Basel Accords : The Basel Accords are a series of three sequential banking regulation agreements (Basel I, II, and III) set by the Basel Committee on Bank Supervision (BCBS).
What are the Basel Accords?
The Basel Accords refer to a set of banking supervision regulations set by the Basel Committee on Banking Supervision (BCBS). The Basel Accords are divided into three parts – Basel I, Basel II, and Basel III.
Need of Basel Accords
The Basel Accords were formed with the goal of creating an international regulatory framework for managing credit risk and market risk. Their key function is to ensure that banks hold enough cash reserves to meet their financial obligations and survive in financial and economic distress. They also aim to strengthen corporate governance, risk management, and transparency.
Basel I
Basel I, also known as the Basel Capital Accord, was formed in 1988. According to Basel I, assets were classified into four categories based on risk weights:
- 0% for risk-free assets (cash, treasury bonds)
- 20% for loans to other banks or securities with the highest credit rating
- 50% for residential mortgages
- 100% for corporate debt
Banks with a significant international presence were required to hold 8% of their risk-weighted assets as cash reserves. International banks were guided to allocate capital to lower-risk investments. Banks were also given incentives for investing in sovereign debt and residential mortgages in preference to corporate debt.
Basel II
Basel II, an extension of Basel I was introduced in 2004. Basel II included new regulatory additions and was centered around improving three key issues – minimum capital requirements, supervisory mechanisms and transparency, and market discipline. These are known as the three pillars of Basel II.
Basel II created a more comprehensive risk management framework. It did so by creating standardized measures for credit, operational, and market risk. It was mandatory for banks to use these measures to determine their minimum capital requirements.
Basel III
The Global Financial Crisis of 2008 exposed the weaknesses of the international financial system and led to the creation of Basel III. The Basel III regulations were created in November 2010 after the financial crisis; however, they are yet to be implemented.
Basel III identified the key reasons that caused the financial crisis. They include poor corporate governance and liquidity management, over-levered capital structures due to lack of regulatory restrictions, and misaligned incentives in Basel I and II.
Basel III strengthened the minimum capital requirements outlined in Basel I and II. In addition, it introduced various capital, leverage, and liquidity ratio requirements.
Basel Committee
Formerly, the Basel Committee consisted of representatives from central banks and regulatory authorities of the Group of Ten countries plus Luxembourg and Spain. Since 2009, all of the other G-20 major economies are represented, as well as some other major banking locales such as Hong Kong and Singapore.
The committee does not have the authority to enforce recommendations, although most member countries as well as some other countries tend to implement the Committee’s policies. This means that recommendations are enforced through national (or EU-wide) laws and regulations, rather than as a result of the committee’s recommendations – thus some time may pass between recommendations and implementation as law at the national level.
