Basel 2

BASEL II IS AN INTERNATIONAL BUSINESS STANDARD THAT REQUIRES FINANCIAL

INSTITUTIONS TO MAINTAIN ENOUGH CASH RESERVES TO COVER RISKS ON BANKING LAWS AND
REGULATIONS ISSUED BY THE BASEL COMMITTEE ON BANKING SUPERVISION.
THE THREE ESSENTIAL REQUIREMENTS OF BASEL II ARE:
MANDATING THAT CAPITAL ALLOCATIONS BY INSTITUTIONAL MANAGERS ARE MORE
RISK SENSITIVE.
SEPARATING CREDIT RISKS FROM OPERATIONAL RISK AND QUANTIFYING BOTH.
ATTEMPTING TO ALIGN ECONOMIC AND REGULATORY CAPITAL MORE CLOSELY TO REDUCE THE
SCOPE FOR REGULATORY ARBITRAGE

FIRST PILLAR (MINIMUM CAPITAL REQUIREMENTS)

o THE FIRST PILLAR DEALS WITH MAINTENANCE OF REGULATORY CAPITAL CALCULATED FOR
THREE MAJOR COMPONENTS OR RISKS THAT A BANK FACES CREDIT RISK, OPERATIONAL RISK
AND MARKET RISK. OTHER RISK ARE NOT CONSIDERED FULLY QUANTIFIABLE AT THIS STAGE.
o The second pillar deals with the regulatory response to the first pillar,
giving REGULATORS much improved 'tools' over those available to them under Basel
I. It also provides a 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.
THIRD PILLAR(MARKET DISCIPLINE)
o The third pillar greatly increases the disclosures that the bank must make.
This is designed to allow the market to have a better picture of the overall risk
position of the bank and to allow the counterparties of the bank to price and deal
appropriately.