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The Basel Accords

The Basel Accords—Basel I (1988), II (2004), and III (2013)—are a series of operational risk regulations for financial organizations designed to ensure liquidity and manage the risk associated with lending activity. The regulations were agreed by the Basel Committee on Banking Supervision (BCBS), a group comprising representatives from 27 major financial centers.

Basel III superseded Basel II and will run from 2013–2018.

Basel II—2004

Basel II, which was agreed before the 2007–08 global financial crisis, was an attempt to regulate the liquidity levels of banks by setting out various minimal capital requirements that they had to hold in order to offset lending and investment losses. The Accord required banks to hold 2% of common equity and 4% of Tier 1 capital.

By attempting to regulate the banking industry on a global level, Basel II aimed to ensure that no individual national system could gain unfair advantage. As was shown by the 2007–08 crisis and its consequences, however, Basel II was limited in its success.

Basel II was viewed by some as overly dogmatic and yet incomplete. Some banks believed self-regulation would be more effective; some banks simply attempted to work through the loopholes in the regulations.

Basel III—2013

Basel III, the 2013 iteration of Basel, was a direct response to the failure of Basel II to prevent the 2007–08 financial crisis.

This Accord was announced in January 2013 with an introduction schedule running to 2018.

It builds on the 2004 version by:

  • increasing common equity requirements to 4.5%
  • increasing Tier 1 capital requirements to 6%
  • introducing a minimum leverage ratio (Tier 1 capital divided by assets) of 3%
  • introducing two required liquidity ratios (one ensuring sufficient liquid assets to cover net cash outflow for 30 days, another ensuring available funding exceeds the required funding “over a one-year period of extended stress”).

Basel III consists of the following principles:

  • “Risk-based capital and leverage requirements,” including first annual capital plans, stress tests, and capital adequacy, “including a tier one common risk-based capital ratio greater than 5 percent, under both expected and stressed conditions.”
  • Market liquidity, requiring liquidity stress tests and setting internal quantitative limits.
  • The Federal Reserve Board will conduct tests annually, “using three economic and financial market scenarios.” Institutions are encouraged to use at least five scenarios reflecting improbable events, including events considered impossible by management.
  • Single-counterparty credit limits to cut “credit exposure of a covered financial firm to a single counterparty as a percentage of the firm's regulatory capital.”
  • “Early remediation requirements” are required to ensure that “financial weaknesses are addressed at an early stage. Required actions would vary based on the severity of the situation, but could include restrictions on growth, capital distributions, and executive compensation, as well as capital raising or asset sales.”

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