What are the Basel Accords?

The Basel Accords is a collection of agreements established by the Basel Committee on Bank Supervision (BCBS). It is named after one of Switzerland's most populous cities. The BCBS's administrative unit is located there, and it also serves as its regular meeting place. The Basel Accords offers recommendations on banking laws and regulations to financial institutions to encourage the management of capital and the ability to handle losses.

The BCBS was formed in 1974 by the central bank governors of a collection of countries known as the Group of Ten: Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom and the United States. These countries form half of the G-20 major economies. Since its founding, other nations from this larger group, which include South Africa, India and China, have joined the BCBS. Countries outside the G-20 realm, such as Singapore and Hong Kong, are also members.

It was a liquidation of the Cologne, Germany-based Bank Herstatt due to a lag in a dollar-payment exchange that resulted in the formation of the BCBS, and also led to the origin of Basel I. Published in 1988, Basel I focuses on unexpected losses of financial institutions such as the one that Bank Herstatt experienced by establishing minimum capital requirements. The accord established five tiers of capital adequacy risks—0, 10, 20, 50 and 100 percent—which measure the extent to which a bank can be hurt by a financial loss; for example, a bank with 0 percent of its risk-weighted assets can be considered as having Tier 1 capital. According to Basel I, the BCBS suggests that institutions operating on an international level operate on an 8 percent risk weight.

Basel II, first published in 2004, expands beyond the credit risk focus of its predecessor. Adding supervisory review and market discipline to the minimum credit requirements, the Basel committee thus established the so-called three pillars of the accords. Basel II's overriding focus is reinforcing and supervising standards for the international financial community.

With the global financial crisis that took hold in the late 2000s, the third edition of the Basel Accords appeared in 2009. Basel III revised the previous accords by focusing on strengthening individual financial institutions to prevent widespread shocks from happening. Such strengthening is encouraged through techniques such as bank leverage and liquidity.

Notably, the BCBS does not exercise the authority to enforce the Basel Accords. What it encourages, however, is an international convergence of basic financial standards. There are non-BCBS members that implement the Basel Accords through their national laws and regulations.