Basel I, II and III are regulatory frameworks for banks, developed by the Basel Committee on Banking Supervision, which is part of the Bank for International Settlements (BIS). These frameworks were created to ensure global financial stability by limiting how banks can risk investors' money.
Basel I
Basel I, also known as the Basel Capital Accord, was introduced in 1988. Its main objective was to ensure that banks maintain a minimum level of capital, relative to the total value of their risk-weighted assets. The aim was to create a capital 'buffer' that could absorb unexpected losses.
Basel I used a fairly simple risk-weighting system that classified banks' assets into four categories based on their perceived risk. Lower-risk assets (such as government bonds) were given a risk weight of 0%, while higher-risk assets (such as unsecured loans) were given a 100% risk weight. Banks were then required to hold capital equal to at least 8% of the total value of their risk-weighted assets.
Basel II
Basel II was introduced in 2004 to address some of the perceived deficiencies in Basel I. In particular, it has been criticized for being too simplistic in its approach to risk weighting. Basel II introduced a much more sophisticated and detailed approach to assessing risk that took into account a much broader range of factors.
Basel II is based on three pillars: minimum capital requirements, supervisory review process and market discipline. The first pillar establishes the minimum capital requirements that banks must maintain to cover operational, credit and market risks. The second pillar allows regulators to review a bank's risk assessment and intervene if necessary. The third pillar requires banks to disclose information about their financial health, to encourage market discipline.
Basel III
Basel III was introduced in response to the 2008 global financial crisis. The aim was to improve banks' ability to absorb financial and economic shocks, improve risk management, and strengthen transparency and disclosures.
Basel III introduced a number of new requirements, including a leverage ratio to limit excessive borrowing, a liquidity coverage ratio to ensure banks have sufficient liquid assets to survive short-term liquidity stress, and a net stable funding ratio to encourage long-term funding stability.
In addition, Basel III increased minimum capital requirements and introduced new capital buffers, including a capital conservation buffer and a countercyclical buffer, which are activated in times of economic stress to ensure that banks have sufficient capital to absorb losses.
In short, Basel I, II and III were important milestones in global banking regulation, each introducing new measures to ensure financial stability and protect investors. They have been instrumental in shaping the modern banking industry and will continue to play an important role in banking risk management well into the future.
