BCBS and the Basel II Accord
In line with its purpose, in 1998 the BCBS issued the first Basel Accord, which came to be known as Basel I, focusing on the capital adequacy risk of the banking sector in an attempt to ensure financial institutions have sufficient capital in order to absorb unexpected losses and meet obligations. Under Basel I, a financial institution’s assets are categorized into five risk categories, being 0%, 10%, 20%, 50%, and 100%. Banks with global reach are expected to have a risk factor of 8% or less.
The Basel II Accord was published in June 2004, with implementation and compliance expected to be in force by 2015. The purpose of Basel II is to created international standards for regulators in member countries to use as a basis for monitoring financial institutions under their jurisdictions. Proponents of Basel II believe that a sound international standard will protect the global financial system from the negative impact of the collapse of a major bank, or series of banks, such as occurred in 2008/2009. Basel II will set up stringent risk and capital management criteria designed to guarantee that a financial institution holds capital reserves in proportion to the bank’s risk created by its lending and investment activities. So the greater the risk, the greater the amount of capital should be in order to safeguard its solvency.
Using a “three pillars” approach – minimum capital requirements; supervisory review; and market discipline – Basel II aims to promote greater stability in the financial system. The Basel II accord addresses issues of global economic importance that were either not addressed in Basel I, or were found to be inadequate.