The Basel II accord establishes three pillars for regulating banks' capital requirements: 1. Pillar I sets minimum capital standards to cover credit, market, and operational risks using standardized or advanced approaches. 2. Pillar II involves supervisory review of banks' risk management strategies and capital adequacy plans. Supervisors ensure banks hold capital above minimum levels. 3. Pillar III promotes market discipline through disclosure requirements for banks to publish details of their risk exposures and capital adequacy. The objectives of Basel II are to promote banking system safety and soundness, enhance competitive equality, and make capital requirements more risk sensitive through a more comprehensive approach to risk management.

1. BASEL II

2. Objectives
 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

3. Basel II „three pillars”
Basel three pillars
Pillar I Pillar II Pillar III
Minimum Capital Supervisory Market Discipline
Requirements Review Process
Establishes minimum Increases the Bank will be required to
standards for responsibilities and levels of increase their information
discretion for supervisory disclosure, especially on the
management of capital
reviews and controls measurement of credit and
on 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

4. The three pillars of Basel II and their
principles 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 external
Issue
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
positions
Principle
- 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

5. 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
Approach
Regulatory Risk
Capital Capital Foundation
Internal Ratings
Internal Ratings
Based (IRB)
Based (IRB)
Advanced
Standard
Standard
Model
Model
Market
Risk
Capital Internal
Internal
Model
Model

6. 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

7. Solvency II versus Basel II
Solvency
Pillar 1 Basel II
II
Minimum 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 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.

8. Supervisory Review Process:
~ Banks assess their own solvency
relative to risk profile.
Solvency II versus Basel II
Solvency Pillar 2 Basel II
II
Supervisory 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.

9. Solvency II versus Basel II
Solvency Pillar 3 Basel II
II
Disclosure 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.

10.  Thank You
Bonus:
http://www.youtube.com/watch?v=o2kGYUP7Vro