Basel accords – definition and meaning

The Basel Accords are a set of banking regulation recommendations created by the Basel Committee on Banking Supervision (BCBS). BCBS is a committee of banking supervisory authorities that was set up by the governors of the central banks of the Group of Ten countries in 1974. The committee provides a forum for regular cooperation on matters related to banking supervision.

The BCBS was set up in order to ensure that banks operate in a safe and sound manner. Essentially, it serves as an international advisory authority on banking systems worldwide.

Just like any other business, banks are at risk of going bankrupt. Because of their massive impact on national economies, if a major bank collapses the consequences can be devastating for the financial system, businesses and individuals.

Basel Accords
Three Basel accords have so far been produced.

Therefore, it is essential for the sake of an economy to establish rules and regulations that the banking industry should adhere to in order to reduce their risk of insolvency and failure.

These rules and regulations are included in the Basel Accords.

According to the Basel Committee on Banking Supervision website, “the Basel Committee on Banking Supervision provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide.”

One of the main aims of the Basel Accords is to ensure that banks maintain sufficient levels of capital. 

The BCBS has produced three different Basel accords to date:

Basel I (1988)

This accord focused on capital adequacy ratio (making banks maintain capital equal to at least 8% of its risk-weighted assets) and categorizing the assets of financial institution into five risk categories:

0% – cash, central bank and government debt and any OECD government debt

10% – public sector debt

20% – development bank debt, OECD bank debt, OECD securities firm debt, non-OECD bank debt (under one year maturity) and non-OECD public sector debt, cash in collection, and public sector debt.

50% – residential mortgages

100% – private sector debt, non-OECD bank debt (maturity over a year), real estate, plant and equipment, capital instruments issued at other banks.

Basel II (2004)

Basel II expanded the number of risk buckets from four to six (adding a 150% risk category and a 35% risk category).

Basel III  (will be implemented on March 31, 2018)

Basel III added a recommendation for banks to maintain an amount of tier 1 capital equal to at least 6% of total risk-weighted assets and maintain a total capital ratio of 10.5%.

Video – Basel III