Banking regulation & compliance: The Basel Accord

Photograph by Davide D'Amico

SCAN Business aims to keep our readers up to date with new corporate and financial regulations and in this article, we will talk about banking regulations & compliance, particularly Basel I-III.

By Shikhar Chokhani

Post the 2008 financial crisis, bankers were under the limelight and were known for being involved in unethical banking practices. Therefore, to avoid the problem of a moral hazard financial regulatory authorities all around the world, formulated regulations under which banks are required to function.

The main aim of this article is to provide an insight into the financial regulations under which banks in the 21st century operate.

The Basel Accord:

The Basel Committee on Banking Supervision (BCBS) set up the framework for the Basel Accord. The prominent motive was this committee was to improve financial stability and the quality of banking supervision amongst financial institutions around the globe. Financial stability could be achieved by ensuring banks and other financial institutions had enough liquidity (capital) to meet their daily objectives and to be used during times of economic uncertainty. In addition, they were also responsible for advising numerous financial institutions regarding matters related to capital, market and operational risk.

Breakdown of the Basel Accord:

Basel 1:

Developed in 1988, the major focus of the Basel 1, also known as the “capital accord” is for financial institutions to maintain adequate amount of capital. International banks are required to have a risk weight of 8% or less. Risk weighted assets are typically defined as the minimum amount if capital banks are required to maintain in order to reduce the risk of going “bust” (defaulting). Countries successfully implemented this with an active banking system by the end of 1992.

Basel 2:

In 1999, the BCBS proposed a further revision of the Basel 1. The Basel 2 primarily focused on three important areas, which came to be known as the “three pillars”. The three pillars include the following:

  1. Minimum capital requirements
  2. Review of a financial institutions capital adequacy and internal controls/ assessment procedures, which would be conducted by the supervisory committee.
  3. To ensure market discipline and sound banking practices by ensuring that banks use a disclosure method to reveal items in/off their balance sheet.

Basel 3:

During the wake of the Lehman Brothers collapse in 2008, the BCBS looked to strengthen the Basel 2 requirements. This was mainly because of the fact that banking sector has been overleveraged, which caused liquidity problems. In addition, the committee also noticed poor corporate governance and risk management techniques; all of which contributed to 2008 credit crunch. In July 2010, the BCBS decided to extend the framework of the three pillars in regards to treatment of certain off balance sheet items and complete exposure of the banks trading book. Additional layers of requirements were also added by the committee, which involved the banks to maintain a minimum liquidity and capital ratio. The framework laid down in the Basel 3 has slowly started to gain momentum and is expected to be completed by early 2019.