The Basel Accords is referred to the banking supervision Accords (recommendations on banking regulations). Basel I, Basel II and Basel III was issued by the Basel Committee on Banking Supervision (BCBS). They are called the Basel accords as the BCBS maintains its secretariat at the Bank for
International Settlements in Basel, Switzerland and the committee normally meets there. The Basel Accords is a set of
recommendations for regulations in the banking industry.
2. The Basel Accords is referred to the banking
supervision Accords (recommendations on
banking regulations). Basel I, Basel II and
Basel III was issued by the Basel Committee
on Banking Supervision (BCBS). They are
called the Basel Accords as the BCBS
maintains its secretariat at the Bank for
International Settlements in Basel,
Switzerland and the committee normally
meets there. The Basel Accords is a set of
recommendations for regulations in the
banking industry.
The basic structure of Basel accords remains
unchanged with three mutually reinforcing
pillars.
1. Pillar 1: Minimum Regulatory Capital
Requirements based on Risk Weighted
Assets (RWAs): Maintaining capital
calculated through credit, market and
operational risk areas.
2. Pillar 2: Supervisory Review Process:
Regulating tools and frameworks for
dealing with peripheral risks that banks
face.
3. Pillar 3: Market Discipline: Increasing
the disclosures that banks must provide
to increase the transparency of banks.
The Basel capital accord in the context of the
international financial architecture.
Basel I: The Basel Capital
Accord
With the foundationsfor supervisionof
internationally active banks laid, capital
adequacy soon became the main focusof the
Committee'sactivities. In the early 1980s,the
onset of the Latin American debt crisis
heightenedthe Committee's concernsthat
the capital ratiosof the main international
bankswere deterioratingat a time of growing
international risks. Backed by the G10
Governors,Committee members resolved to
halt the erosion of capitalstandardsin their
bankingsystems and to work towardsgreater
convergencein the measurementof capital
adequacy. This resulted in a broad consensus
on a weighted approachto the measurement
of risk, both on and off banks' balancesheets.
Advantages of Basel I
• Relatively simple structure
Regulatory capital and economic
capital
• purpose and components of regulatory
capital
• purpose and methods of managing
economic capital
• main differences between the
regulatory and economic capital
by Syed AshrafAli (ID: 2388)
Assignment for the course of “Management of financial institutions”
• Substantially increased the capital ratios
of international banksand enhanced
competitiveequity
• Required capital to be held againstOBS
items
• Widespread adoption world-wide
• Provided a benchmark for analytical
comparativeassessment
Bank Asset Classification
System
The Basel I classification system groups a
bank's assets into five risk categories,
classified as percentages: 0%, 10%, 20%,
50% and 100%. A bank's assets are placed
into a category based on the nature of the
debtor.
The 0% risk category is comprised of cash,
central bank and government debt, and
any Organization for Economic
Cooperation and Development (OECD)
government debt. Public sector debt can
be placed in the 0%, 10%, 20% or 50%
category, depending on the debtor.
Developmentbank debt, OECD bank debt,
OECD securities firm debt, non-OECD
bank debt (under one year of maturity),
non-OECDpublic sector debt and cash in
collection comprises the 20% category.
Prepared by :
(ID: 2388), 4th Batch,
Dept. of Management
Studies
Prepared for :
Lecturer, Dept. of Finance
and Banking,
JahangirnagarUniversity
1
3. THE BASEL NORMS
The 50% categoryis residential mortgages,
and the 100%categoryis represented by
privatesector debt, non-OECDbank debt
(maturity over a year), real estate, plantand
equipment,and capitalinstrumentsissued
at other banks.
The bank must maintain capital (Tier 1 and
Tier 2) equal to at least 8% of its risk-
weighted assets. For example, if a bank has
risk-weighted assets of $100 million, it is
required to maintain capital of at least $8
million.
Implementation of Basel 1
The BCBS regulations do not have legal
force. Members are responsible for their
implementation in their home countries.
Basel I originally called for the minimum
capital ratio of capital to risk-weighted
assets of 8% to be implemented by the end
of 1992. In September 1993, the BCBS
issued a statementconfirmingthat G10
countries'bankswith material international
bankingbusiness were meeting the
minimum requirements set out in Basel I.
Origin facts
Basel is a city in northwestern Switzerland
on the river Rhine. Basel is Switzerland's
third-most-populouscity (after Zürich and
Geneva) with about 175,000 inhabitants.
Responsible for the Basel Accords (Basel I,
Basel II and Basel III),
In June 1999, the Committee issued a
proposal for a new capital adequacy
framework to replace the 1988 Accord.
This led to the release of a revised capital
framework in June 2004. Generally known
as "Basel II", the revised framework
comprised three pillars:
1. minimum capital requirements,
which sought to develop and expand
the standardized rules set out in the
1988 Accord
2. supervisory review of an institution's
capital adequacy and internal
assessment process
3. effective use of disclosure as a lever
to strengthen market discipline and
encourage sound banking practices
The new frameworkwas designed to
improvethe way regulatorycapital
requirements reflect underlyingrisks and to
better address the financialinnovationthat
had occurredin recent years. The changes
aimed at rewardingand encouraging
continued improvementsin risk
measurementand control.
The framework'spublicationin June 2004
followed almost six years of intensive
preparation.During this period, the Basel
Committee consultedextensively with
bankingsector representatives,supervisory
agencies,central banksand outside
observersin order to develop significantly
more risk-sensitive capitalrequirements.
Because bankingregulationssignificantly
Following the June 2004 release, which
focused primarily on the banking book,
2
Limitations of Basel I:
• Limited differentiation of credit risk
• Static measure of default risk
• No recognition of term-structureof
credit risk
• Simplified calculation of potentialfuture
counterpartyrisk
• Lack of recognitionof portfolio
diversificationeffects Not aligned with
the actualrisks faced by banking
organizations
• Broad-brushrisk weightingstructure
• Opportunitiesfor regulatorycapital
arbitrage
• Covered primarily credit risk
4. - the MarketRisk Amendment of 1996
involveda similar requirement - Basel II
cooperation between home and host
supervisors.To help address this issue, the
Committee issued guidanceon information-
sharingin 2006, followed by advice on
supervisorycooperationand allocation
mechanisms in the context of the advanced
measurementapproachesfor operational
risk.
BREAKING DOWN 'Basel 2'
Basel II is a second internationalbanking
regulatoryaccord thatis based on three
main pillars: minimal capital requirements,
regulatorysupervisionand market
discipline. Minimal capital requirements
play the most importantrole in Basel II and
obligate banksto maintain minimum capital
ratios of regulatorycapital over risk-
weighted assets.
Because bankingregulationssignificantly
varied amongcountriesbefore the
introductionof Basel accords,a unified
the Committee turned its attentionto the
tradingbook.In close cooperationwith the
International Organizationof Securities
Commissions(IOSCO), the international
body of securities regulators,the
Committee published in July 2005 a
consensusdocument governingthe
treatmentof banks' tradingbooksunder the
new framework.
For ease of reference, this new text was
integratedwith the June 2004 text in a
comprehensive documentreleased in June
2006: Basel II: International convergenceof
capital measurementand capital standards:
A revised framework- Comprehensive
version.
Committee members and several non-
members agreed to adopt the new rules,
albeit on varyingtimescales. One challenge
that supervisorsworldwide faced under
Basel II was the need to approvethe use of
certain approachesto risk measurementin
multiple jurisdictions.While this was not a
new conceptfor the supervisory community
3
MinimumCapital Requirements
Basel II provides guidelines for calculationof
minimum regulatorycapital ratiosand
confirms the definition of regulatory capital
and 8% minimum coefficient for regulatory
capital overrisk-weightedassets.
Basel II divides the eligible regulatorycapital
of a bank into three tiers. The higher the tier,
the less subordinated securities a bank is
allowed to include in it. Each tier must be of
certain minimum percentageof the total
regulatorycapitaland is used as a numerator
in the calculation of regulatorycapital ratios
frameworkof Basel I and, subsequently,
Basel II helped countries alleviate anxiety
over regulatorycompetitivenessand
drastically different national capital
requirements for banks.
retained earningsand certain innovative
capital instruments.Tier 2 is Tier 1
instrumentsplus variousother bank reserves,
hybrid instruments,and medium- and long-
term subordinatedloans.
Tier 3 consists of Tier 2 plus short-term
subordinated loans.
Anotherimportantpart in Basel II is refining
the definition of risk-weighted assets,which
are used as a denominatorin regulatory
capital ratios,and are calculated by using the
sum of assets that are multiplied by
respective risk weights for each asset type.
The riskier the asset,the higher its weight.
The notionof risk-weightedassets is
intended to punishbanksfor holdingrisky
assets, which significantly increases risk-
weighted assets and lowers regulatory
capital ratios. The main innovation of Basel
II in comparison to Basel I is that it takes
into account the credit rating of assets in
determining risk weights. The higher the
credit rating, the lower risk weight.
Regulatory Supervision and
Market Discipline
Regulatory supervision is the second pillar
of Basel II that provides the framework for
national regulatory bodies to deal with
various types of risks, including systemic
risk, liquidity risk and legal risks. The
market discipline pillar provides various
disclosure requirements for banks' risk
Tier 1 capital is the
strictest definition of
regulatorycapital
that is subordinateto
all other capital
instruments,and
includes
shareholders'equity,
disclosed reserves,
THE BASEL NORMS
5. THE BASEL NORMS
exposures, risk assessmentprocessesand capital
adequacy, whichare helpfulfor users of financial
statements.
Basel II was introduced in 2004, laid down guidelines
for capital adequacy (with more refined definitions),
risk management (Market Risk and Operational Risk)
and disclosure requirements. It uses external ratings
agencies to set the risk weights for corporate, bank
and sovereign claims.
Operational risk has been defined as the risk of loss
resulting from inadequate or failed internal
processes, people and systems or from external
events. This definition includes legal risk, but
excludes strategic and reputation risk, whereby legal
risk includes exposures to fines, penalties, or punitive
damages resulting from supervisory actions, as well
as private settlements. There are complex methods
to calculate this risk.
Advantages over Basel I:
The discrepancybetween economiccapital and
regulatorycapitalis reducedsignificantly,due to thatthe
regulatoryrequirementswill rely on banks’own risk
methods. Basel II is moreRisk sensitive. It has wider
recognitionof creditrisk mitigation.
Contrastof the three
Even before Lehman Brotherscollapsed in
September 2008,the need for a
fundamental strengtheningof the Basel II
frameworkhad become apparent.The
bankingsector entered the financial crisis
with too much leverageand inadequate
liquidity buffers.
These weaknesseswere accompanied by
poorgovernance and risk management,as
well as inappropriateincentive structures.
The dangerouscombinationof these
factorswas demonstratedby the
mispricing of credit and liquidity risks, and
excess credit growth.
Respondingto these risk factors,the Basel
Committee issued Principles for sound
liquidity risk managementand supervision
in the same monththat Lehman Brothers
failed. In July 2009, the Committee issued a
furtherpackageof documents to
strengthen the Basel II capital framework,
notably with regardto the treatment of
certain complex securitization positions,
off-balance sheet vehicles and tradingbook
exposures.These enhancementswere part
of a broader effort to strengthenthe
regulation and supervisionof
internationally active banks,in the light of
weaknessesrevealed by the financial
market crisis.
In September 2010,the Group of Governors
and Heads of Supervision(GHOS)
announcedhigher global minimum capital
standards for commercial banks.This
followed an agreementreached in July
regardingthe overall design of the capital
and liquidity reform package,now referred
to as "Basel III". In November 2010,the new
capital and liquidity standards
were endorsed at the G20 Leaders'Summit
in Seoul and subsequently agreed at the
December 2010 Basel Committee meeting.
The proposedstandardswere issued by the
Committee in mid-December 2010 (and
havebeen subsequently revised). The
December 2010 versionswere set out in
Basel III: Internationalframeworkfor
liquidity risk measurement,standardsand
monitoringand Basel III: A global regulatory
frameworkfor more resilient banksand
bankingsystems.
The enhanced Basel frameworkrevised and
strengthen the three pillars established by
Basel II. It also extended the frameworkwith
several innovations:
• an additional layer of common equity -
the capital conservation buffer - that,
when breached, restricts payoutsto help
meet the minimum common equity
requirement
• a countercyclical capitalbuffer, which
places restrictions on participation by
banksin system-wide credit booms with
the aim of reducing their losses in credit
busts
• a leverage ratio - a minimum amountof
loss-absorbingcapital relative to all of a
bank'sassets and off-balancesheet
exposuresregardless of risk weighting
• liquidity requirements - a minimum
liquidity ratio, the Liquidity Coverage
Ratio (LCR), intended to provide enough
cash to cover fundingneeds over a 30-
day period of stress; and a longer-term
ratio,the Net Stable FundingRatio
(NSFR), intended to address maturity
mismatches over the entire balance
Sheet.
BASEL II Contd.
Limitations:
There is too much regulatorycompliance.It is over
focusedon CreditRisk. This new Accord is complexand
thereforedemanding for supervisors, and
unsophisticatedbanks. Strongrisk differentiation in the
new Accordcan adversely affect theborrowingposition
of riskyborrowers
Basel I
July 1988
Stability
and
fairness of
Internation
al Banking
System
Low Risk
Sensitivity
Backward
looking
Focus
Basel II
July 2004
Capital
Adequacy,
Risk
Manageme
nt and
Disclosure
Requireme
nts
Moderate
Risk
Sensitivity
Somewhat
forward
looking
Focus
Basel III
2010-11
Emphasis
on
Reducing
Systematic
Risk &
Improving
Transparen
cy.
High Risk
Sensitivity
Forward
Looking
Focus
4
6. sheet
• additionalproposalsfor systemically
importantbanks,including
requirements for supplementary
capital,augmented contingentcapital
and strengthenedarrangementsfor
cross-bordersupervisionand
resolution
In January 2012,the GHOS endorsed a
comprehensive processproposed by the
Committee to monitor members'
implementationof Basel III. The
Regulatory ConsistencyAssessment
Programmed(RCAP) consists of two
distinct but complementary work streams
to monitorthe timely adoption of Basel III
standards,and to assess the consistency
and completenessof the adopted
standards includingthe significanceof
any deviationsfrom the regulatory
framework.
These tighteneddefinitions of capital,
significantly higherminimum ratiosand
the introduction of a macroprudential
overlayrepresent a fundamentaloverhaul
for bankingregulation.At the same time,
the Basel Committee, its governingbody
and the G20 Leaders haveemphasized
that the reforms will be introducedin a
way that does not impede the recovery of
the real economy.
In addition,time is needed to translate
the new internationally agreed standards
into nationallegislation.To reflect these
concerns,a set of transitional
arrangementsfor the new standardswas
announcedin September 2010,although
national authoritiesare free to impose
higher standardsand shorten transition
periods where appropriate.
The strengthened definition of capital will
be phased in over five years: the
requirements were introduced in 2013 and
should be fully implemented by the end of
2017. Capital instrumentsthat no longer
qualify as CommonEquity Tier 1 capital or
Tier 2 capitalwill be phased out over a 10-
year period, beginning1 January2013.
Turningto the minimum capital
requirements,the higher minimums for
CommonEquity and Tier 1 capitalwere
phased in from 2013,and became
effective at the beginningof 2015. The
schedule is as follows:
The minimum common equity and Tier 1
requirements increased from 2% and 4%
to 3.5% and 4.5%, respectively, at the
beginningof 2013.
Turningto the minimum capital
requirements,the higher minimums for
CommonEquity and Tier 1 capitalwere
phased in from 2013,and became effective at
the beginningof 2015. The schedule is as
follows:
• The minimum common equity and Tier 1
requirements increased from 2% and 4%
to 3.5% and 4.5%, respectively, at the
beginningof 2013.
• The minimum common equity and Tier 1
requirements rose to 4% and 5.5%,
respectively,at the beginningof 2014.
• The final requirements for common
equity and Tier 1 capitalwere set at 4.5%
and 6%, respectively, at the beginningof
2015.
The 2.5% capital conservationbuffer, which
will comprise common equity and is in
addition to the 4.5% minimum requirement,
will be phased in progressively startingon 1
January2016, and will become fully effective
by 1 January2019.
The leverageratio will also be phasedin
gradually.The test (the so-called "parallel run
period") began in 2013 and will run until 2017,
with a view to migratingto a Pillar 1
treatmenton 1 January 2018 based on review
and appropriate calibration.The exposure
measure of the leverageratio was finalized in
January2014.
The liquidity coverageratio (LCR) will be
phased in from 1 January2015 and will
require banksto hold a buffer of high-quality
liquid assets sufficientto deal with the cash
outflowsencountered in an acute short-term
stress scenarioas specified by supervisors.To
ensure that bankscan implement the LCR
withoutdisruptionto their financing
activities,the minimum LCR requirement
began at 60% in 2015,rising in equal annual
steps of 10 percentagepointsto reach 100%
on 1 January2019.
The otherminimum liquidity standard
introduced by Basel III is the Net Stable
FundingRatio. This requirement,which takes
effect as a minimum standardby 1 January
2018,will promote longer-termfunding
mismatches and provide incentives for banks
to use stable fundingsources.
It is widely felt thatthe shortcomingin Basel
II norms is what led to the global financial
crisis of 2008.Thatis because Basel II did not
haveany explicit regulationon the debt that
bankscould take on their books,and focused
more on individual financial institutions,
while ignoringsystemic risk. The guidelines
aim to promote a more resilient banking
THE BASEL NORMS
system by focusingon fourvital banking
parametersviz. capital,leverage,funding
and liquidity.
"Basel III" is a comprehensiveset of reform
measures,developed by the Basel
Committee on BankingSupervision,to
strengthen the regulation,supervisionand
risk managementof the bankingsector.
Advantages:
• Improved Competitivenessfor the
Chilean BankingSystem
• Greater soundnessfor the financial
system
Limitations:
• stricter bankingregulationsin
developed countriesafter the global
financial crisis
• abundantinternationalliquidity as a
result of extremely low interest rates
It was agreed upon by the members of the
Basel Committee on BankingSupervisionin
2010–11,and was scheduled to be
introduced from 2013 until 2015; however,
changesfrom 1 April 2013 extended
implementationuntil 31 March2018 and
again extended to 31 March2019.
Requirements for common equity and Tier
1 capital will be 4.5% and 6%, respectively.
Also, the liquidity coverageratio (LCR) will
require banksto hold a buffer of high
quality liquid assets sufficientto deal with
the cash outflowsencounteredin an acute
short-termstress scenarioas specified by
supervisors.minimum LCR requirement will
be to reach 100% on 1 January2019. This is
to preventsituationslike "BankRun".
LeverageRatio > 3%: The leverageratio
was calculatedby dividing Tier 1 capital by
the bank'saverage total consolidated
assets; minimum LCR requirement will be
to reach 100%on 1 January 2019. This is to
preventsituationslike "BankRun".
LeverageRatio > 3%: The leverageratio
was calculatedby dividing Tier 1 capital by
the bank'saverage total consolidated
assets;
The minimum LCR requirement will be to
reach 100%on 1 January2019. This is to
preventsituationslike "BankRun".
LeverageRatio > 3%: The leverageratio
was calculatedby dividing Tier 1 capital by
the bank'saverage total consolidated
assets.
5
7. Ensure that no single nationalsystem could
develop an unfaircompetitive advantage.
Followingthe bankingcrisis of 2007/08 a
new, strengthenediteration of the Basel
Accords was released: Basel III. This Accord
was announced in January2013, with an
introductionschedule runningto 2018.
Basel III built on the 2004 version by
increasingcommonequity requirements to
4.5%; increasingTier 1 capital requirements
to 6%; introducinga minimum leverage
ratio (Tier 1 capitaldivided by assets) of 3%;
introducingtwo required liquidity ratios
(one, the Liquidity CoverageRatio, requiring
a bank to hold sufficientliquid assets to
cover its net cash outflowfor 30 days; the
other,the Net Stable FundingRatio,
requiring available.
Reference:
• https://en.wikipedia.org/wiki/Basel_Ac
cords
• http://www.investopedia.com/terms/b/
basel_accord.asp
• http://www.bis.org/bcbs/history.htm
• https://www.itgovernance.co.uk/basel
• https://www.quora.com/What-are-
BASEL-1-2-and-3-norms-What-are-
the-basic-differences-between-these-
norms
• http://www.differencebetween.com/di
fference-between-basel-1-and-vs-2-
and-vs-3/
• https://apps.aima.in/ejournal_new/arti
clesPDF/Dr.BindyaKohli.pdf
• 277010569_Basel_III_in_Chile_Advant
ages_Disadvantages_and_Challenges_
of_Implementing_the_New_Internatio
nal_Standard_for_Bank_Capital
6THE BASEL NORMS