What is the definition of a Basel Accord in finance?

Definition

The Basel Accords are formed by the three-part banking regulations, namely Basel I, Basel II, and Basel III, set up by the Basel Committee on Bank Supervision (BCBS). They function as a global banking regulatory framework which ensures that banks and other financial institutes are able to sustain enough capital on account to fulfill all obligations and cover sudden losses.

Understanding Basel Accords

In 1974, the Basel Committee on Banking Supervision (BCBS) was created by its member countries as a means of regulating its international banking system. By 1988, the first series of the Basel Accord was formed and it has since been improved into three parts. According to the BCBS, the original aim of the Basel Accords was to enhance financial stability by acting upon the regulation and supervision of the international banking system.

When the first Basel Accord was created in 1988 (the 1988 Basel Accord know known as Basel I), the risk weight of asset (RWA) classification was introduced. The RWA classification was categorized into 0,10,20,50, and 100 percent, all according to the nature of the debtor. Capital standards (Tier 1 and Tier 2) were set as proportions for risk-weighted assets and all BHC’s were expected to report their RWA on Y-9C forms starting from 1996.

The Basel Accords form the controversial and authoritative framework of credit risk management in the international banking system. It is the most commonly used and influential blueprint for global banks, providing bank management and regulators the opportunity of possibly tempering and forestalling credit risks.

The Basel Accords can also be said to represent the agreement of the Group of Ten countries (G-10) which form the basis of the Basel Accords member countries. The purpose of this agreement focuses on the need to strengthen global banking regulation and arrive at a standardized international banking system. Other non-member states of the Basel Committee can as well adopt the Basel Accords as a benchmark in banking regulations, though the Basel committee does not have the legal right to enforce its resolutions as a result of the peculiarities of different countries.

The Basel Accords

The Basel Accords are basically a combination of a three-part series of BCBS rules, they are;

• Basel I: this focuses on credit risks/capital adequacy risk, a type of risk that is more associated with the unexpected losses that might hit a bank. It classifies the RWA into five categories, 0%, 10%, 20%, 50%, and 100%. Banks that operate under the Basel I are required to maintain an 8% risk weight.

• Basel II: also known as the Revised Capital Framework is basically the updated version of the Basel I. Its areas of focus are minimum capital requirements, capital adequacy, and internal assessment process, and strengthening market discipline by the use of disclosure.

• Basel III: in 2010, the BCBS decided to once again update the accords, thus, creating the Basel III putting into consideration poor governance and risk management. The Basel III is a continuation of the Basel II with a few advancements such as Banks having a minimum liquidity ratio and a minimum amount of common equity.