Masters of Science in Finance, Smu, Singapore

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Submitted By richag
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BASEL ACCORD
Defines the set of recommendations for set of rules & regulations for the banking industry, mainly for capital requirements to avoid banks going bankrupt
Consists of central bankers from various countries (11 countries of the G20 countries as of now)
Meetings held in Basel, Switzerland
BASEL 1 in 1988
Basel 1 came in 1988 = mainly set rules for capital reserve requirements to be kept by banks (due to risk of bad loans (credit risk) made by banks). 1. Credit risk faced by banks taken into consideration for calculating capital set aside requirement 2. Thus, banks had to set aside 8% of the RWA(risk weighted asset) loan made by banks to avoid bank insolvency if people dint pay back loan.
Assets defined different weights as per their riskiness, eg: Govt bonds =carries 0% risk i.e. 0 weight in risk calculation, Good rating bonds (AAA) = 20%, municipal bonds = 50% risky etc.
Thus, if Banks held bonds worth $10 m of a v good rated Co (AAA) then its RWA would be 20% of that i.e. 20% of 10m i.e. 2 million would be considered risky and thus 8% of this 2 m bank would have to keep aside as capital requirement as per Basel 1. 3. Quality of counter party was not considered = one of the main weaknesses of the Basel 1 (i.e. no differentiation if GE/Apple/Microsoft took loans or any new companies with no CF’s at all)
Basel 2 in 2004
Again calculation of how much capital to be kept aside by banks due to risks arising from credit risk, market risk(banks hold a lot of positions in capital mkt so risk involved) and operational risk(fraud, natural catastrophe, govt changes etc) was discussed in Basel Accord 2. 1. Credit risk+ Market risk+ Operational risk 2. Risk management process brought into place = Regulators can come inhow mgnt structure is of bank and how banks can measure and quantify the risk (Internal Capital Adequacy Assessment…...

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