Basel II: Three Pillars (2024)

FAQs

Basel II: Three Pillars? ›

Basel II uses a "three pillars" concept – (1) minimum capital requirements (addressing risk), (2) supervisory review and (3) market discipline.

Basel II is the second of three Basel Accords. It is based on three main "pillars": minimum capital requirements, regulatory supervision, and market discipline.

Basel II is an international business standard that requires financial institutions to maintain enough cash reserves to cover risks incurred by their operations. The Basel accords are a series of recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision.

Basel III: Necessary, but not sufficient.

The Pillar 2 supervisory review process is an integral part of the Basel Framework. It is intended to ensure that banks not only have adequate capital to support all the risks in their business but also develop and use better risk management techniques in monitoring and managing these risks.

Pillar 3: Market Discipline

Pillar 3 aims to ensure market discipline by making it mandatory to disclose relevant market information. This is done to make sure that the users of financial information receive the relevant information to make informed trading decisions and ensure market discipline.

Pillar 3 promotes market discipline through prescribed public disclosures. As Basel 3 is implemented at the jurisdictional level, not all regulatory agencies require the same measures or levels of detail in their disclosure requirements.

Considered types of risks are: credit risk, operational risk and market risk. The first pillar provides several approaches for risk calculation, so that a bank can choose which technique shall be used.

The Basel III accord raised the minimum capital requirements for banks from 2% in Basel II to 4.5% of common equity, as a percentage of the bank's risk-weighted assets. There is also an additional 2.5% buffer capital requirement that brings the total minimum requirement to 7%.

The disadvantages of Basel II Accord revealed by the international crises can be: the internal rating method of risks evaluation is so complex, that is very difficult to be applied by countries in East and Central Europe, the responsibilities for bank supervisors are very high and the capital markets are full of ...

Do US banks follow Basel III? ›

This is often referred to as “gold-plating” the standards. US banking organizations experienced similar, comparatively more rigorous standards than peers in other jurisdictions in 2013 when the United States adopted the Basel III standards.

Basel I introduced guidelines for how much capital banks must keep in reserve based on the risk level of their assets. Basel II refined those guidelines and added new requirements. Basel III further refined the rules based in part on the lessons learned from the worldwide financial crisis of 2007 to 2009.

The rules stem from the 2008 financial crisis and came out soon after the 2023 collapse of four midsize banks. Industry groups have waged a fierce lobbying campaign against the plan, arguing that it would make them less competitive — and make home and business loans less affordable.

The Pillar 2 requirement is a bank-specific capital requirement which supplements the minimum capital requirement (known as the Pillar 1 requirement) in cases where the latter underestimates or does not cover certain risks.

Pillar Two: Global Minimum Taxation

Pillar Two aims to ensure that income is taxed at an appropriate rate and has several complicated mechanisms to ensure this tax is paid.

Examples of these risks are interest rate risk in the banking book; non-financial risks such as strategic risk, business model risk and reputational risk; and aspects of credit concentration risk.

All European banks are regulated under Basel II. There are three pillars under Basel II: (1) minimum capital requirements, (2) supervisory review, and (3) market discipline.

Tier 2 capital is the second layer of capital that a bank must keep as part of its required reserves. This tier is comprised of revaluation reserves, general provisions, subordinated term debt, and hybrid capital instruments.

Basel II requires all banking institutions to set aside capital for operational risk. Standardized approach falls between basic indicator approach and advanced measurement approach in terms of degree of complexity.