2. Agenda
• Basel Accords
• Base II Accord
• The three pillars
– The first pillar
– The second pillar
– The third pillar
3. Basel Accords
• recommendations on banking laws and
regulations
• issued by the Basel Committee on Banking
Supervision (BCBS)
• BCBS maintains its secretariat at the Bank for
International Settlements in Basel, Switzerland
• the committee normally meets there
4. Base II Accord
• second of the Basel Accords
• initially published in June 2004
• purpose is to create an international standard
that banking regulators can use when creating
regulations about how much capital banks need
to put aside to guard against the types of
financial and operational risks banks face while
maintaining sufficient consistency so that this
does not become a source of competitive
inequality amongst internationally active banks
5. Base II Accord
• Advocates of Basel II believe that such an
international standard can help protect the
international financial system from the types of
problems that might arise should a major bank or
a series of banks collapse
• In theory, Basel II attempted to accomplish this by
setting up risk and capital management
requirements designed to ensure that a bank
holds capital reserves appropriate to the risk the
bank exposes itself to through its lending and
investment practices
6. Base II Accord
• Its aims are-
– Ensuring that capital allocation is more risk sensitive
– Enhance disclosure requirements which will allow
market participants to assess the capital adequacy of
an institution
– Ensuring that credit risk, operational risk and market
risk are quantified based on data and formal
techniques
– Attempting to align economic and regulatory capital
more closely to reduce the scope for regulatory
arbitrage
7. The three pillars
• The first pillar
– deals with maintenance of regulatory capital
calculated for three major components of risk that a
bank faces- credit risk, operational risk, and market
risk
– The credit risk component can be calculated in three
different ways of varying degree of sophistication,
namely standardized approach, foundation IRB and
advanced IRB
– For operational risk, there are three different
approaches - basic indicator approach or BIA,
standardized approach or TSA, and the internal
measurement approach
– For market risk the preferred approach is VaR i.e.
value at risk
8. The three pillars
• The second pillar
– deals with the regulatory response to the first
pillar
– provides a framework for dealing with all the
other risks a bank may face, such as systemic risk,
pension risk, concentrated risk, strategic risk,
reputational risk, liquidity risk and legal risk
– gives banks a power to review their risk
management system
– Internal Capital Adequacy Assessment Process
(ICAAP) is the result of Pillar II of Basel II accords
9. The three pillars
• The third pillar
– aims to complement the minimum capital
requirements and supervisory review process by
developing a set of disclosure requirements which will
allow the market participants to gauge the capital
adequacy of an institution
– allow market discipline to operate by requiring
institutions to disclose details on the scope of
application, capital, risk exposures, risk assessment
processes and the capital adequacy of the institution
– It must be consistent with how the senior
management including the board assess and manage
the risks of the institution
