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Basel Committee Insights for Bankers

The Basel Committee on Banking Supervision was established in 1974 and meets at the Bank for International Settlements to enhance banking supervision worldwide. It formulates broad supervisory standards and guidelines, beginning with the 1988 Capital Accord. Basel II, finalized in 2006, aimed to eliminate regulatory arbitrage, align regulations with risk management best practices, and incentivize banks to enhance risk measurement. It consists of three pillars: the first establishes minimum capital requirements; the second allows supervisory review of banks' risk assessments; and the third enhances market discipline through transparency.

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80 views3 pages

Basel Committee Insights for Bankers

The Basel Committee on Banking Supervision was established in 1974 and meets at the Bank for International Settlements to enhance banking supervision worldwide. It formulates broad supervisory standards and guidelines, beginning with the 1988 Capital Accord. Basel II, finalized in 2006, aimed to eliminate regulatory arbitrage, align regulations with risk management best practices, and incentivize banks to enhance risk measurement. It consists of three pillars: the first establishes minimum capital requirements; the second allows supervisory review of banks' risk assessments; and the third enhances market discipline through transparency.

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19, CABALTICA, EDNALYN A.

What is the Basel Committee?

• Basel Committee on Banking Supervision was established by the central-bank governors of the
G10 countries in 1974 ▫ Belgium, Canada, France, Germany, Italy, Japan, Luxemburg,
Netherlands, Spain, Sweden, Switzerland, UK, US
• Meets at the Bank for International Settlements in Basel
• Its objective was to enhance understanding of key supervisory issues and improve the quality of
banking supervision worldwide.
• Not a formal supranational supervisory authority and conclusions do not have legal force.
• Formulates broad supervisory standards and guidelines
• First major result was the 1988 Capital Accord
• 1997 developed a set of "Core Principles for Effective Banking Supervision ", which provides a
comprehensive blueprint for an effective supervisory system.

Basel Capital Accords Chronology

• Basel I Capital Accord (1988)


▫ Amendment to the capital accord to incorporate market risks (1996)
• Basel II Capital Accord
▫ First Consultative Paper (1999)
▫ Second Consultative Paper (2001)
▫ Third Consultative Paper (2003)
▫ Final Document (2004)
“Basel II: International Convergence of Capital Measurement and
Capital Standards: a Revised Framework”
• Amendment (2005)
The Application of Basel II to Trading Activities and the Treatment of
Double Default Effects
• Final Version(2006)
“Basel II: International Convergence of Capital Measurement and Capital
Standards: A Revised Framework - Comprehensive Version”
• Proposed revisions to the Basel II market risk framework (2008)

Motives for Basel I

• Deregulation period after 1980


• Increase in International presence of banks
• Decline in capital ratios of Banks just as increase
in riskiness
• Risk posed to the stability of the global financial
system by low capital levels of internationally
active banks
• Competitive advantage accruing to banks subject
to lower capital requirements
• Create a level of playing field

Motives and Objectives for Basel II

• Motives: Problems with Basel I


▫ Club-rule (being a member of OECD) is not meaningful in terms of riskiness
▫ “Broad brush” and lacks risk differentiation: One size fits all
▫ Divergence between Basel I risk weights and actual economic risks
▫ Regulatory arbitrage (Solved?)
▫ Inadequate recognition of advanced credit risk mitigation
techniques(securitization and CDS)
• Objectives
▫ Eliminate regulatory arbitrage by getting risk weights right
▫ Align regulation with best practices in risk management
▫ Provide banks with incentives to enhance risk measurement and management
capabilities.
Basel II is not intended simply to ensure compliance with a new set
of capital rules. Rather, it is intended to enhance the quality of risk
management and supervision.

3 Pillars of Basel II

The second pillar – supervisory review – allows supervisors to evaluate a bank’s


assessment of its own risks and determine whether that assessment seems reasonable. It is not
enough for a bank or its supervisors to rely on the calculation of minimum capital under the first
pillar. Supervisors should provide an extra set of eyes to verify that the bank understands its risk
profile and is sufficiently capitalized against its risks.

The third pillar – market discipline – ensures that the market provides yet another set
of eyes. The third pillar is intended to strengthen incentives for prudent risk management.
Greater transparency in banks’ financial reporting should allow marketplace participants to better
reward well-managed banks and penalize poorly-managed ones.

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