Basel II

What Is Basel II?

Basel II is the second major set of international banking standards issued by the Basel Committee on Banking Supervision, a group of central banks and bank regulators that meets at the Bank for International Settlements in Basel, Switzerland. It was published in its comprehensive form in 2004 and succeeded the 1988 accord known as Basel I. Its main aim was to tie the amount of capital a bank must hold more closely to the risks in its business, so that a bank with riskier lending generally needs more capital to absorb potential losses.

How It Works

The framework rests on three pillars. The first sets minimum capital requirements. Banks must hold capital equal to at least 8 percent of their risk-weighted assets, a minimum capital adequacy ratio that is calculated by giving each asset a weight according to its perceived riskiness. Basel II covers credit risk, market risk, and, for the first time in these rules, operational risk, which includes losses from failed internal processes, people, systems, or external events.

Credit risk can be measured in two broad ways. The standardized approach relies on external credit rating agencies to assign risk weights. The internal ratings-based approaches allow larger banks, with supervisory approval, to use their own estimates of default probabilities and losses.

The second pillar, supervisory review, requires national regulators to check that each bank's capital suits its overall risk profile and to act early when it does not. The third pillar, market discipline, requires banks to publish detailed information about their capital and risk exposures so that investors, depositors, and counterparties can assess them.

Why It Matters to Investors

Basel II's disclosure rules gave investors more standardized information about how banks measure risk and how much capital they hold, which made bank financial statements easier to compare. The capital ratios it promoted also shape how much lending a bank can do and how it manages its balance sheet, so changes to these rules can affect bank profitability.

Criticisms and Legacy

Basel II was adopted in many countries during the mid-to-late 2000s. The 2007–2009 financial crisis exposed weaknesses, including heavy reliance on credit ratings and banks' own risk models, thin capital buffers during periods of stress, and inadequate liquidity standards. These concerns led to Basel III, which raised capital requirements and introduced liquidity rules. Basel II remains an important reference point for understanding modern bank regulation.