basel II three pillars, three pillars, basel II, regulatory capital

Three pillars of Basel II

Three Mutually supporting pillars form the basis of the New Accord

The Accord is built around three mutually reinforcing pillars:

Pillar 1 describes the calculation for regulatory capital for credit, operational and market risk. Credit risk regulatory capital requirements are more risk based than the 1988 Accord. an explicit operational risk regulatory capital charge is introduced for the first time while market risk requirements remain the same as in the Current Accord.

Pillar 2 is intended to bridge the gap between regulatory and economic capital requirements and gives supervisors discretion to increase regulatory capital requirements if weaknesses are found in a lender's internal capital assessment process.

The aim of pillar 3 is to allow market discipline to operate by requiring lenders to publicly provide details of their risk management activities, risk rating processes and risk distributions.

For a Basel II industry guide please go here

Basel II, Third Pillar - reporting

Credit Risk reporting requirements under the Accord fall into three categories:

· Public Disclosure

· Regulatory

· Internal Reporting

Companies will calculate their regulatory capital for their own level of credit risk, however financial companies must be able to demonstrate that it is using the same information for internal credit risk management therefore Regulatory reports must show a true reflection of what the companies internal risk reports are showing.

Basel II Software Manufacturers Review

Many different companies are selling risk management software to help financial institutions to get ready fro the implementation date of Basel II, December 2006. Most of these offer modules which can aggregate Credit Risk, Market Risk and Operational Risk

Basel II Background - why

EAD, PD and LGD Credit Risk Models for Basel II

EAD, PD and LGD values will be created by credit risk models that use inputs from underlying transactions/facilities. These models will be the responsibility of the business areas and they will be implemented and operated under formal change control to ensure the integrity of the output. Although these models will be similar to those being developed for Economic Value Management (EVM), they differ in terms of both the inputs needed and calculation. Therefore, the Accord models will be separate and in addition to the EVM models.

Credit Risk exposure data will be referenced in predefined dimensions (such as Asset Class) to enable it to be segmented in a number of ways using the same data. Additional data will be captured to enable the data to be identified by source system, originating business area and the credit risk models used to create the data items.

Reporting

Data will be captured monthly and the underlying on-balance sheet utilisation values will be reconciled General Ledger systems. Data used in reports must be capable of being decomposed into the underlying credit risk elements and these elements must be capable of further decomposition to the models from which they were calculated and in turn to the underlying transactions that they represent.

Data will be captured from business areas at sub-value center level and consolidated into higher-level portfolios from which reports will be produced. This consolidation will be based on internal and legal hierarchies which are held by Group Finance.

A system will be built that will capture, store and consolidate credit risk data to produce the Accord reports in a controlled and auditable way. In order to provide the system with the necessary data, the Project Accord business area workstreams will have to manage changes to source systems and develop Accord compliant credit risk models.