The document discusses the Basel Accords, which are recommendations issued by the Basel Committee on Banking Supervision to strengthen the regulation, supervision, and risk management of the banking sector. It describes the key aspects of Basel I, issued in 1988, and Basel II, issued in 2004. Basel II built on Basel I by establishing three pillars: Pillar 1 sets minimum capital requirements; Pillar 2 establishes supervisory review; and Pillar 3 promotes market discipline through disclosure. The overall goal was to better align regulatory capital with risks and encourage sound risk management practices.

1. By
V.Chaitanya Lakshmi

2.  Refers
to banking supervision Accords
(recommendations on banking laws and
regulations), Basel I and Basel II issued by the
Basel Committee on Banking supervision(BCBS)
 Called
the Basel Accords as the BCBS maintains
its secretariat at the Bank of International
Settlements in Basel, Switzerland

3.  Basel
Committee not a formal regulatory
authority, but has great influence over
supervising authorities in many
countries.
 In 1988, for recognizing the emergence
of larger more global financial services
companies, the Committee introduced
Basel Capital Accord (Basel I) to
strengthen soundness and stability of
international banking system by
requiring higher capital ratios.
 Basel Committee on Banking Supervision
established in 1974 to provide a forum
for banking supervisory matters.

4. •
•
•
Under capital requirements rules, credit
institutions like banks must at all times
maintain minimum financial capital, to cover
the risks
Aim - to ensure financial soundness of such
institutions, maintain customer confidence in
the solvency of the institutions, ensure
stability of financial system at large, and
protect depositors against losses
After extensive communication with banks
and industry groups, the revised framework,
Basel II issued in 2004

5. 
The second of the Basel Accords.

Purpose is to create an international standard that banking regulators
can use when creating regulations about capital banks to be put aside
to guard against financial and operational risks

An international standard can help protect the international financial
system from possible problems should a major bank or a series of
banks collapse.

Basel II attempts to accomplish this by setting up rigorous risk and
capital management requirements to ensure that a bank holds capital
reserves appropriate to the risk the bank exposes itself to through
lending and investment practices.

Greater the risk greater the amount of capital bank needs to hold to
safeguard its solvency and overall economic stability.

6. 


Ensuring that capital allocation is more risk
sensitive
Separating operational risk from credit risk,
and quantifying both
Attempting to align economic and regulatory
capital more closely to reduce scope for
regulatory arbitrage

7. 
Basel I Accord succeeded in raising total level of equity capital
in the system.

However, it also pushed unintended consequences.
Since it does not differentiate risks very well, it perversely
encouraged risk seeking. All loans given to corporate
borrowers were subject to the same capital requirement,
without taking into account ability of the counterparties to
repay.
It ignored credit rating, credit history, risk management and
corporate governance structure of all corporate borrowers. All
were treated as private corporations.
It also promoted loan securitization that led to the unwinding in
the subprime market.




8. • Basel II much more risk sensitive, as it is aligning capital
requirements to risks of loss. Better risk management in a
bank means bank may be able to allocate less regulatory
capital
• The objective of Basel II is to modernise existing capital
requirements framework to make it more comprehensive
and risk sensitive
• The Basel II framework therefore designed to be more
sensitive to the real risks that firms face than Basel I
• Apart from looking at financial figures, it also considers
operational risks, such as risk of systems breaking down or
people doing the wrong things, and also market risk.

9. 3 Pillars of Basel II Framework
• Pillar 1 sets out the minimum capital requirements firms will be required
to meet to cover credit, market and operational risk
• Pillar 2 sets out a new supervisory review process. Requires financial
institutions to have their own internal processes to assess their overall
capital adequacy in relation to their risk profile
• Pillar 3 cements Pillars 1 and 2 and is designed to improve market
discipline by requiring firms to publish certain details of their risks,
capital and risk management as to how senior management and the
Board assess and will manage the institution's risks.

10. FIRST PILLAR




deals with maintenance of regulatory capital calculated
for three major components of risk that a bank facescredit risk, operational risk, and market risk
The credit risk component can be calculated in three
different ways of varying degree of sophistication,
namely standardized approach, foundation IRB and
advanced IRB
For operational risk, there are three different
approaches - basic indicator approach or BIA,
standardized approach or TSA, and the internal
measurement approach
For market risk the preferred approach is VAR i.e. value
at risk

11. Pillar 1 : Minimum capital requirements
Institution's total regulatory capital must be at least
8% (ratio same as in Basel I) of its risk
the amount of capital
8%
Total risk - weighted assets
weighted assets are based on measures of THREE
RISKS

12. CREDIT RISK :
The risk of loss arising from outright default due to
inability or unwillingness of the customer or counter party
to meet commitments in relation to lending, trading,
settlement and other financial transaction of the customer
or counter party to meet commitments
MARKET RISK :
The possibility of loss caused by changes in the market
variables such as interest rate, foreign exchange rate,
equity price and commodity price

13. OPERATIONAL RISK :
Operational risk is risk of loss resulting from inadequate
or failed internal processes, people and systems or from
external events. It includes legal risk, such as exposure
to fines, penalties and private settlements. It does not,
however, include strategic or reputational risk.

14. SECOND PILLAR
deals with the regulatory response to the first
pillar
 provides a framework for dealing with all the
other risks a bank may face, such as systemic risk,
pension risk, concentrated risk, strategic risk,
reputational risk, liquidity risk and legal risk
 gives banks a power to review their risk
management system
 Internal Capital Adequacy Assessment Process
(ICAAP) is the result of Pillar II of Basel II accords


15. 


aims to complement the minimum capital requirements and
supervisory review process by developing a set of disclosure
requirements which will allow the market participants to gauge
the capital adequacy of an institution
allow market discipline to operate by requiring institutions to
disclose details on the scope of application, capital, risk
exposures, risk assessment processes and the capital adequacy
of the institution
It must be consistent with how the senior management
including the board assess and manage the risks of the
institution

16. 
Basel II Framework lays down a more comprehensive
measure and minimum standard for capital adequacy
Seeks to improve on existing rules by aligning regulatory
capital requirements more closely to underlying risks that
banks face.
 In addition, it intends to promote a more forward-looking
approach to capital supervision, that encourages banks to
identify the present and future risks, and develop or
improve their ability to manage them.
 Hence intended to be more flexible and better able to
evolve with advances in markets and risk management
practices.
 Basel II Accord attempts to fix glaring problems with the
original accord. It does this by more accurately defining
risk, but at the cost of considerable rule complexity
