Basel II’s Three Pillars of Compliace

The rules that comprise Basell I are built around the three pillars of minimum capital requirements, supervisory review process and market discipline.

While the minutiae of the supervisory regulations issued for Basel II by the Bank for International Settlements is as drawn out as its official name -- Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework -- there are three simple points around which the accord is based:

Pillar 1: Minimum Capital Requirements

This is the aspect of Basel II that aims to align minimum capital requirements more closely with a bank's risk of loss. It is calculated for the three major aspects of risk that affect financial institutions: credit risk, market risk and operational risk. In most areas of the world, a bank has three options for calculating credit risk under Basel II: the standardized approach, the internal rating-based approach (IRB) and the advanced IRB.

Pillar 2: Supervisory Review Process

This pillar deals with regulatory or supervisory review of a financial institution's risk profile and its internal credit calculations and assessment. Under this process, regulators also examine risks not defined when establishing minimal capital requirements, such as interest rate risk, reputational risk and legal risk.

Pillar 3: Market Discipline

This pillar deals with the increased transparency through public disclosure and reporting requirements. The increased disclosure is aimed at giving the public and the market a clearer vision of where the bank stands on risk.

This story is a sidebar to the feature, Banks Make Headway Towards Basel II
While international banks have made considerable progress toward complying with the provisions of Basel II, U.S. banks still are waiting for the final rules. But that isn't keeping them from reexamining their risk management technologies.