Historical Development of Global Regulations - Basel I & Basel II
In 1988, central bankers from different countries gathered in Basel, Switzerland to deliberate on banking regulations that would chat the way forward for providing minimum capital requirements for banks. Despite being enforced by law in 1992, the 1988 Basel Accord is currently regarded as outmoded. There have been numerous developments with regards to risk management, financial innovation, and financial conglomerate thus making the provisions of Basel 1 outmoded. In 2004, Basel II was published to supersede Basel I. The main aim was to create global standards for central banks. The banking regulators were required to control the capital that banks require to avoid operational risks and financial risks. Through capital management, a bank is able to reduce the risk created by lending out money. This therefore meant that banks that are exposed to maximum financial risk by lending out large amount of money need large amount of capital to guard their operations. However, the main reason for the failure of Basel II was in the regulatory capture. Within this capture, both unscrupulous state controllers and banking regulatory agencies were able to use the interests to accumulate immense wealth at the expense of everyone else in the society. This can therefore, be attributed to be one of the main reasons behind the global recession of witnessed beginning 2008 to date.
Outbreak of the global financial crisis
The outbreak of the global financial crisis and the aftermath effects created a need to review the international banking regulations. Since the financial crisis began, governments have heightened banking regulations by intervening in their activities. It has become apparent that banks are very delicate financial institutions that need support in order to provide safe financial environment. There are a myriad of factors which analysts argue to have contributed to the outbreak of the financial crisis thus affecting banking institutions. As mentioned earlier, de facto controllers of states and banking institutions have corruptible behaviors that only focus at satisfying their selfish interests. In addition, the financial markets that are incomplete contribute to the fragility of banking institutions.
Basel III
Basel III accord of 2010 is a measure intended to reform the regulatory capture of the international banking system. The reform measures also focus on strengthening risk management and supervision of the international banking sector. There are three main aims for the regulatory framework in Basel III accord. Firstly, it aims at improving the ability of the banking sector to be able to deal with risks that arise from both the economic and financial stress. The second aim is to improve the management and governance of risk. Lastly, the reforms aim at ensuring that the banks become transparent in their activities. Basel III accord was formed and adopted as a result of the issues and problems that led to the failure of Basel II. As earlier mentioned, many analysts agree to the perception that Basel II had flaws that led to the global financial crisis. In Basel III, there were several changes that were proposed to offer stringent measures for the regulation of the international banking sector. The measures focus on leverage ratios, risk coverage and capital requirements.
The three pillars upon which Basel III is based on are all an enhancement of the pillar for Basel II. The first pillar is enhancing the minimum capital requirements and liquidity of the banking institutions. The second is enhancing the supervisory review process for firm management of risks and capital planning, while the third pillar focuses on enhancing risk disclosure and market discipline. In Basel III, banks have now been required to have a 4.5 percent of common equity. This is 2.5 percent more of the requirements in Basel II. The 4.5 percent equity involves all the risk weighted assets of a bank besides other capital buffers. The capital that banks require has been described in two tiers. The first tier, which is the core capital, includes common stock, retained earnings, and non redeemable non cumulative preferred stock. The second tier, which is the supplementary capital, includes undisclosed reserves, subordinated debts, hybrid capital instruments, general loan loss reserves, and revaluation reserves.
With regards to liquidity requirements, the banks have to consider liquidity coverage ratio. This entails having liquid assets that can simply be turned into cash to support a bank’s liquidity needs at least for 30 days during a time of stress resulting from whatever cause. For the sake of core capital of tier 1 capital, the liquid assets can comprise high quality sovereign debt, central bank reserves, or cash. Whereas for the sake of supplementary capital, the liquid assets can comprise of non-zero risk weighted debt. The banks also have to consider two other requirements with regards to liquid requirements. They include: additional liquid monitoring metrics and net stable funding ratio. The latter focuses on mismatch of maturity and unencumbered assets while the former focuses on creation of incentives to assist banks in funding their activities using sources that are more stable.
Case study of JP Morgan Chase
JP Morgan Chase is one of the leading financial institutions in the US that rose to greater heights during the global financial crisis. Forbes established that the bank has by far the largest assets compared to any other bank in the US. However, the bank made a whooping loss of 2 billion dollars as a result of bad trading in its London branch. The trading loss led to other losses that the bank has incurred since the announcement. For instance, the bank share prices have decreased by up to 11 percent. In effect, this decreased the value of the shares by over 17 billion dollar. In total, it can be argued that the bank made a loss of almost 20 billion dollars.
The reason behind the loss of the money is bad maneuvering through its activities. According to the Chief Executive Officer of the bank, there were a lot of poor and sloppy judgments done that account for the bad maneuvering through its activities. There is still a lot of volatility with regards to the portfolio assets in doubt. The bank has managed to pull out of the global financial crisis in good shape and even better than any other business establishment. The loss has therefore, been regarded as an embarrassment. It can be noted that during the financial crisis, the bank kept itself away from risky investments that harmed financial institutions.
Even though the bank loss made by the bank is estimated to increase further, the bank still remains at a comfortable position bearing in mind the fact that the bank made overwhelmingly huge revenues during the year 2011. The bank was able to accumulate over 90 billion dollars in revenue.
Compliance of the bank with the capital requirement of Basel III
In order to find the compliance of the JP Morgan Chase, the operational risk has to be determined first. There three approaches that can be used in determining the operational risk of the bank. They include: the basic indicators, the standardized approach, and the advance measurement approach. Using the basic indicator approach, the bank has to hold a capital equal to 15 percent of its gross income annually for the last three years. Assuming that the bank made a profit of 17 billion for the last three years, the basic indicator will be:
Works Cited
Banks for International Settlements. International regulatory framework for banks (Basel III). 2010. Online. 21 May 2012. <http://www.bis.org/bcbs/basel3.htm>.
Basel Committee on Banking Supervision, BCBS. " Basel III and financial stability." report. 2010. Document.
Teamstellar. JPMorgan Chase Loss. 15 May 2012. Online. 21 May 2012. <http://www.montrealmortgage.info/jpmorgan-chase-loss/>.
