Global banking regulation evolved to safeguard financial stability across borders, harmonize prudential norms, and prevent regulatory arbitrage. The Basel Committee on Banking Supervision (BCBS) has led this evolution through milestones like the 1975 Concordat, the 1988 Basel I Accord, the 1996 Market Risk Amendment, and the 2004 Basel II framework.
Basel Committee overview
The BCBS was established by G10 central bank governors in 1974 in response to cross‑border banking disruptions, notably the Herstatt crisis, to enhance cooperation and promote high‑quality supervision globally. It sets standards and best practices but has no supranational legal authority; members implement standards through domestic law and regulation. Its work broadened from coordination to comprehensive capital, liquidity, disclosures, and supervisory principles that became global benchmarks.
The 1975 Concordat
The Concordat set principles for sharing supervisory responsibilities for international banks between home and host authorities. It clarified that the home supervisor should oversee global consolidated operations, while host supervisors oversee local establishments, with coordinated information sharing. Subsequent revisions strengthened consolidated supervision, cross‑border cooperation, and crisis management arrangements, laying the foundation for later minimum standards.
Basel I (1988) capital accord
Basel I introduced a common risk‑weighted capital framework to stop erosion of bank capital and level the playing field across jurisdictions. Core features included:
- Minimum total capital ratio of 8% of risk‑weighted assets, with Tier 1/Tier 2 definitions and limits.
- Standardized credit risk weights by counterparty type and instrument, and conversion factors for off‑balance‑sheet items.
- Encouragement of supervisory convergence for internationally active banks.
Strengths were simplicity and comparability; limitations included coarse risk weights, incentives for regulatory arbitrage, and limited recognition of credit risk differentiation or securitization effects.
1996 Market Risk Amendment
To address trading book risks absent in the original accord, the 1996 amendment added capital charges for market risk in trading activities:
- Specific and general risk for interest rate and equity positions.
- Capital for FX and commodities risk.
- Permission to use internal models (Value‑at‑Risk) subject to qualitative and quantitative standards, back‑testing, and multipliers.
This was a pivotal shift toward model‑based supervision and more risk‑sensitive capital for market activities, while also elevating model risk governance and validation.
Basel II (2004) three‑pillar framework
Basel II aimed for greater risk sensitivity and improved risk management through an integrated structure:
- Pillar 1: Minimum capital requirements
- Credit risk approaches: Standardised (external ratings) and Internal Ratings‑Based (Foundation/Advanced IRB) using bank‑estimated parameters for PD, LGD, EAD, and M.
- Operational risk capital: Basic Indicator, Standardised, and Advanced Measurement Approaches (AMA).
- Continued market risk capital (including the 1996 amendment).
- Pillar 2: Supervisory review process
- Internal Capital Adequacy Assessment Process (ICAAP) and Supervisory Review and Evaluation Process (SREP), covering risks beyond Pillar 1 (e.g., concentration, IRRBB, liquidity, and business model risk).
- Pillar 3: Market discipline
- Enhanced disclosures on risk profile, capital, and methodologies to improve transparency and comparability.
While Basel II was more risk‑sensitive and aligned incentives toward better risk management, its reliance on ratings and internal models, underestimation of systemic and liquidity risks, and procyclicality led to later reforms under Basel III. Nonetheless, for credit and operational risk measurement, Basel II established the analytical backbone still used (with refinements) in modern prudential regimes.
Why these milestones matter
- Cross‑border coherence: The Concordat cemented home–host cooperation, enabling consolidated oversight of global banks.
- Capital adequacy baseline: Basel I anchored a global 8% minimum and standardized risk weights, curbing a “race to the bottom.”
- Trading book discipline: The 1996 amendment recognized market risk and institutionalized internal models with supervisory safeguards.
- Risk sensitivity and transparency: Basel II integrated internal risk estimates, supervisory judgment, and disclosure to align capital with underlying risks and strengthen market discipline.
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