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The Basel Committee (Committee on Banking Regulations and Supervisory Practices) was established by the Central Bank Governors of the Group of Ten countries at the end of 1974 in the aftermath of serious disturbances in international currency and banking markets (notably the failure of Bankhaus Herstatt in West Germany). After the initial meeting held in February 1975, regular meetings were held three to four times a year ever since. The Committee's members come from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom and the United States. Countries are represented by their respective central bank and/or the nominated authority with formal responsibility for the prudential supervision of banking business. The present Chairman of the Committee is Mr Jaime Caruana, Governor of the Bank of Spain.

The Committee provides a forum for regular cooperation on banking supervisory matters, between its member countries. Initially, it discussed modalities for international cooperation in order to close gaps in the supervisory net, but its wider objective has been to improve supervisory understanding and the quality of banking supervision worldwide. It seeks to do this in three principle ways: by exchanging information on national supervisory arrangements; by improving the effectiveness of techniques for supervising international banking business; and by setting minimum supervisory standards in areas where considered desirable.

The Committee does not possess any formal supranational supervisory authority. Its conclusions do not have, and were never intended to have, legal force. Rather, it formulates broad supervisory standards and guidelines and recommends statements of best practice in the expectation that individual authorities will take steps to implement them through detailed arrangements – statutory or otherwise – which are best suited to their own national systems. In this way, the Committee encourages convergence towards common approaches and common standards without attempting detailed harmonisation between the supervisory techniques of its members.

The topic to which most of the Committee's time has been devoted in recent
years is capital adequacy. In the early 1980s, the Committee became concerned that the capital ratios of the main international banks were deteriorating just at the time that international risks, notably those vis-à-vis heavily indebted countries, were growing. Backed by the Group of Ten Governors, the members of the Committee resolved to halt the erosion of capital standards in their banking systems and to work towards greater convergence in the measurement of capital adequacy. This resulted in the emergence of a broad consensus on a weighted approach to the measurement of risk, on and off the balance sheet.

There was a strong recognition within the Committee of the overriding need for a multinational accord to strengthen the stability of the international banking system and to remove a source of competitive inequality arising from differences in national capital requirements. Following comments on a consultative paper published in December 1987, a capital measurement system
commonly referred to as the Basel Capital Accord (or the 1988 Accord) was approved by the G10 Governors and released to banks in July 1988. This system provided for the implementation of the framework with a minimum capital standard of 8 percent by end-1992. Since 1988, this framework has been progressively introduced not only in member countries but also in virtually all other countries with active international banks. In September 1993, a statement was issued confirming that all the banks in the G10 countries with material international banking business were meeting the minimum requirements laid down in the 1988 Accord. Some countries, like South Africa, even adopted
higher capital adequacy requirements than specified.

The 1988 capital framework was not intended to be static but to evolve over time. In June 1999, the Committee issued a proposal for a new capital adequacy framework to replace the 1988 Accord, and this has been refined in the intervening years, culminating in the release of the New Capital Framework on 26 June 2004. Subsequent refinements on the new framework, e.g. The Application of Basel II to Trading Activities and the Treatment of Double default Effects (July 2005) are being published. The new framework consists of three pillars: minimum capital requirements, which seek to develop and expand on the standardised rules, set forth in the 1988 Accord; supervisory review of an institution's capital adequacy and internal assessment processes; and effective use of market discipline as a lever to strengthen disclosure and encourage safe and sound banking practices. The Committee believes that, collectively, these three elements are the essential pillars of an effective capital framework.

CONTENTS
FOREWORD
TABLE OF CONTENTS
LIST OF FIGURES
LIST OF TABLES
LIST OF ABBREVIATIONS
CHAPTERS
1. PART ONE: SCOPE OF APPLICATION

1.1 Introduction
1.2 Application Scope
1.2.1 Banking, securities and other financial subsidiaries
1.2.2 Significant minority investments in banking, securities and other financial entities
1.2.3 Insurance entities
1.2.4 Significant investments in commercial entities

2. PART TWO: MINIMUM CAPITAL REQUIREMENTS

2.1 Calculation of minimum capital requirements
2.1.1 Definition
2.1.2 Regulatory capital
2.1.2.1 Capital elements
2.1.2.2 Definition of capital elements
2.1.2.2.1 Tier 1
2.1.2.2.2 Tier 2
2.1.2.2.3 Tier 3

2.1.3 Risk weighted assets

2.2 Credit risk

2.2.1 Introduction
2.2.2 Risk profile
2.2.3 Risk management and measurement
2.2.3.1 The standardised approach
2.2.3.1.1 Corporate, Bank and Sovereign exposures
2.2.3.1.2 Retail exposures
2.2.3.1.3 Higher risk categories
2.2.3.1.4 Other assets
2.2.3.1.5 Off-balance sheet items
2.2.3.1.6 External credit assessments
2.2.3.1.7 Credit risk mitigation
2.2.3.2 Internal ratings-based approach
2.2.3.2.1 Introduction
2.2.3.2.2 Asset classes
2.2.3.2.3 Eligible purchased receivables
2.2.3.2.4 Unexpected and expected losses
2.2.3.2.5 Capital requirements under the IRB-approach
2.2.3.2.6 IRB-approach for specialised lending
2.2.3.2.7 IRB-approach for equity exposures
2.2.3.2.8 Implementation issues and requirements
2.2.3.3 Securitisation framework
2.2.3.3.1 Introduction
2.2.3.3.2 Standardised approach
2.2.3.3.3 Internal ratings-based approach

2.3 Operational risk

2.3.1 Definition
2.3.2 The measurement methodologies
2.3.2.1 Introduction
2.3.2.2 The basic indicator approach
2.3.2.3 The standardised approach
2.3.2.4 Advanced measurement approaches
2.3.2.5 Partial use – combinations

2.4 Trading book issues

2.4.1 Introduction
2.4.2 Basel II viewpoint
2.4.2.1 Definitions
2.4.2.2 Eligibility for trading book capital treatment
2.4.2.3 Valuation of the trading book
2.4.2.3.1 Marking to market
2.4.2.3.2 Marking to model
2.4.2.3.3 Independent price verification

2.4.3 Basel II applied to trading activities and the treatment of double default effects

2.4.3.1 General
2.4.3.2 Measures of counterparty credit risk
2.4.3.3 The internal model method
2.4.3.4 Non-internal model methods
2.4.3.4.1 Current exposure method
2.4.3.4.2 Standardised method

3. PART THREE: THE SECOND PILLAR – THE SUPERVISORY REVIEW PROCESS

3.1 Introduction
3.2 The importance of supervisory review
3.2.1 Introduction
3.2.2 Four key principles of supervisory review
3.2.2.1 Principle 1
3.2.2.1.1 Board and senior management oversight
3.2.2.1.2 Sound capital assessment
3.2.2.1.3 Comprehensive assessment of risks
3.2.2.1.4 Monitoring and reporting
3.2.2.1.5 Internal control review

3.2.2.2 Principle 2
3.2.2.3 Principle 3
3.2.2.4 Principle 4

3.2.3 Specific issues to be addressed under the supervisory review process

3.2.3.1 Introduction
3.2.3.2 Interest rate risk in the banking book
3.2.3.3 Credit risk
3.2.3.3.1 Stress tests under the IRB-approaches
3.2.3.3.2 Definition of default
3.2.3.3.3 Residual risk
3.2.3.3.4 Credit concentration risk
3.2.3.4 Operational risk

3.2.4 Other aspects of the supervisory review process
3.2.4.1 Supervisory transparency and accountability

3.2.4.2 Enhanced cross-border communication and cooperation

3.2.5 The supervisory review process for Securitisation

3.2.5.1 Introduction
3.2.5.2 Significance of risk transfer
3.2.5.3 Market innovation
3.2.5.4 Provision of implicit support
3.2.5.5 Residual risks
3.2.5.6 Call provisions
3.2.5.7 Early amortisation

4. PART FOUR: THE THIRD PILLAR – MARKET DISCIPLINE

4.1 Introduction
4.2 The disclosure requirements
4.2.1 General disclosure principle
4.2.2 Scope of application
4.2.3 Capital
4.2.4 Risk exposure and assessment

5. CONCLUSION
6. BIBLIOGRAPHY

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