BASEL

Basel Committee on Banking Supervision was established by the central-bank

governors of the G10 countries in 1974 which is named after the city of Basel, in Switzerland.
The Committee objective was by setting the prudential regulation of banks for minimum
supervisory standards, by improving the effectiveness of techniques for supervising
international banking business and provides a forum for cooperation by exchanging
information on banking supervisory arrangements worldwide.
Basel Committee formulates broad supervisory standards and guidelines. An important
aim of the Committee's work was to close gap in international supervisory coverage so that:
i. No foreign banking establishment would escape supervision; and
ii. That supervision would be adequate and consistent across member jurisdictions.
Capital Accord was the first major result in 1988. In 1997 it developed a set of "Core
Principles for Effective Banking Supervision", which provides a comprehensive blueprint for
an effective supervisory system.
Basel Accord I
Basel 1 was designed to incorporate within the capital requirement for the market risks
arising from banks' exposures to foreign exchange, traded debt securities, equities,
commodities and options. Basel Capital Accord I also called the 1988 Accord.
Basel 1 framework was to address risks other than credit risk; it was a minimum capital ratio
of capital to risk-weighted assets also to increase in International presence of banks.
The banks were allowed to use internal value-at-risk models as a basis for measuring their
market risk capital requirements, subject to strict quantitative and qualitative standards.
The Committee issued the so-called Market Risk Amendment to the Capital Accord 1997.

Problems
Problem was divergence between risk weights and actual economic risks and inadequate recognition
of advanced credit risk mitigation techniques (securitization and CDS).
Two approaches like Advance Internal Rating Based (AIRB) and Advanced Measurement Approach
(AMA) for credit and operational risk was very complex implemented by only large banks in U. S.
Basel Accord II
Revised Capital Framework generally known as "Basel II", which was comprised three
pillars in June 2004.
The Objectives of Basel II was:
Eliminate regulatory arbitrage by getting risk weights rights,
Ensuring the capital allocation is more risk sensitive, and align regulation with best practices in
risk management &
Provide banks with incentives to enhance risk measurement and management capabilities.
Three Pillars of Basel II:
Minimum Capital Requirements Supervisory Review Market Discipline
Pillar 1:
Capital Requirements:
i) Credit Risk
ii) Market Risk
iii) Operational Risk
Risk Management Incentives.
Risk Weighted assets for more
risk sensitive.
Market Risk largely unchanged.
New operational risk capital
charge.
Pillar 2:
Regulatory Framework
Regulatory Review & Intervention
Capital Determination
Solvency Reports
Supervisory Framework
Bank or their supervisors rely on the
calculation of minimum capital under the first
pillar
Evaluation of internal system of banks.
Assessment & reviews of risk profile and
compliance.
Pillar 3:
Minimum Disclosure
requirements & scope
Capital Transparency
Capital Adequacy
Risk Profiling
Enhanced comparability
of Banks
Probl ems
The banking Sector was collapsed due to Financial Crisis 2008; the banks were under too
much leverage and inadequate liquidity buffers.
One challenge supervisors faced was the need to approve the use of certain approaches
to risk measurement in multiple jurisdictions.
Another challenge time series data for the banks which is not available which they need
the high quality data for IRB
Another problem they should meet the entire financial and accounting standard for full fill
the third pillar of Basel Accord II.
The operational cost bear by the banks is higher in implementation of Basel accord II.
Basel Accord III
The global economic crisis provides an opportunity for restructuring the approach to risk
& regulation in financial sector. Basel Accord III endorsed by G20 in November 2010.
The framework is the voluntary regulatory standard on bank capital adequacy, stress
testing and market liquidity risk.
Basel III is to strengthen the regulation, supervision and risk management of the banking
sector. The new rules prescribe how to assess risks, and how much capital to set aside for
banks in keeping with their risk profile.
Two Main Objectives:
1. To strengthen global capital and liquidity regulations with the goal of promoting a more resilient
banking sector
2. To improve the banking sectors ability to absorb shocks arising from financial and economic
stress which in turn would reduce the risk of a spillover from financial sector to the real
economy.
Breakdown of Basel III proposals in three main parts:
Capital Reforms Includes quality and quantity of capital, complete risk coverage, leverage ratio
and the introduction of capital conservation buffers along with counter-cyclical capital buffer.
Liquidity- Reform a short term (liquidity coverage ratio, LCR) and long term (Net-stable Funding
Ratio, NSFR).
Other elements relating to general improvements to the Stability of the financial system.
Basel III was supposed to strengthen bank capital requirements by increasing bank
liquidity and decreasing bank leverage.
The changes highlights of Basel III :
1. Increase quality & quantity of capital.
2. Reduced leverage through introduction of backstop leverage ratio.
3. Increase short-term liquidity coverage.
4. Increase stable long-term balance sheet funding.
5. Strengthened risk capture, notably counterparty risk.
The Islamic Banking transactions creating the debts like Ijarah, these financial modes
were not mention in Basel Accord II.

Difference between Basel II & Basel III

Basel accord III the common equity increase from 2% to 4.5%.
The Tier 1 capital reserve is also increase from 4% to 6% to meet the liquidation problem
of the banks.
The additional reserve is require to maintain by the banks which becomes the part of
Basel Accord III which was not included in Basel Accord II is Countercyclical Buffer which
is not fixed it vary from 0% to 2.5%.
The minimum total capital requirements has increased from 8% to 10.5% (including the
conversation buffer)
The capital ratio (ratio of equity capital to risk-weighted assets) from 2% to 4.5%. They will
have to hold core capital equal to 7% of their risk-weighted assets.
A leverage ratio - a minimum amount of loss-absorbing capital relative to all of a bank's
assets and off-balance-sheet exposures regardless of risk weighting.
The leverage limit for banks has been set to 3%, i.e., a banks total assets (including both
on and off-balance sheet assets) should not exceed than 33 times capital.
Basel Committee develop liquidity framework for two minimum standards:
Increased Short-term Liquidity Coverage.
Increased Long-term Liquidity Coverage.
Additional requirements includes for augmented contingent capital and strengthened
arrangements for cross-border supervision and resolution introduced in Basel III.
The Basel Accord III framework provides the more comprehensive and effective
treatment of risk associated with the banks then Basel accord II.