What Is the Basel Accord?
The Basel Accords are three series of banking regulations (Basel I, II, and III) set by the Basel Committee on Bank Supervision (BCBS). The committee provides recommendations on banking regulations, specifically, concerning capital risk, market risk, and operational risk. The accords ensure that financial institutions have enough capital on account to absorb unexpected losses.
Basel Accord Deconstructed
The Basel Accords were developed over several years beginning in the 1980s. The BCBS was founded in 1974 as a forum for regular cooperation between its member countries on banking supervisory matters. The BCBS describes its original aim as the enhancement of "financial stability by improving supervisory knowhow and the quality of banking supervision worldwide." Later, the BCBS turned its attention to monitoring and ensuring the capital adequacy of banks and the banking system.
- The Basel Accords are three series of banking regulations set by the BCBS.
- The accords are designed to ensure that financial institutions have enough capital on account to meet obligations and absorb unexpected losses.
- The latest accord is Basel III, which was agreed in November 2010. Basel III requires banks to have a minimum amount of common equity and a minimum liquidity ratio.
The first Basel Accord, known as Basel I, was issued in 1988 and focused on the capital adequacy of financial institutions. The capital adequacy risk (the risk that an unexpected loss with hurt a financial institution), categorizes the assets of financial institutions into five risk categories (0%, 10%, 20%, 50% and 100%). Under Basel I, banks that operate internationally are required to have a risk weight of 8% or less.
The second Basel Accord, called the Revised Capital Framework but better known as Basel II, served as an update of the original accord. It focused on three main areas: minimum capital requirements, supervisory review of an institution's capital adequacy and internal assessment process, and the effective use of disclosure as a lever to strengthen market discipline and encourage sound banking practices including supervisory review. Together, these areas of focus are known as the three pillars.
In the wake of the Lehman Brothers collapse of 2008 and the ensuing financial crisis, the BCBS decided to update and strengthen the Accords. The BCBS considered poor governance and risk management, inappropriate incentive structures, and an overleveraged banking industry as reasons for the collapse. In November 2010, an agreement was reached regarding the overall design of the capital and liquidity reform package. This agreement is now known as Basel III.
Basel III is a continuation of the three pillars along with additional requirements and safeguards. For example, Basel III requires banks to have a minimum amount of common equity and a minimum liquidity ratio. Basel III also includes additional requirements for what the Accord calls "systemically important banks" or those financial institutions that are considered "too big to fail."
The Basel Committee on Banking Supervision agreed on the terms of Basel III in November 2010, and it was scheduled to be introduced from 2013 until 2015. Basel III implementation has been extended repeatedly, and the latest completion date is expected to be January 2022.