Basel II Summary - What is Important to Know About the Basel II Framework

What is Basel II? Who is behind it? Who developed it? Is it international law? Do I have to comply? Who must follow? Can I get an overview of Basel II? These are very important questions and it is good to start with answers.

Basel II Framework [formal name is “International Convergence of Capital Measurement and Capital Standards: Revised Framework”] A new set of international standards and best practices Define minimum capital requirements for internationally active banks. Banks must maintain minimal capital, fulfill their obligations, cover unexpected losses, and promote public confidence [this is most important for the international banking system].

Banks want to invest money instead of depositing money for future risks. Regulatory capital [minimum required capital] is mandatory. Low level capital is a threat to the banking system itself. Banks can fail and depositors can lose money or distrust the bank. This framework establishes international minimum standards.

Basel II is applied on a consolidated basis [combining banking activities in the home and host countries].

This framework was developed by the Basel Committee on Banking Supervision [BCBS], a committee of the International Settlement Bank [BIS] [established on May 17, 1930], the world's oldest international financial institution.

Basel Committee on Banking Supervision was established by G10 [Group of 10 countries] 1974. These 10 countries [11] are rich and developed countries. Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, United Kingdom, United States.

The G10 is behind the development of the previous [Basel i] framework and now supports a series of new Basel II papers [main paper and many explanatory papers]. Only banks in G10 countries need to implement the framework, More than 100 countries volunteer Adopt these principles or take them into account and use them as a basis for the national rule-making process.

Basel i was not risk sensitive. All loans given to corporate borrowers were subject to the same capital requirements without considering the counterparty's ability to repay. Ignored the credit rating, credit history, risk management and corporate governance structure of all corporate borrowers. They were all the same: private companies.

Basel II is sensitive to risk because it aligns capital requirements with the risk of loss. Improved bank risk management means that banks can allocate less regulatory capital.

Basel II has three pillars.

Pillar 1 Related to the calculation of minimum capital requirements. There are various approaches.

Standardized approach to credit risk: Banks rely on external measurements of credit risk, such as credit rating agencies, to assess borrower credit quality.

The internal rating base [IRB] approaches credit risk too. Banks rely in part or fully on their own measure of counterparty credit risk and use internal models to determine capital requirements.

Banks must allocate capital to cover operational risks [risk of loss due to errors, fraud, IT system disruption, external events, litigation, etc.]. This can be a difficult practice.

The basic indicator approach links the capital charge to the bank's total revenue. The standardized approach splits the bank into seven business lines, with seven different capital allocations, one for each business line. The advanced measurement approach is based on internal models and years of loss experience.

Pillar 2 Describes the supervisory review process. Explain the principles of effective supervision.

Supervisors are obligated to evaluate bank activities, corporate governance, risk management, and risk profiles to determine if more capital [called pillar 2 capital] needs to be changed for risk. There is.

Pillar 3 Covers the transparency and obligation of banks to disclose meaningful information to all interested parties. Customers and shareholders need to fully understand the bank's activities and how to manage its risks.