LO 58.1: Explain the motivations for introducing the Basel regulations, including

LO 58.1: Explain the motivations for introducing the Basel regulations, including key risk exposures addressed, and explain the reasons for revisions to Basel regulations over time.
Prior to 1988, bank capital regulations were inconsistent across countries and ignored the riskiness of individual banks. Requirements were stated as minimum ratios of capital to total assets or as maximum ratios of total assets to capital. Some countries and/or regulatory authorities were more diligent in their enforcement of capital regulations than others. As banks became increasingly global, banks operating in countries with more lax standards were perceived to have a competitive advantage over banks operating in countries with strict enforcement of capital regulations.
There were additional problems with the existing regime. First, high risk loans from international banks to lesser developed countries such as Mexico and Brazil raised questions about the adequacy of existing capital to cover potential losses. Second, banks used accounting games to record some of these transactions, masking risk. Third, bank transactions were becoming more complex. Off-balance sheet transactions in over-the- counter (OTC) derivatives like interest rate swaps, currency swaps, and options were growing. These off-balance sheet deals did not affect total assets, and thus did not affect the amount of capital a bank was required to keep, providing fuel to the growing belief that total assets did not reflect a banks total risk. In 1988, the Basel Committee put forth its first guidance to set international risk-based capital adequacy standards, called the 1988 BIS Accord, now commonly known as Basel I.
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Topic 58 Cross Reference to GARP Assigned Reading – Hull, Chapter 15
Ba s e l I

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