The objective of Basel II Capital accord is: 1. To promote safety and soundness in the financial system 2. To continue to enhance completive equality 3. To constitute a more comprehensive approach to addressing risks 4. To render capital adequacy more risk- sensitive 5. To provide incentives for banks to enhance their risk measurement capabilities
Basel II „three pillars” Pillar I Basel three piPlillla ar r IsI Pillar III Minimum Supervisory Market Capital Review Process Discipline Requirements Increases the responsibilities and Establishes minimum Bank will be required to levels of discretion for standards for increase their supervisory reviews and management of information disclosure, controls covering: especially on the capital on a more risk • Evaluate Bank’s measurement of credit sensitive basis: Capital Adequacy and operational risks. • Credit Risk Strategies • Operational Risk • Certify Internal Expands the content and Models • Market Risk improves the • Level of capital transparency of financial charge disclosures to the • Proactive monitoring market. of capital levels and ensuring remedial action
The three pillars of Basel II and their principles Objectives • Continue to Basel II promote safety and soundness Minimum capital Supervisory review Market disclosure requirements process in the banking system • How is capital • How will supervisory • What and how should e adequacy measured bodies assess, banks disclose to particularly for monitor and ensure external parties? • Ensure capital Advanced capital adequacy? Issu approaches? adequacy is sensitive to the • Better align regulatory • Internal process for • Effective disclosure of: level of risks capital with economic risk assessing capital in - Banks’ risk profiles • Evolutionary approach to relation to risk profile - borne by banks Adequacy of capital assessing credit risk • Supervisors to review positions le - Standardised (external and evaluate banks’ • Specific qualitative and ip • Constitute a factors) internal processes c quantitative disclosures - Foundation Internal • Supervisors to require more - Scope of application rin Ratings Based (IRB) banks to hold capital in comprehensive P - Advanced IRB excess of minimum to - Composition of approach to • Evolutionary approach to cover other risks, e.g. capital addressing risks operational risk strategic risk - Risk exposure - Basic indicator • Supervisors seek to assessment - Standardised intervene and ensure - Capital adequacy - Adv. Measurement compliance • Continue to Pillar 1 Pillar 2 Pillar 3 enhance 4 competitive equality
Overview of Basel II Approaches (Pillar I) Basic Indicator Approach Score Card Operational Risk Standardized Approach Capital Loss Distribution Advanced Measurement Internal Modeling Approach (AMA) Standardized Total Credit Standardized Approach Regulatory Risk Capital Capital Foundation Internal Ratings Based (IRB) Advanced Standard Model Market Risk Capital Internal Model
Credit risk Basel II approaches to Credit Risk Evolutionary approaches to measuring Credit Risk under Basel II Internal Ratings Based (IRB) Approaches Standardised Foundatio Advance Approach n d • RWA based on externally • RWA based on internal • RWA based on internal provided: models for: models for –Probability of Default –Probability of Default –Probability of Default (PD) (PD) (PD) –Exposure At Default • RWA based on externally –Exposure At Default (EAD) provided: (EAD) • Li – mi Lto e sds rG e ive co n g D niteifa o u n lto f –Exposure At Default –Loss Given Default • Internal estimation of cred(iLtG r D is )k mitigation & • Li ( m E it A e D d ) recognition of (LGD) parameters for credit risk supervisory treatment of cr – eLo di s t sr G is ive k n mi De tig fau ati lt o n & mitigation – guarantees, collateral and guarantees su ( p L e G r D vi ) sory treatment of collateral, credit collateral and guarantees derivatives Increasing complexity and data requirement 6 Decreasing regulatory capital requirement
Solvency II versus Basel II Pillar 1 Solvency Basel II Minimum C I api Ital Requirements: Minimum Capital Requirements: -Target and minimum solvency -Minimum acceptable capital levels. capital requirement.
-lntemal ratings-based (IRB) - Minimum solvency capital depends on approach to determining credit the dollar value of policies written. risk charge
- Calculation takes a risk-based - Explicit treatment of operational approach around assets. liabilities, ("event") risk in capital and underwriting information. calculations—3 approaches
with increasing complexity. =Target solvency capital typically the same as economic risk capital to - -Computation of capital charge. cover disaster scenarios. -Credit risk—3 approaches with increasing complexity. ‘ -Operational Risk-3 approaches with increasing complexity.
Supervisory Review Process: ~ Banks assess their own solvency relative to risk pro l ﬁ e. Solvency II versus Basel II Solvency Pillar 2 Basel II SupervisoIrIy Review Supervisory Review Process: Process:
-Insurer supervisors monitoring the ~Banks assess their own solvency amount of their existing capital. relative to risk proﬁle. -improving cooperation and standardiza- -Supervisors review the bank's tion among regulators across assessments and capital strategies national borders.
- Banks hold capital in excess of L -Assessment of internal controls, minimum requirements. risk management, and segregation of duties. stress testing of IT ° Regulators intervene at an infrastructure and systems, early stage if capital levels senior management capabilities, deteriorate. and the balance between assets - Perspective of the supervisor. and liabilities.
Solvency II versus Basel II Solvency Pillar 3 Basel II Disclosur II e and Market Disclosure and Market Discipline: Discipline: -Improved public access to the -Increased disclosure of capital insurer’s financial and risk structure. i management information. -Increased disclosure of risk me surement and management. -Efforts to comply with accepted best practice frameworks. -Increased disclosure of risk profile. - Increased disclosure of capital adequacy. - Qualitative and quantitative information in three general areas: corporate structure, capital structure and adequacy, and risk management.