Origins
The Basel Accords emerged from the Basel Committee on Banking Supervision, an organization established in 1974 to coordinate international banking standards. The first formal agreement, Basel I, was concluded in 1988 as a response to the increasing complexity and internationalization of the banking sector. Its primary goal was to ensure that banks maintained a sufficient buffer of equity capital to absorb losses, preventing systemic failures that could disrupt global trade.
The central problem the accords sought to solve was the lack of a uniform global standard for bank safety, which allowed banks to engage in “regulatory arbitrage” by moving operations to jurisdictions with weaker rules. By establishing minimum capital requirements that applied across major economies, Basel I aimed to create a level playing field and reduce the incentive for a regulatory “race to the bottom.”
Structure & Function
The Basel framework operates through capital ratios—requirements that banks hold a minimum percentage of their assets as equity. Basel I established a simple 8% capital requirement against risk-weighted assets, with different weights assigned to different asset classes (government bonds weighted at 0%, mortgages at 50%, corporate loans at 100%).
Basel II, finalized in 2004, introduced more sophisticated risk-weighting and allowed major banks to use their own internal models to calculate appropriate capital levels. This complexity created opportunities for gaming the system, as banks could structure assets to minimize their apparent risk while maintaining actual exposure. Basel III, announced in 2010 following the financial crisis, raised minimum capital requirements, introduced a leverage ratio as a backstop, and added new liquidity requirements.
Historical Significance
The Basel Accords represent the most ambitious attempt to create uniform global banking standards. Their influence extends to virtually every major economy, as national regulators have adopted Basel standards into their own frameworks. The accords have fundamentally shaped how banks think about risk, capital allocation, and regulatory compliance.
However, the accords have faced significant criticism. The reliance on risk-weighted assets has been accused of incentivizing regulatory arbitrage, as banks structure transactions to minimize capital charges regardless of true risk. The 2008 financial crisis revealed that many “low-risk” assets—including AAA-rated mortgage securities and sovereign debt—were far riskier than Basel weights suggested. Critics like Anat Admati argue that risk-weighting should be abandoned in favor of simple, high leverage ratios of 20-30% of total assets.
Key Developments
- 1974: Basel Committee on Banking Supervision established.
- 1988: Basel I concluded, establishing 8% capital against risk-weighted assets.
- 1996: Market Risk Amendment allows internal models for trading book capital.
- 2004: Basel II finalized, introducing more complex risk-weighting and internal models.
- 2004: SEC creates Consolidated Supervised Entities program, allowing investment banks to use Basel II-style models.
- 2007: Subprime crisis reveals inadequacy of many banks’ capital buffers.
- 2008: Global financial crisis demonstrates systemic failures in risk-weighted approach.
- 2010: Basel III announced, raising minimum capital requirements.
- 2011: Basel Committee identifies 27 “globally systemically important banks” requiring extra buffers.
- 2012: Anat Admati and Martin Hellwig publish The Bankers’ New Clothes, arguing for much higher equity requirements.
- 2013: Federal Reserve announces 5% leverage ratio for largest U.S. bank holding companies.
- 2017: Basel III finalized with additional reforms to risk-weighting.