The Basel Accords for the Organization Responsible for Monitoring International Banking - Report Example

? The Basel Accords Due Introduction When banks are operating at optimum efficiencies they are essentialto the growth of the modern economy, facilitating spending and investments, allowing homes to be purchased, and businesses to expand. Acting as financial intermediaries they are a “…vital part of a nation’s economy.” (Larson, 2011) But as history has shown us that, as during the Depression and the immediate United States financial crisis, when banks fail there are serious consequences. This can cause a domino effect involving millions of citizens. Because banking has become more and more an international endeavor, there is a greater need for banking regulations that encourage international cooperation. The organization responsible for monitoring international banking is the Basel Committee on Bank Supervision, or BCBS. One of their major focuses is in regulating a bank’s capital. These concerns were considered and resulted in the establishment of the standards of banks to meet capital adequacy; these standards are all called the Basel Accords. (Larson, 2011) Background The BCBS was originally established in the 1970s to tackle the new challenges of banking across international boundaries. It became apparent that the failings and collapse of one country's banks was now being felt in other countries all over the world. It was obvious that intervention and prevention was necessary. In the 1980s, the United States Congress, pushed domestic regulatory agencies to set and enforce standards, including a fixed proportion of capital a bank must hold, or capital adequacy.(Lall, 2009) This is how the Basel Accords began. The accords have been adapted and expanded in attempts to meet needs and to speak to aspects that previous version of the accords may not have addressed sufficiently. In order to understand the Basel Accords better it is useful to review them individually in order to better compare and contrast the variations. Basel I The BCBS determined that bank capital would be organized into 2 separate tiers. Tier 1focuses on the higher-quality capital, those that represents items of the lowest priority of repayment and easiest to absorb when lost. Most of Tier 1 involves “core” capital, or common equity, which arises from actual ownership in the bank, like common stock, undivided profits, and surplus monies.(Larson, 2011) Tier 2, also called supplementary capital, include certain reserves, and term debt. The capital under Tier 2 can be divided into 2 more sublevels; the upper focuses on maintaining characteristics of being continuous, like preferred capital, and equity. The lower level, is the least costly for banks to issue because it pertains to debts with a time of maturity of at least 10 years.(Eubanks, 2010) Basel I was the first attempt made to establish a standard of regulating international banking and it came under a great deal of criticism. Opponents felt that the Basel I Accord approach to “risk-weighing assets.” They claimed that this system is too broad and lacks the finite specialization to address all of the unique risks that apply to the differing assets held by the bank. As a response the BCBS released a revision to the accord called the “International Convergence of Capital Measurement and Capital Standards: Revised Framework,” which is, also, known as Basel II.(Larson, 2011) Basel II Basel II differs from Basel I in a distinct way. It introduced a section of “Pillars,” which intended to rectify the capital adequacy issues with Basel I. Pillar 1, specifically, deals with the procedures of calculating the required capital within banking organizations. This accord will determine risk potential based upon the totality of their credit risk, market risks, and operational risks. Pillar 2, ideally, was placed to increase, both, accountability and transparency with the banking system. Pillar 3 works to require banking institutions to disclose risk exposures, allowing for better assessment of the needed safety to help create a stronger modern market.(Katchova & Barry, 2005) This accord, also, received a great deal of criticism. The amount of capital adequacy and how it was determined would be dependent upon whether they chose a standardized or Internal Ratings Based Approach, or IRB. Risk was assessed as being higher for certain monies and lower for others, the lesser risk involved the less capital necessary as a precautionary manners. Basel II insisted upon the use of “rating agencies” to access risk, however, these agencies were employed by the banks that they were meant to rate; therefore questions of their reliability have been leveled. Also, there was no single rating agency that was being used. Banks were free to employ any number of companies, which may use entirely different rating approaches to assess risk. Again, this levels issues of credibility.(Larson, 2011) Basel III Basel III, formally called “A Global Regulatory Framework for More Resilient Banks and Banking Systems,” is the BCBS attempt to correct all the failings of the previous accord incarnations. It does not replace Basel I or II it, simply, builds upon the existing foundation. The ultimate goal of this accord is to grant losses without having a dramatic, negative, affect on the economy as a whole.(Larson, 2011) Basel III works to redefine “regulatory capital” and capital adequacy requirements. It changes what is included in Tier 1. Tangible common shares, preferred stocks, and certain other assets would no longer be included. Basel III requires every bank to have a “capital conservation bumper,” which acts to ensure that the banks will have a reserve to draw from when they are experiencing financial losses. Also, procyclicality refers to the way a bank can change its required capital depending upon the shifts within the economy and in times of greater and lesser risk. (Eubanks, 2010) However, there are many that feel that Basel III is even more complex than Basel II, which can make it much harder to actively implement, particularly, in the differing international markets. Conclusion There are a great many experts that feel that the Basel Accords as a whole have never been able to accomplish what they intended to do. For example, the Basel rules call for commercial United States banks to, “…hold 8% capital against business loans, 4% against mortgages, 1.6% against mortgage based securities, and…0% against government debt.”(Forbes, 2012) This applied even to countries with unstable economies like Greece and Italy; this regulation favors government interests and diminishes businesses, especially small businesses. It remains to be seen if the Basel III will have the rectifying affect that is hoped for, at least until another alternative is found. In the end, it has been suggested that the system be replaced with a different approach; allowing each country to set strong capital standards and a more countercyclical regulatory system.(Forbes, 2012) This option is an improvement in the eyes of many citizens. As it stands, there are no immediate plans to dismiss or replace the Basel Accords; however, with the ever-changing globalization of world economics, it is very likely that the third Basel Accord will, likely, not be the last. References Eubanks, W. W. Congressional Research Service, (2010). Crs report for congress prepared for members and committees of congress the status of the basel iii capital adequacy accord . Retrieved from Congressional Research Service website: http://www.fas.org/sgp/crs/misc/R41467.pdf Forbes, S. (2012, February 9). Slay the basel accord beast. Forbes, 1. Retrieved from http://www.forbes.com/sites/steveforbes/2012/02/08/slay-the-basel-accord-beast/ Katchova , A. L. & Barry, P. J. (2005). The new basel capital accord: Implications for us agricultural lenders. Choices Magazine, 1. Retrieved from http://www.choicesmagazine.org/2005-1/lending/2005-1-08.htm Lall, R. (2009). Why basel ii failed and why any basel iii is doomed’. (Master's thesis, Oxford University)Retrieved from http://www.globaleconomicgovernance.org/wp-content/uploads/GEG-Working-paper-Ranjit-Lall.pdf Larson, J. (2011). What are the basel captial accords?. Manuscript submitted for publication, The University of Iowa Center for international Finance and Development, University of Iowa, University Heights, Retrieved from http://ebook.law.uiowa.edu/ebook/uicifd-ebook/what-are-basel-captial-accords Read More