Presentation of Comparison Between Basel I and Basel II

Background of Basel Committee

¢Named after Basel, Switzerland.

¢Formed in 1974 after the liquidation of Bank Herstatt.

¢Introduced by G-10 countries

¢Developed Under auspices of Bank for International Settlement

Function: regular cooperation on banking supervisory matters.


Basel Committee an Overview

¢Membership: The central bank Governors of the Group Ten.

¢Frequency of meetings: The Basel Committee usually meets four times per year

¢Reporting arrangements: reports to a joint committee of central bank Governors

¢Outreach: maintains links with supervisors not directly participating in the committee

¢Main subgroups:

—The Accord Implementation Group

—The Policy Development Group

—The Accounting Task Force

The International Liaison Group   



Basel Accord I

¢Aimed to standardized the computation of risk based capital across banks and across  countries.

¢Issued in 1988 by the Basel Committee on Banking Supervision, a group of banking supervisors which secretariat is based at the Bank for International Settlements in Basel, Switzerland.

Advantages   & Disadvantages         

¢Advantages of Basel I

¢Relatively simple structure

¢Substantially increased the capital ratios of international banks and enhanced competitive equity

¢Required capital to be held against OBS items

¢Widespread adoption world-wide

¢Provided a benchmark for analytical comparative assessment

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¢Disadvantages of Basel I

¢Not aligned with the actual risks faced by banking organizations

¢Broad-brush risk weighting structure

¢Opportunities for regulatory capital arbitrage

¢Covered primarily credit risk

Basel II

¢Basel 2 aims to make capital requirements more risk sensitive.

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¢Basel I only accounts for credit risk and market risk – Basel II includes operational risk and other risks.

Basel II framework

¢Basel II is a three-pronged approach relying on so called “3 Pillars”:

Basel II underlying principles

1.Banks should have capital appropriate for their risk taking activities (Pillar 1)

2.Banks should be able to properly assess the risk they are taking, and supervisors should be able to evaluate the soundness of these assessments (Pillar 2)3.Banks should be disclosing pertinent information necessary to enable market mechanism to complement the supervisory oversight function (Pillar 3)

Pillar I (Minimum capital requirements)

Prescribes capital charges for:

    1. Credit risk (major revision)

    2. Operational risk (new provision)

    3. Market risk (minor change)

Pillar 2 (Supervisory Review)

¢Emphasizes the 4 key principles of supervisory review:

1.Banks should have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital levels;

2.Supervisors should review and evaluate banks’ internal capital adequacy assessments and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital ratios. Supervisors should take appropriate supervisory action if they are not satisfied with the result of this process;

Pillar 2 (Supervisory Review)

3.Supervisors should expect banks to operate above the minimum regulatory capital ratios and should have the ability to require banks to hold capital in excess of the minimum;

4.Supervisors should seek to intervene at an early stage to prevent capital from falling below the minimum levels required to support the risk characteristics of a particular bank and should require rapid remedial action if capital is not maintained or restored.

Pillar 3 (Market Discipline)

¢Proposes an extensive list of bank disclosure requirements

¢Recognizes that markets contain disciplinary mechanisms that reward banks that manage risk effectively and penalize those whose risk management is inept or imprudent