Table of Contents
- What Is the Basel Accord?
- A Comprehensive Guide to the Basel Accord
- Basel I: Establishing Foundation for Global Banking Stability
- Basel II: Enhancing Risk Management
- Basel III: Strengthening the Banking Sector Post-Crisis
- Basel III Endgame: Finalizing Key Reforms for Enhanced Stability
- Why Is Basel So Important?
- Why Did Basel I Fail?
- Who Set Up the Basel Accords?
- The Bottom Line
What Is the Basel Accord?
Let me explain the Basel Accords directly: they're essential banking regulation frameworks set by the Basel Committee on Bank Supervision to make sure banks around the world keep enough capital on hand. Covering Basel I, II, and III, these accords adapt to changing economic issues to strengthen the safety of financial institutions. You need to know they're about preventing banks from collapsing under unexpected losses.
A Comprehensive Guide to the Basel Accord
The Basel Accords started developing in the 1980s. The BCBS was established in 1974 as a place for member countries to cooperate on banking supervision. Its initial goal was to boost financial stability by improving supervisory skills and banking oversight globally. Later, it shifted focus to checking and securing banks' capital adequacy.
Basel I came from central bankers in the G10 countries, who were building new international financial systems after the Bretton Woods collapse. These accords are named after Basel because the BCBS is based at the Bank for International Settlements in Basel, Switzerland. Members include countries like Australia, Argentina, Belgium, Canada, Brazil, China, France, Hong Kong, Italy, Germany, Indonesia, India, Korea, the United States, the United Kingdom, Luxembourg, Japan, Mexico, Russia, Saudi Arabia, Switzerland, Sweden, the Netherlands, Singapore, South Africa, Turkey, and Spain.
Basel I: Establishing Foundation for Global Banking Stability
Basel I, issued in 1988, targeted capital adequacy for financial institutions. It deals with capital adequacy risk by sorting assets into five risk categories: 0%, 10%, 20%, 50%, and 100%. Banks operating internationally had to hold at least 8% capital (Tier 1 and Tier 2) against their risk-weighted assets to cover obligations.
For instance, if a bank has $100 million in risk-weighted assets, it must keep at least $8 million in capital. Tier 1 is the bank's most liquid primary funding, while Tier 2 includes hybrid instruments, loan-loss reserves, revaluation reserves, and undisclosed reserves.
Basel II: Enhancing Risk Management
Basel II, the Revised Capital Framework, updated the original accord. It emphasized three areas: minimum capital requirements, supervisory review of capital adequacy and internal processes, and using disclosure to enforce market discipline and sound practices. These are the three pillars.
It expanded regulatory capital to three tiers, with higher tiers limiting subordinated securities. Each tier makes up a portion of total regulatory capital for ratio calculations. Tier 3, for market, commodities, and currency risks in trading, included varied but lower-quality debt; Basel III later removed it.
Basel III: Strengthening the Banking Sector Post-Crisis
Following the 2008 Lehman Brothers failure and crisis, the BCBS decided to toughen the accords. They pointed to poor governance, bad incentives, and overleveraging as causes. In November 2010, they agreed on a capital and liquidity reform package called Basel III.
Basel III builds on the three pillars with extra requirements, like minimum common equity and liquidity ratios. It adds rules for 'systemically important' too-big-to-fail banks and dropped Tier 3 capital. These reforms are now in the consolidated Basel Framework, with Basel III tier 1 implemented and most member countries in monitoring as of June 2021.
Basel III Endgame: Finalizing Key Reforms for Enhanced Stability
The final Basel III phase, Basel III Endgame, starts rolling out in 2025. Proposed in July 2023 to match U.S. rules with Basel III, it requires more capital for stress cushions. Phased over three years to full compliance by July 1, 2028, it hits banks with $100 billion+ assets hardest—37 in the U.S.—while sparing smaller banks.
There's pushback; JPMorgan's Jamie Dimon says it raises requirements 20-25% for sound large banks, hurting everyday people. Critics warn of reduced lending, less green funding, and weaker U.S. competitiveness. Supporters say it's essential to avoid failures and bailouts.
Why Is Basel So Important?
The Basel Accords make sure banks have enough money to survive. They set standards for a safe global banking system and stop governments from using taxpayer money to bail out overspending banks.
Why Did Basel I Fail?
Basel I and II didn't stop the 2007-2009 crisis and recession, leading to stricter controls. Criticisms include its simplistic risk weighting, focus only on credit risk, ignoring other risks, and reducing lending capital.
Who Set Up the Basel Accords?
The BCBS, created by G10 central bank governors after 1970s bank failures in Germany and the U.S., set them up.
The Bottom Line
The Basel Accords—I, II, and III—provide full regulatory frameworks for banking to protect stability. They ensure banks hold capital against losses and crises. Basel I laid the groundwork in 1988 with adequacy norms, and Basel III addresses post-2008 risks with better capital and liquidity. These are key for reducing global banking risks and building trust in institutions.
Key Takeaways
- The Basel Accords are international banking regulatory agreements developed to ensure banks maintain adequate capital to absorb unexpected losses.
- Basel I, introduced in 1988, categorized bank assets into risk categories, requiring banks to hold a minimum of 8% capital against risk-weighted assets.
- Basel II refined the approach with three pillars: minimum capital requirements, supervisory review, and market discipline through disclosure.
- Basel III, initiated after the 2008 financial crisis, introduced stringent capital and liquidity requirements for banks, removing Tier 3 capital considerations.
- The ongoing Basel III Endgame aims to further increase capital requirements for large banks to enhance stability and prevent future financial crises.
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