Basel II
Basel II is the second of the Basel Accords, a series of recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision (BCBS). It was intended to create an international standard that banking regulators could use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face. Basel II aimed to refine the measurement and management of risk compared to its predecessor, Basel I.
The framework has three main pillars:
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Minimum Capital Requirements: This pillar focuses on maintaining sufficient regulatory capital to cover credit risk, operational risk, and market risk. Basel II provides more sophisticated methods for calculating credit risk than Basel I, including standardized and internal ratings-based (IRB) approaches. It also introduces a capital charge for operational risk.
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Supervisory Review Process: This pillar emphasizes the importance of bank supervision and requires regulators to ensure that banks have adequate capital to support all their risks, not just those covered in Pillar 1. It encourages banks to develop and use better risk management techniques and supervisors to review and evaluate banks' internal assessments and strategies. This pillar also grants supervisory authorities greater power to intervene early if a bank is not maintaining adequate capital levels.
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Market Discipline: This pillar aims to promote market discipline by requiring banks to disclose certain information about their risk exposures, capital adequacy, and risk management practices. The goal is to allow market participants to better understand a bank's risk profile and to encourage banks to operate in a safe and sound manner. Increased transparency should encourage sound banking practices.
Basel II was intended to be more risk-sensitive than Basel I and to provide incentives for banks to improve their risk management practices. Its implementation was complex and varied across different countries, and it has been succeeded by Basel III.