Basel

Basal accords are introduced by Basel Committee

of Banking Supervision (BCBS), a committee of banking supervisory authorities that was
incorporated by the central bank governors of the Group of Ten (G-10) countries in 1974. The
main objective of this committee is to provide guidelines for banking regulations. BCBS has
issued 3 accords named Basel 1, Basel 2 and Basel 3 so far with the intention of enhancing
banking credibility by strengthening the banking supervision worldwide.

Basel 1

Basel I was the BCBS' first accord. Basel 1 was released in July 1988 to provide a
framework to address risk management from a bank’s capital adequacy perspective. The
principle concern here was the capital adequacy of banks. . One of the main reasons for the same
was the Latin American debt crisis during the early 1980s, where the committee realized that
capital ratios of international banks are diminishing over time. A minimum ratio of capital to
risk-weighted assets of 8% was stated to be implemented effective from 1992. It focused mainly
on credit risk by creating a bank asset classification system.

Basel 2

Basel II was introduced in 2004. Basel II expanded rules for minimum capital
requirements established under Basel. The main objective of Basel 2 was to replace the
minimum capital requirement with a need to conduct a supervisory review of the bank’s capital
adequacy. Basel 2 consist of 3 pillars. They are,

 Minimum capital requirements, which sought to develop and expand the standardized
rules set out in the Basel 1
 Supervisory review of an institution’s capital adequacy and internal assessment process
 Effective use of disclosure as a lever to strengthen market discipline and encourage sound
banking practices.

Basel 3

It is widely felt that the shortcoming in Basel II norms is what led to the global
financial crisis of 2008. That is because Basel II did not have any explicit regulation on the debt
that banks could take on their books, and focused more on individual financial institutions,
while ignoring systemic risk. To ensure that banks don’t take on excessive debt, and that they
don’t rely too much on short term funds, Basel III norms were proposed in 2010. The main
objective of Basel 3 is to specify an additional layer of common equity (a capital conservation
buffer) for banks. The aim of Basel 3 is to improve bank ability to absorb loss, improve risk
management and strengthen bank transparency and disclosures.

- The guidelines aim to promote a more resilient banking system by focusing on four vital
banking parameters viz. capital, leverage, funding and liquidity.

- Requirements for common equity and Tier 1 capital will be 4.5% and 6%, respectively.

- The liquidity coverage ratio(LCR) will require banks to hold a buffer of high quality liquid
assets sufficient to deal with the cash outflows encountered in an acute short term stress scenario
as specified by supervisors. The minimum LCR requirement will be to reach 100% on 1 Jan
2019. This is to prevent situations like bank run.

- Leverage Ratio > 3%:The leverage ratio was calculated by dividing Tier 1 capital by the bank's
average total consolidated assets.

Difference between Basel 1 & Basel 2

Basel 1 was formed with the main objective of enumerating a minimum capital requirement for
banks. Basel 2 was established to introduce supervisory responsibilities and to further strengthen
the minimum capital requirement.

Pillar
Basel 1 has only one pillar that is minimum capital requirement and Basel 2 has three pillars i-g
minimum capital requirement, supervisory review &role, and market discipline and disclosure.

Risk
Basel 1 has credit risk and Basel 2 has credit risk, operational risk and market risk.

Predictability of Future Risk

Basel 1 is backward-looking as it only considered the assets in the current portfolio of banks. Basel 2 is
forward-looking compared to Basel 1 since the capital calculation is risk-sensitive.

Approach
Basel 1 is standard approach of measurement and capital calculation and
Basel 2 is multiple approach for measurement of each of the risk and then capital c alculation.
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