) launched a consultation document on the matter.

FSA managing director, Hector Sants acknowledged the benefits of the new system, however he said, "Considerable uncertainties remain however , not least in the timing of its introduction."

The models that the banks are required to build are extremely complex. Indeed regulators are not entirely sure exactly which kind of internal models they do want.

The models that the banks are required to build are extremely complex. Indeed regulators are not entirely sure exactly which kind of internal models they do want.

The models that the banks are required to build are extremely complex. Indeed regulators are not entirely sure exactly which kind of internal models they do want.

Two main criteria are used, the likelihood of loan default and the potential loss arising from such a default. Depending on the perceived accuracy of the models by regulators, banks may be allowed to maintain lower levels of capital.

As with any new system, there are those that do not trust it. The first potential problem is that banks data does not extend far back enough to capture major shocks. Potentially painting a too optimistic picture.

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