Basel II

International Convergence of Capital Measurement and Capital Standards: A Revised Framework

Basel II, the second of the Basel Accords, was first published in 2004 by the Basel Committee on Banking Supervision (BCBS) to keep pace with the increased sophistication of lenders' operations and risk management and overcome some of the distortions caused by the lack of granularity in Basel I. In the EU, all deposit takers had to implement Basel II by no later than 1 January 2008. The US delayed this date to January 2009.

Basel II attempts to:

1. ensure that capital allocation is more risk sensitive
2. enhance disclosure requirements which will allow market participants to assess the capital adequacy of an institution
3. ensure that credit risk, operational risk and market risk are quantified based on data and formal techniques
4. align economic and regulatory capital more closely to reduce the scope for regulatory arbitrage

Basel II applies to internationally active banks. The extent to which individual supervisors will apply the Basel requirements to individual banking subsidiaries, particularly if these are in the same jurisdiction as the holding company, depends on local rules.

Basel II is based on a three-pillar structure

Pillar 1: Minimum Capital Requirements

The first pillar sets out the mechanism for calculating minimum regulatory capital for three major components of risk that a bank faces: credit risk, operational risk, and market risk. Under Basel I this calculation related only to credit risk, with a calculation for market risk added in 1996.

Pillar 2: Supervisory Review Process

Supervisors have the obligation to evaluate the activities, corporate governance, risk management, and risk profiles of banks to determine whether they have to change or to allocate more capital for their risks.

Pillar 3: Market Discipline

Pillar 3 covers transparency and the obligation of banks to disclose meaningful information to all stakeholders. Clients and shareholders should have a sufficient understanding of the activities of banks and the way they manage their risks.

References:

• http://www.bis.org/publ/bcbsca.htm

We hope that this information will assist you, but it should not be used or relied upon as a substitute for your own independent research. For a more comprehensive view of the standards/requirements, please visit the respective issuer's website.