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1 Objective 2 The accord in operation
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2.1 The first pillar 2.2 The second pillar 2.3 The third pillar 3.1 September 2005 update 3.2 November 2005 update 3.3 July 2006 update 3.4 November 2007 update 3.5 July 16, 2008 update 3.6 January 16, 2009 update 3.7 July 8–9, 2009 update 4.1 Implementation progress
3 Recent chronological updates
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4 Basel II and the regulators
5 Basel II and the global financial crisis 6 See also 7 References 8 External links Objective The final version aims at: 1. Ensuring 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. Ensuring that credit risk, operational risk and market risk are quantified based on data and formal techniques; 4. Attempting to align economic and regulatory capital more closely to reduce the scope for regulatory arbitrage. While the final accord has at large addressed the regulatory arbitrage issue, there are still areas where regulatory capital requirements will diverge from the economic capital. The accord in operation
(2) supervisory review and (3) market discipline. liquidity risk and legal risk. namely standardized approach. Foundation IRB. pension risk.Basel II uses a "three pillars" concept – (1) minimum capital requirements (addressing risk). It also provides a framework for dealing with systemic risk. As the Basel II recommendations are phased in by the banking industry it will move from standardised requirements to more refined and specific requirements that have been developed for each risk category by each individual bank. It is the Internal Capital Adequacy Assessment Process (ICAAP) that is the result of Pillar II of Basel II accords. For market risk the preferred approach is VaR (value at risk). operational risk. The Basel I accord dealt with only parts of each of these pillars. which the accord combines under the title of residual risk. and market risk. strategic risk. Other risks are not considered fully quantifiable at this stage. The upside for banks that do develop their own bespoke risk measurement systems is that they will be rewarded with potentially lower risk capital requirements. reputational risk. In the future there will be closer links between the concepts of economic and regulatory capital. The second pillar This is a regulatory response to the first pillar. IRB stands for "Internal Rating-Based Approach". For example: with respect to the first Basel II pillar. standardized approach or STA. credit risk. Advanced IRB and General IB2 Restriction. and the internal measurement approach (an advanced form of which is the advanced measurement approach or AMA). Banks can review their risk management system. there are three different approaches – basic indicator approach or BIA. only one risk. For operational risk. The credit risk component can be calculated in three different ways of varying degree of sophistication. The first pillar The first pillar deals with maintenance of regulatory capital calculated for three major components of risk that a bank faces: credit risk. The third pillar . giving regulators better 'tools' over those previously available. was dealt with in a simple manner while market risk was an afterthought.concentration risk. operational risk was not dealt with at all.
Market discipline supplements regulation as sharing of information facilitates assessment of the bank by others. Institutions are also required to create a formal policy on what will be disclosed and controls around them along with the validation and frequency of these disclosures. Recent chronological updates September 2005 update On September 30.This 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. and rating agencies. These changes had been flagged well in advance. When market participants have a sufficient understanding of a bank's activities and the controls it has in place to manage its exposures. and the Office of Thrift Supervision) announced their revised plans for the U. except qualitative disclosures providing a summary of the general risk management objectives and policies which can be made annually. the Board of Governors of the Federal Reserve System. implementation of the Basel II accord. the Federal Deposit Insurance Corporation. The aim of Pillar 3 is to allow market discipline to operate by requiring institutions to disclose details on the scope of application. the four US Federal banking agencies (the Office of the Comptroller of the Currency. including the board. the committee released a comprehensive version of the Accord. as part of a paper released in July 2005. assess and manage the risks of the institution. the disclosures under Pillar 3 apply to the top consolidated level of the banking group to which the Basel II framework applies. These disclosures are required to be made at least twice a year. including investors. risk assessment processes. In general. This delays implementation of the accord for US banks by 12 months. analysts. 2006. they are better able to distinguish between banking organizations so that they can reward those that manage their risks prudently and penalize those that do not. risk exposures. other banks.S. capital. It must be consistent with how the senior management. incorporating the June 2004 Basel II Framework. the elements of . customers. incorporating changes to the calculations for market risk and the treatment of double default effects. July 2006 update On July 4. which leads to good corporate governance. November 2005 update On November 15. 2005. and the capital adequacy of the institution. the committee released a revised version of the Accord. 2005.
the Office of the Comptroller of the Currency. No new elements have been introduced in this compilation. through the Internal Ratings Based Approach (IRB). 2008. 2009 update For public consultation. is aimed at helping banking institutions meet certain qualification requirements in the advanced approaches rule. through the Advanced Measurement Approach (AMA). the Office of the Comptroller of the Currency (U. November 2007 update On November 1. and the Office of Thrift Supervision) issued a final guidance outlining the supervisory review process for the banking institutions that are implementing the new advanced capital adequacy framework (known as Basel II). These measures include the enhancements to the Basel II framework. Basel II and the regulators . banks.S. This rule establishes regulatory and supervisory expectations for credit risk. and articulates enhanced standards for the supervisory review of capital adequacy and public disclosures for the largest U. relating to the supervisory review. It releases a consultative package that includes: the revisions to the Basel II market risk framework. July 8–9. and operational risk. which took effect on April 1. and the proposed enhancements to the Basel II framework. and the November 2005 paper on Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework. The final guidance. Department of the Treasury) approved a final rule implementing the advanced approaches of the Basel II Capital Accord. This version is now the current version. the Federal Deposit Insurance Corporation. the guidelines for computing capital for incremental risk in the trading book. 2007.the 1988 Accord that were not revised during the Basel II process. 2008 update On July 16. a series of proposals to enhance the Basel II framework was announced by the Basel Committee. 2008 the federal banking and thrift agencies (the Board of Governors of the Federal Reserve System. January 16. the revisions to the Basel II market-risk framework and the guidelines for computing capital for incremental risk in the trading book.S. July 16. the 1996 Amendment to the Capital Accord to Incorporate Market Risks. 2009 update A final package of measures to enhance the three pillars of the Basel II framework and to strengthen the 1996 rules governing trading book capital was issued by the newly expanded Basel Committee.
Without proper capital regulation. TheUnited States' various regulators have agreed on a final approach. Federal Deposit Insurance Corporation Chair Sheila Bair explained in June 2007 the purpose of capital adequacy requirements for banks. banks do benefit from implicit and explicit government safety nets. but with widely varying timelines and use of the varying methodologies being restricted. To assist banks operating with multiple reporting requirements for different regulators according to geographic location. banks can operate in the marketplace with little or no capital. The final bill for inadequate capital regulation can be very heavy.S. In India. These include capital calculation engines and extend to automated reporting solutions which include the reports required under COREP/FINREP. Reserve Bank of India has implemented the Basel II standardized norms on 31 March 2009 and is moving to internal ratings in credit and AMA(Advanced Measurement Approach) norms for operational risks in banks. and the standardized approach will be available for smaller banks. We wouldn't be doing our jobs or serving the public interest if we did. there are several software applications available. For example. . And governments and deposit insurers end up holding the bag. bearing much of the risk and cost of failure. The fact is. varying structural models. such as the accord: There are strong reasons for believing that banks left to their own devices would maintain less capital—not more—than would be prudent. History shows this problem is very real … as we saw with the U.One of the most difficult aspects of implementing an international agreement is the need to accommodate differing cultures. regulators can't leave capital decisions totally to the banks. based in part on how Basel II is ultimately interpreted by various countries' legislatures and regulators. Investing in a bank is perceived as a safe bet.S. complexities of public policy. Banks' senior management will determine corporate strategy. In short. and existing regulation. as well as the country in which to base a particular type of business. U. banking and S & L crisis in the late 1980s and 1990s. Implementation progress Regulators in most jurisdictions around the world plan to implement the new accord. They have required the Internal Ratings-Based approach for the largest banks.
off-balance sheet exposures and trading activities which would promote transparency. Total Capital : 9% of risk weighted assets. wrote an article in September 2009 outlining some of the strategic responses which the Committee should take as response to the crisis. Nout Wellink. and (e) cross-border supervisory cooperation.5% (Counter Cyclical Buffer). In response to the financial crisis.Existing RBI norms for banks in India (as of September 2010): Common equity (incl of buffer): 3. increased coverage of risk for capital market activities and better liquidity standards among other benefits. Thus the actual capital requirement is between 11 and 13.5% (including Capital Conservation Buffer and Counter Cyclical Buffer). .). both before and after the global financial crisis. 7% of Tier 1 capital and minimum capital adequacy ratio (excluding Capital Conservation Buffer) of 9% of Risk Weighted Assets. the BCBS also Authority. In response to a questionnaire released by the Financial Stability Institute (FSI). former Chairman of the BCBS.6%(Buffer Basel 2 requirement requirements are zero. Given one of the major factors which drove the crisis was the evaporation of liquidity in the financial markets.others have criticized it for actually increasing the effect of the crisis. in some form or another. has been discussed widely. Tier 1 requirement: 6%. Basel II and the global financial crisis The role of Basel II. While some argue that the crisis demonstrated weaknesses in the framework. The European Union has already implemented the Accord via the EU Capital Requirements Directives and many European banks already report their capital adequacy ratios according to the new system. Australia. (c) better risk management and supervision including enhanced Pillar 2 guidelines. popularly known as Basel III. All the credit institutions adopted it by 2008-09. by 2015. He proposed a stronger regulatory framework which comprises five key components: (a) better quality of regulatory capital. According to the draft guidelines published by RBI the capital ratios are set to become: Common Equity as 5% + 2. (b) better liquidity management and supervision. 95 national regulators indicated they were to implement Basel II. through its Australian Prudential Regulation implemented the Basel II Framework on 1 January 2008. (d) enhanced Pillar 3 disclosures related to securitization. the Basel Committee on Banking Supervision published revised global standards.5% (Capital Conservation Buffer) + 0–2. The Committee claimed that the new standards would lead to a better quality of capital.
is another likely candidate to increase bank incentives to exploit regulation. . they forced private banks. Thus. Tighter capital requirements based on risk-weighted assets. effective since 2008. transposed in European Union law through the Capital Requirements Directive (CRD). introduced in the Basel III. and bank regulators to rely more on assessments of credit risk by private rating agencies. notwithstanding its good intentions. capital regulation based on riskweighted assets encourages innovation designed to circumvent regulatory requirements and shifts banks' focus away from their core economic functions. may further contribute to these skewed incentives. Think-tanks such as the World Pensions Council (WPC) have also argued that European legislators have pushed dogmatically and naively for the adoption of the Basel II recommendations. According to the study. In essence. adopted in 2005. New liquidity regulation.published principles for better liquidity management and supervision in September 2008. A recent OECD study  suggest that bank regulation based on the Basel accords encourage unconventional business practices and contributed to or even reinforced adverse systemic shocks that materialised during the financial crisis. central banks. part of the regulatory authority was abdicated in favor of private rating agencies.
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