Objectives The objective of Basel II Capital accord is:1. To promote safety and soundness in the financial system2. To continue to enhance completive equality3. To constitute a more comprehensive approach to addressing risks4. To render capital adequacy more risk- sensitive5. To provide incentives for banks to enhance their risk measurement capabilities
Basel II „three pillars” Basel three pillars Pillar I Pillar II Pillar III Minimum Capital Supervisory Market Discipline Requirements Review ProcessEstablishes minimum Increases the Bank will be required tostandards for responsibilities and levels of increase their information discretion for supervisory disclosure, especially on themanagement of capital reviews and controls measurement of credit andon a more risk sensitive operational risks. covering:basis: • Evaluate Bank’s Capital • Credit Risk Adequacy Strategies Expands the content and • Operational Risk • Certify Internal Models improves the transparency • Market Risk • Level of capital charge of financial disclosures to the market. • Proactive monitoring of capital levels and ensuring remedial action
The three pillars of Basel II and theirprinciples Objectives • Continue to Basel II promote safety Minimum capital Supervisory review and soundness in Market disclosure the banking requirements process • How is capital adequacy • How will supervisory • W and how should hat system measured particularly for bodies assess, monitor banks disclose to externalIssue Advanced approaches? and ensure capital parties? • Ensure capital adequacy? adequacy is sensitive to the • Better align regulatory • Internal process for • Effective disclosure of: capital with economic risk assessing capital in level of risks - Banks’ risk profiles • Evolutionary approach to relation to risk profile - Adequacy of capital borne by banks assessing credit risk • Supervisors to review and positionsPrinciple - Standardised (external evaluate banks’ internal • Constitute a more • Specific qualitative and factors) processes - Foundation Internal • Supervisors to require quantitative disclosures comprehensive - Scope of application approach to Ratings Based (IRB) banks to hold capital in - Advanced IRB - Composition of capital excess of minimum to addressing risks • Evolutionary approach to cover other risks, e.g. - Risk exposure operational risk strategic risk assessment - Basic indicator • Supervisors seek to - Capital adequacy - Standardised intervene and ensure - Adv. Measurement compliance • Continue to enhance Pillar 1 Pillar 2 Pillar 3 competitive equality 4
Overview of Basel II Approaches (Pillar I) Basic Indicator Basic Approach Approach Score Card Operational Standardized Standardized Risk Approach Approach Capital Loss Distribution Advanced Advanced Measurement Measurement Internal Modeling Approach (AMA) Approach (AMA) Standardized Standardized Total Credit Approach ApproachRegulatory Risk Capital Capital Foundation Internal Ratings Internal Ratings Based (IRB) Based (IRB) Advanced Standard Standard Model Model Market Risk Capital Internal Internal Model Model
Credit risk Basel II approaches to Credit Risk Evolutionary approaches to measuring Credit Risk under Basel II Internal Ratings Based (IR Approaches B) Standardised Approach Foundation Advanced • RW based on externally A • RW based on internal A • RW based on internal A provided: models for: models for – Probability of Default – Probability of Default – Probability of Default (PD) (PD) (PD) – Exposure At Default • RW based on externally A – Exposure At Default (EAD) provided: (EAD)• Limited recognition of credit – Loss Given Default – Exposure At Default – Loss Given Default • Internal estimation of risk mitigation & supervisory (LGD) • Limited recognition of credit (EAD) (LGD) parameters for credit risk treatment of collateral and – mitigation Default riskLoss Given & mitigation – guarantees, guarantees (LGD) supervisory treatment of collateral, credit derivatives collateral and guarantees Increasing complexity and data requirement 6 Decreasing regulatory capital requirement
Solvency II versus Basel II Solvency Pillar 1 Basel II IIMinimum Capital 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 creditthe dollar value of policies written. risk charge- Calculation takes a risk-based - Explicit treatment of operationalapproach around assets. liabilities, ("event") risk in capitaland underwriting information. calculations—3 approaches with increasing complexity.=Target solvency capital typically thesame 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 proﬁle. Solvency II versus Basel II Solvency Pillar 2 Basel II IISupervisory Review Supervisory ReviewProcess: Process: -Insurer supervisors monitoring the ~Banks assess their own solvencyamount of their existing capital. relative to risk proﬁle. -improving cooperation and standardiza- -Supervisors review the bankstion among regulators across assessments and capital strategiesnational borders. - Banks hold capital in excess ofL -Assessment of internal controls, minimum requirements.risk management, and segregationof duties. stress testing of IT ° Regulators intervene at aninfrastructure and systems, early stage if capital levelssenior management capabilities, deteriorate.and the balance between assets - Perspective of the supervisor.and liabilities.
Solvency II versus Basel II Solvency Pillar 3 Basel II IIDisclosure and Market Disclosure and MarketDiscipline: 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 acceptedbest 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.