Counterparty Credit Risk and Credit Value Adjustment: A Continuing Challenge for Global Financial Markets, 2nd Edition

17.2 Basel II

17.2.1 Background

Most large banks operate in multiple countries. To minimise the effect that conflicting regulatory practices in different jurisdictions may have on international banks, the Basel Committee on Banking Supervision (BCBS) was established by the central bank governors of the Group of Ten (G10) countries in 1974. The Basel Committee does not possess any formal authority, and its conclusions do not have legal force. Instead, it formulates broad supervisory standards and issues recommendations that reflect its view on the current best practice. The supervisory authorities in the relevant countries follow the BCBS guidelines when they develop their national regulation rules.

In 1988, the BCBS introduced a capital measurement framework known as the Basel Capital Accord (nowadays often referred to as Basel I). This framework was adopted not only in the G10 countries, but also in other countries with internationally active banks. However, the Basel I Accord lacked risk sensitivities, and banks learned how to game the system: reduce the minimum capital requirements without actually reducing the risk taken. To reduce this practice, known as regulatory arbitrage, work on the more risk-sensitive Revised Capital Adequacy Framework, commonly known as Basel II, started in 1999. The Basel II framework, now covering the G20 group of countries, is described in the Basel Committee's document entitled “International Convergence of Capital Measurement and Capital Standards” ...