Page 216 - DMGT303_BANKING_AND_INSURANCE

Unit 10: Non-performing Assets

Most other countries, currently numbering over 100, have also adopted, at least in name, the Notes
principles prescribed under Basel I. The efficiency with which they are enforced varies, even
within nations of the Group.

Basel II

Basel II is the second of the Basel Accords, (now extended and effectively superseded by Basel
III), which are recommendations on banking laws and regulations issued by the Basel Committee
on Banking Supervision.
Basel II, initially published in June 2004, was intended to create an international standard for
banking regulators to control how much capital banks need to put aside to guard against the
types of financial and operational risks banks (and the whole economy) face. One focus was to
maintain sufficient consistency of regulations so that this does not become a source of competitive
inequality amongst internationally active banks. Advocates of Basel II believed that such an
international standard could help protect the international financial system from the types of
problems that might arise should a major bank or a series of banks collapse. In theory, Basel II
attempted to accomplish this by setting up risk and capital management requirements designed
to ensure that a bank has adequate capital for the risk the bank exposes itself to through its
lending and investment practices. Generally speaking, these rules mean that the greater risk to
which the bank is exposed, the greater the amount of capital the bank needs to hold to safeguard
its solvency and overall economic stability.

Politically, it was difficult to implement Basel II in the regulatory environment prior to 2008,
and progress was generally slow until that year's major banking crisis caused mostly by credit
default swaps, mortgage-backed security markets and similar derivatives. As Basel III was
negotiated, this was top of mind, and accordingly much more stringent standards were
contemplated, and quickly adopted in some key countries including the USA.
The final version aims at:
 Ensuring that capital allocation is more risk sensitive;

 Enhance disclosure requirements which will allow market participants to assess the capital
adequacy of an institution;
 Ensuring that credit risk, operational risk and market risk are quantified based on data
and formal techniques;
 Attempting to align economic and regulatory capital more closely to reduce the scope for
regulatory arbitrage.

While the final accord has largely addressed the regulatory arbitrage issue, there are still areas
where regulatory capital requirements will diverge from the economic capital.
Basel II has largely left unchanged the question of how to actually define bank capital, which
diverges from accounting equity in important respects. The Basel I definition, as modified up to
the present, remains in place.

Basel III

BASEL III is a global regulatory standard on bank capital adequacy, stress testing and market
liquidity risk agreed upon by the members of the Basel Committee on Banking Supervision in
2010-11.

The third installment of the Basel Accords (see Basel I, Basel II) was developed in response to the
deficiencies in financial regulation revealed by the late-2000s financial crisis. Basel III strengthens

LOVELY PROFESSIONAL UNIVERSITY 211