Basel II, 3 Pillars

Basel II mainly talks about guidelines for supervisory bodies for proposing revisions in maintenance of adequate capital by banks active in international capital markets.

It Specifies Framework for measuring Capital adequacy/sufficiency and the minimum standard to be achieved which the national supervisory authorities will propose for adoption by the banks in respective countries.

This framework and standards has been endorsed by Central Bank Governors and Heads of

Banking supervision of G-10 countries.
Expanded list [Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom, and the United States.]

Basel II promotes/Advocates:
Adoption of stronger risk management practices by the banking industry.
Assessment of Risk provided by banks internal systems as inputs to capital Calculations
To ensure that bank systems and controls are adequate enough and comply with minimal requirements to serve as the basis for capital calculations.
Provides a range of options for determining the capital requirements for Credit risk, Market Risk and Operational risk
Allows limited degree of national discretion for implementation of framework
Changes in the approach to the treatment of Expected Losses and Un Expected Losses (UL) and to the treatment of securitization exposures.
Treatments of Credit Risk Mitigation and revolving retail exposures.

Some of the Activities in scope which financial entities are involved in are:
Financial Leasing
Issuing Credit Cards
Portfolio Management
Investment Advisory
Custodial and Safe Keeping Services

3 Pillars on which the Framework is based on:

1. Minimum Capital Requirements
a. Banks to asses the minimum capital requirements for Credit, Market, Operational Risks, Interest Rate risk in the banking book, Liquidity Risk etc.
b. The Capital Ratio is calculated using definition of Regulatory Capital and risk-weighted assets.
c. The total Capital Ratio should not be lower than 8%

2. Supervisory Review
a. Review of Assessments done in pillar I
b. Set Guidelines to ensure that Banks have sufficient capital to support their business.
c. Recognizes the responsibility of bank management in developing an internal capital assessment process and setting capital targets that are commensurate with the bank’s risk profile and control environment.

3. Market Discipline
a. Disclosures and Effective complement of above 2 pillars
b. Encourage market discipline by developing a set of disclosure requirements which will allow market participants to asses key pieces of information on the scope of application capital risk exposures, risk assessment processes and hence the capital adequacy of the institution.

Basel Framework is an Extension to 1988 Accord Capital Adequacy Framework

Banks to hold capital equivalents of 8% of its Risk-Weighted assets. (As per 1996 Market Risk Amendment.)