- An increase in bureaucracy
- An increase of expenses related to reports and maintaining a capital reserve
- A more burdensome investment process
- Reestablishing trust within the markets
- Maintaining a correct and orderly market
In 1974 the bankruptcy of Herstatt Bank made it impossible for this institution to settle exchange transactions between the US dollar and the Deutschemark which led to losses in excess of 620 million dollars worldwide. This event, which has been known since then as the “Herstatt risk”, was one of the major factors which determined the G10 to create the Basel Committee for Banking Supervision.
In 1988, the first Basel I accord was developed and it was implemented in 1992. Until 1996 the only risk targeted by this accord was credit risk. In 1996, Basel I was revised to allow it to take into consideration the market risk as well – this is when new capital requirements were implemented. The main concept which was introduced by Basel I was Risk-Weighted-Asset (RWA) which is the basis for calculating credit exposure. This accord set the level of regulatory capital to 8% of the RWA.
Basel IIIn 2006 Basel II was finalized. For the first time operational risk was taken into account in addition to market and credit risk. Among the objectives of this accord were:
- Creating a more sensitive framework for risk
- Improving risk management
- Increasing transparency
The implementation of the Basel II accord started in 2006-2007 which meant that very few financial institutions had implemented it before the financial crisis begun. US banks for example had hardly implemented it.
In 2009 and 2010 Basel II was updated to Basel 2.5. These adjustments were implemented in 2011 (and 2013 in the USA) for the following reasons:
- Certain market risks hadn’t been correctly assessed
- The liquidity of certain assets had been assessed on false assumptions
Basel IIIIn 2010 The Basel Committee published the requirements for the Basel III accord. This was an improvement on Basel II and became official on the 1st of January 2013. If Basel II focused on RWA, Basel III is focused on capital structure.
Regulatory capital was maintained at 8% of the RWA but two new extra capital categories were implemented:
- Capital preservation which had to be at 2.5% of the RWA
- Countercyclical capital of a 2.5% maximum which had to be created at the request of central banks in situations of accelerated increase of lending
Another request of Basel III is that banks must maintain a level of equity of at least 3% of gross exposure. With regard to liquidity, banks must maintain a level of high liquid assets at least equal to the net outflow of capital for the next 30 days.
The requirements of the Basel III accord must be implemented until March 2019. The Basel Committee for Banking Supervision doesn’t have an official role as a legislative body, its actions are merely recommendations. Some provisions of the Basel accords have been directly implemented into the legislation of various countries and are now mandatory. Therefore the Basel accords aren’t mandatory unless a state institution imposes them.
We must also add that the requirements of the Basel accords are minimal, which means that institutions in charge of regulation in each country can impose tougher conditions.
The intent of the Basel III accord is to prevent other financial crises. Because financial crises can’t be simulated, we will have to wait until the next financial crises to see how effective Basel III is. Until then the financial community is slowly whispering about Basel IV...
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Investment Banking Specialist