Question

Outline the evolution and purpose of Capital Requirements through Basel 1, Basel 2 and Basel3

Answer 1

Basel 1 is a set of international banking regulation put forward Basel committee on Bank supervision. The main purpose was to establish a stable banking system , in oder to decrease the competitive inequality among international banks and to set up a minimum risk based capital adequacy applying to all the banks of the world, which led to increase in overall level of capital in financial market. The main pitfalls of Basel 1 was limited differentiation of credit risk.

The pitfall of Basel 1 was overcomed by Basel 2 . There were three main objective of Basel 2 . The objectives are minimum capital requirement , regulatory supervision and market discipline. The minimum capital requirement is an expansion of Basel 1 to overcome the limitation. This minimum capital requirement now takes into consideration credit risk, operation risk and market risk while determining the capital requirement. This helps to protect the financial system from possible collapse of major banks.

Basel 3 is an enhanced version of Basel 2 . The main goal of basel 3 is to force banks to act more prudently by improving their ability to absorb shocks arising from financial and economic stress by requiring them to maintain a much larger capital base, increasing transparency and improving liquidity. This tries to reduce the damage to the economy from banks which take excess risk.