Basel II

What is the definition o a Basel II

Definition

Basel II is the second part of what is known as the Basel Accords, a three-part international banking framework created by the Basel Committee on Bank Supervision (BCBS). It can be defined as an international banking framework that requires banks and other financial institutions to maintain tangible cash reserves to be able to cover unexpected losses.

Understanding the Basel II

The Basel II is an improvement done on Basel I considering the fact that Basel I had a few lapses such as being inconsiderate of other risks besides credit risks and its failure to put market value into consideration. The Basel II is originally titled, ‘The International Convergence of Capital Management and Capital Standards- A Revised Framework’.

The introduction of the Basel II paved a way for the entrance of updated models for calculating regulatory capital. It requires banks with high-risk assets to have more capital on reserve to cover the unexpected loss. It also requires financial institutions to publish the details of risky investments and risk management practices per time. The requirements of the Basel II are as follows;

• Considering operational risks alongside credit risks (Capital adequacy)

• Ensuring that capital allocations of financial institutions are more risk-sensitive (supervisory review)

• Strengthening market discipline by the use of a disclosure (Market discipline)

These three requirements are known as the three pillars under Basel II; each playing an important role.

The purpose of the first pillar, capital adequacy is to improve the policies of Basel I by considering operational risks, liquidity risks and market risks, alongside the overly emphasized credit risk of Basel I. It not only requires that banks maintain an 8% RWA but also, provides better approaches for banks to calculate capital requirements.

The second pillar, supervisory review, deals with the improving efficient supervision of the internal capacity of banks which was missing in Basel I. Here, it is required of banks to assess the internal capital adequacy and ability to cover all potential risks that they are likely to face during the course of their operations.

The third pillar, market discipline, ensures that relevant market information is disclosed. The purpose of this is to ensure that the users of this information find useful and relevant information that would shape trading decisions.