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), which provides recommendations on banking regulations in regards to capital risk, market risk and operational risk. The purpose of the accords is to ensure that financial institutions have enough capital on account to meet obligations and absorb unexpected losses.

BREAKING DOWN 'Basel Accord'

The Basel Accords were developed over a number of years, starting 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 on, it turned its attention to monitoring and ensuring the capital adequacy of banks and the banking system.

Basel I

The first Basel Accord, known as Basel I, was issued in 1988 and focuses on the capital adequacy of financial institutions. The capital adequacy risk (the risk that a financial institution will be hurt by an unexpected loss), 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.

Basel II

The second Basel Accord, called Revised Capital Framework but better known as Basel II, served as an update of the original accord. It focuses on three main areas: minimum capital requirements, supervisory review of an institution's capital adequacy and internal assessment process, and 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.

Basel III

In the wake of the Lehman Brothers collapse of 2008 and the ensuing financial crisis, the BCBS decided to update and strengthen the Accords. It saw poor governance and risk management, inappropriate incentive structures and an overleveraged banking industry as reasons for the collapse. In July 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, including requiring banks to have 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 colloquially called "too big to fail."

The implementation of Basel III has been gradual and began in January 2013. It is expected to be completed by Jan. 1, 2019.

RELATED TERMS
  1. Basel Committee on Banking Supervision

    The Basel Committee on Banking Supervision is an international ...
  2. Bank for International Settlements ...

    The Bank for International Settlements is an international financial ...
  3. Cooke Ratio

    The Cooke Ratio is a capital adequacy ratio that expresses the ...
  4. Bank Capital

    Bank capital is the measurement of a bank's assets minus its ...
  5. Tier 1 Capital Ratio

    The tier 1 capital ratio is the ratio of a bank’s core tier 1 ...
  6. Capital Buffer

    A capital buffer is mandatory capital that financial institutions ...
Related Articles
  1. Investing

    Using Economic Capital To Determine Risk

    Discover how banks and financial institutions use economic capital to enhance risk management.
  2. Tech

    What Are the Biggest Risks Associated With Banks Today?

    Evolving mechanisms and techniques of cybercrime have become the most severe risk associated with banks today.
  3. Insights

    Banks Could Unlock Over $200 Billion for Investors

    Passage of a recently introduced Republican bill could free up $200 billion in bank capital.
  4. Small Business

    Understanding the Capital Adequacy Ratio

    The capital adequacy ratio (CAR) is an international standard that measures a bank’s risk of insolvency from excessive losses. Currently, the minimum acceptable ratio is 8%. Maintaining an acceptable ...
  5. Insights

    What Do the Federal Reserve Banks Do?

    These 12 regional banks are involved with four general tasks: formulate monetary policy, supervise financial institutions, facilitate government policy and provide payment services.
  6. Investing

    Understanding Bank of America's Capital Structure (BAC)

    For banks, especially large banks such as Bank of America, capital structure has to both meet funding needs and satisfy the regulator's capital requirements.
  7. Insights

    A Comparison Between a Default and a Collapse

    Is the Greek default similar to the Lehman Brothers collapse?
  8. Financial Advisor

    Why Banks Don't Need Your Money to Make Loans

    Contrary to the story told in most economics textbooks, banks don't need your money to make loans, but they do want it to make those loans more profitable.
  9. Personal Finance

    Does Deutsche Bank Have Similarities to Lehman? (DB)

    Learn why Deutsche Bank's mounting debt and need to raise capital lead some analysts to believe it may be the next Lehman Brothers.
RELATED FAQS
  1. How are risk weighted assets used to calculate the solvency ratio in regulatory capital ...

    Learn how risk-weighted assets are used to determine solvency ratio requirements under the Basel III accord, and see how ... Read Answer >>
  2. What Does a High Capital Adequacy Ratio Indicate?

    Learn about the capital adequacy ratio, what the ratio measures, how it is calculated and what it means when a bank has a ... Read Answer >>
  3. What is the Federal Reserve Board's market risk capital rule?

    Learn about the market risk capital rule enacted by the Federal Reserve, and understand how this rule reflects the Basel ... Read Answer >>
  4. Why is the capital adequacy ratio important to shareholders?

    Understand what the capital adequacy ratio is and why it is a very important metric of financial soundness for evaluating ... Read Answer >>
Hot Definitions
  1. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  2. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  3. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  4. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  5. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  6. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
Trading Center