The paper 'The Importance of Capital and the Basel Accord " is a perfect example of finance and accounting coursework. Despite their significance to the growth of the economy, banks are susceptible to failure. Just like any other business, banks can go bankrupt. Unlike businesses, if banks fail, especially large ones, their implication on the economy can be far-reaching. As recently witnessed during the Great Depression or rather, during the financial crisis, the welfare of the bank system if affected, can trigger economic calamities affecting thousands of economies. As a consequence, it has become imperative that banks operate in a sound and safer manner to avoid failures.
There were some risks such as those arising from maturity and liquidity transformation which in the past, has been mitigated by central banks acting as lenders of last resorts. However, credit risks have been a big issue to deal with. This is the reason why the Basel Committee on Banks Supervision (BCBS) was introduced. Its main purpose has been to promulgate guidance on affairs critical to ensuring that banking services across the world are healthy.
Duncan (2005) adds that the Basel Committee acts as an international advisory on matters to do with bank regulation. One of the issues that have called for regulation is the capital. As a matter of fact, this has led to the promulgation of capital adequacy levels that regulators from different countries can implement. This is what is termed as the Basel Accord (Basel Committee on Banking Supervision, 1988). The Accord has elicited mixed reactions from different countries but still stands as the most vital formulation for regulatory policy regarding bank capital. At the heart of the debate regarding the Basel Accord has been the regulation of bank capital.
This has been well documented in some literal materials as developing strategies or rules that ensure banks maintain sufficient levels of capital. Therefore before understanding the idea regarding Capital Accord (in this case Basel I and the Market Risk Amendment), there is a need for understanding the concept of capital. Just like any profit-making business, banks have a balance sheet comprising of equity, assets and liabilities. And they are able to fund their assets through equity and liabilities.
In such a case, liabilities will reflect the bank’ s debt. On the other hand, there are the assets (another side of the balance sheet) that comprises of its loans to customers. If we have a bank with its assets exceeding its liabilities then the difference is the bank’ s capital. If the same bank has its liabilities exceeding its assets then it is capitalized negatively. This is why it is advisable that banks keep positive capital so as to manage repayment of its liabilities.
Australian Treasury (2011), ‘Financial Claims Scheme – Consultation Paper’, May. Available at http://www. treasury.gov.au/documents/2025/PDF/CP_Financial_ Claims_Scheme.pdf
Basel Committee on Banking Supervision, Basel I and Market Risk Amendment, http://www.bis.org/list/bcbs/tid_21/index.htm.
Cornish, S. (2012), ‘Prudential Regulation and Supervision’, in The Evolution of Central Banking in Australia, Reserve Bank of Australia, Sydney, pp 79–91.
Duncan W. (2005). Governing global banking: The Basel Committee and the Politics of Financial Globalisation