Supervision of financial institutions. The transition from Basel I to Basel III. A critical appraisal of the newly established regulatory framework
| Date | 09 November 2015 |
| Published date | 09 November 2015 |
| Pages | 383-402 |
| DOI | https://doi.org/10.1108/JFRC-02-2015-0011 |
| Author | Georgios L Vousinas |
| Subject Matter | Accounting & Finance,Financial risk/company failure,Financial compliance/regulation |
Supervision of nancial
institutions
The transition from Basel I to Basel III. A
critical appraisal of the newly established
regulatory framework
Georgios L. Vousinas
Industrial Management and Operational Research,
National Technical University of Athens, Athens, Greece
Abstract
Purpose – This paper aims to highlight the new regulatory framework established by Basel III.
Design/methodology/approach – This paper provides a critical review of the existing literature
concerning bank supervision, while providing an overview of the transition from Basel I to Basel III
rules and critical appraisal of the current regulatory framework. Review of the existing literature.
Findings – Basel III introduces new measures in favor of bank stability and in order to mitigate the
propagation of nancial shocks. But on the other hand, the new regulatory framework adds an extra
burden to banks’ business plans, affecting credit policies and thus, the real economy. Another issue that
is not properly addressed is the rising of nancial innovations that are able to pass by the new
regulations. Overall, Basel III rules are moving to the right direction, but need to stay always up-to-date
in order to catch up with the modern ever-evolving nancial system. Pros and cons. Need for
improvement.
Originality/value – The paper presents an up-to-date review of Basel rules with future prospects.
Keywords Regulation, Basel Committee
Paper type Literature review
1. Introduction
The banks’ equity is highly volatile due to uctuations in the prices of nancial
instruments, which makes it extremely difcult to estimate the required funds so as to
be secured against major risks. As a result, the potential failure of a banking institution
is very difcult to assess, a fact that mainly explains the signicantly large number of
banks bankruptcies during the recent nancial crisis. The collapse of a nancial
institution may lead to a chain reaction (domino effect) in the market in which it
operates, spreading the economic recession to the whole economy. Therefore, the need
for supervision in the banking sector worldwide is mandatory and the implementation
of proper prudential rules is more than necessary for the global nancial system to
operate safely.
1.1 Overview of Basel
The Basel Committee on Banking Supervision (BCBS) was established in 1974 by the
Central Bank Governors of the “Group of 10” (Group of Ten or G-10) member countries
(Belgium, Canada, France, Italy, Japan, The Netherlands, the United Kingdom, the USA,
Germany and Sweden). Specically, the above committee, whose members are
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Supervision of
nancial
institutions
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Journalof Financial Regulation
andCompliance
Vol.23 No. 4, 2015
pp.383-402
©Emerald Group Publishing Limited
1358-1988
DOI 10.1108/JFRC-02-2015-0011
representatives of the central banks of the member countries and other banking
supervisory authorities of the Member States of the G-10 as well as Switzerland,
Luxembourg and Spain (since 2001). The European Commission and the European
Central Bank participate as observers. The Basel Committee meets regularly four to ve
times a year.
The main task of the Basel Committee is to reinforce the system and to ensure the
stability of the international banking system. The main tools for achieving this goal are
the cross-border cooperation of banking supervisor authorities, the prudential
supervision and, above all, the appropriate assessment and management of risks in
which banks are exposed.
In 1973, the abolition of the Bretton Woods International Monetary System of xed
exchange rates marked a period of intense volatility and uctuations in both exchange
and interest rates. As a result, banks have become vulnerable to hitherto unknown risk
of currency and interest rate changes. In 1974, the German bank Bankhaus ID Herstatt
caused a huge disruption in the international interbank market. It was bankrupt due to
anomalous activities in forward transactions and caused a domino effect in the nancial
system. This incident, along with other minor operations, has demonstrated the need for
international cooperation in the eld of banking supervision. Priority was given to
institutionalize cooperation between the monetary and banking supervision to prevent
systemic crises and to ensure the stability of the international banking system and led to
the creation of the well-known Basel Committee. The central banks of the G-10 countries
undertook the coordination and implementation of a coherent strategy around risk
management, creating the Basel Committee, which is a special committee of the Bank of
International Settlements that deals with banking supervision. Since then, the
Commission reviews and analyzes the economic developments and the banking system
so as to create an, as much as possible, effective regulatory framework.
The BCBS seeks to improve the quality of banking supervision through the
following:
• the information exchange on national supervisory arrangements;
• the improvement of the efciency of the techniques used for the supervision of
international banking institutions; and
• the determination of the minimum supervisory levels which are considered
desirable.
The Commission is not any kind of supranational authority on banking supervision, and
that is why its recommendations and dened standards do not have the legal power, in
the sense that it depends on national authorities to implement them. Thus, the BCBS has
neither authority nor can impose its rules on anyone, unless a state chooses to adopt
them. Consequently, the Basel Committee began to concentrate on drawing a set of
International Rules with the main target been introducing and applying the highest and
uniform standards for all banks. These standards were introduced in 1988 as the
Basel I Accord. In July 1988, the Basel Committee published the “International
Convergence of Capital Measurement and Capital Standards” to introduce a capital
measurement system for the nancial sector institutions. The text is known as Basel
Capital Accord or Basel I.
The timeline of Basel can be seen in Figure 1.
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