BASEL ACCORD: WORKING AND LIMITATIONS

The Basel Accords refer to the banking supervision Accords Basel I, Basel II and Basel IIIissued by the Basel
Committee on Banking Supervision (BCBS). They are called the Basel Accords as the BCBS maintains its secretariat at
the Bank for International Settlements in Basel, Switzerland and the committee normally meets there.. Formerly, the
Basel Committee consisted of representatives from central banks and regulatory authorities of the Group of Ten
countries plus Luxembourg and Spain. Since 2009, all of the other G-20 major economies are represented, as well as
some other major banking locales such as Hong Kong and Singapore.
The committee does not have the authority to enforce recommendations, although most member countries as well as
some other countries tend to implement the Committee's policies. This means that recommendations are enforced
through national (or EU-wide) laws and regulations, rather than as a result of the committee's recommendations thus some time may pass between recommendations and implementation as law at the national level.
Starting in June 1999, Basel Accord committee on banking supervision released several proposals to reform the
original Basel Accord. these efforts were shown in Basel 2, based on three pillars.
1. Pillar 1 combines capital requirements for large banks to actual risk of three types: market risk, credit risk and
operational risk. it does so by classifying assets with different risk weights in standardized way.
2. Pillar 2 focuses on strengthening the supervisory process, in assessing the quality of risk management in banking
institutions and measuring whether these institutions have procedures to determine how much capital they need.
3. Pillar 3 tells about improving market discipline through increased disclosure of details about a bank's credit
exposure, its amount of reserves and capital, the official who controls the bank, and the effectiveness of its internal
rating system.
4. Pillar 4 tells that Basel 2 did not focus on the dangers of a possible drying up of liquidity, which brought financial
institutions down during the financial crisis.
Although Basel 2 moved towards limiting excessive risk taking by banks, it indirectly or directly increased complexity
of accord. the original Based Accord consist of 26 pages, while final draft was more then 500 pages. the original
timetable called for the completion of final round was by end of 2001 in effect by 2004. but due to criticism by banks
and regulators Basel Accord lead to several postponements. Basel 2 started to implemented at the start of 2008 only
by European banks.
The financial crisis of 2007 to 2009, revealed many drawbacks of new accord. first Basel 2 did not require banks to
have sufficient amount of capital. second, risk weights in standardized approach are heavily dependent on credit
rating, which were unreliable in the run-up of financial crisis. Third Basel 2 demands that banks hold less capital
when times are good and hold more capital when times are bad, thereby exacerbating credit cycles. Because
probability of default and expected losses for different classes of Assets rises during bad times, Basel 2 may require
more capital at exactly the time when capital is most short. this has been a major concern after 2007-2009 crisis,
bank's capital balances eroded, as a result there was cut back on lending, doing more harm to economy.

As a result of above mentioned limitations, the Basel committee has started a work on new accord, Basel 3. its goals
are to define properly capital standards, make new rules on the use of credit ratings and require financial institutions
to have more stable funding so the can better absorb the liquidity shocks. Measures to achieve these objectives are
highly controversial because there are concerns that tightening up capital standards might cause banks to restrict
their lending, which would make it harder for economies throughout the world to recover from the deep recession.
Basel 3 is on its way and banks and other financial institutions only hope that regulator will get it right this time.