Practical Guide to Basel II Implementation: Part 2 of 6
In part 1, we provided a general overview to get started with the Basel II implementation. We will now discuss the factors to be considered in determining the application of Basel II from both a supervisor and a bank perspective.
A key objective of Basel II is to encourage improved risk management through the use of three mutually reinforcing Pillars. In their efforts to achieve improved risk management, focusing on one pillar and neglecting the others is not suggested. So, apart from the minimum capital requirements under Pillar 1, it is important to build strong risk-based supervisory review with early intervention and market discipline under Pillars 2 and 3.
Given the economic and banking conditions, the supervisors in each country will adopt the Basel II standards to suit their needs. For example, supervisors in some jurisdictions may wish to retain their current approach to minimum capital requirements and to focus their efforts on building a robust supervisory review framework and to enhance market discipline, consistent with the principles underlying Pillars 2 and 3. Supervisors will also have to consider the cross-border implications of their implementation choice.
Banks in each jurisdiction will be required to follow the Basel II requirements in their jurisdiction. A few requirements for banks a briefly discussed below:
Supervisory framework: All banks should look at developing processes for assessing their capital needs and a strategy for maintaining capital levels, consistent with the principles embodied in Pillar 2. Supervisors are encouraged to review these. The capital level and processes should be tailored to the bank's risk profile, operations and controls. In turn, supervisors should engage in a dialogue with the bank regarding these processes.
Disclosure requirements: All banks are required to make periodic disclosures of information that are timely, accurate and sufficiently comprehensive to provide a basis for effective market discipline.
Human resources: Having the right personnel will be critical to the successful implementation of Basel II. This may involve hiring more qualified staff and enhancing training programmes. In particular, for countries implementing the advanced approaches for Basel II, there is a need to retain both bank and supervisory personnel with the quantitative expertise and skills to understand banks’ rating systems, models and capital assessment strategies in advance of Basel II implementation. Even for the simpler approaches, both bank and supervisory staff may need to upgrade their skills in the areas of credit risk mitigation and operational risk as well as capital adequacy assessment under Pillar 2.
Factors to be considered in choosing a Basel II approach
The decision to implement a particular approach to capital regulation should not be driven by a bank's desire to minimize regulatory capital requirements. At the same time, banks must evaluate what the differences between Basel I and Basel II will mean in practice, and assess the costs and benefits of making such a transition. The main decision points for evaluating the transition to the simple and advanced approaches, respectively, are set out below.
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