Capital rules changed as banks found risks that an earlier framework measured poorly. Broad credit weights encouraged arbitrage; trading losses exposed short risk horizons; the financial crisis showed that capital quality, leverage, and funding mattered together. Later reforms also sought more comparable results across banks using different internal models.
This lesson follows the historical frameworks in the assigned readings. A stated Basel standard or implementation date is not automatically the rule currently applied in every jurisdiction. In a calculation, identify the framework, permitted approach, and supplied transition assumptions first.
The original Basel I framework sought to strengthen bank capital and reduce competitive differences across internationally active banks. Credit risk-weighted assets (RWA) combine exposures with prescribed weights. An off-balance-sheet commitment first becomes a credit-equivalent exposure through a credit conversion factor (CCF), then receives the counterparty risk weight.
The historical weights distinguished broad categories, including qualifying sovereign claims at 0%, certain bank claims at 20%, qualifying residential mortgages at 50%, and many corporate claims at 100%.
Common mistakes
- Using a current national implementation assumption in a question about an assigned historical framework. Identify the specified approach and date.
- Treating the standardized credit approach as an IRB approach, or putting expected loss back into an IRB unexpected-loss charge without checking provision treatment.
- Using three as the BIA denominator after excluding a negative year, or excluding negative TSA years from its three-year denominator. The averaging rules differ.
Bottom line
- Identify the historical framework and supplied eligibility rules before applying weights, models, or dates.
- Basel II combines minimums, supervisory review, and disclosure; IRB separates expected from unexpected loss.
- BIA and TSA use different averaging rules; AMA relied on approved models and several evidence sources.
- Basel 2.5 adds stressed trading-risk measurement and portfolio-specific default, migration, and correlation charges.
Exam shortcut
Write the approach name beside every denominator. In a capital stack, calculate eligible components before percentages. In SMA, use the sequence BI, marginal BIC, loss component, applicable ILM, and capital. In a historical comparison, explain which weakness the next reform addresses and what tradeoff remains.
The full lesson (about 6,326 words, 42 min read) adds 3 worked examples, all 6 common mistakes, a self-check, free in the app.
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