Basel Accords

What Are The Basel Accords?

The Basel Accords are a set of standards created by the Basel Committee to establish uniform banking regulation among the world's financial systems. The Basel Committee was originally called the Committee on Banking Regulations and Supervisory Practices, and it was headquartered at the Bank for International Settlements in Basel, Switzerland. It was created in 1974 by the central bank governors of the Group of Ten (G10) countries in order "to enhance financial stability by improving the quality of banking supervision worldwide."^[1] The committee has since been expanded to 45 institutions from 28 jurisdictions.

Basel I

Amid the backdrop of the debt crisis in Latin America in the early 1980s, the committee was concerned that the capital ratios of the primary banks doing business internationally were weakening just as global credit risks were rising. At the same time, it wanted to remove the "competitive inequality" due to the different capital requirements from one country to another.^[1]

In July 1988, the G10 governors released the Basel Capital Accord—later known as "Basel I"—that called for banks to establish a minimum capital ratio of 8% to risk-weighted assets. Banks were set to implement the rule by the end of 1992, and not just those in the 10 member countries but also those in "virtually all countries with active international banks."^[1] In September 1993, the committee said that banks in the G10 countries with material international banking businesses were meeting the Accord's minimum requirements.

In January 1996, the committee amended the Accord to include capital requirements to cover the banks' exposure to market risks in stocks and bonds, foreign exchange, commodities and options. The amendment took effect at the end of 1997.

Basel II

In June 2004, the Basel Committee issued a new set of capital adequacy rules—known as Basel II—to replace and improve on Basel I. According to the committee, "The new framework was designed to improve the way regulatory capital requirements reflect underlying risks and to better address the financial innovation that had occurred in recent years."^[1]

Basel II focused on minimum capital requirements, regulatory review of each bank's capital adequacy, and the "effective use of disclosure as a lever to strengthen market discipline and encourage sound banking practices."^[1] The goal was to encourage banks to improve how they measure and control risk, both in their lending activities and in securities and asset trading.

Basel III

In the runup to the global financial crisis, culminating in the September 2008 failure of Lehman Brothers, the committee saw the need to strengthen the Basel II accord. It cited "too much leverage and inadequate liquidity buffers" among the world's banks, made worse by "poor governance and risk management," which led to "mispricing of credit and liquidity risks, and excess credit growth."^[1]

In July 2009, the committee issued new proposals to improve the regulation and supervision of global banks. Specifically, these proposals covered "complex securitisation positions, off-balance sheet vehicles and trading book exposures," all of which contributed to the financial crisis.^[1] In September 2010, higher minimum capital standards for commercial banks were mandated. These became part of a new capital and liquidity reform package that was endorsed at the G20 summit in Seoul, South Korea, which became known as "Basel III."

The Basel III rules, some of which will be phased in through this year (2019), include stricter regulatory capital requirements for banks, an additional layer of common equity, a "countercyclical capital buffer," a leverage ratio and new liquidity requirements. There are other requirements for so-called "systemically important banks," i.e., those "too big to fail," which means they're so large that they would require government intervention if a financial crisis or failure occurred.^[1]

The Basel III reforms were completed in 2017 with additional reforms intended to "address shortcomings of the pre-crisis regulatory framework and provide a regulatory foundation for a resilient banking system that supports the real economy."^[1]

Summary

The Basel Accords are a set of standards created by the Basel Committee to create a uniform bank regulatory regime around the world in order to enhance financial stability and improve banking supervision.

The committee, which is situated at the Bank for International Settlements, has released three sets of standards. The first was in response to the Latin American debt crisis of the early 1980s and the third, Basel III, is a series of standards meant to address the various risks and activities exposed by the 2008 financial crisis. Some of these standards are still being implemented.