Basel Framework

The Basel Framework is the set of prudential standards for large internationally active banks, issued by the Basel Committee on Banking Supervision (BCBS).

Initiated in 1975 with the so-called Basel Concordat, it has grown into an increasingly elaborate and complex corpus that integrates the Basel Core Principles for Effective Banking Supervision as well as the successive Basel Accords on bank capital requirements and other parameters, namely Basel I (first issued in 1988), Basel II (first issued in 2004), and Basel III (first issued in 2010).

Basel Accords

Basel I, published in 1988, covered capital requirements for credit risk. The Accord was enforced by law in the Group of Ten (G-10) countries in 1992. It was augmented in 1996 with a framework for market risk, which included both a standardised approach and a modelled approach, the latter based on value at risk.

Basel II, first published in 2004, added capital requirements for operational risk for the first time. It was revised several times during subsequent years. Bank regulators in the United States took the position of requiring a bank to follow the set of rules (Basel I or Basel II) giving the more conservative approach for the bank. Because of this it was anticipated that only the few very largest US banks would operate under the Basel II rules, the others being regulated under the Basel I framework. However Basel II standards were criticised by some for allowing banks to take on too much risk with too little capital. This was considered part of the cause of the US subprime mortgage crisis, which started in 2008.

The so-called Basel 2.5 revisions introduced stressed VaR and IRC for modelled market risk in 2009-10.

Basel III was initially published in 2010/11, following the 2008 financial crisis. The standards set new definitions of capital, higher capital ratio requirements, and a leverage ratio requirement as a "back stop" measure. Risk-based capital requirements (RWAs) for CVA risk and interest rate risk in the banking book were introduced for the first time, along with a large exposures framework, a revised securitisation framework, and a standardised approach to counterparty credit risk (SA-CCR) to measure exposure to derivative transactions. A specific framework for exposures to central counterparty clearing was introduced.

The BCBS also published regulatory standards for the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR);

In subsequent years, the Basel Committee updated the standards for market risk, based on a “Fundamental Review of the Trading Book” (FRTB). In addition, further reforms of the framework were published by the Basel Committee in 2017 under the title Basel III: Finalising post-crisis reforms. These reforms were sometimes referred to as "Basel IV". However, the secretary general of the Basel Committee said, in a 2016 speech, that he did not believe the changes are substantial enough to warrant that title and the Basel Committee refer to only three Basel Accords. These new standards came into effect on 1 January 2023, although national implementation of the standards is generally running behind this schedule and still ongoing.

Criticism

The framework's approach to risk which is based on risk weights derived from the past was criticised for failing to account for the uncertainty in the future. A recent OECD study suggest that bank regulation based on the Basel accords encourage unconventional business practices and contributed to or even reinforced adverse systemic shocks that materialised during the 2008 financial crisis. According to the study, capital regulation based on risk-weighted assets encourages innovation designed to circumvent regulatory requirements and shifts banks' focus away from their core economic functions. Tighter capital requirements based on risk-weighted assets, introduced in the Basel III, may further contribute to these skewed incentives. New liquidity regulation, notwithstanding its good intentions, is another likely candidate to increase bank incentives to exploit regulation.

In an October 24, 2020 speech at the Bund Financial Summit in Shanghai, Jack Ma described the Basel Accords as a "club for the elderly."

See also

• Basel IA
• Capital Requirements Directive
• Financial Stability Board

Further reading

• Deventer, Donald R. Van; Mesler, Mark (2003). Credit Risk Models and the Basel Accords. Wiley. ISBN 978-0-470-82091-9.
• Elbannan, Mona (2011). Basel Accords Consequences. Lap Lambert Academic Publishing GmbH KG. ISBN 978-3-8443-8363-8.
• Eubanks, Walter W.; Division, Government and Finance (2006). The Basel Accords: The Implementation of II and the Modification of I. Congressional Research Service, the Library of Congress.
• Han, Yicheng (2020). Historical Capital Regulation of Banks. Standards and Influence of Basel Accords. GRIN Verlag. ISBN 978-3-346-30865-8.
• Liew, Venus Khim-Sen; Rahim, Rossazana Ab; Riaz, Samina (2019). Basel Accords, Bank Capital and Portfolio Risk Behavior. Cambridge Scholars Publishing. ISBN 978-1-5275-3889-4.
• Quillin, Bryce (2008). International Financial Co-Operation: Political Economics of Compliance with the 1988 Basel Accord. Routledge. ISBN 978-1-135-97959-1.
• Onyiriuba, Leo (2016). "Applications of Basel Accords in Emerging Economies". Emerging Market Bank Lending and Credit Risk Control. pp. 617–635. doi:10.1016/B978-0-12-803438-5.00036-2. ISBN 978-0-12-803438-5.
• Ong, Michael (2007). The Basel Handbook: A Guide for Financial Practitioners. Risk Books. ISBN 9781904339557.