National bank governors of the G10 nations built up a Committee on Banking Regulations and Supervisory Practices toward the end of 1974 known as, the Basel Committee on Banking Supervision. They act through the role of their central banks in addition to their privileges with formal responsibility for the hedging supervision of banking business. Further, this Committee was composed as a gathering for standard collaboration between its members to upgrade money related security, by enhancing supervisory expertise and the nature of managing account supervision around the world (BIS, 2014). This could be done through setting rules for the regulation and supervision of banks and sharing supervisory issues, systems and methodology to lift fundamental recognition,also to upgrade cross-edge coordinated effort. In addition, to exchange information to enhance the liquidity part and budgetary markets to recognize present or expected perils for the overall financial structure.
While countries that are part of the committee have to oblige with the regulations and requirements it assume, applying the committee’s decisions by the non-participant countries has no legitimate force to commit. Nevertheless, because of the arranged supervisory measures, guidelines and recommends sound practices, it was mandatory to control the financial sector of these non-participant countries using the guidelines proposed by the committee, to improve the adaptability of the overall sparing cash system, development of trusted hedging proportions and playing supervisory level over all banks element.
From the beginning, the Committee's target was to strengthen the administrative coverage role so that no financial institution would escape from such supervision. In addition, supervision would be satisfactory and steady for all parties. Thus, an initial phase in this heading was the paper issued in 1975 that came to be known as the ‟Concordat". The Concordat set out standards for sharing supervisory obligation regarding banks. As a result and implying to these aims, the committee started to release its standards and regulations under Basel I, Basel II and what’s now released under the name of Basel III.
2.2 Basel I:
Since risk and returns are main fundamentals of financial regulation and banking sector. In 1988, Basel Committee on Banking Supervision (BCBS) has presented first International regulation Basel I. Moreover, Basel I aims at supervising banking risk and stress with the aid of standardized Capital Adequacy Ratio (CRAR), and focusing on the credit risk and market risk, as the main business of banks is lending and borrowing, in addition to treasury & investment operations.
CRAR found to guarantee minimum capital to cover depositors’ money from risky assets. Unfortunately, after failing in various frauds and weakness in Basel I regulations, and due to changes in technology, financial industry and many other factors, it was essential to start working to develop and strengthening the current standards through moving to new additional requirements that named Basel II
2.3 Basel II:
Since one of the faults in Basel I standards was that it didn’t include and cover the operational risk, which is a major element that should be taken into consideration. In addition to other weaknesses such as uncovering the liquidity risk. Thus, basel committee started to move into more risk accurate standards, that introduced in June 26, 2004 under the concept of Basel II that included the operational risk as one of the main risks that should be hedged, in addition to the market and credit risks, which were already included in Basel I.
On the other hand, the Basel II concept shed the light on three Aspects; first, is lesser capital requirement, though taking into consideration three types of risks, which are: credit, operational and market risks. While other types of risks were not included in this stage. Second, external auditing and monitoring by central bank, to insure implementing and achieving bank’s capital adequacy in addition to sufficient internal audit. Third, reaching the target of Market Discipline by effective disclosure to encourage safe and sound banking Practices (Roy et al, 2013).
2.4 Basel III:
Basel II characterized as “the wrong kind of regulations” that led for the crisis, because it miserably failed to protect the portions of bank’s investors, through inability to achieve its main peril such as, capital Adequacy. Also the regulators didn’t take into consideration the liquidity and leverage ratios, which are considered the main important risks that could affect the banking sector.However; while Basel III is assumed to establish safer banking system, the committee worked on it as a far reaching set of change measures, to support the regulation, supervision and risks administration of the management of the banking section. These measures concerned to enhance the banking sector's ability to resist any expected financial shocks, as well as to enhance risk handling and governance, and empowering banks' transparency and disclosures (BIS, 2014).
Therefore, basel III guidelines were declared in December 2010.Wheras, the cash related crisis of 2008 was the basic role for the presentation of these standards which go for profiting activities and Provide a stronger framework to keep money by concentrating on four essential saving money parameters which are; capital, leverage, funding and, liquidity (Roy et al, 2013).In contrast, the committee focused to enhance the liquidity framework through developing two distinguished but complementary standards to supply liquidity. The first standard aims to guarantee resilience of banks to cover short term obligations and survive through stress periods that maintain for 30 calendar days, which is represented in the LCR. The other standard, which is NSFR that founded to complement the resilience of Liquidity by assuring to cover obligations that banks could incur within long term periods that has a horizon of one year.
In particular, the LCR will be presented partially starting from 1 January 2015, and will be completely implemented and applied in banks on 1 January 2019. This new methodology, will be combined with the adjustments that will retain until 2010, in order to guarantee that the LCR can be obtained without material interruption and with the systematic strengthening of saving money frameworks. Further, table (2.1) shows the minimum required liquidity coverage ratio for each year, starting from the year 2015 by keeping minimum required portions of High Quality Liquid Assets in order to achieve the mentioned ratios over years.
Table (2.1): Represent Minimum required liquid coverage ratio
Year 2015 2016 2017 2018 2019
Minimum LCR Requirement 60% 70% 80% 90% 100%
Source: Bank for International Settlements, 2013
Two conditions should be available in order to consider the assets sufficient to be a HQLA; the first one is the ability to convert these assets into cash with small amounts or without losses in order to defense against any cash flow gaps. The other one is the ability to convert these assets within short time period to avoid any delay in covering the financial obligations. As well as, these HQLAs will be used to achieve the required 100% percentage of LCR, which mean that these assets will be used to cover the expected cash outflows that are expected to be paid during the next 30 days. In other words, it’s assumed that the LCR should be always 100% or higher, so in the case of stress these assets will be used. In such circumstances LCR will decrease and here come the role of the bank’s supervision to be more flexible on maintaining this ratio within short period.
However; fixing the LCR require supervisory decisions regarding the required amounts of deductions from HQLA. These decisions should not only focus on achieving LCR objectives, but also to forecast how these restricted assets could affect the bank and market participants, taking into consideration the evaluation of macroeconomic, financial and macro financial conditions in that time . According to the BIS (2013) the analysis of bank’s supervisors and their reactions against the decline in LCR should take into considerations the following points:
1. Supervisors should consider all circumstances in advance, and follow them with the appropriate reactions if required.
2. Managers ought to take into consideration separated reactions to a reported LCR under 100%. Any potential supervisory reaction ought to be proportionate with the drivers, size, and length of time and recurrence of the reported deficiency.
3. They ought to evaluate various firm and market particular elements in deciding the fitting reaction and different considerations identified with both local and worldwide structures and conditions.
4. Supervisors should have a set of tools that are available to serve the bank at any time to address a reported LCR under the required 100%.
5. Supervisor’s reactions should be harmonized with the generic approach of hedging framework.