What is meant by opportunity cost and Basel II Accord?

Q. What is meant by opportunity cost (May’11, Nov’11, and Dec’12)?

Opportunity cost: Opportunity cost is the cost of any activity measured in terms of the value of the next best alternative that is not chosen. It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices.

The opportunity cost is a key concept in economics, and has been described as expressing "the basic relationship between scarcity and choice".

Example: The difference in return between a chosen investment and one that is necessarily passed up. Say you invest in a stock and it returns a paltry 2% over the year. In placing your money in the stock, you gave up the opportunity of another investment - say, a risk-free government bond yielding 6%. In this situation, your opportunity costs are 4% (6% - 2%).

Q. What is Basel II Accord (Nov’10, Dec’12)?

Basel II Accord: The Basel Accords determine how much equity capital - known as regulatory capital - a bank must hold to buffer unexpected losses. Equity is assets minus liabilities. For a traditional bank, assets are loans and liabilities are customer deposits. But even a traditional bank is highly leveraged (i.e., the debt-to-equity or debt-to-capital ratio is much higher than for a corporation). If the assets decline in value, the equity can quickly evaporate. So, in simple terms, the Basel Accord requires banks to have an equity cushion in the event that assets decline, providing depositors with protection.

The regulatory justification for this is about the system: If big banks fail, it spells systematic trouble. If not for this, we would let banks set their own levels of equity -known as economic capital - and let the market do the disciplining. So, Basel attempts to protect the system in much the same way that the Federal Deposit Insurance Corporation (FDIC) protects individual investors.