Basel Accords

Basel Accords is a set of three agreements that mitigated risks associated with banking and financial institutions. The accords determined whether a bank possesses adequate reserves to deal with unexpected losses. With every update, banking regulations became stricter.

The Basel Committee on Banking Supervision (BCBS) created the Basel accords. Banks and financial institutions worldwide follow Basel accords standards of capital requirements and risk management. The three landmark updates are called the Basel I, Basel II, and Basel III accords, among multiple revisions. Basel III was released in November 2010.

• Basel Accords are a set of agreements that benchmarked banking regulations and credit policies—followed by banks and financial institutions worldwide.
• The Basel Committee on Banking Supervision was established in 1974. Consequently, Basel accords I, II, and III were released in 1988, 2004, and 2010.
• Each accord added guidelines for banking. Primarily, Basel principles focused on financial safety, liquidity issues, equity, credit risks, and risk management.
• Basel III increased common equity requirements from 2% to 4.5%, with an additional buffer of 2.5%. Common equity is a percentage of Banks’ risk-weighted assets.

The Basel accords were established by the Basel Committee of Banking Supervision (BCBS). The committee is named after BCBS's headquarters—the Bank of International Settlements, situated in Basel, Switzerland.

The accords were formed with the sole objective of improving financial stability worldwide. The resolutions had a direct impact on banking. The Basel committee reviews risk factors associated with international banking. 

Basel resolutions advocate for stricter regulations and specific guidelines. To have a positive impact, though, these guidelines should be followed by every bank and financial institution. If the resolutions are not implemented, banks will face acute monetary crises.

However, the 2008 resolutions were more streamlined. The 2008 financial crisis affected the entire world—and its impact lasted years. In response, the committee decided upon a monitoring and administration system to ensure banking safety.

The committee formulated new banking benchmarks and regulations. Capital adequacy regulations are the most notable among them. Owing to its popularity, capital adequacy guidelines are referred to as Basel I, Basel II, and Basel III.

In the Basel accords history, a committee was formed in 1974; it was named: The Banking Regulations and Supervisory Practices. Ten countries backed it. The collaboration responded to the aftermath of the Bankhaus Herstatt failure (West Germany). Bankhaus severely disturbed international currency and banking.

The committee's first meeting was held in February 1975. Consequently, the members held regular meetings—four times a year.

Initially, the Basel committee comprised the G10 countries—the Netherlands, the US, the UK, Italy, Japan, Sweden, Switzerland, Belgium, Canada, France, and Germany. Over time though, the network expanded to 45 institutions and 28 jurisdictions.

The committee worked relentlessly to seal loopholes witnessed in international banking—so that no bank could escape supervision. This function is formally known as international supervisory coverage. In 1975, banking regulations were declared in the Concordat. This document was further revised in May 1983 and renamed, Principles for the Supervision of Banks’ foreign establishments.

In October 1996, the Basel committee established a cross-border banking supervision authority. In 1996, a document was drafted with G7 finance ministers calling for adequate supervision in all marketplaces, including emerging markets and economies. The document was revised in 1997, comprising 25 Basel accords principles of supervision.

The September 2012 Basel principles update is the most recent addition. Since then, the document has underlined 29 principles, supervisory powers, and standards.

The three main Basel accords are as follows.

Basel Accords I: The Basel Capital Accord

The Basel I resolution was called the Basel Capital Accords; it was formed in the 1980s in response to the American debt crisis. The debt crisis exposed concerns about the capital ratios of international banks.

G10 countries supported the introduction of stricter capital standards and adequacy measures. As a result, the updated banking requirements were sent to banks in July 1988.

The critical features of Basel 1 are as follows.

• Basel-I mandated banks to hold a minimum of 8% in risk-weighted assets.
• The framework was introduced in all countries, not just member countries.
• The accord was amended in 1998 to include general provisions for loan losses.
• The drafted accord covered credit risks and monetary risks.

Basel Accords II: The New Capital Framework

The second Basel resolution was introduced in 2004. But it was preceded by perpetual efforts. In June 1999, the committee proposed a new capital adequacy framework to replace the 1988 accord.

The features of Basel II are as follows.

• The accord extended rules set out in the 1998 accord (added details and specifics).
• The new accord reviewed the internal assessment process and utilized the disclosure to strengthen market discipline. As a result, it further induced quality banking practices.
• The second accord focused on regulating capital requirements.
• It widened the scope of cooperation between home and host supervisors.

Basel Accords III: Response to the 2008 Financial Crisis

Many believe the Basel III resolution was merely a response to the 2008 financial crisis. But the banking system highlighted loopholes even before the collapse of Lehman Brothers (September 2008).

The banking sector faced liquidity issues; it was simply a case of poor governance and a flawed incentive structure. The housing market collapse was simply the consequence of fundamental inefficiencies. Basel resolutions keep evolving, but banking systems will become stable only if the guidelines are enforced.

In September 2010, the Basel committee introduced another agreement about overall capital design and liquidity reforms. This agreement was named the Basel III. Basel III was further revised in December 2010.

The features of Basel III are as follows.

• Basel III updated the framework responsible for monitoring liquidity risks.
• It advocated for increased resilience in banking systems.
• It focused on the quality and quantity of common equity.
• It increased common equity requirements from 2% to 4.5%, with an additional buffer of 2.5%. Here, common equity refers to a percentage of banks’ risk-weighted assets.
• The accord also introduced a leverage ratio that could provide for a month of stress (30 days).

This article has been a guide to what are Basel Accords. Here, we explain their history, capital requirements, and the three main Basel accords. You can learn more about it from the following articles -

• Tier 1 Capital Ratio
• Capital Adequacy Ratio
• Tier 2 Capital