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The Basel Committee Role in Banking Essay

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Updated: Apr 2nd, 2020

Goals of Basel I and II

The Basel committee was established in the 70s by ten countries with the aim of streamlining operations of the banks. The committee established a minimum capital requirement for financial institutions in member countries. The establishment of minimum capital requirement was aimed at reducing the risks associated with credit.

The establishment of Basel I was in response to the decline in the capital held by financial institutions. As a result, it developed a number of goals aimed at improving the banking sector within member countries. The committee intended to introduce a minimum ratio of capital of 8% based on the risk-weighted assets (Tatom 465).

The Basel I committee also categorized borrowers based on their level of risks. This was aimed at protecting financial institutions from defaulters. The first Basel accord also provided a platform for information exchange within the banking sector. Accomplishing this goal would enhance credit access and reduce the risks associated with defaulting.

Risk management within banks was poor prior to the Basel I report and recommendation. The committee improved risk management practices within these banks. The accomplishment of this goal provided an enabling environment for banks to supervise credit services and lower risks on credit.

Basel II is the second banking supervisory recommendations that the committee provided. While Basel I concentrated on credit risk within the banking sector, the second recommendations focused on capital limits. The committee intended to establish a minimum capital requirement for financial institutions in member countries.

The second Basel accord improved the capital base of financial institutions. This was achieved by setting aside a certain minimum capital to reduce risks incurred by banks. Banks are exposed to risks associated with poor investment decisions and lending practices.

What Basel II failed to address

Despite the goals and recommendation of Basel II, it failed to address a number of issues in the financial sector. The main goal of the second committee was to create a safe banking environment. The committee foresaw a safe banking environment due to the presence of a minimum reserve maintained by banks. However, Basel II failed to protect banks and financial institutions from risky lending and investment behaviors. The financial crisis was attributed to the failure of Basel II to safeguard banks against losses.

Representation at Basel II committee can also be attributed to the failure of its recommendation to safeguard the financial institutions. Before 2008, the Basel committee had no representatives from the developing world. Observer status was only granted to members of the European Union and the European central banks. This affected uniform adoption and implementation of the recommendations of Basel II by most countries.

Though the Basel committee makes inclusive recommendations to guide the operations of the financial sector, the members are not accountable to any organ (Tatom 65). Accountability is common in most international organizations and committees as a way of ensuring commitment to the process. This is not possible with the Basel committees as members are unaccountable for the recommendations they make.

The presence of operational independence affects their judgment and informs the decisions they make. High handedness of Basel committee members has affected the willingness of central bank governors to implement the recommendations. Lack of uniformity in the implementation of the recommendations of Basel II committee has also contributed to its failure.

How Basel III seeks to address the failures of the second Basel accord

Basel III was developed to address the shortcomings of the second committee recommendations. The failure of Basel II to protect financial institutions during the financial crisis informed the need for further resolutions. The third Basel accord seeks to increase banks liquidity by reducing their leverages.

This will improve the utilization of capital adequacy and enhance risk management measures. While the first and second Basel accords required banks to hold loss reserves for its different loan products, the third accord emphasized on the need for banks to have different levels of reserves for its loan products. This demonstrates that the third Basel accord is not aimed at replacing the previous two accords, but to improve their acceptance (Cecchetti and Schoenholtz 44).

The third accord also intends to strengthen the capital reserves held by financial institutions across the globe. This will be achieved through the introduction of stringent reporting frameworks. Such frameworks will cover risks, the liquidity of the assets and the level of leverage enjoyed by the institutions.

Basel I and II failed to develop a common framework for the operation of central banks. The third accord seeks to improve the link between financial institutions in different parts of the world through the establishment of the central clearing houses (Cecchetti and Schoenholtz 57).

However, the accord will maintain the overall capital established by the first and second accords. This will affect both tiers I and II financial institutions with a decline of 2% for tier two institutions in the developing world. The introduction of capital conservation buffer for tier 1 is also aimed at cushioning financial institutions from losses associated with investment decisions. Such a buffer was not captured by the first two accords of the Basel committee (Tatom 65).

The success or failure of Basel III

The success of the third Basel accord has been the subject of discussion within the financial market circles. The recommendations intend to address the inadequacies of the first and the second Basel accord. Despite the improvements made on the third Basel accord, it is unlikely to succeed like the first two accords.

The first proposal of the third Basel accord is the development of consistent and transparent capital base. This was aimed at ensuring that any losses that may arise are cushioned by high quality capital. This is will not address issues associated with the capital ratios of financial institutions. Most organizations use independent risk-weighted formulas, a situation that makes the resolutions non-inclusive (Cecchetti and Schoenholtz 47).

The third Basel accord also seeks to widen the risk coverage as a way of enhancing the process of risk management in the financial sector. This is a promising approach that most analysts have supported. However, the banking sector regulators must be forced to implement most of the risk management proposals covered under this accord. Most countries in the developing world have failed to implement most of its provisions as was witnessed with the previous recommendations.

The cost of implementing most of the recommendations of the third Basel accord has affected its success level. Most regulators and central banks have indicated that increasing the risk reserve will negatively affect the operation of banks. This presents a number of challenges to the success of the third Basel accord.

Works Cited

Cecchetti, Stephen, and Schoenholtz, Kermit. Money, Banking and Financial Markets. 4th ed. 2006. Boston: McGraw-Hill. Print.

Tatom, John. Financial market regulation: legislation and Implications. New York: Springer, 2011. Print.

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