Risk Management under Basel II :

The Second Accord brought in significant changes in risk management in banks. The Basel II accord introduced a new approach based on the three pillars:

Pillar I: Minimum Capital Requirements:

The minimum capital requirement should be calculated based on three risks viz., (a) Credit Risk – (i) Standardized Approach (ii) Internal Ratings Based Approach (b) Operational Risk and (c) Market Risk

Pillar II: Supervisory Review Process: This pillar addresses the issues like the key aspects of supervisory review, risk management guidance and transparency and accountability. It also covers the treatment of interest rate risk in the banking book, credit risk (stress testing, credit concentration risk etc) operational risk, enhanced cross border risks.

The committee had identified four key principles of supervisory review:

(i) Banks should have in place a process for assessing their overall capital adequacy in respect of their risk profile vs. maintenance of capital level

(ii) Supervisors should play a key role in reviewing and evaluating banks’ internal capital adequacy assessments and strategies. Supervisors should also be satisfied with the banks’ abilities in managing the capital adequacy ratios and comply with the regulators’ guidelines. If not satisfied with the performance of banks in their compliance requirements, the supervisors should take appropriate

(iii) Supervisors should ensure that banks maintain and operate above the minimum regulatory capital ratios

(iv) Supervisors should intervene at an early stage, to prevent capital level from falling below the minimum levels required and take quick remedial measures

Pillar III – Market Discipline:

As part of an effective risk management, banks are expected to disclose important information. Such market discipline can contribute to a safe and sound banking environment. These disclosures would assist various stakeholders to review and understand the status of the banks’ operations and strategies in a competitive business environment. These disclosures would assist the investors to make their investment decisions