Basel II consulting

Pillars

Basel II is built on three pillars:

  • Pillar One:  The rules that define the minimum ratio of capital to risk weighted assets, i.e. the determination of regulatory capital, heavily influenced by the use of banks' internal risk weighting models and the views of ratings agencies

  • Pillar Two:  The supervisory review pillar, which requires supervisors to undertake a qualitative review of their bank’s capital allocation techniques and compliance with relevant standards.

  • Pillar Three: The disclosure requirements - market discipline enforced by greater disclosure of banks' financial status and their internal risk management procedures.

Basel II requires rigorous understanding and control over operational and credit risk exposures with supervisory review, risk management, transparency and accountability.

To comply, a framework is needed to ensure that you have adequate capital is on hand to balance risk, ensure a stable and reliable system and to demonstrate control over your bank's risk.

Banks must be able to estimate and report on:

  • Credit Risk, including portfolio management, credit analysis, securitization and large risk exposure and concentrations.

  • Credit Analysis, with support for the identification and measurement of risk by customer and integrated into the banks overall risk exposure.

  • Portfolio Analysis, to identify weaknesses in portfolio for concentrations of risk by segment, geography, and other portfolio issues as well as analysis of counterparty risk.

  • Operational Risk, to manage tolerance and appetite for operational risk and evaluate adequacy for capital needed with provisions to identify, assess, and monitor, control and mitigate risk.

  • Risk exposure, to establish a system for monitoring and reporting risk exposures and assess the changing nature of risk exposure as it affects the bank's capital requirements.

At EBC we can help with all of these.

History

The Basel Committee was set up at the end of 1974, as central banks and financial regulators tried to get a grip on newly liberalised international financial markets. The collapse of the old Bretton Woods system and the need to hedge the new risks associated with fluctuating exchange rates, led to the wholesale dismantling of financial controls. Today's global market in monetary instruments was created. But regulators were trapped in increasingly irrelevant national boundaries.

A framework of international regulation was soon needed. When the Bankhaus Herstatt collapsed in 1974, its unfunded dollar liabilities seriously threatened the American banking system, an eventuality that neither German nor United States regulators were equipped to tackle. So the Basel Committee was established to coordinate the work of national regulators trying to deal with international problems.

Later the Committee moved on from coordination to rule making, notably promoting the capital adequacy rules for banks introduced in 1988.

The principles underpinning Basel II are a reaction to the failings of the 1988 capital adequacy rules that are now frequently circumvented by clever financial innovators. Future capital requirements are to be far more flexible, and more closely aligned to free market forces.