Comparison of Basel i ii and iii

Assignment On: Comparison of Basel I, II and III Prepared By: Md. Zahidul Alam Class ID: 227 19th Batch MBA Program

Prepared For: Mr. Alamgir Hossen Assistant Professor Course Instructor Strategic Banking

Institute of Business Administration Jahangirnagar University

Date of Submission: December 18, 2014

The Basel Accords refer to the banking supervision Accords (recommendations on banking regulations)—Basel I, Basel II and Basel III—issued by the Basel Committee on Banking Supervision (BCBS). They are called the Basel Accords as the BCBS maintains its secretariat at the Bank for International Settlements in Basel, Switzerland and the committee normally meets there. The Basel Accords is a set of recommendations for regulations in the banking industry. The basel accord came into practice after on 26 June 1974, a number of banks had released payment of Deutsche Marks (DEM - German Currency at that time) to Herstatt (Based out of Cologne, Germany) in Frankfurt in exchange for US Dollars (USD) that was to be delivered in New York. Because of time-zone differences, Herstatt ceased operations between the times of the respective payments. German regulators forced the troubled Bank Herstatt into liquidation. The counter party banks did not receive their USD payments. Responding to the cross-jurisdictional implications of the Herstatt debacle, the G-10 countries, Spain and Luxembourg formed a standing committee in 1974 under the auspices of the Bank for International Settlements (BIS), called the Basel Committee on Banking Supervision. The basic structure of Basel accords remains unchanged with three mutually reinforcing pillars. Pillar 1: Minimum Regulatory Capital Requirements based on Risk Weighted Assets (RWAs): Maintaining capital calculated through credit, market and operational risk areas. Pillar 2: Supervisory Review Process: Regulating tools and frameworks for dealing with peripheral risks that banks face. Pillar 3: Market Discipline: Increasing the disclosures that banks must provide to increase the transparency of banks

Basel I: In 1988, the Basel Committee on Banking Supervision (BCBS) in Basel, Switzerland, published a set of minimum capital requirements for banks. These were known as Basel I. It focused almost entirely on credit risk (default risk) - the risk of counter party failure. It defined capital requirement and structure of risk weights for banks. Under these norms: Assets of banks were classified and grouped in five categories according to credit risk, carrying risk weights of 0%(Cash, Bullion, Home Country Debt Like Treasuries), 10, 20, 50 and100% and no rating. Purpose: One of the major roles of Basel norms is to standardize the banking practice across all countries. It was implemented to strengthen the stability of international banking. Also it would set up a fair and a consistent international banking system in order to decrease competitive inequality among international banks. Limitations: 

Limited differentiation of credit risk



Static measure of default risk



No recognition of term-structure of credit risk



Simplified calculation of potential future counterparty risk



Lack of recognition of portfolio diversification effects

Basel II: Basel II was introduced in 2004, laid down guidelines for capital adequacy (with more refined definitions), risk management (Market Risk and Operational Risk) and disclosure requirements. It uses external ratings agencies to set the risk weights for corporate, bank and sovereign claims. Operational risk has been defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputation risk, whereby legal risk includes exposures to fines, penalties, or punitive damages resulting from supervisory actions, as well as private settlements. There are complex methods to calculate this risk. Advantages over Basel I: The discrepancy between economic capital and regulatory capital is reduced significantly, due to that the regulatory requirements will rely on banks’ own risk methods. Basel II is more Risk sensitive. It has wider recognition of credit risk mitigation. Limitations: There is too much regulatory compliance. It is over focused on Credit Risk. This new Accord is complex and therefore demanding for supervisors, and unsophisticated banks. Strong risk differentiation in the new Accord can adversely affect the borrowing position of risky borrowers

Basel III: It is widely felt that the shortcoming in Basel II norms is what led to the global financial crisis of 2008. That is because Basel II did not have any explicit regulation on the debt that banks could take on their books, and focused more on individual financial institutions, while ignoring systemic risk. The guidelines aim to promote a more resilient banking system by focusing on four vital banking parameters viz. capital, leverage, funding and liquidity. Purpose: Basel – III norms aim to: Improve the banking sector's ability to absorb shocks arising from financial and economic stress, Improve risk management and governance and Strengthen banks' transparency and disclosures. To ensure that banks don’t take on excessive debt, and that they don’t rely too much on short term funds, Basel III norms were proposed in 2010. It was agreed upon by the members of the Basel Committee on Banking Supervision in 2010–11, and was scheduled to be introduced from 2013 until 2015; however, changes from 1 April 2013 extended implementation until 31 March 2018 and again extended to 31 March 2019. Requirements for common equity and Tier 1 capital will be 4.5% and 6%, respectively. Also , the liquidity coverage ratio (LCR) will require banks to hold a buffer of high quality liquid assets sufficient to deal with the cash outflows encountered in an acute short term stress scenario as specified by supervisors. The

minimum LCR requirement will be to reach 100% on 1 January 2019. This is to prevent situations like "Bank Run". Leverage Ratio > 3%: The leverage ratio was calculated by dividing Tier 1 capital by the bank's average total consolidated assets;. Comparison of Basel I, Basel II and Basel III : Features

Basel I

Released in:

July 1988

Basel II

Basel III

June 2004

2010-11

Main Focus:

Stability and fairness Capital Adequacy, Risk Emphasis on Reducing of International Management and Systematic Risk & Banking System Disclosure Requirements Improving Transparency.

Risk Sensitivity:

Low

Moderate

Focus:

Backward looking

Somewhat looking

High forward

Forward Looking

Comparison of Capital Requirements: Minimum Ratio of Total Capital To 8% Risk Weighted Assets(RWAs)

8%

10.50%

Minimum Ratio of Common Equity to 2% RWAs

2%

4.50% to 7.00%

Tier I capital to RWAs

4%

4%

6.00%

Core Tier I capital to RWAs

None

2%

5.00%

None

None

2.50%

Leverage Ratio

None

None

3.00%

Countercyclical Buffer

None

None

0% to 2.50%

Minimum Liquidity Coverage Ratio

None

None

TBD (2015)

Minimum Net Stable Funding Ratio

None

None

TBD (2018)

Systemically important Institutions Charge

None

None

TBD

Capital RWAs

Conservation

Buffers

to

Financial