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Basel Three Pillars
Pillar 1” of the new capital framework revises the
1988 Accord’s guidelines by aligning the minimum capital
requirements more closely to each bank's actual risk of economic
Pillar 2 ” Supervisors will evaluate the activities
and risk profiles of individual banks to determine whether those
organisations should hold higher levels of capital than the minimum
requirements in Pillar 1 would specify and to see whether there
is any need for remedial actions.
||Pillar 3” leverages the ability of market discipline
to motivate prudent management by enhancing the degree of transparency
in banks’ public reporting to shareholders and customers.
I. “Pillar 1” of the new capital framework
revises the 1988 Accord’s guidelines by aligning the minimum
capital requirements more closely to each bank’s actual risk
of economic loss.
- First, Basel II improves the capital framework’s sensitivity
to the risk of credit losses generally by requiring higher levels of
capital for those borrowers thought to present higher levels of credit
risk, and vice versa. Three options are available to allow banks and
supervisors to choose an approach that seems most appropriate for the
sophistication of a bank’s activities and internal controls.
- Under the “standardised approach” to credit risk,
banks that engage in less complex forms of lending and credit underwriting
and that have simpler control structures may use external measures
of credit risk to assess the credit quality of their borrowers for
regulatory capital purposes.
- Banks that engage in more sophisticated risk-taking and that
have developed advanced risk measurement systems may, with the approval
of their supervisors, select from one of two “internal ratings-based”
(“IRB”) approaches to credit risk. Under an IRB approach,
banks rely partly on their own measures of a borrowers’ credit
risk to determine their capital requirements, subject to strict
data, validation, and operational requirements.
- Second, the new Framework establishes an explicit capital charge
for a bank’s exposures to the risk of losses caused by failures
in systems, processes, or staff or that are caused by external events,
such as natural disasters. Similar to the range of options provided
for assessing exposures to credit risk, banks will choose one of three
approaches for measuring their exposures to operational risk that they
and their supervisors agree reflects the quality and sophistication
of their internal controls over this particular risk area.
- By aligning capital charges more closely to a bank’s own measures
of its exposures to credit and operational risk, the Basel II Framework
encourages banks to refine those measures. It also provides explicit
incentives in the form of lower capital requirements for banks to adopt
more comprehensive and accurate measures of risk as well as more effective
processes for controlling their exposures to risk.
II. “Pillar 2” of the new capital
framework recognises the necessity of exercising effective supervisory
review of banks’ internal assessments of their overall risks
to ensure that bank management is exercising sound judgement and has set
aside adequate capital for these risks.
- Supervisors will evaluate the activities and risk profiles of individual
banks to determine whether those organisations should hold higher levels
of capital than the minimum requirements in Pillar 1 would specify and
to see whether there is any need for remedial actions.
- Basel Three Pillars - The Committee expects that, when supervisors
engage banks in a dialogue about their internal processes for measuring
and managing their risks, they will help to create implicit incentives
for organisations to develop sound control structures and to improve
III. “Pillar 3” leverages the ability
of market discipline to motivate prudent management by enhancing
the degree of transparency in banks’ public reporting. It sets out
the public disclosures that banks must make that lend greater insight
into the adequacy of their capitalisation.
- Basel Three Pillars - The Committee believes that, when marketplace
participants have a sufficient understanding of a bank’s activities
and the controls it has in place to manage its exposures, they are better
able to distinguish between banking organisations so that they can reward
those that manage their risks prudently and penalise those that do not.
> Basel Three Pillars