Basel I and Basel II

• Basel II much more risk sensitive, as it is aligning capital requirements to risks of loss. Better risk management in a bank means bank may be able to allocate less regulatory capital.

• The objective of Basel II is to modernise existing capital requirements framework to make it more comprehensive and risk sensitive.

• The Basel II framework therefore designed to be more sensitive to the real risks that firms face than Basel I. 

• Apart from looking at financial figures, it also considers operational risks, such as risk of systems breaking down or people doing the wrong things, and also market risk.

Why BASEL II

• Ensuring that capital allocation is more risk sensitive

• Separating operational risk from credit risk, and quantifying both

• Attempting to align economic and regulatory capital more closely to reduce scope for regulatory arbitrage

FINAL OBJECTIVE Basel II

•Pillar 1 sets out the minimum capital requirements firms will be required to meet to cover credit, market and operational risk.

•Pillar 2 sets out a new supervisory review process.  Requires financial institutions to have their own internal processes to assess their overall capital adequacy in relation to their risk profile. 

•Pillar 3 cements Pillars 1 and 2 and is designed to improve market discipline by requiring firms to publish certain details of their risks, capital and risk management  as to how senior management and the Board assess and will manage the institution's risks.

Three Pillars of Basel II Framework

Pillar 1 : Minimum capital requirements

Institution's total regulatory capital must be at least 8% (ratio same as in Basel I) of its risk

weighted assets, based on measures of THREE RISKS

• Covers Supervisory Review Process, describing principles for effective supervision.

• Supervisors obliged to evaluate 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 (called Pillar 2 capital)

• Deals with regulatory response to the first pillar, giving regulators much improved 'tools' over those available to them under Basel I

• Also provides framework for dealing with all the other risks a bank may face, such as Systemic risk, pension risk, concentration risk, strategic risk, reputation risk, liquidity risk and legal risk, which the accord combines under the title of residual risk

• It gives banks a power to review their risk management system.

Pillar 2 : Supervisory Review

• Covers transparency and the obligation of banks to disclose meaningful information to all stakeholders

• Clients and shareholders should have sufficient understanding of activities of banks, and the way they manage their risks

Pillar 3 : Market Discipline

THANK YOU

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