Basel III Essay Example | Topics and Well Written Essays - 2000 words

Basel III - Essay Example When the housing bubble collapsed before the financial crisis, the asset-backed securities loss value and many banking firms faced insolvency and required federal bailouts. This paper will review the Basel Accords and the economic impact on banks because of the Basel Accords. Basel I and II background Basel I, which centered mainly on credit risk, came into existence in 1988 and became legally enforceable in the G10 nations in 1992 (Barron, J 2011). The goals of Basel I was to mandate that banks preserve enough capital to absorb losses without creating universal difficulties. Basel I was criticized for being inadequate in its assessment of assets to risk categories because assets with different risk composition would be categorized into the same risk groups. The Basel III established the amount of reserves required by banks to avert losses and cushion the financial industry against possible future financial catastrophes. Basel II was created in June 2004 after concerns arose with Bas el I because of the regulatory arbitrage. Basel II was seen as a more risk-sensitive standard that applied bank’s own approximates of risk in deciding minimum capital demands. Basel II placed measures on the amount and usage of a bank’s capital to cover the risks they experienced. One of the fundamental modifications suggested by Basel II is the heightened sensitivity of a bank’s capital obligations to the risk of its assets: the quantity of capital that a bank has to capture is to be directly associated to the riskiness of its underlying assets (Drumond, I 2009). Because Basel II connected the riskiness of banking institution lending with the funds it held, basically making higher risk transactions have elevated reserve requirements than lower risk ones (Barron, J 2011). A chief concern of the Basel II imitative was the practice of securitization. Banks grouped risky loans into asset-backed securities and sold the securities to investors. This practice allowed the banks to move the risky assets off their balance sheets. This process allowed financial institutions to decrease their capital obligations, take on increasing risks and augment their leverage ('FOCUS: The Business Impact of Basel III' 2010).