Assignment On:Comparison of Basel I, II and III Prepared By: Md. Zahidul Alam Class ID: 227 19th Batch MBA Program Prepared For: Mr. Alamgir Hossen Assistant Professor Course Instructor Strategic Banking Institute of Business Administration Jahangirnagar University Date of Submission: December 18, 2014 The BaselAccords refertothebankingsupervisionAccords(recommendationsonbanking regulations)BaselI, BaselII and BaselIIIissuedbythe BaselCommitteeonBanking Supervision (BCBS).They are called the Basel Accords as the BCBS maintains its secretariat at the Bank forInternationalSettlements inBasel, Switzerland andthecommitteenormallymeetsthere.TheBasel Accords is a set of recommendations for regulations in the banking industry. The basel accord came into practice after on 26 June 1974, a number of banks had released payment of Deutsche Marks (DEM - German Currency at that time) to Herstatt (Based out of Cologne, Germany) in Frankfurt in exchange for US Dollars (USD) that was to be delivered in New York. Because of time-zone differences,Herstattceasedoperationsbetweenthetimesoftherespectivepayments.German regulatorsforcedthetroubledBank Herstattintoliquidation.Thecounterpartybanksdidnotreceive their USD payments. Responding to the cross-jurisdictional implications of the Herstatt debacle, the G-10 countries, Spain and Luxembourg formed a standing committee in 1974 under the auspices of the Bank for International Settlements (BIS), called the Basel Committee on Banking Supervision. The basic structure of Basel accords remains unchanged with three mutually reinforcing pillars. Pillar 1: Minimum Regulatory Capital Requirements based on Risk Weighted Assets (RWAs): Maintaining capital calculated through credit, market and operational risk areas. Pillar 2: Supervisory Review Process: Regulating tools andframeworksfordealing with peripheral risks that banks face. Pillar3:MarketDiscipline:Increasingthedisclosuresthatbanksmustprovidetoincreasethe transparency of banks Basel I:In1988,theBaselCommitteeonBankingSupervision(BCBS)inBasel,Switzerland,publishedasetof minimumcapitalrequirementsforbanks.ThesewereknownasBaselI.Itfocusedalmostentirelyon credit risk (default risk) - the risk of counter party failure. It defined capital requirement and structure of risk weights for banks. Underthesenorms:Assetsofbankswereclassifiedandgroupedinfivecategoriesaccordingtocredit risk, carrying risk weights of 0%(Cash, Bullion, Home Country Debt Like Treasuries), 10, 20, 50 and100% and no rating.Purpose:OneofthemajorrolesofBaselnormsistostandardizethebankingpracticeacrossall countries. It was implemented to strengthen the stability of international banking. Also it would set up a fairandaconsistentinternationalbankingsysteminordertodecreasecompetitiveinequalityamong international banks.Limitations:Limited differentiation of credit risk Static measure of default riskNo recognition of term-structure of credit riskSimplified calculation of potential future counterparty risk Lack of recognition of portfolio diversification effects Basel II:BaselIIwasintroducedin2004,laiddownguidelinesforcapitaladequacy(withmorerefined definitions),riskmanagement(MarketRiskandOperationalRisk)anddisclosurerequirements.Ituses external ratings agencies to set the risk weights for corporate, bank and sovereign claims. Operationalriskhasbeendefinedastheriskoflossresultingfrominadequateorfailedinternal processes, peopleand systemsorfromexternalevents.Thisdefinitionincludes legalrisk,but excludes strategicandreputationrisk,wherebylegal riskincludesexposurestofines,penalties, orpunitive damagesresulting fromsupervisory actions,aswellas privatesettlements.Therearecomplexmethods to calculate this risk. Advantages over Basel I: The discrepancy between economic capital and regulatory capital is reduced significantly,duetothattheregulatoryrequirementswillrelyonbanksownriskmethods.BaselIIis more Risk sensitive. It has wider recognition of credit risk mitigation. Limitations:Thereistoomuchregulatorycompliance.ItisoverfocusedonCreditRisk.Thisnew Accordiscomplexandthereforedemandingforsupervisors,andunsophisticatedbanks.Strongrisk differentiation in the new Accord can adversely affect the borrowing position of risky borrowers Basel III: It is widely felt that the shortcoming in Basel IInorms is what led to the global financial crisisof2008. That is because Basel II did not have any explicit regulation on the debt that banks could take on their books,andfocused moreonindividualfinancialinstitutions,whileignoringsystemic risk.Theguidelines aim to promote a more resilient banking system by focusing on four vital banking parameters viz. capital, leverage, funding and liquidity. Purpose:BaselIIInormsaimto:Improvethebankingsector'sabilitytoabsorbshocksarisingfrom financialandeconomicstress,ImproveriskmanagementandgovernanceandStrengthenbanks' transparency and disclosures.Toensurethatbanksdonttakeonexcessivedebt,andthatthey dontrelytoomuchonshortterm funds,BaselIIInormswereproposed in2010. Itwasagreeduponbythemembersofthe Basel CommitteeonBankingSupervision in201011,andwasscheduledtobeintroducedfrom2013until 2015;however,changesfrom1April2013extendedimplementationuntil31March2018andagain extended to 31 March 2019. Requirements for common equity and Tier 1 capital will be 4.5% and 6%, respectively. Also , the liquidity coverage ratio (LCR) will require banks to hold a buffer of high quality liquid assets sufficient to deal with thecashoutflowsencounteredinanacuteshorttermstressscenarioasspecifiedbysupervisors.The minimumLCRrequirementwillbetoreach100%on1January2019.Thisistopreventsituationslike "BankRun".LeverageRatio>3%:TheleverageratiowascalculatedbydividingTier1capitalbythe bank's average total consolidated assets;. Comparison of Basel I, Basel II and Basel III : FeaturesBasel IBasel IIBasel III Released in: July 1988June 20042010-11 Main Focus:Stabilityandfairness ofInternational Banking System CapitalAdequacy,Risk Managementand Disclosure Requirements EmphasisonReducing SystematicRisk& Improving Transparency. Risk Sensitivity:Low ModerateHigh Focus:Backward looking Somewhatforward looking Forward Looking Comparison of Capital Requirements: MinimumRatioofTotalCapitalTo Risk Weighted Assets(RWAs) 8%8%10.50% Minimum Ratio of Common Equity to RWAs 2%2%4.50% to 7.00% Tier I capital to RWAs4%4%6.00% Core Tier I capital to RWAsNone2%5.00% CapitalConservationBuffersto RWAs NoneNone2.50% Leverage RatioNoneNone3.00% Countercyclical BufferNoneNone0% to 2.50% Minimum Liquidity Coverage RatioNoneNoneTBD (2015) Minimum Net Stable Funding RatioNoneNoneTBD (2018) SystemicallyimportantFinancial Institutions Charge NoneNoneTBD