Learning Objectives:

  • Trace the evolution of the Basel Accords.

  • Understand the three pillars of Basel II/III.

  • Explain key Basel III reforms: capital, liquidity, and leverage.

2.1 The Evolution of the Basel Framework

The Basel Accords, developed by the Basel Committee on Banking Supervision (BCBS), are the primary international regulatory framework for banks . The framework has evolved significantly over time:

Basel I (1988): Focused primarily on credit risk, introducing a simple risk-weighting system for assets and a minimum 8% capital requirement. The PwC study notes that Basel I established the foundation for international capital standards .

Basel II (2004): Introduced a three-pillar framework:

  • Pillar 1 – Minimum Capital Requirements: Quantitative rules for credit, market, and operational risk.

  • Pillar 2 – Supervisory Review Process: The bank’s own assessment of capital adequacy (ICAAP) and regulatory oversight.

  • Pillar 3 – Market Discipline: Enhanced public disclosure of risk profiles and capital adequacy .

Basel III (2010–2017): Developed in response to the 2008 financial crisis, Basel III significantly strengthened capital and liquidity requirements . The PwC study details the key components of Basel III :

2.2 Key Basel III Components

Capital Requirements:

  • Common Equity Tier 1 (CET1): Minimum 4.5% of risk-weighted assets (RWA).

  • Tier 1 Capital: Minimum 6% of RWA.

  • Total Capital: Minimum 8% of RWA.

  • Capital Conservation Buffer: An additional 2.5% of CET1.

Liquidity Requirements:

  • Liquidity Coverage Ratio (LCR): Requires banks to hold sufficient High-Quality Liquid Assets (HQLA) to meet 100% of net liquidity outflows under a 30-day stress scenario .

  • Net Stable Funding Ratio (NSFR): Requires banks to have available stable funding at least 100% of required stable funding over a one-year time horizon .

Leverage Ratio:

  • A non-risk-based “backstop” measure requiring banks to hold sufficient Tier 1 capital against total assets and on- and off-balance sheet exposures. Basel III introduces a minimum leverage ratio of 3% .

2.3 Basel IV

Basel IV refers to the 2017 reforms that revise the standardized approaches for credit, operational, and market risk, and introduce an output floor limiting internal model benefits. As the PwC study notes, “The finalised RWA rules that raise risk weights for securitisation exposures held by banks will also have an impact on banks’ willingness to make markets in securitisation” .

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