Basel II is the
second of the Basel Accords, which are recommendations on banking laws and
regulations issued by the Basel
Committee on Banking Supervision.
Basel
II, initially published in June 2004, was intended to amend international
standards that controlled how much capital banks need to hold to guard against
the financial and operational risks banks face. These rules sought to ensure
that the greater the risk to which a bank is exposed, the greater the amount of
capital the bank needs to hold to safeguard its solvency and
economic stability. Basel II attempted to accomplish this by establishing risk and capital
management requirements to ensure that a bank has adequate capital for
the risk the bank exposes itself to through its lending, investment and trading
activities. One focus was to maintain sufficient consistency of regulations so
to limit competitive inequality amongst internationally active banks.
Basel
II uses a "three pillars" concept – (1) minimum capital requirements (addressing risk), (2) supervisory review and (3) market discipline.
Objective
The final
version aims at:
- Ensuring that capital allocation is more risk sensitive;
- Enhance disclosure requirements which would 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.
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 Basel I accord
dealt with only parts of each of these pillars. For example: with respect to
the first Basel II pillar, only one risk, credit risk, was dealt with in a
simple manner while market risk was an afterthought; operational risk was not
dealt with at all.
Minimum capital requirements: 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.
Supervisory review: This is a regulatory response to the first
pillar, giving regulators
better 'tools' over those previously available. It also provides a framework
for dealing with systemic risk, pension
risk, concentration risk, strategic
risk, reputational risk, liquidity risk and legal risk, which
the accord combines under the title of residual risk. Banks can review their
risk management system.
The Market Discipline: 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.
Basel III, The third installment of the Basel Accords,was developed in response to the deficiencies
in financial regulation revealed by the financial crisis of
2007–08. Basel III is intended to strengthen bank capital requirements by increasing bank liquidity and decreasing bank leverage.