Managing Risks in the Banking Industry Using the Basel Accords

Risk Management Strategies for Developing Countries The Basel Accords are among the most influential but misunderstood agreements in today's global finance. Developed in 1988 and 2004 (Deventer & Imai, 2003), Basel I and II have brought in a new era of international banking collaboration. Through quantitative and technological requirements, both accords have assisted balance banking regulation, supervision and capital adequacy requirements across the 11 nations of the Basel affiliates and many other developing market economies.

Even when the Basel Accords have been used correctly and completely, neither agreement has, properly secured long-term stability within the country's banking industry. The Basel Committee established Basel I and 11 to reduce credit risk via the minimum specifications of capital of banking institutions. Worldwide operating financial institutions are required to maintain most moderate amount of money based on a percentage of risk-weighted resources. Compared with Basel I, Basel II, which was released initially in 2004, had set up the lowest capital of financial institutions to ensure institution's liquidity (Dewatripont et al. 2010).

Alternatively, it can be described that Basel II focused on how much capital banks must have put aside to decrease the risk associated with its investing and lending methods. In 2009, the Basel Committee released the first version of Basel III. It was a comprehensive collection of reform measures designed to improve the supervision, regulation, and risk management within the financial industry, built on Basel I and Basel II angles.

It also helps the financial industry develop its ability to handle economic and financial stress, update risk management and enhance the transparency of banks. Especially, it concentrates on promoting greater resilience at the individual bank level to prevent the risk of system wide shocks. Financial institutions were given at least three years to satisfy all specifications. As a response to the credit crisis, financial institutions are instructed to maintain accurate advantage ratios and meet certain capital specifications (Dewatripont et al., 2010).

Given that Basel 1 and II are developed for G-10 countries, their guidelines have several possible adverse effects on developing market countries. First, the high obligations given to regulators and the considerable amount of regulatory variation allowed to financial organizations in their loan book reserve calculations may burden the regulatory systems of many developing economies. Because of the high technicality in Basel I and II and the addition of inner systems in risk measurement, regulators are forced to hire and hold highly trained workers through long-term.

Unfortunately, the schools needed to train such workers may not exist in the country, and many growing market regulators do not have the budget to add costly high-skilled workers to their positions. Hence, central banks might become lax in their control of private financial organizations, enabling them to manage risk internally without proper management. In turn, this incentivizes private financial organizations to take on increasing threat, increasing the chance of a system-wide banking failure.

In developed economies, Basel 1 and II guarantees its visitors that industry self-discipline would prevent such a situation. However, in emerging economies, markets might be so illiquid and shallow that commercial organizations could effectively take on extreme risks without a creditor or shareholder revolt (Deventer & Imai, 2003). The changes of Basel III are very significant to develop not.