Post on 19-May-2015
2. BASEL ACCORDS
Refers to banking supervision Accords (recommendations on banking
laws and regulations), Basel I and Basel II issued by the Basel
Committee on Banking Supervision(BCBS).
Called the Basel Accords as the BCBS maintains its secretariat at
the Bank of International Settlements in Basel, Switzerland
3. Background
Under capital requirements rules, credit institutions like banks
must at all times maintain minimum financial capital, to cover the
risks
Aim - to ensure financial soundness of such institutions, maintain
customer confidence in the solvency of the institutions, ensure
stability of financial system at large, and protect depositors
against losses.
Basel Committee on Banking Supervision established in 1974 to
provide a forum for banking supervisory matters. Members are from
Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the
Netherlands, Spain, Sweden, Switzerland, UK and USA.
4. Background
Basel Committee not a formal regulatory authority, but has great
influence over supervising authorities in many countries.
Committee hopes to achieve common approaches and common standards
across member countries, without detailed harmonisation of each
member country's supervisory techniques.
In 1988, recognising the emergence of larger more global financial
services companies, the Committee introduced Basel Capital Accord
(Basel I) to strengthen soundness and stability of international
banking system by requiring higher capital ratios.
5. Background
Since 1988, the framework of Basel I progressively introduced not
only in member countries but also in virtually all other countries
with active international banks.
In June 1999, proposal issued for a new Capital Adequacy framework
to replace Basel I.
After extensive communication with banks and industry groups, the
revised framework, Basel II issued in 2004.
Basel II has been or will be implemented by regulators in most
jurisdictions but with varying timelines and may be restricted
methodologies.
6. BASEL II
The second of the Basel Accords.
Purpose is to create an international standard that banking
regulators can use when creating regulations about capital banks to
be put aside to guard against financial and operational risks
An international standard can help protect the international
financial system from possible problems should a major bank or a
series of banks collapse.
Basel II attempts to accomplish this by setting up rigorous risk
and capital management requirements to ensure that a bank holds
capital reserves appropriate to the risk the bank exposes itself to
through lending and investment practices.
Greater the risk greater the amount of capital bank needs to hold
to safeguard its solvency and overall economic stability.
7. FINAL OBJECTIVE
Ensuring that capital allocation is more risk sensitive
Separating operational risk from credit risk, and quantifying
both
Attempting to align economic and regulatory capital more closely to
reduce scope for regulatory arbitrage
8. Why BASEL II
Basel I Accord succeeded in raising total level of equity capital
in the system.
However, it also pushed unintended consequences.
Since it does not differentiate risks very well, it perversely
encouraged risk seeking. All loans given to corporate borrowers
were subject to the same capital requirement, without taking into
account ability of the counterparties to repay.
It ignored credit rating, credit history, risk management and
corporate governance structure of all corporate borrowers. All were
treated as private corporations.
It also promoted loan securitization that led to the unwinding in
the subprime market.
9. Why BASEL II
Basel II much more risk sensitive, as it is aligning capital
requirements to risks of loss. Better risk management in a bank
means bank may be able to allocate less regulatory capital.
The objective of Basel II is to modernise existing capital
requirements framework to make it more comprehensive and risk
sensitive.
The Basel II framework therefore designed to be more sensitive to
the real risks that firms face than Basel I.
Apart from looking atfinancial figures, it also considers
operational risks, such as risk of systems breaking down or people
doing the wrong things, and also market risk.
10. Three Pillars of Basel II Framework
11. Pillar 2 sets out a new supervisory review process. Requires financial institutions to have their own internal processes to assess their overall capital adequacy in relation to their risk profile. 12. Pillar 3 cements Pillars 1 and 2 and is designed to improve market discipline by requiring firms to publish certain details of their risks, capital and risk management as to how senior management and the Board assess and will manage the institution's risks.