With the foundations for supervision of internationally active banks laid, capital adequacy soon became the main focus of the Committee’s activities. In the early 1980s, the onset of the Latin American debt crisis heightened the Committee’s concerns that the capital ratios of the main international banks were deteriorating at a time of growing international risks. Backed by the G10 Governors, Committee members 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 a broad consensus on a weighted approach to the measurement of risk, both on and off banks’ balance sheets.

There was 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 (1988 Accord) was approved by the G10 Governors and released to banks in July 1988.

The 1988 Accord called for a minimum capital ratio of capital to risk-weighted assets of 8% to be implemented by the end of 1992. Ultimately, this framework was introduced not only in member countries but also in virtually all other countries with active international banks. The Accord was always intended to evolve over time. It was amended first in November 1991. The 1991 amendment gave greater precision to the definition of general provisions or general loan-loss reserves that could be included in the capital adequacy calculation. In April 1995, the Committee issued an amendment, to take effect at end-1995, to recognize the effects of bilateral netting of banks’ credit exposures in derivative products and to expand the matrix of add-on factors. In April 1996, another document was issued explaining how Committee members intended to recognize the effects of multilateral netting.

The Committee also refined the framework to address risks other than credit risk, which was the focus of the 1988 Accord. In January 1996, following two consultative processes, the Committee issued the so-called Market Risk Amendment to the Capital Accord (or Market Risk Amendment), to take effect at the end of 1997. This was designed to incorporate within the Accord a capital requirement for the market risks arising from banks’ exposures to foreign exchange, traded debt securities, equities, commodities and options. An important aspect of the Market Risk Amendment was that banks were, for the first time, allowed to use internal models (value-at-risk models) as a basis for measuring their market risk capital requirements, subject to strict quantitative and qualitative standards. Much of the preparatory work for the market risk package was undertaken jointly with securities regulators.

The new framework was designed to improve the way regulatory capital requirements reflect underlying risks and to better address the financial innovation that had occurred in recent years. The changes aimed at rewarding and encouraging continued improvements in risk measurement and control. The framework’s publication in June 2004 followed almost six years of intensive preparation. During this period, the Basel Committee consulted extensively with banking sector representatives, supervisory agencies, central banks and outside observers in an attempt to develop significantly more risk-sensitive capital requirements.

Following the June 2004 release, which focused primarily on the banking book, the Committee turned its attention to the trading book. In close cooperation with the International Organization of
Securities Commissions (IOSCO), the international body of securities regulators, the Committee published in July 2005 a consensus document governing the treatment of banks’ trading books under the new framework. For ease of reference, this new text was integrated with the June 2004 text in a comprehensive document released in June 2006: Basel II: International convergence of capital measurement and capital standards: a revised framework - comprehensive version.

Even before Lehman Brothers collapsed in September 2008, the need for a fundamental strengthening of the Basel II framework had become apparent. The banking sector had entered the financial crisis with too much leverage and inadequate liquidity buffers. These defects were accompanied by poor governance and risk management, as well as inappropriate incentive structures. The dangerous combination of these factors was demonstrated by the mispricing of credit and liquidity risk, and excess credit growth.

Responding to these risk factors, the Basel Committee issued Principles for sound liquidity risk management and supervision in the same month that Lehman Brothers failed. In July 2009, the Committee issued a further package of documents to strengthen the Basel II capital framework, notably with regard to the treatment of certain complex securitization positions, off-balance sheet vehicles and trading book exposures. These enhancements were part of a broader effort to strengthen the regulation and supervision of internationally active banks, in the light of weaknesses revealed by the financial market crisis.

In September 2010, the Group of Governors and Heads of Supervision announced higher global minimum capital standards for commercial banks. This followed an agreement reached in July regarding the overall design of the capital and liquidity reform package, now referred to as “Basel III”.

The proposed standards were issued by the Committee in mid-December 2010 (and have been subsequently revised). The December 2010 versions were set out in Basel III: International framework for liquidity risk measurement, standards and monitoring and Basel III: A global regulatory framework for more resilient banks and banking systems. The enhanced Basel framework revised and strengthen the three pillars established by Basel II. It also extended the framework with several innovations, namely:

The tightened definitions of capital, significantly higher minimum ratios and the introduction of a macro prudential overlay represent a fundamental overhaul for banking regulation. At the same time, the Basel Committee, its governing body and the G20 Leaders have emphasized that the reforms will be introduced in a way that does not impede the recovery of the real economy.

In addition, time is needed to translate the new internationally agreed standards into national legislation. To reflect these concerns, a set of transitional arrangements for the new standards was announced in September 2010, although national authorities are free to impose higher standards and shorten transition periods where appropriate.

The strengthened definition of capital will be phased in over five years: the requirements were introduced in 2013 and should be fully implemented by the end of 2017. Capital instruments that no longer qualify as common equity Tier 1 capital or Tier 2 capital will be phased out over a 10-year period beginning 1 January 2013.