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BO draft

BO draft

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Published by: ekee_1 on Mar 20, 2011
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History Bank for International Settlement
History of the Bank for International Settlement (BIS) was founded in 1930, making itworld¶s oldest international financial institution and remains the principal center for international central bank cooperation(Felsenfeld & Bilali, 2004; Toniolo, 2005). OnJanuary 20, 1930, the BIS was established at the Hague Conference (Hague Conventionof 1930) in the context of the Young Plan or Dawes Loans (the international loans issuedto finance reparations) which can dealt with the coordinating settlement of reparationpayment by the German government and its allies after First World War (Felsenfeld &Bilali, 2004). The primary intention of Bank¶s founders¶ was to create a focus for cooperation among central banks. Thus, the BIS act as the bank for central banks toaccept deposits of a portion of the foreign exchange reserves of central banks and investthem prudently for a yield in market return(Bank for International Settlements ArchiveGuide, 2007).Following the World War II until early 1970s, BIS monetary policy focused onimplementing and defending the Bretton Woods system(BISA Guide, 2007). In the1970s and 1980s, the focus was on managing cross-border capital flow transactionsfollowing the oil crises and the international debt crisis. The 1970s crisis also brought theissue of regulatory supervision of internationally active banks to the fore, resulting in the1988 Basel Capital Accord and its "Basel II " revision of 2001-2006. More recently, theissue of financial stability in the wake of economic integration and globalization, ashighlighted by the 1997 Asian crisis, has received a lot of attention. Next is relating to themonetary unification of Europe. BIS was the key meeting place for European centralbankers as they laid the groundwork for monetary union from the mid- 1970s to early1990s. Since the increase in globalization, deregulation and sophistication of financialmarkets have focused the attention of the BIS firmly on the issues related to thesoundness of the international financial architecture and the threats posed by systemicrisks(BISA Guide, 2007).
History of Basel
The Basel Committee on banking supervision (the committee) has been dealing with thecreation of a framework to measure capital adequacy on a multinational scale as aguideline for an appropriate capital level of internationally active banks(Bieg & Kramer,2006). It was commenced in respect that a frighteningly low level of the capital whichwas held by most banks worldwide. The aim of the Committee was also include thatremoving the disadvantages in competition between banks which resulted from differentcapital requirements of different states. The results of the Committee¶s work were socalled as International Convergence of Capital Measurement and Capital Standard, it alsoknown as Basel Capital Accord, Basel Capital Adequacy Framework or in short Basel Iwhile it is adoption in July 1988(Bieg & Kramer, 2006). The implementation of Basel Ibecame effective as of the year-end 1992. Meanwhile, Basel I has been changed on asmall scale by amendments and revisions that are amendment to the capital accord toincorporate market risks and also called market risk amendment regarding the treatment
of market risk in January 1996(Bieg & Kramer, 2006). The changes were necessarysince Basel I just limited only for a bank¶s credit risks that will influence losses due to thereason for a bank¶s poor performance. The changes to the Basel I framework made by theMarket Risk Amendment became effective as of year-end 1997.Due to the capital framework is no longer up-to-date and is effective in reaching thetarget of the Basel Committee on Banking Supervision so that the Committee publishedthe first consultative paper concerning Basel II (The New Basel Capital Accord) inJune1999. Interested parties (foremost banks) were given the chance to comment on theseproposals until the end of March 2000. In January 2001, second consultative paper concerning Basel II was published that contains the revision of the first consultativepaper of 1999 concerning the fundamental adjustment of the capital adequacy framework of 1988 and took into consideration many comments and suggestions made by bankswithin the first comment period(Bieg & Kramer, 2006). In the planned implementationof Basel II at the year-end of 2004 was postponed until the end of 2006. In order to beable to include the suggested comments for improvement in the framework, theCommittee decided to postpone the completion of Basel II which should actually havebeen adopted at the end of 2001 and to publish a third consultative paper in April 2003(Bieg & Kramer, 2006). The deadline for the third comment period was 31 July 2003.Basel III is a work in progress that is far from completion. Basel III is a consultativedocument entitled ³Strengthening the Resilience of the Banking Sector that was firstpromulgated on 17 December 2009 by the Basel Committee on Banking Supervision atthe BIS(Eubanks, 2010). On December 2010, the Basel Committee released a near finalversion of its amendments to Basel II that can be referred to as Basel III(Eubanks, 2010).This Basel III is entitled ³A Global Regulatory Framework for More Resilient Banks andBanking Systems(Eubanks, 2010). Besides, the Basel Committee issues a final elementof the reforms to raise the quality of regulatory capital on January 13, 2011(Eubanks,2010).
Indicator of Basel I
Basel I is primarily focus on credit risk which is the risk weighted assets of the bank.There are three general purposes of Basel I. Basel I is created to promote theharmonization of regulatory and capital adequacy standards only within the member states of the Basel Committee, to provide adequate capital to guard against risk in thecreditworthiness of a bank¶s loan book and proposes minimum capital requirements for internationally active banks, and invites sovereign authorities and central banks alike tobe more conservative in their banking regulations.(Balin, 2008) The Basel I Accord divides itself into four ³pillars´. The first pillar is The Constituents of Capital which define capital in two board terms which is tier 1 capital and tier 2 capital.(Balin, 2008) Tier 1 capital also known as core capital that are consist of the universallyrecognized elements of shareholder¶s equity, retained earnings and perpetual preferredstock. The elements such as asset revaluation reserve, subordinated debt, general loan-
loss reserves and hybrid capital instruments were specified as tier 2 capital.(Fadi Zaher,2011) The second pillar is Risk Weighting which creates a comprehensive system to risk-weighta bank¶s assets, or in other words, its loan book. In order to allow for different risk profiles, risk weighted capital are placed into 4 categories. The higher the asset¶s creditrisk, the higher their weight. Category 1 (0% weight) consists of riskless assets which areinclude cash, claims on central governments and central banks denominated in nationalcurrency and funded in that currency, other claims on OECD countries, centralgovernments and central banks, claims collateralized by cash of OECD centralgovernment securities or guaranteed by OECD central governments. Category 2 (20%weight) consist of low risk assets .Securities in this category include multilateraldevelopment bank debt, bank debt created by banks incorporated in the OECD, non-OECD bank debt with a maturity of less than one year, cash items in collection, and loansguaranteed by OECD public sector entities. Category 3 (50%) consist of moderate risk asset which is only includes residential mortgages. Category 4 (100%) consist of highrisk assets. This category include a bank¶s claims on the private sector, non-OECD bank debt with a maturity of more than one year, claims on non-OECD dollar-denominateddebt or Eurobonds, equity assets held by the bank, and all other assets.(Balin, 2008)Capital adequacy ratio= Total capital (tier 1+ tier 2)Risk weighted assetsThe third pillar is A Target Standard Ratio. Minimum risk-based capital adequacy or minimum capital requirement which is 8% is specified in Basel I in order to help bank covers unanticipated losses. This is a universal standard that banks should hold. In order to lower credit risk, bank should hold minimum requirement of 8% total capital to itsrisk-weighted assets ratio. This capital requirement is focus in reducing credit risk. Withhigher amount of capital, banks have more to lose if they take on too much risk. Capitalrequirements reduce the probability of banks to take excessive risk. Thus make the bank become more stable. Moreover, Tier 1 capital must cover 4% of a bank¶s risk-weightedassets. This ratio is seen as ³minimally adequate´ to protect against credit risk in depositinsurance-backed international banks in all Basel Committee member states.(Balin, 2008) The fourth pillar is Transitional and Implementing Agreements which sets the stage for the implementation of the Basel Accords. Each country¶s central bank is requested tocreate strong surveillance and enforcement mechanisms to ensure the Basel Accords arefollowed, and ³transition weights´ are given so that Basel Committee banks can adaptover a four-year period to the standards of the accord.(Balin, 2008)The Basel I Capital Accord aimed to reducing the credit risk through the capitalrequirement ratio. Although Basel I is successfully issued but most of the people does notknow why they need to follow this requirement, they just follow it blindly. Besides that, afocus on bank capital at a point in time may not be effectively in indicating whether abank is taking on excessive risk in near future. In addition, its over-simplifiedcalculations, and classifications have simultaneously called for appearance of Basel IICapital Accord. The introduction of Basel II is to improve Basel I and teach bank how to

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