Basel II
Topic: Banking Regulation, NPAs and Financial Stability · NCERT: Beyond NCERT
Meaning
Basel II was the second Basel accord, agreed in 2004. India implemented it in 2008-09. It widened the capital rule to cover three kinds of risk:
- Credit risk: the risk that borrowers do not repay
- Market risk: losses from changes in prices, such as bond values
- Operational risk: losses from failed systems, errors or fraud
It is built on three pillars:
- Pillar 1: minimum capital
- Pillar 2: supervisory review
- Pillar 3: market discipline through public disclosure
It also let banks measure risk either with a standardised approach or with their own internal ratings.
Example
Under Basel II, an Indian bank has to set aside capital for more than possible loan defaults. It also needs capital for potential losses on its bond holdings (market risk) and from events like a system failure or internal fraud (operational risk).
Don't confuse with
- Basel I (1988): it covered credit risk only and had no pillar structure.
- Basel III (2010): it came after the 2008 crisis and added capital buffers, a leverage ratio and liquidity rules (LCR, NSFR) on top of Basel II.
Related concepts
- Leverage
- Basel norms
- Basel I
- Three pillars of Basel
- Capital adequacy ratio
- Risk-weighted assets
- Tier 1 capital
- Common Equity Tier 1
- Additional Tier 1 capital
- Tier 2 capital