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The Basel Agreements Creation, Evolution, and Impact

Paper Type: Free Essay Subject: Banking
Wordcount: 2027 words Published: 08 Feb 2020

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Introduction: The Basel Agreements and Their Creation, Evolution, and Impact on International Banking

Financial systems have always evolved, from simple bartering to today’s complex global networks. As these systems grow, so do the risks and opportunities. Because of this, global financial markets need strong rules to ensure stability. The Basel Agreements provide this structure, setting standards for banks to follow. These agreements aim to make banking safer and more reliable for everyone, especially in international banking.

The Creation of the Basel Agreements

The Basel Agreements begin with the Bank for International Settlements (BIS), which was formed in 1930. The BIS was designed to help central banks work together and manage international financial issues. After World War II, the BIS continued to play a key role, even as new institutions like the World Bank and International Monetary Fund (IMF) emerged.

In the 1970s, several banking crises highlighted the need for better international cooperation. The collapse of Bankhaus Herstatt in Germany in 1974 caused chaos in global currency markets. This event, along with others, convinced central bankers from major economies to act. They formed the Basel Committee on Banking Supervision (BCBS) at the end of 1974. The committee met in Basel, Switzerland, which is why the agreements carry the city’s name.

The main goal of the Basel Committee is to improve the quality of banking supervision worldwide. It does not have legal power, but its guidelines are widely adopted. The committee brings together central banks and regulators from many countries, creating a platform for cooperation and shared standards.

Evolution of the Basel Agreements

Early Steps: The Concordat

The first major document from the Basel Committee was the Concordat in 1975. This paper set out principles for supervising international banks. Over the years, the Concordat was revised to address new challenges and to clarify the responsibilities of home and host country regulators.

Basel I: The First Accord

In 1988, the Basel Committee introduced Basel I, the first major international agreement on bank capital. Basel I required banks to hold capital equal to at least 8% of their risk-weighted assets. This rule aimed to ensure that banks could absorb losses and protect depositors. Basel I focused mainly on credit risk, assigning different weights to assets based on their risk level.

Basel I was a big step forward, but it had limitations. It did not cover all types of risks, and banks could sometimes move assets to lower-risk categories to reduce their capital requirements. Despite these issues, Basel I set a global standard and was adopted by more than 100 countries.

Basel II: Expanding the Framework

By the late 1990s, it was clear that Basel I needed improvement. Financial markets had become more complex, and new risks had emerged. In 2004, the Basel Committee released Basel II. This new agreement introduced three pillars:

  • Minimum capital requirements for credit, market, and operational risks.
  • Supervisory review of banks’ internal processes and capital adequacy.
  • Market discipline through greater disclosure.

Basel II allowed banks to use advanced risk measurement techniques, encouraging better risk management. However, it also relied heavily on banks’ own models and ratings. This created new challenges, as it became harder for regulators to compare banks across countries.

Basel III: Responding to Crisis

The global financial crisis of 2007-2009 exposed serious weaknesses in the banking system. Many banks had too much leverage and not enough liquidity. Risk management and governance were often poor. In response, the Basel Committee developed Basel III, which was agreed in 2010 and began to be phased in from 2013.

Basel III introduced stricter capital requirements, new liquidity standards, and capital buffers. It also required banks to hold more high-quality capital and introduced limits on leverage. These changes aimed to make banks more resilient to shocks and to prevent future crises.

Basel IV: The Latest Developments

Basel IV builds on the earlier agreements. It focuses on refining risk measurement and ensuring that banks do not underestimate their risks. Basel IV introduces new rules for credit, market, and operational risks, and tightens the use of internal models. These changes aim to make the system fairer and more transparent.

The Impact of the Basel Agreements

On International Banking

The Basel Agreements have transformed international banking. By setting minimum standards, they have made banks safer and more stable. Banks now hold more capital and manage risks more carefully. This reduces the chance of bank failures and protects the wider economy.

The agreements also promote a level playing field. By applying the same rules to banks in different countries, they reduce the risk of regulatory arbitrage. This means banks cannot simply move risky activities to countries with weaker rules.

On Developed Economies

In developed economies, the Basel Agreements have increased confidence in the banking system. Banks are better able to withstand shocks, and investors feel more secure. However, the rules have also increased costs for banks. They must hold more capital, which can reduce their ability to lend and lower their returns on equity.

Some critics argue that the rules are too strict for smaller banks, especially those that do not pose systemic risks. These banks may face higher costs without a clear benefit to financial stability.

On Emerging Economies

Emerging economies face unique challenges under the Basel Agreements. They often need large amounts of funding for infrastructure and development. The higher capital requirements can make it harder for banks in these countries to lend, especially to small and medium-sized enterprises (SMEs).

Despite these challenges, many emerging markets have managed to adapt. Studies show that, after an initial slowdown, lending and profitability in these markets have recovered. Banks have increased their capital ratios, often by retaining more earnings rather than raising lending costs.

On Cross-Border Banking

The Basel Agreements have also affected cross-border banking. Tighter rules have led some banks to rethink their international strategies. Some have reduced their presence in certain markets or focused on core activities. This has led to a decline in cross-border lending, especially from developed to emerging markets.

Trade finance has also been affected. Stricter capital requirements make it more expensive for banks to support international trade, which can slow economic growth in some regions.

On Risk Management and Governance

One of the biggest impacts of the Basel Agreements is the improvement in risk management and governance. Banks are now required to assess and manage a wider range of risks. They must disclose more information to regulators and the public, which increases transparency and market discipline.

Basel III, in particular, has strengthened oversight of risk models and executive compensation. It has also introduced stress testing and limits on large exposures. These measures help to identify and address risks before they become serious problems.

Ongoing Challenges and Criticisms

Complexity and Implementation

The Basel Agreements are complex and can be difficult to implement. Basel III, for example, is over 1,000 pages long and has many technical details. This complexity makes it hard for banks and regulators to ensure full compliance.

National differences in implementation can also create challenges. The Basel Committee does not have legal authority, so each country must adopt the rules in its own way. This can lead to inconsistencies and gaps in supervision.

Costs and Lending

Higher capital and liquidity requirements increase costs for banks. These costs can be passed on to customers through higher loan rates or lower returns on deposits. Some critics argue that the rules have reduced lending, especially to businesses and households.

However, recent studies suggest that the long-term benefits of stability outweigh the short-term costs. Over time, banks have adapted, and lending has resumed in many markets.

Applicability to All Banks

Another criticism is that the Basel Agreements apply the same rules to all banks, regardless of size or risk. Smaller banks, especially those with strong deposit insurance, may not pose a systemic risk. For these banks, the rules may add unnecessary costs without clear benefits.

Enforcement and Oversight

The Basel Committee relies on national regulators to enforce its rules. There is no global supervisor to ensure consistent application. This can lead to differences in interpretation and enforcement, reducing the effectiveness of the agreements.

The Future of the Basel Agreements

The Basel Committee continues to review and update the agreements. Basel IV is the latest step, focusing on refining risk measurement and closing loopholes. The committee is also working to improve consistency in implementation and to address new risks, such as those from digital currencies and climate change.

As financial markets evolve, the Basel Agreements will need to adapt. The goal remains the same: to create a safe, stable, and fair global banking system.

Conclusion

The Basel Agreements have played a crucial role in shaping modern banking. They have made banks safer, improved risk management, and increased transparency. While the rules have increased costs and created challenges, especially for smaller and emerging market banks, the overall impact has been positive.

Banks are now better prepared to withstand shocks and protect their customers. The agreements continue to evolve, responding to new risks and changing markets. As students of international banking and regulation, understanding the Basel Agreements is essential. They are at the heart of efforts to create a stable and resilient global financial system.

For further reading on the Basel Agreements and their impact, you can explore this UKessays.com article on the Basel Agreements.

You may also find it helpful to review related articles on the history and future of the Basel Accords, such as those available at the Bank for International Settlements and the Corporate Finance Institute.

Additional Reading and Resources

By staying informed about the Basel Agreements, you will be better equipped to understand the challenges and opportunities in international banking today.

References

A-G Sources

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  • Beck, T. (2018, May 17). Basel III & Unintended Consequences for Emerging Markets and Developing Economies-Part 4: Challenges on Infrastructure and SME Lending. Retrieved from https://www.cgdev.org/blog/basel-iii-unintended-consequences-emerging-https://www.cgdev.org/blog/basel-iii-unintended-consequences-emerging-markets-developing-economies-part-iv-challenges
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H-Z Sources

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