Question

What is the difference in the risk-weighted asset for a bank under Basel I and Basel II? Suppose the bank has entered into a £50 million interest rate swap with an OECD bank (currently rated at A). The interest rate swap has a current value of £3 million with 3 years remaining maturity.

A. £0.9 million

B. £0.975 million

C. £10 million

D. £15 million

Answer 1

Basel I

The first Basel Accord, known as Basel I, was issued in 1988 and focuses on the capital adequacy of financial institutions. The capital adequacy risk (the risk that a financial institution will be hurt by an unexpected loss), categorizes the assets of financial institutions into five risk categories (0%, 10%, 20%, 50% and 100%). Under Basel I, banks that operate internationally are required to have a risk weight of 8% or less.

Basel II

The second Basel Accord, called Revised Capital Framework but better known as Basel II, served as an update of the original accord. It focuses on three main areas: minimum capital requirements, supervisory review of an institution's capital adequacy and internal assessment process, and effective use of disclosure as a lever to strengthen market disciplineand encourage sound banking practices including supervisory review. Together, these areas of focus are known as the three pillars.

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