Basel Accords (Basel I, II, III, IV)

 What are the Basel Accords?

The Basel Accords are international regulatory frameworks developed by the Basel Committee on Banking Supervision (BCBS) to ensure that banks worldwide operate safely by:

• Holding enough capital to cover risks.

• Managing credit, market, and operational risks.

• Preventing bank failures and financial crises.

These accords are named after Basel, Switzerland, where the Bank for International Settlements is headquartered.

📘 Basel I (1988) – Capital Adequacy

Main Focus: Minimum capital requirements for credit risk

• Introduced the concept of Capital Adequacy Ratio (CAR):

  CAR = (Bank's Capital) / (Risk-Weighted Assets)

• Required banks to hold at least 8% capital of their risk-weighted assets.

• Assets were categorized into risk classes (0%, 20%, 50%, 100%).

🔑 Purpose: Ensure banks had a capital buffer to cover potential loan losses.

📗 Basel II (2004) – Risk-Sensitive Approach

Main Focus: More comprehensive and refined risk measurement

Three Pillars:

1. Minimum Capital Requirements (credit, market, operational risks)

2. Supervisory Review Process (internal risk assessment by regulators)

3. Market Discipline (transparency through disclosure)

• Introduced concepts like:

  • Credit Risk Mitigation

  • Internal Ratings-Based (IRB) approach

  • Operational Risk measurement

🔑 Purpose: Encourage better risk management and transparency in banks.

📘 Basel III (2010–2017) – Post-Crisis Reform

Main Focus: Address weaknesses revealed by the 2008 global financial crisis

Key Features:

• Higher capital requirements:

  • Common Equity Tier 1 (CET1) Ratio: 4.5%

  • Capital Conservation Buffer: 2.5%

• Leverage Ratio (non-risk-based)

• Liquidity Ratios:

  • LCR (Liquidity Coverage Ratio): enough high-quality assets for 30-day stress

  • NSFR (Net Stable Funding Ratio): stable funding over a 1-year period

• Countercyclical Buffer: up to 2.5% during economic booms

🔑 Purpose: Make banks more resilient to shocks and reduce systemic risk.

📙 Basel IV (2023 onward) – Refinement of Basel III

Although referred to as Basel IV, it's officially an extension of Basel III. It aims to standardize risk measurement and improve comparability.

Key Additions:

• Output floor: Internal models must not go below 72.5% of standardized risk calculations.

• Revisions to credit and operational risk models

• More robust capital floor to limit variation in risk-weighted assets across banks

🔑 Purpose: Reduce reliance on internal models and ensure global consistency.

🧠 Summary Table