Basel Accord

The Basel Accord is a set of rules on banking regulations for capital risk, market risk and operational risk that plays a big role in the global financial system. These were developed by the Basel Committee on Banking Supervision (BCBS), an international body of 27 banking regulators. Their purpose is to help the banking industry to cope with financial stress, improve risk management and strengthen banks’ transparency.

What is Basel Accord?

The Basel Accord is a set of standards for banks to ensure stability and soundness of the global banking system. The BCBS, comprising global banking regulators, developed these standards to manage the risks of banking. There are three versions of the Basel Accords, Basel III is the latest.

1. Basel I (1988) Basel I in 1988 introduced a uniform approach to banking capital adequacy standards. It focused mainly on credit risk and required banks to have a minimum capital of 8% of their risk weighted assets. This was to ensure banks have enough capital to absorb unexpected losses so depositors are protected and financial stability is maintained.
2. Basel II (2006) Basel II which replaced Basel I in 2006 expanded the framework to include trading and lending activities in capital adequacy standards. It introduced three pillars: minimum capital requirements, supervisory review process and market discipline. These pillars aimed to strengthen the regulatory framework by incorporating a more comprehensive approach to risk management including operational risk and improved disclosure standards for bank supervision by regulators.
3. Basel III (2010) In response to the 2007-2009 financial crisis, Basel III was introduced. This version further strengthened the regulatory framework by addressing both company specific (idiosyncratic) risk and market level (systemic) risk. Basel III introduced stricter capital requirements, leverage ratios and liquidity requirements to enhance the banking industry’s ability to absorb shocks from financial and economic stress.

Why is it essential to know Basel Accord?

You should know the Basel Accord if you are in the financial industry, especially if you are a risk professional. Here’s why:

• Risk – Basel II is the foundation of risk management. It tells banks how to manage and disclose their risk exposures, so there is a common approach across the global banking industry. That’s key to stability and reducing systemic risk, so it’s a must know for risk managers.
• Financial Stability – The Basel Accords are key to the global financial system’s stability. By setting minimum capital requirements and good risk management practices, the accords prevent bank failures and financial crises. For risk professionals, understanding these frameworks is essential to develop strategies that make the financial sector more stable and resilient.
• Compliance – Basel Accords are mandatory for banks in countries that have adopted them. Risk professionals need to know Basel I, II and III to ensure their institution is compliant. Non compliance can result in severe penalties and damage to the institution’s reputation, so knowledge of these accords is critical for regulatory compliance.
• Changing Risk Management – The Basel Accords have changed to address new risks and challenges in the banking industry. Basel III introduced liquidity risk and leverage ratios, lessons learned from the crisis. Keeping up to date with these changes is critical for risk professionals so they can adapt their risk management to changing regulatory standards and industry best practices.

For Risk Professionals

For those in risk management Basel Accords provide a framework for managing all types of risk in the banking industry. Here’s how they impact:

• Credit Risk Management – Basel I introduced minimum capital requirements based on risk weighted assets. This serves as foundation of credit risk management. Understanding this framework helps risk professionals assess creditworthiness of borrowers. It ensures their institution has enough capital buffers to absorb losses.
• Operational Risk Management – Basel II added operational risk. This covers risks from internal processes, systems and external events. Risk professionals need to develop internal controls. They also need risk assessment frameworks to manage these risks
• Market Risk Management – Basel II also covered market risk, the risk of losses from market movements. Risk professionals need to implement advanced risk measurement techniques, such as VaR, to measure and manage market risk exposures.
• Liquidity Risk Management – Basel III introduced new liquidity standards, banks need to hold sufficient high quality liquid assets to withstand financial stress. Risk professionals need to develop strategies to manage liquidity risk and comply with these regulations.
• Capital and Leverage Ratios – Basel III also introduced tighter capital and leverage ratios. Risk professionals need to know these and develop capital plans to ensure their institution has enough capital.

Conclusion

The Basel Accords have formed the global banking regulatory landscape and the financial system is more stable and resilient. As risk professionals understanding the current standards and looking to the future and the challenges is key to effective risk management. By staying up to date and proactive risk professionals can navigate the complexities of the evolving regulatory landscape and ensure their institution is robust, compliant and resilient to emerging risks. The future of risk management is about adapting to change, leveraging technology and integrating new dimensions of risk into the risk management framework.