The Basel Accords I and II have had a huge impact since their formulation on the way banking is conducted today. They were formed and initiated in 1988 and 2004 respectively. These accords have set new standards for banking and finance on a global scale by setting new standards of performance to be met by all countries who are members of the Basel Group (Balin, 2008). Despite the efficiency and generally improved performance resulting from the Basel Accords, they have been subjected to criticism due to their highly technical nature which has caused them to be misunderstood by many parties. This paper aims to supply a brief history of the accords, their evolution, the reasons for their implementation and the roles of these accords.
A total of 11 countries comprise the Basel Committee, which was formed to standardize rules related to banking after the collapse of Herstatt Bank due to settlement risk issues. The goal of the committee is to “…extend regulatory coverage, promote adequate banking supervision, and ensure that no foreign banking establishment can escape supervision” (Basle Committee on Banking Supervision, 1988).
After the creation of the BCBS, the member nations discussed the fact that certain banks avoided the regulatory authorities by hiding under their country’s laws when it came to international disputes and settlements. This led to the creation of the “International Convergence of Capital Measurements and Capital Standards” more commonly known as Basel I (Balin, 2008).
The main purpose of Basel I was to provide benchmarks for banks related to “capital adequacy” for developed economies which were the member countries. It was not to be used in lesser developed or emerging countries. Basel I was also implemented to help set rules to guard against risk related to a company’s credit strength. The accord does not set any standards for risks related to recessions or exchange rate fluctuations. Basel I asks banks to adopt a conservative pattern and has also set minimum reserve standards for banks to implement (Balin, 2008).
Despite the standards set by Basel I, it faced many criticisms such as the fact that it did not cover countries outside the member states, its implementation and the fact that the jargon used created problems for laymen to decipher its meaning.
Due to the financial turmoil in the last decade of the twentieth century and also because of the drawbacks of Basel I, Basel II was introduced as a new and improved model of its predecessor. Whereas Basel I asked the lending authorities to apply one risk set to the restricted amount of asset categories for the purpose of calculation of a minimum amount of capital; Basel II gives the freedom to a select number of nations to apply unique paradigms for calculation of minimum capital. Basel II also requires the lenders to adopt a framework within their institutions that takes the issue of risk management to all levels of the hierarchy (Council of Mortgage Lenders, 2009).
Besides for the original member nations, 95 other nations (excluding China) have decided to enforce Basel II in their regulatory frameworks through their central banks by the year 2015. The Basel II format has so far undergone two revisions before a unanimous agreement in 2006. The disagreements and revisions were due to US, UK and Canada’s requests that Basel II apply only to large banks and this rule was enforced in 2006 (Balin, 2008).
The main problem with both Basel Accords has been that they have excluded the developing economies from their frameworks. These countries are in a dilemma of which accord to implement and on doing so will face high risks related to international flows of money. Conversely, if these countries do not use the accords, they run the risk of being disbarred from international transactions (Balin, 2008). The Basel committees need to take the role of developing economies into account when making changes in the future.
Works Cited
Balin, B. (2008). Basel I, Basel II, and Emerging Markets: A Nontechnical Analysis. Washington DC: The Johns Hopkins University School of Advanced International Studies (SAIS).
Basle Committee on Banking Supervision. (1988). International Convergence of Capital Measurement and Capital Standards. Web.
Council of Mortgage Lenders. (2009). Basel II – questions and answers. Web.