BASEL ACCORDS

Basel I
1.Minimum Capital Requirements: Basel I's
central objective was to ensure that banks
maintained a minimum level of capital to
absorb losses and protect depositors and the
stability of the financial system. Capital acts as
a buffer against financial distress and
insolvency.
2. Risk-Based Capital Adequacy: Basel I introduced
a risk-based approach to calculating capital
requirements. It categorized bank assets into
four broad risk categories:
– Category 1 (0% Risk Weight): Includes government
bonds from developed countries, central banks'
deposits, and cash. These assets were considered to
have no risk.
– Category 2 (20% Risk Weight): Included claims on
public sector entities and interbank loans.
– Category 3 (50% Risk Weight): Included loans to the
private sector and residential mortgages.
– Category 4 (100% Risk Weight): Covered other assets
like corporate loans and unsecured consumer loans.
3. Capital Adequacy Ratio (CAR): Basel I
established a minimum Capital Adequacy
Ratio, which required banks to maintain a
capital-to-risk-weighted-assets ratio of at
least 8%. In other words, a bank's capital had
to be at least 8% of its risk-weighted assets.
For example, if a bank had $100 million in
risk-weighted assets, it needed to have at
least $8 million in capital.
4.Uniformity and Simplification: One of the key
features of Basel I was its simplicity and
uniformity. It provided a standardized
approach to capital adequacy requirements
that could be easily applied by banks and
regulators worldwide.
5.International Consistency: Basel I aimed to
ensure international consistency in capital
regulation. Banks that operated
internationally were required to meet Basel I
standards, which helped create a level playing
field and maintain financial stability across
borders.
 Basel II
• Three Pillar Structure: Basel II introduced a
three-pillar framework for banking regulation
and supervision, which expanded upon the
relatively simple rules of Basel I.
1.Pillar 1 - Minimum Capital Requirements:
Similar to Basel I, Pillar 1 of Basel II established
minimum capital requirements. However, it
introduced more risk-sensitive approaches to
calculating these capital requirements. The
key innovation was the adoption of three
distinct risk categories:
• Credit Risk: Basel II allowed banks to use their
internal models to estimate credit risk for individual
assets and portfolios more accurately. This approach,
known as the Internal Ratings-Based (IRB) approach,
allowed banks to assign specific risk weights based
on their own assessments of credit risk.
• Operational Risk: Basel II introduced capital
requirements for operational risk, which
encompasses risks related to a bank's internal
processes, systems, people, and external events.
Banks were given the option to use their internal
models to estimate operational risk capital or to use
a standardized approach.
• Market Risk: Basel II included an updated framework
for calculating capital requirements for market risk,
which arises from fluctuations in interest rates,
foreign exchange rates, and other market variables.
Banks were required to have capital reserves to cover
market risk.
• Pillar 2 - Supervisory Review Process (SRP):
Pillar 2 emphasized the importance of banks'
internal risk management practices and
required supervisory assessments of a bank's
capital adequacy. Banks were expected to
have rigorous internal processes for assessing
and managing risks. Supervisors had the
authority to review and enforce additional
capital requirements if they deemed it
necessary to address specific risks.
• Pillar 3 - Market Discipline: Pillar 3 aimed to
enhance transparency and market discipline
by requiring banks to disclose more
information about their risk profiles and
capital adequacy. This increased disclosure
helped market participants, including
investors and depositors, make informed
decisions about the banks they engaged with.
• Advanced Approaches: Basel II provided
banks with the option to use more advanced
approaches for calculating capital
requirements. For instance, banks could use
the Advanced IRB approach for credit risk or
the Advanced Measurement Approach (AMA)
for operational risk if they met certain
eligibility criteria and received regulatory
approval.
• Liquidity Standards: While Basel II primarily
focused on capital adequacy, it did not initially
include detailed liquidity standards. These
were addressed in subsequent frameworks,
particularly Basel III, in response to the global
financial crisis.
• International Consistency: Like Basel I, Basel II
aimed to ensure international consistency in
capital regulation, making it easier for banks
operating globally to comply with similar
standards.
 Basel III
1.Capital Requirements:
• Common Equity Tier 1 (CET1) Capital: Basel III
introduced a higher minimum CET1 capital
requirement. CET1 capital primarily consists of
common equity and retained earnings and
represents the highest quality of capital. Banks
are required to maintain a CET1 capital ratio
of at least 4.5% of risk-weighted assets (RWA).
• Capital Conservation Buffer: In addition to the
minimum CET1 requirement, Basel III
introduced a capital conservation buffer of
2.5% of RWA. Banks are required to build this
buffer in good times to ensure they have an
extra cushion of capital during economic
downturns. The total CET1 capital
requirement, including the buffer, is 7%.
• Countercyclical Buffer: Basel III introduced a
countercyclical buffer, which varies depending
on the credit cycle in a particular jurisdiction.
It is designed to ensure that banks accumulate
additional capital during periods of excessive
credit growth to address the risk of future
credit losses.
• Other Capital Buffers: Basel III also introduced
other capital buffers, such as the systemic risk
buffer and the buffer for global systemically
important banks (G-SIBs), to address specific
risks posed by large, systemically important
banks.
2. Liquidity Standards:
• Liquidity Coverage Ratio (LCR): Basel III
introduced the LCR to ensure that banks have
sufficient high-quality liquid assets to cover their
short-term liquidity needs in times of stress.
Banks are required to maintain an LCR of at least
100%, meaning they must hold liquid assets
equal to or greater than their expected net cash
outflows over a 30-day stress period.
• Net Stable Funding Ratio (NSFR): The NSFR
was introduced to promote more stable
funding profiles in banks. It requires banks to
maintain a stable funding base that is at least
as long-term as the liquidity of their assets.
The NSFR is aimed at reducing the reliance on
short-term funding sources.
3.Risk Management:
• Risk Management and Governance: Basel III
emphasizes the importance of robust risk
management practices and effective
governance within banks. It requires banks to
have comprehensive risk management
frameworks, including credit risk, operational
risk, market risk, and liquidity risk.
• Enhanced Supervision: Basel III enhances the
supervisory review process, requiring
regulators to have a deeper understanding of
banks' risk profiles and risk management
practices.
4.Market Risk:
• Basel III introduced more comprehensive and
risk-sensitive standards for the management
of market risk, particularly for trading
activities in banks.
5.Enhanced Disclosure: Basel III introduced
enhanced disclosure requirements to improve
transparency and market discipline. Banks are
required to provide more detailed information
about their capital, risk exposures, and risk
management practices.
6.Systemically Important Financial Institutions:
Basel III includes measures to address the
systemic importance of certain financial
institutions, including additional capital
requirements for G-SIBs and enhanced
supervision.