BANK ACCOUNTING

(Basel I, II, III)

Submitted by: (Group 3)

BBF 3-1
Espiritu, Lemuel Zandro B.
Estrella, Dorotea S.
Garcia, Beatrix P.
Garcia, Mary Joy A.
Gulla, Mikka A.
Orejola, Arianne Michelle O.
San Jose, Adrian P.
San Jose, Ana Anaea B.

BASEL COMMITTEE
The Basel Committee on Banking Supervision started when the Bretton Woods system of
managed exchanged rates in 1973 collapsed. After its loss, many banks incurred large foreign currency
losses. In order to respond to the continuous disorder in the financial markets, the central governors of the
G10 countries Belgium, Canada, Italy, France, Japan, Netherlands, UK, US, Germany, and Sweden,
established the Committee on Banking Regulations and Supervisory Practices at end of 1974. It was later
renamed Basel Committee on Banking Supervisions. In the year 2009, they expanded their memberships.
From G10 body, it became G20 countries. It now involves Argentina, Australia, Brazil, Canada, China,
France, Germany, India, Indonesia, Italy, Japan, South Korea, Mexico, Russia, Saudi Arabia, South
Africa, Turkey, UK, US, and European Union. In 2014, it now includes 28 jurisdictions. And in 2016, it
became G23 countries. 10 countries from the G20 are still members of the committee while the other 10
left. And 13 other countries Austria, Belgium, Denmark, Finland, Hong Kong SAR, Ireland,
Luxembourg, Netherlands, New Zealand, Singapore, Spain, and Switzerland. The Committee was
designed as a forum for regular cooperation between its member countries on banking supervisory
matters. Its aim was and is to enhance financial stability by improving supervisory knowhow and the
quality of banking supervision worldwide. Since the first meeting in February 1975, meetings have been
held regularly three or four times a year.
The Basel Committee is the primary global standard-setter for the prudential regulation of banks
and provides a forum for cooperation on banking supervisory matters. Its mandate is to strengthen the
regulation, supervision and practices of banks worldwide with the purpose of enhancing financial
stability. Mr. Stefan Ingves, Governor of Sveriges Riksbank, is the chairman of the Basel Committee from
2011 to present. He was appointed as Basel Committee chairman in July 2011 and has been reappointed
until June 2017. The Committee reports to the Group of Governors and Heads of Supervision (GHOS).
The Committee seeks the endorsement of GHOS for its major decisions and its work program. The
Committee's Secretariat is located at the Bank for International Settlements in Basel, Switzerland, and is
staffed mainly by professional supervisors on temporary secondment from member institutions. In
addition to undertaking the secretarial work for the Committee and its many expert sub-committees, it
stands ready to give advice to supervisory authorities in all countries. Mr. William Coen is the Secretary
General of the Basel Committee.
BASEL COMMITTEE MEMBERSHIP
Institutions represented on the Basel Committee on Banking Supervision

Members
Argentina

Central Bank of Argentina

Australia

Reserve Bank of Australia

Australian Prudential Regulation Authority

Belgium

National Bank of Belgium

Brazil

Central Bank of Brazil

Canada

Bank of Canada
Office of the Superintendent of Financial Institutions

China

People's Bank of China

China Banking Regulatory Commission

European Union

European Central Bank

European Central Bank Single Supervisory Mechanism

France

Bank of France
Prudential Supervision and Resolution Authority

Germany

Deutsche Bundesbank
Federal Financial Supervisory Authority (BaFin)

Hong Kong SAR

Hong Kong Monetary Authority

India

Reserve Bank of India

Indonesia

Bank Indonesia
Indonesia Financial Services Authority

Italy

Bank of Italy

Japan

Bank of Japan
Financial Services Agency

Korea

Bank of Korea
Financial Supervisory Service

Luxembourg

Surveillance Commission for the Financial Sector

Mexico

Bank of Mexico
Comisin Nacional Bancaria y de Valores

Netherlands

Netherlands Bank

Russia

Central Bank of the Russian Federation

Saudi Arabia

Saudi Arabian Monetary Agency

Singapore

Monetary Authority of Singapore

South Africa

South African Reserve Bank

Spain

Bank of Spain

Sweden

Sveriges Riksbank
Finansinspektionen

Switzerland

Swiss National Bank

Swiss Financial Market Supervisory Authority FINMA

Turkey

Central Bank of the Republic of Turkey

Banking Regulation and Supervision Agency

United Kingdom

Bank of England
Prudential Regulation Authority

United States

Board of Governors of the Federal Reserve System

Federal Reserve Bank of New York
Office of the Comptroller of the Currency
Federal Deposit Insurance Corporation

Observers
Country observers
Chile

Central Bank of Chile / Banking and Financial Institutions Supervisory

Agency

Malaysia

Central Bank of Malaysia

United Arab Emirates

Central Bank of the United Arab Emirates

Supervisory groups, international agencies and other bodies

Bank for International Settlements
Basel Consultative Group
European Banking Authority
European Commission
International Monetary Fund

Secretariat
Bank for International Settlements

Chairmen of the Basel Committee

19741977: Sir George Blunden, Executive Director, Bank of
England
Within the Bank of England Sir George Blunden was for many years
regarded as something close to indispensable, both an
administrative mainstay and a calm operator in a crisis. As a high-level
he played an important role in dealing with many of banking's
recurring crises, using his talents to calm and reassure the often
nervy worlds of banking and the markets. Since none of the
emergencies he helped deal with approached the scale of the
banking problem of recent years his efforts were generally seen

fixer

as successful. Perhaps this helped create a belief that banking was vulnerable to periodic bushfires rather
than afflicted by deep-lying flaws in the system. One of the tributes to him came from Brian Quinn, who like
Blunden served as Deputy Governor. Describing him as "Bank of England through and through", Quinn said
he was "truly one of the giants of the Bank of England who did much to shape this country's central bank
over his long career." His time at Threadneedle Street began in 1947, when he followed his father into the
Bank. Born in Sutton, Surrey, he had been educated at the City of London School and served during the war
with the Royal Sussex Regiment before attending University College, Oxford, where he took a degree in
philosophy, politics and economics. In his almost 40 years at the bank Blunden held a range of senior
positions, establishing himself as a safe pair of hands, a reputation much prized in banking. His posts
included deputy head of the discount office, head of the supervision division, chief of management services
and deputy chief cashier. He also gained wider experience on secondments, first to the International
Monetary Fund and later to the Monopolies Commission. In the mid-1970s he was first chairman of the
Basel Committee on Banking Supervision, sometimes referred to as the Blunden committee, which sought to
set out global standards of international oversight. As he put it, since a country's banking system was central
to the management of its economy, its supervision would inevitably be a jealously guarded national
prerogative. What was needed, he argued, was a more dynamic internalized approach with incentives for
institutions and individuals to engage in more risk-averse behavior. His first major bout of firefighting came
in the early 1970s when he was called in to help cope with what he called "a problem of the possible collapse
of confidence in the whole system." This involved the 1973 oil crisis, which in turn led to a collapse in the
property market. Some smaller institutions which had been rash in their lending decisions were close to
insolvency. He helped stave off disaster, and helped to put together a supervisory system aimed at avoiding a
repetition. He went into semi-retirement in 1984, stepping down as an executive director and, in line with
tradition, joining the boards of major concerns such as Eagle Star and Grindlays Bank. But, in a departure
from Threadneedle-Street precedent, a call went out for him in late 1985. Volatility had manifested itself in
the banking system with events such as the collapse of the Johnson Matthey bank and the Guinness takeover
of Distillers. With the approval of Margaret Thatcher, Blunden was drafted back as Deputy Governor to
restore order.
He took a stern line against a merchant bank involved in the Guinness takeover, later saying: "It was an
unpleasant thing that we had to do but I have no doubt that it was right. It did a great deal to establish a more
responsible and moral attitude in the City." As the Bank's No 2 he helped calm the general sense of upheaval
and improve confidence, working well with the Governor, Robin Leigh-Pemberton. "I can do anything I like
now," he quipped to a journalist. "I have been brought back from the dead." Knighted in 1987, he retired for

a second time in 1990 after spending four years as Deputy Governor. He was active in his retirement, picking
up further directorships, becoming involved in charitable causes and chairing a committee on a proposed
code of conduct for banks. Warm tributes were paid to him by old colleagues, in particular Leigh-Pemberton,
since ennobled as Lord Kingsdown. He recalled: "He'd retired and he came back as Deputy Governor, which
was very good of him because we needed somebody with his experience. I was new to it and he was the most
experienced man at the Bank of England when I was there, and we were able to turn to him with confidence
to deal with any situation that arose. We knew that if he approved, it was likely to be the right answer."
19771988: Peter Cooke, Associate Director, Bank of England
William Peter Cooke was born on February 1, 1932 in Wendover, England. Son of Douglas Edgar and
Florence May (Mills) Cooke. Bachelor in History with honors, Oxford (England) University, 1955. Master of
Arts, Oxford (England) University, l96l. With Bank of England, London, 1955-1988, lst deputy chief cashier,
1970-1973, advisor to governors, 1973-1976, head banking supervision, 1976-1985, associate director, 19821988. Chairman City European Economic Community Committee, 1973-1980. Seconded to Bank for
International Settlements, Basle, Switzerland, 1958-1959, and chairman committee on banking regulations
and supervisory practices Switzerland, 1977-1988. Personal assistant to managing director International
Monetary Fund, Washington, 1961-1965. Chairman world regulatory advisory practice Price Waterhouse,
London, 1989-1997. Advisor PricewaterhouseCoopers, since 1998. Board directors Safra Republic Holdings,
Luxembourg, l989-99, Bank China International Holdings, State St. Bank Europe, The Housing Finance
Corporation, since 1998, Household Bank Republic, since 1999. Peter Cooke is best remembered for his
chairmanship of the so-called Cooke Committee at the BISmore formally known as the Basel (then, Basle)
Committee on Banking Supervision. He was responsible for formulation and introduction of the first riskweighted capital rules for major international banks, now known as Basel 1. He was also Head of Banking
Supervision at the Bank of England. Following his retirement from the Bank in 1988, he was for a decade
chairman of the global regulatory advisory practice of PricewaterhouseCoopers in London. He has also been
an advisor and non-executive director to a range of banks and other financial organizations. He is a member
of the CSFI's Governing Council.

19881991: Huib J Muller, Executive Director, Netherlands Bank

19911993: E Gerald Corrigan, President, Federal

Reserve Bank of New York
Jerry is a managing director in the firms Executive Office.
He is co-chair of the Firmwide Risk Management Committee,
a senior member of the Firmwide Commitments Committee
and a member of the Firmwide Client and Business Standards
Committee. Jerry served as co-chair of Firmwide Business
Standards Committee from 2010 to 2011. He is also a nonexecutive chairman of the Goldman Sachs banks in the
United States and the United Kingdom. Jerry joined Goldman
Sachs as a managing director in 1994 and was named partner in 1996. Since joining the firm in 1994, Jerry
has served as chair or co-chair of several firmwide and industry-wide groups dealing with various issues
having major implications for financial market efficiency and stability. In addition, he provides a wide range
of strategic advice to the firm and its clients. Prior to joining the firm, Jerry served as president and chief
executive officer of the Federal Reserve Bank of New York, where he worked for 25 years. While at the New
York Fed, he served as chief executive officer and vice chairman of the Federal Open Market Committee
from 1984 to 1993. Jerry has also served as president of the Federal Reserve Bank of Minneapolis and
special assistant to Federal Reserve chairman Paul A. Volcker. Jerry earned a Bachelor of Social Science in
Economics from Fairfield University and an MA and PhD in
Economics from Fordham University in New York City. He serves
as chairman, trustee and member of several nonprofit organizations.

19931997:

Tommaso

Padoa-Schioppa,

Deputy

Director

General, Bank of Italy

Born in the mountain town of Belluno, in north-eastern Italy. Both
his parents were intellectuals. His father, Fabio (19112012), whom
he did not meet until after the war in 1945, was a teacher and later
became a senior executive at the insurance company Assicurazioni
Generali. He graduated from Bocconi University (Milan) in 1966

and received a master's degree from the Massachusetts Institute of Technology in 1970. After a first job in
Germany with the retailer C&A Brenninkmeijer, he joined the Bank of Italy in 1968, eventually becoming
Vice-Director General from 1984 to 1997. In 1980 he became a member of the influential Washington-based
financial advisory body, the Group of Thirty and remained one till his death. From 1993-97, he was president
of the Basel Committee on Banking Supervision, and from 2000-05 Chairman of the Committee on Payment
and Settlement Systems. In 199798 he was head of Consob, Italy's stock market supervision agency. He was
a member of the European Central Bank's six-member executive board from its foundation in 1998 until the
end of May 2005. In October 2005 he became president of Paris-based think tank Notre Europe. On 17 May
2006 he was appointed as Economy and Finances Minister in the government of Romano Prodi, serving in
that post until May 2008, when a new government headed by Silvio Berlusconi took office following
the April 2008 general election. From October 2007 to April 2008 he was Chairman of the IMFC
(International Monetary and Financial Committee), the top policy steering committee of the International
Monetary Fund (IMF). In June 2009 he was appointed as chairman for Europe of the private finance
consulting Promontory Financial Group. In 2006 Padoa-Schioppa coined the expression "il tesoretto" (the
little treasure) to describe the increased government revenues under his administration. The term was widely
used by politicians as they debated how this new money should be spent. In October 2007 he spoke to a
parliamentary committee about the government's plan for tax relief (approx. 500/year) to people 2030
years old still living with their family, saying it would help them move out on their own. He used the ironic
or sarcastic term "bamboccioni" (big dummy boys, or big stuffed children) and this created a big fuss in
Italian public opinion. Newspapers received numerous letters from readers personally taking offence and
pointing out that he understood little about the situation of a considerable part of the 2030 years old Italian
population, who live on approximately 1,000 per month and cannot afford to leave their parents'
house. According to some lexicographers, "bamboccioni" was the most popular new Italian word of 2007.
He was the first to describe the euro as "a currency without a State" (in a book published in 2004), a term
that was later popularized by Otmar Issing.

Padoa-Schioppa has been called the "intellectual impetus" behind the euro and the "founding father" of the
new currency.In an economics paper written in 1982 he pointed out that it is impossible for a group of
countries like the EU to simultaneously aim at:
free trade, capital mobility, independent domestic monetary policies, and fixed exchange rates.

These four goals, each apparently desirable on its own, he called "the inconsistent quartet" (see also the
similar Impossible trinity concept).
At that time, European Union countries maintained some restrictions on trade and (especially) on capital
movements. These were gradually eliminated through the Single Market programme and the liberalization of
capital movements, so that by the late 1980s one of the two remaining objectives had to go to for consistency
to be maintained. He proposed that the third objective (independent monetary policies) be abandoned, by
creating a single currency and a single European central bank, so that the other three objectives could be
attained. The Delors Report of April 1989 endorsed this view and recommended a European Monetary
Union (EMU) with a single currency. He worked on designing and setting up the new European Central
Bank and became one of the first executive board members (June 1998-May 2005).

19971998: Tom de Swaan, Executive Director, Netherlands Bank

Tom de Swaan, Chairman of Zurich Insurance Group Ltd has served in
the banking industry of the Netherlands for over 40 years. He has been
a Member of the Boards of Zurich Insurance Group Ltd and of Zurich
Insurance Company Ltd since April 2006. In March 2012 he was
elected Vice-Chairman, and then as Chairman in August 2013. In 1972
Mr de Swaan joined De Nederlandsche Bank N.V. and in 1986 became
a Member of the Governing Board. Between 1987 and 1988, he was
Chairman of the Amsterdam Financial Center. He was a Member of the Basel Committee on Banking
Supervision from 1991 to 1996, its Chairman from 1997 to 1998. From 1995 to 1997 he also served as
Chairman of the Banking Supervisory Sub-Committee of the European Monetary Institute. In January 1999
until May 2006, Mr de Swaan served a Member of the Managing Board and Chief Financial Officer of ABN
AMRO Bank and continued as an Adviser to the Managing Board until June 2007. He was also NonExecutive Director on the Board of the UKs Financial Services Authority from January 2001 until the end of
2006. From 2006 until May 2015 he was a non-executive member of the board of GlaxoSmithKline Plc.
From 2008 until February 2016, Mr de Swaan was a Member of the Supervisory Board of Van Lanschot NV.
He also served as its Chairman until December 2015. In addition Mr de Swaan had been Chief Executive
Officer a.i. from December 2015 to early March 2016. Mr de Swaan is Vice-Chairman of the supervisory

board of Royal DSM; Chairman of the Board of the Netherlands Cancer Institute and Chairman of the Board
of Trustees of the Van Leer Jerusalem Institute. He is also a Member of the IIF Board of Directors, of the
European Financial Services Round Table (EFR) and of the Advisory Board of China Banking Regulatory
Commission in Beijing. He graduated from the University of Amsterdam with a masters degree in
economics.
19982003: William J McDonough, President, Federal Reserve Bank of
New York
William J. McDonough, at the age of fifty-nine, became the eighth president
and chief executive officer of the Federal Reserve Bank of New York on July
19, 1993. McDonough joined the Bank in 1992 as the executive vice
president and head of the Markets Group. McDonough earned his bachelor's
degree in economics from the College of the Holy Cross in Worcester,
Massachusetts, and a master's degree in economics from Georgetown University. He also served as an
advisory board member for the Yale School of Management. McDonough served in the US Navy from 1956
to 1961 and with the State Department from 1961 to 1967. Prior to coming to the New York Fed, he spent
twenty-two years working at the First Chicago Corporation and its subsidiary bank, First National Bank of
Chicago. He also served as an adviser to a variety of domestic and international organizations before joining
the New York Fed. While president of the New York Fed, McDonough made a number of significant
contributions to both banking and the United States economy. While chairman of the Basel Committee on
Banking Supervision, the Committee developed major revisions in the Basel Capital Accord to modernize
the capital rules for internationally active banks. This development was noted by Peter G. Peterson, thenchairman of the New York Fed's board of directors, as being "a singular and enormously challenging
achievement" for McDonough personally and for the international banking community in general.
McDonough served as president and chief executive officer of the New York Fed for ten years, making him
the longest-serving president of the Reserve Bank since Alfred Hayes, the Bank's fourth president. Almost
immediately upon stepping down from his post at the New York Fed, he was appointed to serve as the first
chairman of the Public Company Accounting Oversight Board (established by the Sarbanes-Oxley Act of
2002) in Washington, DC. He served in that post until 2005 when he returned to New York to join Merrill
Lynch as vice chairman and special adviser to the chairman. He also served as a member of Executive Client
Coverage Group of Bank of America Merrill Lynch until December 31, 2009. McDonough is currently
director emeritus of the Philharmonic-Symphony Society of New York, Inc., a member of the Council on
Foreign Relations, and former chairman and current member of the Economic Club of New York.

20032006: Jaime Caruana, Governor, Bank of Spain

Jaime Caruana became General Manager of the Bank for International
Settlements on 1 April 2009. Previously, Mr Caruana was Financial
Counsellor to the Managing Director and Director of the Monetary and
Capital Markets Department of the International Monetary Fund. From
2000 to 2006, Mr Caruana was the Governor of the Bank of Spain,
Spains central bank, and in that capacity, served on the Governing
Council of the ECB. He was also the Chairman of the Basel Committee
on Banking Supervision from 2003 to 2006 and has been a member of
the Financial Stability Forum (now the Financial Stability Board) since
2003. From 2004 to 2006, he chaired the Coordination Group, a senior
group of supervisory standard setters from the Basel Committee, the International Organization of Securities
Commissions (IOSCO), the International Association of Insurance Supervisors (IAIS) and the Joint Forum.
Prior to joining the Bank of Spain, Mr Caruana served as Director General of the Spanish Treasury and
headed an investment services company and a fund management company for nearly 10 years.
20062011: Nout Wellink, President, Netherlands Bank
Nout Wellink has served as a member of the Executive Board of the
Dutch Central Bank (DNB) for almost 30 years, the last 14 years as
its President. He retired from DNB on 1 Juli 2011. Since the
establishment of the European Monetary Union Mr. Wellink served as a
Member of the Governing Council of the European Central Bank
(ECB). Starting from 1997, Mr. Wellink served as a member of the
Board of Directors of the Bank for International Settlements (BIS),
which he chaired from 2002 to 2006. From 2006 to 2011 he also chaired
the Basel Committee on Banking Supervision. From 1997 to 2011, Mr.
Wellink was a member of the Group of Ten Governors and a Governor
of the International Monetary Fund (IMF). Prior to his appointment in
1982 as an executive director of DNB, Mr. Wellink held several posts in the Dutch Ministry of Finance,
including as the Treasurer General from 1977 to 1982. After studying Dutch law at the Leyden University
from 1961 to 1968, with a Masters degree obtained, Mr. Wellink obtained a doctors degree in economics
at the Rotterdam Erasmus University in 1975. In 2008 he received an honorary doctorate from Tilburg

University. From 1988 to 1998, Mr. Wellink was an Extraordinary Professor at the Free University in
Amsterdam. Mr. Wellink has and had many secondary functions and is currently an independent nonexecutive director of the Bank of China, the chairman of PwCs Public Interest Committee, and the
chairman of the Supervisory Board of the Leyden University. He was awarded a Knighthood in the Order of
the Netherlands Lion in 1980 and is since 2011 Commander of the Order of Orange-Nassau.

2011present: Stefan Ingves, Governor, Sveriges Riksbank

Stefan

Nils

Magnus

Ingves (born

23

May

1953)

is

a Swedish banker, economist and civil servant currently serving

as the Governor of Sveriges Riksbank, the central bank of
Sweden. Ingves was named Governor of Sveriges Riksbank in
2006. In response to the Icelandic financial crisis of 2008,
Ingves argued that "in times of uncertainty and turmoil, the
central banks have a responsibility to cooperate." Ingves
confronted the "task of safeguarding macroeconomic and
financial stability" in 2008; and in 2009, he presided over a
decline to the lowest official Swedish interest rate since records
began in 1907. In 2011, Ingves became the Chairman of
the Basel Committee on Banking Supervision. Stefan Ingves
took up the post of Governor of the Riksbank and Chairman of the Executive Board on 1 January 2006 with
a term of office of six years. His term of office has now been extended by another six years from 1 January
2012. Stefan Ingves holds a PhD in economics. Mr. Ingves has previously been Director of the Monetary and
Financial Systems Department at the International Monetary Fund, Deputy Governor of the Riksbank and
General Director of the Swedish Bank Support Authority. Prior to that he was Under-Secretary and Head of
the Financial Markets Department at the Ministry of Finance.

Stefans International assignments:

- Chairman of the Basel Committee
- Chairman of the BIS Banking and Risk Management Committee (BRC) and member of the Board of
Directors of the BIS

- Chairman of the Advisory Technical Committee (ATC) of the European Systemic Risk Board (ESRB)
- Member of the General Council of the ECB
- Governor for Sweden in the IMF
- Chairman of the Nordic-Baltic Macroprudential Forum (NBMF)

JOINT FORUM
In 1996, a Joint Forum was established under the aegis of the Basel Committee on Banking
Supervision (BCBS), the International Organization of Securities Commissions (IOSCO) and the
International Association of Insurance Supervisors (IAIS) to deal with issues common to the banking,
securities and insurance sectors, including the regulation of financial conglomerates. It comprised an
equal number of senior bank, insurance and securities supervisors representing each supervisory
constituency. The Joint Forum was discontinued in 2015, after it was superseded by bilateral and other
arrangements for cooperation. The secretariat for the Joint Forum was provided by the Basel Committee.

BASEL ACCORDS
The Basel Capital Accord, the current international framework on capital adequacy, was adopted
in 1988 by a group of central banks and other national supervisory authorities, working through the Basel
Committee on Banking Supervision. It refer to the banking supervision Accords (recommendations on
banking regulations)Basel I, Basel II and Basel IIIissued by the Basel Committee on Banking
Supervision (BCBS). They are called the Basel Accords as the BCBS maintains its secretariat at the Bank
for International Settlements in Basel, Switzerland and the committee normally meets there. The Basel
Accords is a set of recommendations for regulations in the banking industry.
BASEL I: THE BASEL CAPITAL ACCORD
In 1988, the Basel Committee on Banking Supervision (BCBS) in Basel, Switzerland,
published a set of minimum capital requirements for banks. These were known as Basel I. It
focused almost entirely on credit risk (default risk) - the risk of counter party failure. It defined
capital requirement and structure of risk weights for banks.

Under these norms: Assets of banks were classified and grouped in five categories
according to credit risk, carrying risk weights of 0%(Cash, Bullion, Home Country Debt Like
Treasuries), 10, 20, 50 and100% and no rating. Banks with an international presence are required
to hold capital equal to 8% of their risk-weighted assets (RWA) - At least, 4% in Tier I Capital
(Equity Capital + retained earnings) and more than 8% in Tier I and Tier II Capital. Target - By
1992.
One of the major role of Basel norms is to standardize the banking practice across all
countries. However, there are major problems with definition of Capital and Differential Risk
Weights to Assets across countries, like Basel standards are computed on the basis of book-value
accounting measures of capital, not market values.

Accounting practices vary significantly

across the G-10 countries and often produce results that differ markedly from market
assessments.
Other problem was that the risk weights do not attempt to take account of risks other than
credit risk, viz., market risks, liquidity risk and operational risks that may be important sources of
insolvency exposure for banks.
Basel I, that is, the 1988 Basel Accord, is primarily focused on credit risk and
appropriate risk-weighting of assets. Assets of banks were classified and grouped in five
categories according to credit risk, carrying risk weights of 0% (for example cash, bullion, home
country debt like Treasuries), 20% (securitizations such as mortgage-backed securities(MBS)
with the highest AAA rating), 50% (municipal revenue bonds, residential mortgages), 100% (for
example, most corporate debt), and some assets given No rating. Banks with an international
presence are required to hold capital equal to 8% of their risk-weighted assets (RWA).
The tier 1 capital ratio = tier 1 capital / all RWA
The total capital ratio = (tier 1 + tier 2 + tier 3 capital) / all RWA
Leverage ratio = total capital/average total assets
Banks are also required to report off-balance-sheet items such as letters of credit, unused
commitments, and derivatives. These all factor into the risk weighted assets. The report is
typically submitted to the Federal Reserve Bank as HC-R for the bank-holding company and
submitted to the Office of the Comptroller of the Currency (OCC) as RC-R for just the bank.

From 1988 this framework was progressively introduced in member countries of G-10,
comprising 13 countries as of 2013: Belgium, Canada, France, Germany, Italy, Japan,
Luxembourg, Netherlands, Spain, Sweden, Switzerland, United Kingdom and the United States
of America.
Over 100 other countries also adopted, at least in name, the principles prescribed under
Basel I. The efficacy with which the principles are enforced varies, even within nations of the
Group.
HOW BASEL I AFFECTED BANKS
TWO-TIERED CAPITAL
Basel I defines capital based on two tiers:
1. Tier 1 (Core Capital): Tier 1 capital includes stock issues (or
shareholders equity) and declared reserves, such as loan loss reserves set
aside to cushion future losses or for smoothing out income variations.
2. Tier 2 (Supplementary Capital): Tier 2 capital includes all other capital
such as gains on investment assets, long-term debt with maturity greater
than five years and hidden reserves (i.e. excess allowance for losses on
loans and leases). However, short-term unsecured debts (or debts without
guarantees), are not included in the definition of capital.
Credit Risk is defined as the risk weighted asset (RWA) of the bank, which are
banks assets weighted in relation to their relative credit risk levels. According to Basel I,
the total capital should represent at least 8% of the bank's credit risk (RWA). In addition,
the Basel agreement identifies three types of credit risks:

The on-balance sheet risk (see Figure 1 for example).

The trading off-balance sheet risk. These are derivatives, namely interest
rates, foreign exchange, equity derivatives and commodities.

The non-trading off-balance sheet risk. These include general guarantees,

such as forward purchase of assets or transaction-related debt assets.

Let's take a look at some calculations related to RWA and capital requirement.
Figure 1 displays predefined categories of on-balance sheet exposures, such as
vulnerability to loss from an unexpected event, weighted according to four relative risk
categories.

Figure 1: Basel\'s Classification of risk weights of on-balance sheet assets

As shown in Figure 2, there is an unsecured loan of $1,000 to a non-bank, which

requires a risk weight of 100%. The RWA is therefore calculated as RWA=$1,000
100%=$1,000. By using Formula 2, a minimum 8% capital requirement gives 8%

RWA=8% $1,000=$80. In other words, the total capital holding of the firm must be $80
related to the unsecured loan of $1,000. Calculation under different risk weights for
different types of assets are also presented in Table 2.

Figure 2: Calculation of RWA and capital requirement

on-balance sheet assets
Market risk includes general market risk and specific risk. The general market
risk refers to changes in the market values due to large market movements. Specific risk
refers to changes in the value of an individual asset due to factors related to the issuer of
the security. There are four types of economic variables that generate market risk. These
are interest rates, foreign exchanges, equities and commodities. The market risk can be
calculated in two different manners: either with the standardized Basel model or with
internal value at risk (VaR) models of the banks. These internal models can only be used
by the largest banks that satisfy qualitative and quantitative standards imposed by the

Basel agreement. Moreover, the 1996 revision also adds the possibility of a third tier for
the total capital, which includes short-term unsecured debts. This is at the discretion of
the central banks.
PITFALLS OF BASEL I
Basel I Capital Accord has been criticized on several grounds. The main
criticisms include the following:

Limited differentiation of credit risk

There are four broad risk weightings (0%, 20%, 50% and 100%), as shown in
Figure1, based on an 8% minimum capital ratio.

Static measure of default risk

The assumption that a minimum 8% capital ratio is sufficient to protect banks
from failure does not take into account the changing nature of default risk.

No recognition of term-structure of credit risk

The capital charges are set at the same level regardless of the maturity of a credit
exposure.

Simplified calculation of potential future counterparty risk

The current capital requirements ignore the different level of risks associated
with different currencies and macroeconomic risk. In other words, it assumes a
common market to all actors, which is not true in reality.

Lack of recognition of portfolio diversification effects

In reality, the sum of individual risk exposures is not the same as the risk
reduction through portfolio diversification. Therefore, summing all risks might
provide incorrect judgment of risk. A remedy would be to create an internal credit
risk model - for example, one similar to the model as developed by the bank to
calculate market risk. This remark is also valid for all other weaknesses.

These listed criticisms have led to the creation of a new Basel Capital Accord,
known as Basel II, which added operational risk and also defined new calculations of
credit risk. Operational risk is the risk of loss arising from human error or management
failure. Basel II Capital Accord was implemented in 2007.
PURPOSE OF BASEL 1
In 1988, the Basel I Capital Accord was created. The general purpose was to:
1. Strengthen the stability of international banking system.
2. Set up a fair and a consistent international banking system in order to decrease
competitive inequality among international banks.
The basic achievement of Basel I has been to define bank capital and the socalled bank capital ratio. In order to set up a minimum risk-based capital adequacy
applying to all banks and governments in the world, a general definition of capital was
required. Indeed, before this international agreement, there was no single definition of
bank capital. The first step of the agreement was thus to define it.
SHORTCOMINGS OF BASEL I
Basel I was a major step forward in capital regulation. Indeed, for most banks in
this country Basel I, as it has been augmented by U.S. supervisors, is nowand for the
foreseeable future will bemore than adequate as a capital framework. It is too simple,
however, to address the activities of the most complex banking organizations. As
implemented in the United States, it specifies only four levels of risk, even though loans
assigned the same risk weight (for example, 100 percent for commercial loans) can vary
greatly in credit quality. The limited differentiation among degrees of risk means that
calculated capital ratios are often uninformative and may provide misleading information
about a bank's capital adequacy relative to its risks. The limited differentiation among
degrees of risk also creates incentives for banks to ''game'' the system through regulatory
capital arbitrage by selling, securitizing, or otherwise avoiding exposures for which the
regulatory capital requirement is higher than the market requires and pursuing those for
which the requirement is lower than the market would apply to that asset, say, in the
economic enhancement necessary to securitize the asset. Credit card loans and residential

mortgages are types of assets that banks securitize in large volumes because they believe
required regulatory capital to be more than market or economic capital. Economic capital
is a bank's internal estimate of the capital needed to support its risk-taking activities. Such
capital arbitrage of the regulatory requirements by banks is perfectly understandable, and
in some respects even desirable in terms of economic efficiency. Because, of course,
banks retain those assets for which the regulatory capital requirement is less than the
market would apply, large banks engaging in capital arbitrage may, as a result, hold too
little capital for the assets they retain, even though they meet the letter of the Basel I
rules. Although U.S. supervisors are still able to evaluate the true risk position of a bank
through the examination process, the regulatory minimum capital ratios of the larger
banks are, as a result of capital arbitrage, becoming less meaningful. Not only are
creditors, counterparties, and investors hampered in evaluating the capital strength of
individual banks from the ratios as currently calculated, but regulations and statutory
requirements tied to those ratios have less meaning as well. For the larger banks, in short,
Basel I capital ratios neither reflect risk adequately nor measure bank strength accurately.
BASEL I IN THE PHILIPPINES

Circular No. 400

09.01.2003

Guidelines on the adoption of the risk-based capital adequacy

framework by stand-alone quasi-banks
Guidelines on the adoption in the Philippines of the risk-based

Circular No. 280

03.29.2001

capital adequacy framework pursuant the General Banking Law

of 2000 (superseded by Circular No. 688)

BASEL 1.5

Circular No. 688

05.26.2010

Revised Risk-Based Capital Adequacy Framework For StandAlone Thrift Banks, Rural Banks and Cooperative Banks

BASEL II: THE NEW CAPITAL FRAMEWORK

So, Basel II was introduced in 2004, laid down guidelines for capital adequacy (with
more refined definitions), risk management (Market Risk and Operational Risk) and disclosure
requirements.
- use of external ratings agencies to set the risk weights for corporate, bank and sovereign claims.
- Operational risk has been defined as the risk of loss resulting from inadequate or failed internal
processes, people and systems or from external events. This definition includes legal risk,
but excludes strategic and reputation risk, whereby legal risk includes exposures to fines,
penalties, or punitive damages resulting from supervisory actions, as well as private settlements.
There are complex methods to calculate this risk.
- Disclosure requirements allow market participants assess the capital adequacy of the institution
based on information on the scope of application, capital, risk exposures, risk assessment
processes, etc.
Basel 2, and its associated Basel 2.5 enhancements, were harshly criticized for not doing
enough to stave off the financial crisis of 2008.

It was felt that the average levels of capital requirements enforced were inadequate, and
that the assessment of credit risks was improperly delegated to inappropriate (non-banking)
institutions.

Furthermore, Basel II and Basel II.5 were criticized for making assumptions that the
internal models used by banks, to measure risk exposure, were superior to those which external
(supervisory) agencies could have implemented.
The framework was also seen as providing an incentive to banking intermediaries to
"hide" (deconsolidate) risky exposures from the banks' balance sheet.

BASEL I AND BASEL II DIFFERENCES

MAIN DIFFERENCES BETWEEN BASEL I AND BASEL II

BASEL I

BASEL II

Capital Adequacy Ratio

Capital Adequacy Ratio

Capital / (Credit Risk + Market Risk)

Capital / (Credit Risk + Market Risk +

Operational Risk)

Market Risk

Market Risk Internal

Market risk is measured by the standard method.

VaR models are used for market risk calculation.

The ratings of the issuer of the security will be
determinant factor in calculating specific risk.

Credit Risk

Credit Risk

The credit risk is calculated according to credits

For corporate firms, external or internal ratings

amount and collateral. The ratings of the firms do

are used to calculate capital requirement. For

not affect the capital requirement.

retail credits, proper pools are created and rated.

Operational Risk

Operational Risk

Operational risk is not taken into account in

Operational risk is calculated based on three

capital adequacy calculations.

alternative methods.

BASEL II MAIN ELEMENTS

Box 1. Basel II: Main Elements
The Basel II capital adequacy rules are based on a "menu" approach. Banks and regulators are offered
two distinct sets of options for banks for computing credit risk capital charges: (i) two "standardized"
approaches based on external credit assessments; and (ii) two "IRB" approaches which use internal
ratings based on banks' own data. For operational risk, banks and regulators can choose either: (i) the
basic indicator approach, based on overall income; (ii) the standardized approach based on income of
business lines; or (iii) the "advanced measurement approach" (AMA) based on internal models, and
using actual loss data. The minimum requirements for the advanced approaches are technically more
demanding and require extensive databases and more sophisticated risk management techniques.
Pillar 1: Capital
Adequacy
Credit Risk 1

Main Features
Greater risk sensitivity than Basel I through more

Key Requirements

Simplified

risk buckets and risk weights for sovereigns and

Standardized

banks based on Export Credit Agency (ECA) risk

Approach (SSA)

scores. Operational risk charge 15 percent of annual

Credit Risk 2

gross income. Pillars 2 and 3 applicable.

More risk buckets than SSA.

Ratings of ECAIs.

Standardized

Risk weights for asset classes based on ratings of

Ability and capacity to

Approach (SA)

external credit assessment agencies (ECAIs) or ECA

qualify rating agencies

scores.

and map agency scores

Credit Risk 3

Enhanced credit risk mitigation available.

Based on risk components: probability of default

Ability to assess banks'

Foundation

(PD), loss given default (LGD), exposure at default

rating system design.

Internal Ratings

(EAD), and maturity (M).

Based Approach

Banks can use own PD estimates and supervisory

Ability to validate banks'

(F-IRB)

estimates for other components.

risk management and

stress testing systems.

Stress testing required.

Ability to provide
supervisory estimates of

Credit Risk 4

Capital requirements determined as in F-IRB Banks

LGD and EAD

Ability to assess banks'

Advanced

can use own estimates for PD, LGD, EAD and M;

rating system design.

Internal Ratings

subject to supervisory validation of systems.

Based Approach

Stress testing required.

(A-IRB)

Ability to validate banks'

risk management and
stress testing systems.

Operational

Flat rate of 15 percent of gross annual income.

Risk 1
Basic Indicator
Approach
Operational

Operational risk charges for each business line,

System to distinguish

Risk 2

based on annual income per business line,

business lines and

Standardized

multiplied by risk factor per business line.

supervisory ability for

Approach

validation of this system

Data on operational risk

Operational

Full reliance on banks' internal risk measurement

occurrences and cost.

Capacity for supervisory

Risk 3

systems, subject to supervisory approval.

validation.

Main Features
Banks have a process for assessing capital adequacy

Key Requirements
Supervisory ability and

(CAAP) and a strategy for maintaining capital level.

capacity to make the

Supervisors evaluate banks' internal capital

necessary assessments.

Advanced
Measurement
Approach
Pillar 2:
Supervisory
Review

adequacy systems and compliance. Higher capital

adequacy levels for individual banks if risk profile

Adequate legal and

requires. Early intervention by supervisors. Stress

regulatory framework to

tests and Assessment of interest rate risk and

take action.

concentration risk.
Pillar 3: Market
discipline
Information to be disclosed includes

Available capital in the group, capital

Banks' information
systems to produce
required breakdowns;

structure, detailed capital requirements for

credit risk;

Accounting and auditing

Breakdown of asset classification and

accuracy of disclosures;

provisioning

systems that safeguard

Breakdown of portfolios according to risk

and

buckets and risk components

Credit risk mitigation (CRM) methods and

Ability to require
disclosure, monitor and

exposure covered by CRM

Operational risk; and

THE ACCORD IN OPERATION: THREE (3) PILLARS

verify.

Basel II uses a "three pillars" concept (1) minimum capital requirements (addressing
risk), (2) supervisory review and (3) market discipline.
The Basel I accord dealt with only parts of each of these pillars. For example: with
respect to the first Basel II pillar, only one risk, credit risk, was dealt with in a simple manner
while market risk was an afterthought; operational risk was not dealt with at all.

THE FIRST PILLAR: MINIMUM CAPITAL REQUIREMENTS

The first pillar deals with maintenance of regulatory capital calculated for three
major components of risk that a bank faces: credit risk, operational risk, and market risk.
Other risks are not considered fully quantifiable at this stage.
1.The credit risk component can be calculated in three different ways of varying
degree

of

sophistication,

namely standardized

approach, Foundation

IRB, Advanced IRBand General IB2 Restriction. IRB stands for "Internal
Rating-Based Approach".

2. For operational risk, there are three different approaches basic indicator
approach or BIA, standardized approach or TSA, and the internal measurement
approach (an advanced form of which is the advanced measurement approach or
AMA).
3. For market risk the preferred approach is VaR (value at risk).
As the Basel II recommendations are phased in by the banking industry it will
move from standardized requirements to more refined and specific requirements that
have been developed for each risk category by each individual bank. The upside for
banks that do develop their own bespoke risk measurement systems is that they will be
rewarded with potentially lower risk capital requirements. In the future there will be
closer links between the concepts of economic and regulatory capital.

THE SECOND PILLAR: SUPERVISORY REVIEW

This is a regulatory response to the first pillar, giving regulators better 'tools' over
those previously available. It also provides a framework for dealing with systemic
risk, pension

risk, concentration

risk, strategic

risk, reputational

risk, liquidity

risk and legal risk, which the accord combines under the title of residual risk. Banks can
review their risk management system.
The Internal Capital Adequacy Assessment Process (ICAAP) is a result of Pillar
2 of Basel II accords.

THE THIRD PILLAR: THE MARKET DISCIPLINE

This pillar aims to complement the minimum capital requirements and

supervisory review process by developing a set of disclosure requirements which will
allow the market participants to gauge the capital adequacy of an institution.

Market discipline supplements regulation as sharing of information facilitates

assessment of the bank by others, including investors, analysts, customers, other banks,
and rating agencies, which leads to good corporate governance. The aim of Pillar 3 is to
allow market discipline to operate by requiring institutions to disclose details on the
scope of application, capital, risk exposures, risk assessment processes, and the capital
adequacy of the institution. It must be consistent with how the senior management,
including the board, assess and manage the risks of the institution.
When market participants have a sufficient understanding of a bank's activities
and the controls it has in place to manage its exposures, they are better able to distinguish
between banking organizations so that they can reward those that manage their risks
prudently and penalize those that do not.
These disclosures are required to be made at least twice a year, except qualitative
disclosures providing a summary of the general risk management objectives and policies
which can be made annually. Institutions are also required to create a formal policy on
what will be disclosed and controls around them along with the validation and frequency
of these disclosures. In general, the disclosures under Pillar 3 apply to the top
consolidated level of the banking group to which the Basel II framework applies.
IMPLICATIONS OF BASEL II
1. Pressure to implement Basel II. Some countries report pressure from their major banks
and from the market to adopt Basel II promptly. As Basel II is viewed by many as the
new global capital standard, it may be difficult for countries to explain to market analysts
why they are not immediately moving to implement it. Hurried implementation, however,
may lead to weaker rather than stronger supervision. The more sophisticated variants of
Pillar 1 require data, skills, and systems that are lacking in many developing countries;
applying models with parameters that are borrowed from other countries could provide a
misleading indication of required capital. Therefore, the BCBS has emphasized that Basel

II "may not be a first priority for all non-G 10 supervisory authorities in terms of what is
needed to strengthen their banking supervision, and should adopt Basel II only in a
timeframe consistent with national priorities and capacities."
2. A strong supervisory foundation should be a precondition for Basel II
implementation. The IMF's "Gaps Paper reports weak compliance with many of the
BCPs across countries that are important to the effective implementation of Basel II.
A solid infrastructure for financial services needs to be in place before a
country embarks on implementing Basel II. Banking, as well as banking
supervision, can only function properly in an environment of good
accounting and auditing rules and practices, a functioning legal
framework for financial transactions and banking supervision, including
reliable financial information, contract enforcement, loan performance
data, data sharing, market transactions disclosure and collateral
execution.

BCPs with which compliance is often weak include standards on

adequate

supervisory

resources,

capital

adequacy

regimes, loan

evaluation and provisioning, internal controls, consolidated supervision,

and cross-border supervision.
3.

Higher capital requirements likely for loans to emerging markets. For many emerging
and developing countries, the increased risk sensitivity in Basel II may lead to higher
bank capital requirements for loans to these countries. The BCBS' Third Quantitative
Impact Study showed that banks lending to emerging and developing markets will face
higher capital charges for credit risk and operational risk. This could result in higher
borrowing costs as well as reduced capital flows to higher risk countries. The effect of
Basel II on banks' lending rates, however, is not straightforward. Banks lending to
emerging markets may already incorporate the higher risk in their current lending rates.
Moreover, many other factors besides the cost of capital determine bank lending rates,
including competitive pressures and strategic considerations. Even if bank-intermediated
flows to emerging markets declined, nonbank flows might well offset some or all of the
decline.

4. Portfolio adjustments arising from Basel II. The application of different capital charges
based on the credit risk of a type of loan (e.g., residential mortgage loans) or borrower

may lead banks to change the composition of their asset portfolios. Banks may tend to
increase their holding of low risk assets (with lower capital charges) and may reduce their
holdings of those assets, which under Basel II, generate a higher capital charge and put
upward pressure on lending rates. These factors could shift the flow of credit from higher
risk sectors (e.g., commercial real estate), to less risky sectors (e.g., residential housing).
More work needs to be done to assess the likelihood of the occurrence of such portfolio
shifts and their potential macroeconomic consequences.
5.

Increased procyclicality. In addition to higher provisions against corporate loans,

triggered by deteriorating corporate performance, Basel II may require banks to assign
higher risk weights in an economic downturn. This raises banks' cost of extending credit,
which may in turn have the effect of further restricting bank lending. While this is
arguably an inherent part of a risk-based capital regime, and can lead to more accurate
pricing of risk, it may also have the effect of exacerbating business cycles. A more risksensitive and forward looking capital framework may, on the other hand, also provide
incentives for banks to better analyze risk and avoid excessive "herd behavior."

6. Risk of selective implementation of Basel II. Basel II offers a large number of options,
starting with legitimate choices between the simpler and the more advanced approaches
to capital adequacy. However, some countries may wish to exercise national discretion to
adopt lower risk weights for certain asset categories permitted under Basel II, without
meeting the Basel II requirements of a safe lending environment and without taking into
account the loss experience of their countries. Such practices, such as application of
lower risk weights for residential mortgages, retail and SME lending should not be
authorized by supervisors unless countries have the historical loss data and appropriate
legal judicial and accounting environment to justify these lower risk weights. To do
otherwise could lead to unwarranted reductions in bank capital and increased systemic
vulnerability.
7. Incentives to develop credit rating agencies. Basel II may create an incentive for
countries to facilitate the development of credit rating agencies and foster an improved
credit culture. For instance, implementation of the Standardized Approach under Pillar I
allows the use of borrower ratings issued by rating agencies to determine asset risk
weights. This is only feasible, however, in countries with sufficient rating agency
penetration. If rating agency penetration is low, and ratings are not available for major

borrowers, then the standard risk weights of Basel I will be applied. For ratings to
qualify for use under Basel II, supervisors are expected to assess the quality of the rating
agencies, based on criteria of objectivity, independence, availability to foreign and
domestic institutions, disclosure of methodologies, adequacy of resources and
credibility. Such evaluations will require additional resources and expertise.
8. Increased resource pressures to build financial infrastructures. Supervisors and banks
wishing to implement Basel II, and particularly the IRB approaches, may need to build
considerable additional infrastructure, i.e., data and reporting systems, and verification
and validation capacity. The advanced approaches to measuring credit risk require a
minimum of reliable five-year data sets on credit performance, according to the Basel
Committee. Other experts argue that five years is insufficient to obtain an accurate
estimation of risk; if the time series of data available is less than that of a typical
business cycle, then the models will exacerbate cyclical swings more than an approach
that looks at risk over the entire cycle. Such data sets are currently only partially
available in many countries. Where neither banks nor supervisors have developed their
own databases, credit registries or data pooling arrangements can be used.
9. Shortage of trained supervisors. To build their supervisory capacity, countries will need
to recruit additional specialized staff, and provide extensive training to existing staff on
Basel II. The FSI Survey on Implementation of the new capital adequacy framework
estimates that responding countries could require training of over 9,000 supervisors.
Demand for expertise in risk-based supervision, credit and operational risk management
is likely to increase significantly in the next few years. In most countries, supervisory
agencies, operating under government pay scales, will be disadvantaged in competing
against the private sector for these skills. The prospect of a "brain drain" of Basel IItrained supervisors to the private sector is very real, further challenging the ability of
supervisory agencies to build the necessary capacity to implement Basel II.
10. The role of the host supervisor. For foreign banks operating under the more advanced
versions of Basel II, host supervisors are responsible for deciding to what extent they
wish to rely on home country supervisors to validate the systems and policies of the
parent banks' major foreign subsidiaries. For instance, if a home supervisor authorizes
one of its large international banks to operate under advanced-IRB, it will expect the
bank to operate all of its major subsidiaries, both domestic and foreign, under Advanced-

IRB. Such arrangements could raise a number of home-host issues. For instance, is it
feasible for the supervisors in every country in which that bank has major subsidiaries to
require each subsidiary to go through an approval/validation process? Alternatively,
should the host supervisor of a foreign bank subsidiary rely, in essence, on the home
supervisor to judge the adequacy of that subsidiary's capital adequacy? In the event that
the foreign subsidiary encountered capital problems, what would be the accountability of
the home supervisor to the host authorities and legislature? These are difficult questions
that are being discussed between a number of home and host regulators, and the banks
operating in their jurisdictions. Ultimately, the host supervisory agency has the
responsibility for maintaining a safe and sound banking system in its country and can be
expected to retain the authority to impose the "rules of the house" upon foreign banks'
local subsidiaries. Host supervisors will in any case need to develop resources to
dialogue effectively with home supervisors on Basel II implementation, and will in this
context, where applicable, also need to be able to assess the quality of implementation of
more advanced Basel II systems in the host country.
11. Home-host supervisory cooperation. Effective working relationships, including
agreements on information sharing, need to be formed between home and host
authorities.13 The challenge will be to strike an appropriate balance between efficient
home country consolidated supervision, host country responsibility, and avoidance of
duplicative and overlapping regulation/supervision of foreign banks. These agreements
should take account of the differences between home and host supervisory systems and
capabilities and between the capital frameworks used by foreign banks and domestic
banks. The Accord Implementation Group (or AIG, a subgroup of the BCBS), has
developed guidance for the development of mechanisms for home-host cooperation, and
is compiling materials on current arrangements between home and host regulators ("case
studies"). In countries where foreign banks control a substantial portion of the banking
assets, the national authorities will need to work very closely with the foreign banks'
home supervisors to develop an effective supervisory process and will need staff with
sufficient expertise to be able to conduct a meaningful dialogue with the home
supervisors of these foreign banks. In the EU, renewed efforts are underway to address
issues of home-host supervisory cooperation, in the form of multilateral arrangements
with regard to conglomerate supervision and crisis management, to supplement an
extensive system of bilateral MOUs among EU supervisory authorities.

12. Commercial bank implementation. Basel II has reinforced the need for commercial
banks to focus more on risk management and to better align capital and risk. Large,
internationally active banks in developed countries have already begun to take steps to
implement Basel II according to the Basel timetable. Medium-income countries have
adopted a variety of approaches depending on the degree of sophistication of their banks
and resources available to the supervisory authorities. Banks in lower-income countries
are the most challenged by implementation of the advanced approaches under Pillar 1, as
are their supervisors.
BASEL II RECENT CHRONOLOGICAL UPDATES
September 2005 update
On September 30, 2005, the four US Federal banking agencies (the Office of the
Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the
Federal Deposit Insurance Corporation, and the Office of Thrift Supervision) announced
their revised plans for the U.S. implementation of the Basel II accord. This delays
implementation of the accord for US banks by 12 months.

November 2005 update

On November 15, 2005, the committee released a revised version of the Accord,
incorporating changes to the calculations for market risk and the treatment of double
default effects. These changes had been flagged well in advance, as part of a paper
released in July 2005.

July 2006 update

On July 4, 2006, the committee released a comprehensive version of the Accord,
incorporating the June 2004 Basel II Framework, the elements of the 1988 Accord that
were not revised during the Basel II process, the 1996 Amendment to the Capital Accord
to Incorporate Market Risks, and the November 2005 paper on Basel II: International

Convergence of Capital Measurement and Capital Standards: A Revised Framework. No

new elements have been introduced in this compilation. This version is now the current
version.

November 2007 update

On November 1, 2007, the Office of the Comptroller of the Currency (U.S.
Department of the Treasury) approved a final rule implementing the advanced approaches
of the Basel II Capital Accord. This rule establishes regulatory and supervisory
expectations for credit risk, through the Internal Ratings Based Approach (IRB), and
operational risk, through the Advanced Measurement Approach (AMA), and articulates
enhanced standards for the supervisory review of capital adequacy and public disclosures
for the largest U.S. banks.

July 16, 2008 update

On July 16, 2008 the federal banking and thrift agencies (the Board of Governors
of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of
the Comptroller of the Currency, and the Office of Thrift Supervision) issued a final
guidance outlining the supervisory review process for the banking institutions that are
implementing the new advanced capital adequacy framework (known as Basel II). The
final guidance, relating to the supervisory review, is aimed at helping banking institutions
meet certain qualification requirements in the advanced approaches rule, which took
effect on April 1, 2008.

January 16, 2009 update

For public consultation, a series of proposals to enhance the Basel II framework
was announced by the Basel Committee. It releases a consultative package that includes:
the revisions to the Basel II market risk framework; the guidelines for computing capital

for incremental risk in the trading book; and the proposed enhancements to the Basel II
framework.

July 89, 2009 update

A final package of measures to enhance the three pillars of the Basel II
framework and to strengthen the 1996 rules governing trading book capital was issued by
the newly expanded Basel Committee. These measures include the enhancements to the
Basel II framework, the revisions to the Basel II market-risk framework and the
guidelines for computing capital for incremental risk in the trading book.
BASEL II AND THE GLOBAL FINANCIAL CRISIS
The role of Basel II, both before and after the global financial crisis, has been
discussed widely. While some argue that the crisis demonstrated weaknesses in the
framework, others have criticized it for actually increasing the effect of the crisis. In
response to the financial crisis, the Basel Committee on Banking Supervision published
revised global standards, popularly known as Basel III. The Committee claimed that the
new standards would lead to a better quality of capital, increased coverage of risk for
capital market activities and better liquidity standards among other benefits.

Nout Wellink, former Chairman of the BCBS, wrote an article in September 2009
outlining some of the strategic responses which the Committee should take as response to
the crisis. He proposed a stronger regulatory framework which comprises five key
components: (a) better quality of regulatory capital, (b) better liquidity management and
supervision, (c) better risk management and supervision including enhanced Pillar 2
guidelines, (d) enhanced Pillar 3 disclosures related to securitization, off-balance sheet
exposures and trading activities which would promote transparency, and (e) cross-border
supervisory cooperation. Given one of the major factors which drove the crisis was the
evaporation of liquidity in the financial markets, the BCBS also published principles for
better liquidity management and supervision in September 2008.

A recent OECD study suggest that bank regulation based on the Basel accords
encourage unconventional business practices and contributed to or even reinforced
adverse systemic shocks that materialized during the financial crisis. According to the
study, capital regulation based on risk-weighted assets encourages innovation designed to
circumvent regulatory requirements and shifts banks' focus away from their core
economic functions. Tighter capital requirements based on risk-weighted assets,
introduced in the Basel III, may further contribute to these skewed incentives. New
liquidity regulation, notwithstanding its good intentions, is another likely candidate to
increase bank incentives to exploit regulation.

Think-tanks such as the World Pensions Council (WPC) have also argued that
European legislators have pushed dogmatically and naively for the adoption of the Basel
II recommendations, adopted in 2005, transposed in European Union law through
the Capital Requirements Directive (CRD), effective since 2008. In essence, they forced
private banks, central banks, and bank regulators to rely more on assessments of credit
risk by private rating agencies. Thus, part of the regulatory authority was abdicated in
favor of private rating agencies.

Long before the implementation of Basel II George W. Stroke and Martin H.

Wiggers pointed out, that a global financial and economic crisis will come, because of its
systemic dependencies on a few rating agencies. After the breakout of the crisis Alan
Greenspan agreed to this opinion in 2007. At least the Financial Crisis Inquiry
Report confirmed this point of view in 2011.

BASEL II IN THE PHILIPPINES

Circular No. 538

08.04.2006

Revised Risk-Based Capital Adequacy Framework For Universal and

Commercial Banks and their Subsidiary Banks and Quasi-banks.

BASEL III
Basel III were proposed on 2010 in order to ensure that banks dont take on excessive
debt, and that they dont rely too much on short term funds.
Basel III aims to:
1. to make participating banks strong enough to withstand future financial shocks (similar to
the 2008/09 crises) without causing contagion to other economies/sectors
2. to enforce greater risk management within all aspects (including operational) of the
financial industry
3. to strengthen the financial industries' transparency, governance, and disclosure practices
Basel III History

Even before Lehman Brothers collapsed in September 2008, the need for a
fundamental strengthening of the Basel II framework had become apparent. The banking
sector had entered the financial crisis with too much leverage and inadequate liquidity
buffers. These defects were accompanied by poor governance and risk management, as well
as inappropriate incentive structures. The dangerous combination of these factors was
demonstrated by the mispricing of credit and liquidity risk, and excess credit growth.
Responding to these risk factors, the Basel Committee issued Principles for sound
liquidity risk management and supervision in the same month that Lehman Brothers failed. In
July 2009, the Committee issued a further package of documents to strengthen the Basel II
capital framework, notably with regard to the treatment of certain complex securitization
positions, off-balance sheet vehicles and trading book exposures. These enhancements were
part of a broader effort to strengthen the regulation and supervision of internationally active
banks, in the light of weaknesses revealed by the financial market crisis. In September 2010,
the Group of Governors and Heads of Supervision announced higher global minimum capital

standards for commercial banks. This followed an agreement reached in July regarding the
overall design of the capital and liquidity reform package, now referred to as "Basel III". In
November 2010, the new capital and liquidity standards were endorsed at the G20 Leaders
Summit in Seoul and subsequently agreed at the December 2010 Basel Committee meeting.

The proposed standards were issued by the Committee in mid-December 2010 (and
have been subsequently revised). The December 2010 versions were set out in Basel
III: International framework for liquidity risk measurement, standards and
monitoring and Basel III: A global regulatory framework for more resilient banks and
banking systems. The enhanced Basel framework revised and strengthen the three
pillars established by Basel II. It also extended the framework with several

innovations, namely:
an additional layer of common equity - the capital conservation buffer - that, when
breached, restricts payouts of earnings to help protect the minimum common equity
requirement;

a countercyclical capital buffer, which places restrictions on participation by banks in

system-wide credit booms with the aim of reducing their losses in credit busts;

a leverage ratio - a minimum amount of loss-absorbing capital relative to all of a

bank's assets and off-balance sheet exposures regardless of risk weighting (defined as
the "capital measure" (the numerator) divided by the "exposure measure" (the
denominator) expressed as a percentage);

liquidity requirements - a minimum liquidity ratio, the liquidity coverage ratio

(LCR), intended to provide enough cash to cover funding needs over a 30-day period
of stress; and a longer-term ratio, the net stable funding ratio (NSFR), intended to
address maturity mismatches over the entire balance sheet; and

Additional proposals for systemically important banks, including requirements for

supplementary capital, augmented contingent capital and strengthened arrangements
for cross-border supervision and resolution.

In January 2012, the GHOS endorsed a comprehensive process proposed by the

Committee to monitor members' implementation of Basel III. The Regulatory
Consistency Assessment Programme (RCAP) consists of two distinct but complementary
work streams to monitor the timely adoption of Basel III standards, and to assess the

consistency and completeness of the adopted standards including the significance of any
deviations in the regulatory framework.
The Basel Committee has worked in close collaboration with the Financial
Stability Board (FSB) given the FSB's role in coordinating the monitoring of
implementation of regulatory reforms. The Committee designed its programme to be
consistent with the FSB's Coordination framework for monitoring the implementation of
financial reforms (CFIM) as agreed by the G20.
These tightened definitions of capital, significantly higher minimum ratios and
the introduction of a macroprudential overlay represent a fundamental overhaul for
banking regulation. At the same time, the Basel Committee, its governing body and the
G20 Leaders have emphasised that the reforms will be introduced in a way that does not
impede the recovery of the real economy.
In addition, time is needed to translate the new internationally agreed standards
into national legislation. To reflect these concerns, a set of transitional arrangements for
the new standards was announced in September 2010, although national authorities are
free to impose higher standards and shorten transition periods where appropriate.
The strengthened definition of capital will be phased in over five years: the
requirements were introduced in 2013 and should be fully implemented by the end of
2017. Capital instruments that no longer qualify as common equity Tier 1 capital or Tier
2 capital will be phased out over a 10-year period, beginning 1 January 2013.
Turning to the minimum capital requirements, the higher minimums for common
equity and Tier 1 capital were phased in from 2013, and will become effective at the
beginning of 2015. The schedule is as follows:

The minimum common equity and Tier 1 requirements increased from 2%

and 4% to 3.5% and 4.5%, respectively, at the beginning of 2013.

The minimum common equity and Tier 1 requirements rose to 4% and 5.5%,
respectively, at the beginning of 2014.

The final requirements for common equity and Tier 1 capital will be 4.5%
and 6%, respectively, beginning in 2015.

The 2.5% capital conservation buffer, which will comprise common equity and is
in addition to the 4.5% minimum requirement, will be phased in progressively starting on
1 January 2016, and will become fully effective by 1 January 2019.
The leverage ratio will also be phased in gradually. The test (the so-called
"parallel run period") began in 2013 and will run until 2017, with a view to migrating to a
Pillar 1 treatment on 1 January 2018 based on review and appropriate calibration. The
exposure measure of the leverage ratio was finalised in January 2014.
The liquidity coverage ratio (LCR) will be phased in from 1 January 2015 and
will require banks to hold a buffer of high-quality liquid assets sufficient to deal with the
cash outflows encountered in an acute short-term stress scenario as specified by
supervisors. To ensure that banks can implement the LCR without disruption to their
financing activities, the minimum LCR requirement will begin at 60% in 2015, rising in
equal annual steps of 10 percentage points to reach 100% on 1 January 2019.
The other minimum liquidity standard introduced by Basel III is the net stable
funding ratio. This requirement, which takes effect as a minimum standard by 1 January
2018, will promote longer term funding mismatches and provide incentives for banks to
use stable funding sources.

Under Basel 3, banks would be mandated to maintain healthier amounts of "true"

capital. The way that the Committee did this was to have banks exclude the use of
Preferred Equity and other hybrid capital instruments from the calculation of "Tier 1"
capital reserves. Other areas, that Basel III focused on include:

stress testing

practices governing "fair value" assessment

executive compensation/remuneration practices

stronger corporate governance

scrutiny over "large exposures"

increased oversight of "concentration risk"

While some of these protocols existed in previous Basel accords, they have been
updated and strengthened in Basel III. Others, like stress testing requirements, are not
new and are in direct response to the 2008 crisis.
Basel III Pushback

When the initial Basel III guidelines were published in 2010, the world
(especially regulators, investors, and consumers of financial products and services)
waited in great anticipation for its January 2013 implementation. US banking lobbyists
pushed back hard to have the liquidity restrictions on its members relaxed. They
contended that in the three years since the initial draft was published, most US banks had
already done a lot to improve their liquidity (Tier 1 capital) ratios even before Basel III
implementation kicked in. However, observers were quick to point out that was not the
case. They pointed out that:

"American banks were only able to raise their holdings of liquid assets by
$700bn, less than half the $1.5trn identified as target at the end of 2010." When January
2013 finally rolled around, the Basel Committee released a newly-updated accord, which
observers felt had "watered-down some of its most important requirements"

To the disappointment of many a financial watchdog, the implementation

timelines of Basel III, as envisioned in the original draft, were also significantly relaxed
in the final version of the proposal. Critics of Basel III believe that this third kick at the
can is doomed to fail, just as the previous two-and-a-half kicks have failed.

And one key reason why this could happen is because of how Basel III deals with
the calculation of risk. In the words of one critic:

"The most serious failure in Basel III is that it doesn't address the principal
contribution of Basel II to the last financial crisis, namely, the calculation of riskweights.

Because it doesn't really change the risk-weighting, Basel III doesn't force banks
to increase the amount of capital they must hold against some of the higher-risk assets
they do hold. In that sense, Basel III simply reinforces Basel II under whose watch the
2008 crises took place.

Overall however, both Basel 2.5 and Basel 3 have:

made it costlier for banks to indulge in riskier behavior

made it more difficult (due to new oversight and stringent restrictions) for
financial institutions to take unwanted risks

provided a more robust early-warning system to detect and prevent many

financial disasters from happening

What to Expect

The full implementation of Basel III is not likely to be finalized (globally) until 2019,
subject to local (country-specific) phase-in requirements. For instance, based on a report from the
Congressional Research Service, the implementation of key Basel III framework proposals in the
US were harmonized to work in tandem with other U.S legislation, specifically the Dodd-Frank
Act.

Given how interconnected today's global financial institutions are, and how quickly
"contagion" from one country can spread to another's financial system, a lot could happen
between now and 2019. As the milestone dates for implementing key Basel III proposals tick by,
the Basel Committee will continue to monitor its implementation, through its Regulatory
Consistency Assessment Program (RCAP), as will other member, central bankers. It is very
conceivable that, in the event of yet another financial crisis of major proportion, the world could
very well see a Basel III.5 come forth from the Basel Committee.

TOP 7 ways why Basel III Affects U.S. Banks and Their IT Departments

1. Basel III makes regulatory arbitrage harder. Basels I and II were loose enough to
allow banks to play games to set aside as little capital as they could get away with. For

example, Basel I has a simple set of risk weights assigned to categories of assets. The
weight assigned to Brazilian and U.S. government bonds, for instance, was the same
regardless of their actual risk of defaulting. "People loaded up on Brazilian bonds," Kelly
recalls. The Basel II rules called for a more risk-sensitive estimate of weightings but
mispriced the risk inherent in securitizations; banks reacted by loading up on off-balancesheet instruments and collateralized debt obligations. "With Basel III, now the committee
is saying we know there will be another hole, as hard as we've worked to prevent it,
therefore we're going to build in these other provisions," Kelly says. For instance, Basel
III adds a leverage ratio: capital has to be at least 3% of total assets even where there is
no risk weighting.
2. It requires large banks to modify their risk models. Under the Basel II rules,large,
global banks were advised to use their own internal risk rating models to determine the
risk weightings for their assets. "The idea was to align regulatory risk calculations with
the considerably more sophisticated risk models that were being used by major banks in
their own decision-making," according to a paper by the Brookings Institute. "This
concept counts on the self-interest of the banks to lead them to use the best possible
estimates of risk in their own management of assets." For international banks like
JPMorgan Chase, Goldman Sachs and Morgan Stanley, "the additional provisions of
Basel III around securitized products adds more complexity to their models," says Kelly.
Such banks probably don't need to buy new risk modeling software, but their models will
need to be modified.
3. Basel III presents data integration/data management challenges.Basel III requires
banks to consolidate positions from all their trading desks and to make their trading book
compatible with their banking book; to accomplish this the data must be clean and
accurate. This requirement is designed to eliminate regulatory arbitrage in the form of
banks transferring assets out of their banking book into the trading book to get better
capital treatment, Kelly says. "Basel III picked up on that and said we're going to make
you use the same method, especially for securitizations," he says. This will be an
implementation challenge, especially for U.S. banks that have not been following the
Basel rules.
4. Regional banks may start using their own risk models, like the biggest banks
do. Regional banks have had the ability under previous iterations of Basel to run

standardized methods for calculating risk-weighted assets, which is easier than coming up
with their own risk models. "Their challenge is determining whether that puts them at a
competitive disadvantage from a capital perspective," Kelly says. "It could, because
banks will find arbitrages and they will optimize their capital." Banks that use advanced,
internal models may be able to gain more favorable risk weightings.
5. Basel III discourages loan securitization, which in turn will restrict lending. The
packaging and selling of loans is no longer the great way to avoid capital requirements
that it once was. "The new rules are punitive toward securitization," Kelly says. "Given
the role securitization has played over the last two years in causing large, unexpected
losses, the new rules have higher capital charges for these assets, and there's a
discouragement of originating securitized products." Because securitization played a
large role in providing greater credit access, credit will constrained by lessened
securitization activity. However, Kelly disagrees with the common notion that higher
capital ratios in and of themselves will constrain lending. "I have yet to see evidence that
that's the case," he says. "Right now we have a lot of mid-tier and smaller banks that
exceed the capital ratios," he observes. "We want to assign blame [for tight credit
markets] to Basel or the capital rules. But I think uncertainty about the environment plays
a big role in this, too. I've heard a counter-argument that Basel III rules should remove a
lot of uncertainty, free up capital, and encourage lending, because we believe we're going
to have a better banking system."
6. Banks will need to find new ways of calculating capital, leverage and liquidity
ratios. For banks that already have software making these calculations, these will be
substantial projects but not huge overhauls, according to Kelly. "There will be new things
for banks to deal with, for example the new leverage ratio involves your balance sheet, so
along with running Monte Carlo simulations on your portfolio of transactions, now you
need a system that also can calculate a balance sheet leverage ratio." The new liquidity
ratio required in Basel III will force banks to perform stress tests on their 30-day cash
flows.
7. Banks will have to perform additional data recordkeeping in the way they measure
capital. Basel III increases the quality of Tier 1 capital by eliminating some types of
capital, such as contingent convertible bonds (bonds that can be converted into shares of
stock only if the share price achieves a certain level), that used to be allowed in this

category. Now Tier 1 capital is more narrowly defined as common equity, retained
earnings and limited other products, Kelly says. The new rules also stipulate that
anything banks count as capital must be loss-absorbing. "For any sort of debt-like product
to be loss absorbing, it has to be convertible into equity," Kelly says. "What's complicated
is, at what point would a debt instrument, say a bond, be convertible to equity?" Software
providers like quantitative credit analysis software provider Moody's KMV may come
out with products that model the conversion of debt to equity and tie that into the bank's
capital ratio, Kelly theorizes.

BASEL III IN THE PHILIPPINES

Implementation of Basel III

On 15 January 2013, the Bangko Sentral ng Pilipinas (BSP) released Circular No. 781 which provides the
implementing guidelines on the revised risk-based capital adequacy framework particularly on the
minimum capital and disclosure requirements. The new framework which took effect in 2014 is
applicable to all universal and commercial banks (U/KBs) and their subsidiary banks and quasi-banks.
This framework allowed a reasonable transition period for banks to comply with the new minimum
requirements. While the international rules allow staggered implementation, the BSP adopted the capital
reforms in full, in recognition of the strong capital position of the banking industry.
The BSP implements new minimum capital ratios of 6.0 percent Common Equity Tier 1 (CET1) ratio, 7.5
percent Tier 1 ratio and 10.0 percent Total Capital Adequacy Ratio (CAR). A capital conservation buffer
(CCB) of 2.5 percent, comprised of CET1 capital was also prescribed.
In recognition of the distinct structure of foreign bank branches (FBBs) which operate under the U/KB
license, a calibrated Basel III framework was issued under Circular No. 822 dated 13 December 2014.
The reform highlighted the role of Permanently Assigned Capital which is the CET1 equivalent for FBBs.
Shortly after, R.A. No. 10641 amending R.A. No. 7721, was approved to further liberalize the entry of

foreign banks. To implement this law, the BSP issued Circular No. 858 dated 21 November 2014,
providing the new capital computation for FBBs.
In October 2014, Circular No. 856 Basel III Framework for Dealing with Domestic Systemically
Important Banks (DSIBs) was issued to address systemic risk and interconnectedness by identifying
banks which are deemed systemically important within the domestic banking industry. Minimum buffers
composed of CET1 capital shall be required of systemically important banks starting January 2017.

Basel III

Circular No. 781

01.15.2013

Basel III Implementing Guidelines on Minimum Capital

Requirements

Basel III: international regulatory framework for banks

Highlights

Basel III: A global regulatory framework for more resilient banks and banking systems - revised version
June 2011

The Basel Committee on Banking Supervision has completed its review of and finalized the Basel III capital treatment fo

credit risk in bilateral trades. The review resulted in a minor modification of the credit valuation adjustment (CVA), whic

loss caused by changes in the credit spread of a counterparty due to changes in its credit quality (also referred to as the m
counterparty credit risk).

Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools
January 2013
The Basel Committee has issued the full text of the revised Liquidity Coverage Ratio (LCR)
following endorsement on 6 January 2013 by its governing body - the Group of Central Bank Governors
and Heads of Supervision (GHOS). The LCR is an essential component of the Basel III reforms, which
are global regulatory standards on bank capital adequacy and liquidity endorsed by the G20 Leaders.
To promote short-term resilience of a banks liquidity risk profile, the Basel Committee developed the
Liquidity Coverage Ratio (LCR). This standard aims to ensure that a bank has an adequate stock of
unencumbered high quality liquid assets (HQLA) which consists of cash or assets that can be converted
into cash at little or no loss of value in private markets to meet its liquidity needs for a 30 calendar day
liquidity stress scenario. The LCR has two components: (a) the value of the stock of HQLA; and (b) total
net cash outflows.

The LCR is one of the Basel Committee's key reforms to strengthen global capital and liquidity
regulations with the goal of promoting a more resilient banking sector. The LCR promotes the short-term
resilience of a bank's liquidity risk profile. It does this by ensuring that a bank has an adequate stock of
unencumbered high-quality liquid assets (HQLA) that can be converted into cash easily and immediately
in private markets to meet its liquidity needs for a 30 calendar day liquidity stress scenario. It will
improve the banking sector's ability to absorb shocks arising from financial and economic stress,
whatever the source, thus reducing the risk of spillover from the financial sector to the real economy.
The LCR was first published in December 2010. At that time, the Basel Committee put in place a rigorous
process to review the standard and its implications for financial markets, credit extension and economic
growth. It committed to address unintended consequences as necessary.
The revisions to the LCR incorporate amendments to the definition of high-quality liquid assets (HQLA)
and net cash outflows. In addition, the Basel Committee has agreed a revised timetable for phase-in of the
standard and additional text to give effect to the Committee's intention for the stock of liquid assets to be
used in times of stress. The changes to the definition of the LCR, developed and agreed by the Basel
Committee over the past two years, include an expansion in the range of assets eligible as HQLA and
some refinements to the assumed inflow and outflow rates to better reflect actual experience in times of
stress.
Once the LCR has been fully implemented, its 100% threshold will be a minimum requirement in normal
times. During a period of stress, banks would be expected to use their pool of liquid assets, thereby
temporarily falling below the minimum requirement. The GHOS agreed that the LCR should be subject to
phase-in arrangements which align with those that apply to the Basel III capital adequacy requirements.
Specifically, the LCR will be introduced as planned on 1 January 2015, but the minimum requirement will
begin at 60%, rising in equal annual steps of 10 percentage points to reach 100% on 1 January 2019. This
graduated approach is designed to ensure that the LCR can be introduced without disruption to the orderly
strengthening of banking systems or the ongoing financing of economic activity.

Minimum LCR requirement

2015

2016

2017

2018

2019

60%

70%

80%

90%

100%

The GHOS agreed that, during periods of stress it would be entirely appropriate for banks to use their
stock of HQLA, thereby falling below the minimum. Moreover, it is the responsibility of bank supervisors
to give guidance on usability according to circumstances.

The GHOS also agreed that, since deposits with central banks are the most - indeed, in some cases, the
only - reliable form of liquidity, the interaction between the LCR and the provision of central bank
facilities is critically important. The Committee will therefore continue to work on this issue over the
course of 2013.
Mervyn King, Chairman of the GHOS and Governor of the Bank of England, said, "The Liquidity
Coverage Ratio is a key component of the Basel III framework. The agreement reached today is a very
significant achievement. For the first time in regulatory history, we have a truly global minimum standard
for bank liquidity. Importantly, introducing a phased timetable for the introduction of the LCR, and
reaffirming that a bank's stock of liquid assets are usable in times of stress, will ensure that the new
liquidity standard will in no way hinder the ability of the global banking system to finance a recovery."

Basel III: the net stable funding ratio

October 2014
The NSFR is a significant component of the Basel III reforms. It requires banks to maintain a stable
funding profile in relation to their on- and off-balance sheet activities, thus reducing the likelihood that
disruptions to a bank's regular sources of funding will erode its liquidity position in a way that could
increase the risk of its failure and potentially lead to broader systemic stress. The NSFR will become a
minimum standard by 1 January 2018.
NSFR is defined as the amount of available stable funding relative to the amount of the required stable
funding. This ratio should be equal to at least 100%.
Proposals on the NSFR were first published in 2009, and the measure was included in the December 2010
Basel III agreement. At that time, the Committee put in place a rigorous process to review the standard
and its implications for financial market functioning and the economy. In January 2014 the Committee
issued a revised standard that was recalibrated to focus on the riskier types of funding profile employed
by banks while improving alignment with the Liquidity Coverage Ratio (LCR) and reducing cliff effects
in the measurement of available and required stable funding.

The final NSFR retains the structure of the January 2014 consultative proposal. The key changes
introduced in the final standard published today cover the required stable funding for:short-term
exposures to banks and other financial institutions;

derivatives exposures; and

assets posted as initial margin for derivative contracts.

In addition, the final standard recognises that, under strict conditions, certain asset and liability items
are interdependent and can therefore be viewed as neutral in terms of the NSFR.

SUMMARY OF THE THREE BASELS

On 26 June 1974, a number of banks had released payment of Deutsche Marks (DEM - German Currency
at that time) to Herstatt ( Based out of Cologne, Germany) in Frankfurt in exchange for US Dollars (USD)
that was to be delivered in New York. Because of time-zone differences, Herstatt ceased operations
between the times of the respective payments. German regulators forced the troubled Bank Herstatt into
liquidation.The counter party banks did not receive their USD payments. Responding to the crossjurisdictional implications of the Herstatt debacle, the G-10 countries, Spain and Luxembourg formed a
standing committee in 1974 under the auspices of the Bank for International Settlements (BIS), called the
Basel Committee on Banking Supervision. Since BIS is headquartered in Basel, this committee got its
name from there. The committee comprises representatives from central banks and regulatory authorities.

Basel I:
In 1988, the Basel Committee on Banking Supervision (BCBS) in Basel, Switzerland, published a set of
minimum capital requirements for banks. These were known as Basel I. It focused almost entirely on
credit risk (default risk) - the risk of counter party failure. It defined capital requirement and structure of
risk weights for banks.

Under these norms:Assets of banks were classified and grouped in five categories according to credit risk,
carrying risk weights of 0%(Cash, Bullion, Home Country Debt Like Treasuries), 10, 20, 50 and100%
and no rating. Banks with an international presence are required to hold capital equal to 8% of their riskweighted assets (RWA) - At least, 4% in Tier I Capital (Equity Capital + retained earnings) and more than
8% in Tier I and Tier II Capital. Target - By 1992.
One of the major role of Basel norms is to standardize the banking practice across all countries. However,
there are major problems with definition of Capital and Differential Risk Weights to Assets across
countries, like Basel standards are computed on the basis of book-value accounting measures of capital,
not market values. Accounting practices vary significantly across the G-10 countries and often produce
results that differ markedly from market assessments.
Other problem was that the risk weights do not attempt to take account of risks other than credit risk, viz.,
market risks, liquidity risk and operational risks that may be important sources of insolvency exposure for
banks.
Basel II:
So, Basel II was introduced in 2004, laid down guidelines for capital adequacy (with more refined
definitions), risk management (Market Risk and Operational Risk) and disclosure requirements.
- use of external ratings agencies to set the risk weights for corporate, bank and sovereign claims.
- Operational risk has been defined as the risk of loss resulting from inadequate or failed internal
processes, people and systems or from external events. This definition includes legal risk, but excludes
strategic and reputation risk, whereby legal risk includes exposures to fines, penalties, or punitive
damages resulting from supervisory actions, as well as private settlements. There are complex methods to
calculate this risk.
- Disclosure requirements allow market participants assess the capital adequacy of the institution based on
information on the scope of application, capital, risk exposures, risk assessment processes, etc.
Basel III:
It is widely felt that the shortcoming in Basel II norms is what led to the global financial crisis of 2008.

That is because Basel II did not have any explicit regulation on the debt that banks could take on their
books, and focused more on individual financial institutions, while ignoring systemic risk. To ensure that
banks dont take on excessive debt, and that they dont rely too much on short term funds, Basel III norms
were proposed in 2010.
- The guidelines aim to promote a more resilient banking system by focusing on four vital banking
parameters viz. capital, leverage, funding and liquidity.
- Requirements for common equity and Tier 1 capital will be 4.5% and 6%, respectively.
- The liquidity coverage ratio (LCR) will require banks to hold a buffer of high quality liquid assets
sufficient to deal with the cash outflows encountered in an acute short term stress scenario as specified by
supervisors. The minimum
LCR requirement will be to reach 100% on 1 January 2019. This is to prevent situations like "Bank Run".
- Leverage Ratio > 3%: The leverage ratio was calculated by dividing Tier 1 capital by the bank's average
total consolidated assets.