The Bank for International Settlements’ Basel Committee’s BIS Ratio Regulation is widely followed around the world, even though it is not legally binding. This is largely due to the importance of building confidence in international financial markets and maintaining financial system stability, and demonstrates the normative nature of these recommendations.
In international law, treaties are generally norms created by states or international organizations that explicitly agree on specific rights and obligations to be observed between them. These treaties play an important role in regulating relations between states and maintaining peace and stability. In particular, because treaties are voluntarily agreed upon by the parties, they are legally binding and their fulfillment has a significant impact on trust between states. For this reason, treaties serve as an important means of preventing and resolving disputes between states.
Customary international law is a set of universal norms that are accepted and upheld by the international community at large, regardless of whether a treaty has been signed. These customary laws are norms that have been recognized and upheld by the international community for a long time, and countries adhere to them even without a specific document or treaty. For example, norms such as diplomatic immunity or freedom of navigation on the high seas are accepted by most countries as customary law, and violation of them can result in international condemnation. This customary law forms the basis of international law and, along with treaties, plays an important role in maintaining legal order in the international community.
On the other hand, when an international organization makes a decision on an economic issue, the decision itself is usually only advisory and not legally binding. With the growing importance of international cooperation on economic issues, several international organizations have emerged to facilitate cooperation and regulation between countries. However, the decisions made by these organizations are primarily based on voluntary agreements between member states and are therefore not legally binding, and each country can choose whether or not to apply them in its own context. In recent years, however, these recommendations have increasingly taken on a normative character in the international community, and even non-binding norms are having a practical effect.
This is why we often see things like the BIS ratio rules, which are determined by the Basel Committee of the Bank for International Settlements, being strictly adhered to even in non-member countries. This shows that international financial regulation is more than just a set of recommendations; it is an important norm that maintains the stability of the global financial system. Given the devastating impact of the financial crisis on the global economy, these international regulations have become an essential means for countries to work together to stabilize the global economy.
There is a debate on how to understand this reality, which is of a normative nature. This brings us back to the general tendency to focus on securing the effectiveness of international law through sanctions for violations: the binding power of trust. In the international financial system, trust is an essential element of cross-border trade and investment, which is directly linked to economic stability. The normative binding power of trust shows that norms based on trust can be powerful in practice, even if they are not treaties or legally binding norms.
The BIS ratio was introduced by the Basel Committee to set the minimum capital ratios required to maintain a bank’s financial strength, ultimately protecting depositors and the financial system. It serves as an important benchmark for assessing how well banks can respond to economic shocks and is considered an essential safeguard for preventing financial crises. The Basel Committee set a standard that the BIS ratio should be at least as high as the regulatory ratio of 8%. The formula for this is as follows
Where equity capital is the sum of a bank’s Tier 1 capital, supplementary capital, and short-term subordinated debt, and risk-weighted assets are the sum of assets held multiplied by the risk weight for each asset’s credit risk. The risk weights reflect the credit risk of each type of asset, with a uniform weight of 0% for government bonds and 100% for corporate bonds in OECD countries. Later, in response to growing calls for the BIS ratio to also reflect the market risk of price movements in financial assets, the Basel Committee redefined risk-weighted assets as the sum of the credit risk and market risk components to calculate the BIS ratio. The Basel I Accord was finalized in 1996, allowing banks to use any measure of market risk they chose, subject to supervisory approval.
However, the limitations of the Basel I Accord led to the introduction of the Basel II Accord in 2004 with the aim of financial innovation. Under Basel II, risk-weighted assets in the BIS ratio were modified to take into account both the type and credit quality of the asset in the risk weighting for credit risk. Banks can use either a standardized model or an internal model to measure credit risk. In the standard model, sovereign bonds from OECD countries are risk-weighted from 0% to 150% and corporate bonds from 20% to 150%, with the higher the credit quality, the lower the charge. For example, if you actually own 10 billion won in corporate bonds and the credit risk weight is 20%, the bonds are counted as 2 billion won in your risk-weighted assets. The internal model allows banks to use the risk measurement methodology of their choice, subject to supervisory approval. Supervisors also sought to compensate for the rigid capital standards by allowing them to require their banks to have a minimum ratio of equity to risk-weighted assets that exceeds the regulatory ratio, if necessary.
More recently, the Basel III Accord excluded short-term subordinated debt from equity. It also strengthened the loss resilience of Tier 1 capital by requiring a minimum ratio of Tier 1 capital to risk-weighted assets of 6%. These new Basel Accords have the effect of amending the relevant standards contained in the previous Accords. These changes are part of an effort to respond to rapid changes in the international financial environment and the increasing complexity of the financial system.
The Basel Accord has been adopted and institutionalized by numerous countries, including South Korea. Currently, the Basel Committee has financial authorities from 28 countries as members. Korea’s financial authorities joined in 2009. However, Korea had adopted and implemented the BIS ratios long before joining, and the current legislation reflects this. By following Basel standards, Korea was required to show international financial markets that its banks are trustworthy. Banks whose financial health is questionable may not be able to participate in international financial markets, or worse, may not be able to participate at all.
The Basel Committee sets banking supervisory standards in consultation. Its charter obliges its members to adopt Basel standards in their own countries. However, it is also clear that the Basel Committee does not have supranational supervisory powers and its decisions are not legally binding. The Basel standards have been adopted and followed by more than 100 countries. This means that even countries that are not formally bound by the decisions of international organizations have voluntarily accepted and implemented them, a reality that is sometimes described as soft law. In contrast, treaties and customary international law are referred to as hard law. The Basel standards may become hard law in the future.
