BASEL

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Source: http://www.bis.org/publ/bcbs107.pdf

Basel Accords

  • banking supervision Accords
  • recommendations on banking regulations (Basel I, Basel II and Basel III)
  • issued by the Basel Committee on Banking Supervision
  • secretariat at the Bank for International Settlements in Basel (BIS), Switzerland

Which bank must comply

  • $250B of total assets or $10B of foreign assets
  • Basel II compliance is optional for all others
  • examiners can require compliance on a case-by-case basis

Basel Accords History

  • 1988 - Basel (I)
  • 2004 - Basel II (covered in OCEB v1)
  • 2010 - Basel III (covered in OCEB v2)

Basel II goals

  • Ensuring that capital allocation is more risk sensitive;
  • Enhance disclosure requirements which will allow market participants to assess the capital adequacy of an institution
  • Ensuring that credit risk, operational risk and market risk are quantified based on data and formal techniques
  • Attempting to align economic and regulatory capital more closely to reduce the scope for regulatory arbitrage

Pillars

  1. Minimum capital requirements (addressing risk)
  2. Supervisory review
  3. Market discipline

First pillar

Regulatory capital is calculated for three major components of risk.

  1. credit risk
  2. operational risk
  3. market risk
Credit risk
  • can be calculated using:
    • standardized approach
  • Foundation Internal Rating-Based Approach (IRB)
  • Advanced IRB
  • General IB2 Restriction
Operational risk]
  • Basic indicator approach (BIA)
  • Standardized approach (STA)
  • Internal measurement approach (advanced measurement approach - AMA).
Market risk]]
  • Value at risk (VaR)


Second pillar

Deals with the regulatory response to the first pillar Provides a framework for dealing with other risks (residual risk):

  • Systemic risk
  • Pension risk
  • Concentration risk
  • Strategic risk
  • Reputational risk
  • Liquidity risk
  • Legal risk.

The result of this pillar: Internal Capital Adequacy Assessment Process (ICAAP)

Third pillar

  • Complements the minimum capital requirements and supervisory review process
  • Develops a set of disclosure requirements which will allow the market participants to gauge the capital adequacy of an institution
Market discipline
  • supplements regulation as sharing of information facilitates assessment of the bank by others including investors, analysts, customers, other banks and rating agencies which leads to good corporate governance
  • Market discipline operates by requiring institutions to disclose details on the scope of application, capital, risk exposures, risk assessment processes and the capital adequacy of the institution
  • Must be consistent with how the senior management including the board assess and manage the risks of the institution.
Market Participant assessment
  • If market participants have a sufficient understanding of a bank's activities and the controls it has in place to manage its exposures,
  • they are better able to distinguish between banking organisations so that they can reward those that manage their risks prudently and penalise those that do not
  • Disclosures are required to be made at least twice a year
  • Qualitative disclosures (providing a summary of the general risk management objectives and policies ) can be made annually
  • Institutions are also required to create a formal policy on what will be disclosed, controls around them along with the validation and frequency of these disclosures.
  • Disclosures apply to the top consolidated level of the banking group


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