Basel I and Basel II

Why BASEL II

Basel II much more risk sensitive, as it is aligning capital

requirements to risks of loss. Better risk management in a bank
means bank may be able to allocate less regulatory capital.

The objective of Basel II is to modernise existing capital

requirements framework to make it more comprehensive and
risk sensitive.

The Basel II framework therefore designed to be more sensitive

to the real risks that firms face than Basel I.

Apart from looking at financial figures, it also considers

operational risks, such as risk of systems breaking down or
people doing the wrong things, and also market risk.

FINAL OBJECTIVE Basel II

Ensuring that capital allocation is more

risk sensitive
Separating operational risk from credit
risk, and quantifying both
Attempting to align economic and
regulatory capital more closely to reduce
scope for regulatory arbitrage

Three Pillars of Basel II Framework

Pillar 1 sets out the minimum capital requirements firms will be

required to meet to cover credit, market and operational risk.
Pillar 2 sets out a new supervisory review process. Requires
financial institutions to have their own internal processes to assess
their overall capital adequacy in relation to their risk profile.
Pillar 3 cements Pillars 1 and 2 and is designed to improve market
discipline by requiring firms to publish certain details of their risks,
capital and risk management as to how senior management and the
Board assess and will manage the institution's risks.

Pillar 1 : Minimum capital requirements

Institution's total regulatory capital must be at
least 8% (ratio same as in Basel I) of its risk
weighted assets, based on measures of THREE
RISKS

Pillar 2 : Supervisory Review

Covers Supervisory Review Process, describing principles for
effective supervision.
Supervisors obliged to evaluate activities, corporate governance,
risk management and risk profiles of banks to determine whether
they have to change or to allocate more capital for their risks
(called Pillar 2 capital)
Deals with regulatory response to the first pillar, giving regulators
much improved 'tools' over those available to them under Basel I
Also provides framework for dealing with all the other risks a
bank may face, such as Systemic risk, pension risk, concentration
risk, strategic risk, reputation risk, liquidity risk and legal risk,
which the accord combines under the title of residual risk
It gives banks a power to review their risk management system.

Pillar 3 : Market Discipline

Covers transparency and the obligation
of banks to disclose meaningful
information to all stakeholders
Clients and shareholders should have
sufficient understanding of activities of
banks, and the way they manage their
risks

THANK YOU

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