Basel II Implementation

Basel III, along with CRR/CRD IV, is a regulatory requirement and is monitored by ECB/CBI for financial and capital reporting. It regulates minimum capital requirements, sets the levels for Regulatory and Risk Capital. In the longer run the bank intends to adopt the Advanced methodology for Risk Capital calculation and disclosure. Credit Risk has large influence over Risk Capital and is impacted by the data quality, policies, scorecards and strategies.

Basel II scope

By offering more complex models for regulatory capital calculation, Basel II can be seen as an improvement on Basel I. Essentially, banks which are holding riskier assets should be required to have more capital compare to those banks which are maintaining safer portfolios. Another Basel II requirement is that companies have to publish the details of their risky investments and risk management practices.

The essential requirements of Basel II are:

• Capital allocations are more risk sensitive.
• Using quantification in order to separating credit risks from operational risks;
• Align the real or economic risk precisely with regulatory assessment.

Basel II, Pillar 1: Minimum capital requirements guides the following main points:

 

• Regulatory Capital – regulatory capital calculations for three major components of risk that a bank faces: credit, operational and market risk where new and more sensitive approaches are available;
• Minimum Capital Adequacy Ratio / CRR – capital requirements are expressed as “Risk Weighted Assets” (RWA) and the minimum adequacy ratio under Basel II is 8%;
• ICG (individual capital guidance/scalars) – a menu of approaches is available for each risk type, ranging from simple standardized methods, to advanced methods permitting some use of a bank internal models, subject to regulatory approval of standards;

 

Basel II, Pillar 2: Focus on supervisory review, which covers the following main points:

 

• ICAAP IRC (all risks) – Tools for supervising regulators to ensure a bank has an appropriate  Internal Capital Adequacy Assessment Process (ICAAP) and sound risk management process, covering it’s overall risk profile on an ongoing basis;
• Stress testing – it assesses Pillar 1 risk beyond the regulatory minimum as well as additional risks not covered by Pillar 1, e.g. liquidity risk, concentration risk, business risk;
• SREP – The Supervisory Review Process assesses bank’s ICAAP and allows for additional regulatory capital;

Basel II, Pillar 3: Main focus on market discipline, which covers the following main points:

• Regulatory Reporting Market Discipline – increased public disclosures, both quantitative and qualitative, to allow market to have better picture of the overall risk profile of the bank;
• Transparency and disclosure – this promotes transparency and encourages improved capital management processes in banks;