Basel Accord - Explained
What is the Basel Accord?
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What is the Basel Accord?
The Basel Accords refer to a set of banking regulations that gives recommendations with respect to market risk, capital risk, and operational risk. The Basel Accords are set by the Basel Committee on Bank Supervision (BCBS) to guide financial institutions on capital risk, market risk, and operational risk. BCBS acts as a supervisory authority for banks, this authority ensures that banks have enough liquidity to meet their financial obligations and liabilities.
How Does the Basel Accord Work?
The Basel Accords comprises a series of banking regulations names Basel I, Basel II and Basel III. These sets of regulations are internationally agreed upon as a response to the Financial Crisis in the banking industry. These banking regulations were created by the ten largest economies. The Basel Committee on Bank Supervision (BCBS) was established in 1974 to act as the supervisory authority over banking matters. When it was established, the objective of BCBS was to enhance the financial stability of banks and improve the quality of banks through adequate banking supervision. BCBS also ensures that banks have enough capital to absorb risks and perform their obligations.
Basel I is the first Basel Accord, which was issued in 1988 to ensure the capital adequacy of banks and financial institutions. This Basel Accord was a response to the capital risk that financial institutions were exposed to. Given that banks are expected to face unexpected losses, they must possess enough capital to withstand the risk. The Basel I accord stipulates that banks have a capital adequacy risk weight of 8% or less before they operate. Assets owned by financial institutions are grouped into five risk categories which are; 0%, 10%, 20%, 50%, and 100%.
Basel II is otherwise known as the Revised Capital Framework given that it is an updated version of the original Basel Accord. This second Base Accord has three key focus areas which are capital requirements, capital adequacy and the use of disclosure. Basel II sets the minimum capital requirements for banks and financial institutions, it also oversees the assessment process of capital adequacy and ensures that sound market practices exist in the banking sector.
Basel III was third the Basel Accord that was created as a response to the 2008 financial crisis. After the 2008 crisis. The supervisory authority, BCBS set up Basel II as a way of strengthening the existing accords. This accord proffers solution to inadequate management, bad governance, and poor structures that wretched the financial industry. The three focus areas of Basel II were maintained and continued by Basel III, this accord also introduced additional regulations and requirements for financial institutions. The implementation of Basel III commenced in January 2013 and this implementation is expected to be fully achieved in January 2019.