Basel II: International Convergence of Capital Measurement & Capital Standards: A Revised Framework
The framework is structured around three pillars:
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Minimum Capital Requirements (Pillar 1): This pillar sets forth the calculation of capital requirements for credit risk, market risk, and operational risk. Banks can choose from different approaches to measure these risks, ranging from standardized methods to more advanced internal models, depending on their sophistication and risk profiles.
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Supervisory Review Process (Pillar 2): This component emphasizes the importance of regulatory oversight in evaluating banks’ internal assessments of their capital adequacy relative to their risk profiles. It encourages banks to develop sound risk management practices and ensures that they maintain capital levels commensurate with their risk exposures.
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Market Discipline (Pillar 3): This pillar aims to bolster market discipline through enhanced disclosure requirements. By providing comprehensive information on their risk exposures, capital adequacy, and risk management strategies, banks enable market participants to make informed assessments of their financial health.
The document also addresses the scope of application, detailing how the capital requirements apply to different entities within a banking group, including banking, securities, and other financial subsidiaries. It outlines the treatment of investments in insurance entities and significant investments in commercial entities, specifying the deductions and adjustments necessary to prevent double counting of capital.
Overall, this revised framework seeks to align regulatory capital requirements more closely with the actual risks faced by banks, promoting a more resilient and transparent banking sector globally.
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Citation: “International Convergence of Capital Measurement and Capital Standards” Bank for International Settlements. June, 2004.
