Basel II Capital Accord (Basel II)
Basel II Information:Basel II, also called The New Accord (correct full name is the International Convergence of Capital Measurement and Capital Standards - A Revised Framework) is the second Basel Accord and represents recommendations by bank supervisors and central bankers from the 13 countries making up the Basel Committee on Banking Supervision (BCBS) to revise the international standards for measuring the adequacy of a bank's capital. It was created to promote greater consistency in the way banks and banking regulators approach risk management across national borders. The Bank for International Settlements (often confused with the BCBS) supplies the secretariat for the BCBS and is not itself the BCBS.
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An earlier accord, Basel I, adopted in 1988, is now widely viewed as outmoded as it is risk insensitive and can easily be circumvented by regulatory arbitrage.
The Basel II deliberations began in January 2001, driven largely by concern about the arbitrage issues that develop when regulatory capital requirements diverge from accurate economic capital calculations.
With the first draft (called Consultative Paper 1) published in June 1999, further consultative papers followed together with a large quantity of other releases, Quantitative Impact Studies Nos. 2, 3 and 4, and papers, a final version was issued in June 2004, with a minor revision released in November 2005. In June 2006 a Comprehensive version was published including all Basel regulations up to this date. Implementation of the Accord is expected by 2008 in many of the over 100 countries currently using the Basel I accord.
The final version aims at:
• 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 the scope for regulatory arbitrage.
While the final accord has largely addressed the regulatory arbitrage issue, there are still areas where regulatory capital requirements will diverge from the economic.
Basel II has largely left unchanged the question of how to actually define bank capital, which diverges from accounting equity in important respects. The Basel I definition, as modified up to the present, remains in place
The Accord In Operation
Basel II uses a "three pillars" concept - (1) minimum capital requirements; (2) supervisory review; and (3) market discipline - to promote greater stability in the financial system.
The Basel I accord only dealt with parts of each of these pillars. For example: of the key pillar one risk, credit risk, was dealt with in a simple manner and market risk was an afterthought. Operational risk was not dealt with at all.
The First Pillar
The first pillar provides improved risk sensitivity in the way that capital requirements are calculated for three major components of risk that a bank faces: credit risk, operational risk and market risk. In turn, each of these components can be calculated in two or three ways of varying sophistication. Other risks are not considered fully quantifiable at this stage.
Technical terms in the more sophisticated measures of market risk include VaR (Value at Risk), EL (Loss function) whose components are PD (Probability of Default), LGD (Loss Given Default), and EAD (Exposure At Default). Calculation of these components requires advanced data collection and sophisticated risk management techniques.
The Second Pillar
The second pillar deals with the regulatory response to the first pillar, giving regulators much improved 'tools' over those available to them under Basel I. It also provides a framework for dealing with all the other risks a bank may face, such as name risk, liquidity risk and legal risk, which the accord combines under the title of residual risk.
The Third Pillar
The third pillar greatly increases the disclosures that the bank must make. This is designed to allow the market to have a better picture of the overall risk position of the bank and to allow the counterparties of the bank to price and deal appropriately.
September 2005 update
On September 30, 2005, the four US Federal banking agencies (the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision) announced their revised plans for the U.S. implementation of the Basel II accord. This delays implementation of the accord for US banks by 12 months.
November 2005 update
On November 15, 2005, the committee released a revised version of the Accord, incorporating changes to the calculations for market risk and the treatment of double default effects. These changes had been flagged well in advance, as part of a paper released in July 2005.
July 2006 update
On July 4, 2006, the committee released a comprehensive version of the Accord, incorporating the June 2004 Basel II Framework, the elements of the 1988 Accord that were not revised during the Basel II process, the 1996 Amendment to the Capital Accord to Incorporate Market Risks, and the November 2005 paper on Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework. No new elements have been introduced in this compilation. This version is now the current version.
Basel II and the Regulators
One of the most difficult aspects of implementing an international agreement is the need to accommodate differing cultures, varying structural models, and the complexities of public policy and existing regulation. Banks’ senior management will determine corporate strategy – as well as the country in which to base a particular type of business-based in part on how Basel II is ultimately interpreted by various countries' legislatures and regulators.
To assist banks operating with multiple reporting requirements for different regulators according to geographic location, there are several software applications available. These include capital calculation engines and extend to automated reporting solutions which include the reports required under COREP/FINREP
Regulators in most jurisdictions around the world plan to implement the new Accord - but with widely varying timelines and use of the varying methodologies being restricted. The United States of America's various regulators are yet (October 2006) to agree on a final approach, see Basel IA for a discussion. In response to a questionnaire released by the Financial Stability Institute (FSI), 95 national regulators indicated they were to implement Basel II, in some form or another, by 2015.
Work is apparently already underway on Basel III, at least in a preliminary sense. The goals of this project are to refine the definition of bank capital, quantify further classes of risk and to further improve the sensitivity of the risk measures.
Above article is licensed under the GNU Free Documentation License. It uses material from the Wikipedia article "Basel II".
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