What is the Basel Accord (in brief)
The Basel Accord is a set of international regulatory standards that tell banks how much capital and liquidity they should hold to reduce the chance of failure. The rules are created by the Basel Committee on Banking Supervision (BCBS), an international forum of bank regulators hosted at the Bank for International Settlements (BIS) in Basel, Switzerland.
Key definitions
– Capital adequacy: a measure of whether a bank holds enough capital (loss-absorbing resources) to cover unexpected losses.
– Risk-weighted assets (RWA): bank assets adjusted by risk categories so that higher-risk assets count for more when measuring capital needs.
– Tier 1 capital: the highest-quality capital (most able to absorb losses immediately).
– Tier 2 capital: supplementary capital that is less readily available to absorb losses.
– Systemically important banks: banks judged big or interconnected enough that their failure would threaten the broader financial system; often subject to extra requirements.
Who wrote these rules and why
– The BCBS, formed in 1974, develops the Basel standards to make banking supervision more consistent across countries and to help maintain financial stability.
– The name “Basel” comes from the committee’s host city (BIS headquarters). Member jurisdictions include a wide set of countries across continents.
A short history: Basel I → Basel II → Basel III
– Basel I (1988): Introduced a simple capital rule. Bank assets were grouped into five risk categories (0%, 10%, 20%, 50%, 100%). International banks had to keep total capital (Tier 1 + Tier 2) equal to at least 8% of their risk-weighted assets. Example: $100 million in RWA requires $8 million of capital.
– Basel II (revised framework): Expanded focus beyond a single capital ratio to three pillars: minimum capital requirements, supervisory review, and market discipline through disclosure. It introduced more detailed capital tiering (Tier 3 existed briefly for certain trading risks).
– Basel III (post‑2008 reforms): After the 2008 crisis regulators tightened rules to address poor governance, leverage, and liquidity shortfalls. Basel III raised the quality and quantity of capital required, added liquidity requirements, and eliminated Tier 3 capital. It also added extra buffers for very large or systemically important banks.
Basel III “Endgame” (most recent phase)
– The Basel Committee finalized additional reforms often called the “Basel III Endgame.” Implementation steps began rolling out in 2025, with a three-year phasing period and full compliance expected by July 1, 2028.
– In the United States, these final rules aim to align domestic capital rules more closely with the global Basel standards and are designed to force larger banks to hold more capital. The most stringent parts apply to banks with $100 billion or more in assets (about 37 U.S. banks); smaller community banks are largely unaffected.
– The reforms have sparked debate: critics warn of higher costs for large banks and possible effects on lending and competitiveness; supporters argue the extra capital increases resilience in stress.
Why Basel matters
– Basel standards reduce the probability that individual bank failures will cascade into wider financial crises by ensuring minimum loss-absorbing capacity and stronger liquidity positions.
– International consistency helps level the regulatory playing field for banks operating across borders.
Why Basel I was judged insufficient
– Basel I used a relatively simple approach to risk weighting that could misstate true economic risk. Over time, evolving financial products and risk practices made its measures too blunt to capture actual exposures and behavior that led to excessive leverage.
Practical checklist (for analysts, students, and retail traders who want to understand bank health)
– Confirm which Basel framework(s) a bank reports under (local adoption of Basel I/II/III varies by jurisdiction).
– Check a bank’s common equity and Tier 1 capital levels relative to its reported risk-weighted assets.
– Review any disclosed buffers for systemically important banks.
– Note liquidity metrics and references to minimum liquidity requirements where reported.
– Watch for implementation dates or phasing schedules tied to Basel reforms (e.g., major milestones in 2025–2028).
– Read management discussion and regulatory filings for commentary on capital plans and impacts of new standards.
Worked example: computing a simple capital requirement
Assume a bank holds three asset types:
– Asset A: $50 million at 0% risk weight → RWA contribution = $0
– Asset B: $20 million at 20% risk weight → RWA contribution = $4 million
– Asset C: $30 million at 100% risk weight → RWA contribution = $30 million
Total RWA = $0 + $4m +
+ $30 million = $34 million.
Step 2 — apply the capital ratio formula
– Formula: Capital ratio = Capital measure / Risk-weighted assets (RWA).
– If the minimum common equity tier 1 (CET1) ratio is 4.5% (Basel III minimum), required CET1 = 0.045 × $34,000,000 = $1,530,000.
Step 3 — add regulatory buffers (example)
– Capital conservation buffer (example under Basel III): 2.5%. Combined CET1 requirement = 4.5% + 2.5% = 7.0%.
– Required CET1 with buffer = 0.07 × $34,000,000 = $2,380,000.
– If the bank is designated as globally systemically important and faces an additional SIB (systemic) buffer, add that percentage to the 7.0% before multiplying.
Worked examples of surplus / shortfall
– Suppose the bank reports CET1 capital of $3,000,000.
– Against the plain minimum (4.5%): surplus = $3,000,000 − $1,530,000 = $1,470,000.
– Against the minimum plus conservation buffer (7.0%): surplus = $3,000,000 − $2,380,000 = $620,000.
– If reported CET1 were $2,000,000:
– Shortfall vs 7.0% requirement = $2,380,000 − $2,000,000 = $380,000 (i.e., the bank would need to raise capital or reduce RWA).
Quick checklist for applying this approach to real bank disclosures
1. Confirm which capital measure the jurisdiction uses for minimums (CET1, Tier 1, total capital). Jurisdictions and regulators can vary.
2. Extract reported RWA from the regulatory reporting table; use the same RWA basis as the capital numerator (e.g., consolidated).
3. Note all applicable buffers and countercyclical/add-on requirements (conservation buffer, SIB buffer, countercyclical buffer).
4. Check for differences between standardized and internal-ratings-based (IRB) RWA; IRB portfolios can materially change RWA levels.
5. Include off-balance-sheet exposures using credit-conversion factors if not already embedded in reported RWA.
6. Recompute required capital = (Regulatory minimum + buffers) × RWA and compare to reported capital to get surplus/shortfall.
Key caveats and practical notes
– This example uses simplified, static risk weights; many banks use more granular weights or IRB models that change RWA materially.
– Market risk, operational risk and CVA (counterparty valuation adjustment) charges may add to total capital requirements and are often calculated separately.
– Jurisdictions may phase in new Basel revisions over multiple years; check effective dates and transitional arrangements in filings.
– RWA can be reduced by credit risk mitigation (collateral, guarantees) but the treatment varies by approach and jurisdiction.
Useful references (official and educational)
– Basel Committee on Banking Supervision — Basel III: https://www.bis.org/bcbs/basel3.htm
– Bank for International Settlements — Basel III monitoring reports: https://www.bis.org/publ/bcbs.htm
– U.S. Federal Reserve — Regulatory Capital: https://www.federalreserve.gov/supervisionreg/topics/regulatory-capital.htm
– Investopedia — Basel Accord (background summary): https://www.investopedia.com/terms/b/basel_accord.asp
Educational disclaimer
I’m providing general information for educational purposes, not individualized investment or regulatory advice. Always check primary regulatory filings and speak with a qualified professional for decisions about specific institutions or investments.