The global economic scenario which seems to repeat its history after time intervals is marked with a whole series of financial failures. These failures often turned into crisis situation for the entire economies and regulators find themselves in a position where they are not able to draft a solution to quickly manage these difficult situations and economies are left with deepening scars from damaging impacts of these crisis.
These crisis situations have not stopped at any time and continue to weaken the trust and confidence which stakeholders have vested in the workings of financial institutions and other major corporations. The global economic crisis has unveiled the weakness in the regulatory framework and the results are closure of various financial institutions and intervention from the state to manage the slow down and billions of dollars being withdrawn from financial institutions due to the lack of confidence in their operations.
In this paper we will outline the basis for the establishment of the Basel Committee and its long strived objectives to play a supervisory role for the banking industry. The implementation of Basel Accord is assessed for its role as a journey which central bank and financial institutions have to go through to achieve the desired results. The financial institutions which put across people their role as guardian of their funds have been blamed since globalization modern banking for their negligence and misuse of deposit funds for their investment activities.
After the recession of 1970s and a series of smaller crashes came the collapse of Herstatt Bank due to settlement risk issues it was decided in 1974 to establish the Basel Committee on Banking Supervision (BCBS) under the auspices of Banking International Settlement (BIS) with its headquarters in Switzerland which was seen as a move by the central-bank governors of ten counties to "…
extend regulatory coverage, promote adequate banking supervision, and ensure that no foreign banking establishment can escape supervision" (BIS, 2009). The objectives of this committee therefore were to stabilize the international banking system and to provide a leveled playing field for internationally active banks.
The initial years working of the committee was aimed to highlight different banking issues and provide draft papers to addresses various issues and develop guidelines for financial institutions to manage their risky operations and portfolios. Balin (2008) indicates Later there were further discussions between member nations aimed at the fact that certain banks hide under their country's laws when international disputes and settlements and regulatory bodies are not able to make them accountable for these acts.
This led to the creation of the "International Convergence of Capital Measurements and Capital Standards" more commonly known as Basel I in the year 1988 which introduced a capital measurement system that provided basis for regulating a credit risk measurement framework and set out requirements for banking institutions to maintain minimum capital requirements comprising of allowable Tier I and Tier II capital with restrictions. In addition to Tier I and Tier II the accord also incorporate two other pillars.
According to the third pillar classification of banks assets was introduced that led to grouping of assets in five categories according to the credit risk. Assets were assigned risks weights of zero, ten, twenty, fifty, and up to one hundred percent. A capital requirement for banks with international presence was set at 8% of their risk-weighted assets. Finally the fourth pillar Transitional and Implementing Agreements laid out the grounds for implementation of rules of Basel Accords with banking system of member countries (Balin, 2008).
Furthermore, in 1998 to accommodate banks' market risk exposure related to their assets a Tier III capital was proposed to be maintained with national discretion allowed. The weaknesses of Basel I including lack of addressing issues pertaining to less developed or emerging economies as they were ignored during the its formation process and not tackling those risks related with recession or exchange rate fluctuations. The major criticism came from the use of jargon that was difficult to decipher.
These allowed banks to use their interpretation of its rules and unduly maintain low capital reserves and entering into positions which were risky (Balin, 2008). As Basel I became less desirable for implementation and as a way for addressing the inbuilt weaknesses of Basel I the Basel Committee took the lead in the year 1999 to formulate A Revised Framework on International Convergence of Capital Measurement and Capital Standards simply known as Basel II (BIS, 2009). The revised accord expanded the scope, technicality and depth of the regulatory framework.
It was constituted around three pillars identified as minimum capital requirements for credit, market and operations risk; supervisory review of an institutions internal assessment process and enhanced market discipline through effective use of disclosure. The first one comprising of major portion of guidelines of Basel II strengthened the sensitive measurement of a bank's weighted assets and attempted to remove the ambiguity of Basel I. The remaining two are simpler and are aimed improving regulator-bank relationship and market discipline within a country's banking sector (Balin, 2008).
These were viewed as a way to improve regulatory capital requirement, risk management and better address the financial innovation that has taken place in recent years (Noyer, 2008). The development process did not stop after drafting and Basel II remained under further consideration and improvement process as a result of which two revisions were carried out in 2005 with changes in the three pillars of the framework and finally consensus between G10 countries was achieved with a condition set out by the U. S. , U. K. and Canada to restrict its application to large banks only.
The result of introduction of Basel II was a change in the approach that where Basel I restricted the lending authorities to apply one risk set to the restricted amount of asset categories to calculate a minimum level of capital. On the other hand, Basel II allows a choice of unique paradigms for calculation of minimum capital by adding details to risk identification process and ensures that financial institutions adopt a monitoring framework that takes the issue of risk management to all levels of the hierarchy (Dr Hall, 2002).