1-
The basel committee
2- Basel I
3- Basel II
2-
Basel I
Basel I refers to a set of recommandations published in 1988
by the Basel Committee, a committee gathering the central bankers
of the G 10 countries under the authority of the Bank of international
regulations, in Basel.
These recommendations, also known as « the 1988 Basel
Agreement », aimed at insuring the stability of the international
financial system by fixing a minimum limit to the amount of
equity in banks. This minimum has been fixed by setting up a
minimal ratio of 8% of equity compared with all the credits
granted by banks. It means that when a bank grants 1000€
to a customer, it has to tie up 80€ of equity and use up
to 920€ from other financing sources.
2.1 The History
The Basel Committee has been created by the governors of the
central banks of the G 10 in 1974, which first aim was to improve
the stability of the international banking system, which vouches
for the stability of a more and more internationalised financial
system. At first the aim was to limit the risk of bankruptcy,
so the Committee concentrated on the credit risk.
When a bank undergoes losses on the granted credits, it can
only cover its losses by consuming its capital. When the entire
capital is consumed, the banks begins to consume the funds deposited
or which have been lent to it, and it is in a virtual bankruptcy
state (it is very unlikely to reach the consumption of the entire
capital).
The Committee’s approach has therefore been to fix a rough
estimate (very conservative) of the global credit in percent
of the credit portfolio in general, and to use this percentage
to fix the minimum equity to relate to credits.
2.2
The Agreement
To be more specific, the Basel Agreement of 1988 put the ratio
Cooke (called ratio Cooke in reference to Peter Cooke, a manager
of the Bank of England, president of the Committee at the time
of the setting up of the recommendations) at the centre of its
aim, it wanted the regulatory equity (in the widest sense) of
a credit establishment compared with all the credit commitments
of this establishment not to be less than 8% (which we can translate
this way: the bank has to finance each 100 (euros) of credit
this way: a minimum of 8 (euros) in equity and a maximum of
92 (euros) by using its other financing resources such as deposits,
borrowings, interbank financings…
This ratio presented a double bind:
(equity + quasi-equity) / all the commitments > 8% &
equity / all the commitments >4%. This ratio was first of
all a ratio of banking solvency and a cautious ratio. But it
ony took into account the highest or the lowest risk of the
various loans granted.
The agreement specified what needed to be considered as regulatory
equity and what needed to be considered as the series of credit
commitments.
In addition to the capital (equity, in the strictest sense),
some funds considered as « almost capital » can
also be included in regulatory equity, it means the debts subjected
(some subjected debts can only be taken into account in equity
for 50% at the most of it).
The series of credit commitments of the bank that were aimed,
with however some adjustments:
- some credits were balanced with values inferiors to 100% according
the quality of the credit or to the counterparty. So, some credits
were balanced at 50% (credits guaranteed by a mortgage), 20%
(banking counterparty, international organism or non-OECD states)
or even 0 %( counterparty=OECD);
- some commitments, such as the commitments of less than a year,
were not taken back into the credit commitments.
Strictly speaking, the agreement only holds recommendations,
it is the charge of each state, whether it is a member or not,
and of each regulation authority, to transpose them in its own
right and to apply them.
In the European Union, the agreement has been translated into
the European solvency ratio (directive 89/647/EEC of December,
18th, 1989).
The Basel agreements are currently applied in more than a hundred
countries.
It rapidly appeared that Basel I was just a step on a path that
has no end.
First of all, the weighting of the credit commitments was insufficiently
varied to debrief all the real complexity of the credit risk.
Banks generally have taken advantage of this lack of discrimination
to set up operations of cautious arbitrage.
Then, in the 1990s a new phenomenon appeared, the explosive
growth of by-products and so of “off balance-sheet”
risks. Those have been processed in additional recommendations
which were inserted in the agreement around 1996 and which imposed
a ratio of equity distinct from the sum of off balance-sheet
commitments.
After several years of preparation, the agreement called Basel
II was finalized in 2005 and it has already been translated
in a European directive. It is totally applied in the Union
from January, 1st, 2007.
