We use cookies on our website to support technical features that enhance your user experience. We also use analytics. To opt-out from analytics, click for more information. Navigation menu. The goals of Basel II are: Ensuring that capital allocation reflects level of risk Separating operational risk from credit risk, and quantifying both Attempting to align economic and regulatory capital more closely to reduce the scope for regulatory arbitrage The following figure depicts the scope of application of this framework.
Basel II approach is based on three so-called pillars : Minimum Capital Requirements Supervisory Review Process Market Discipline The first pillar relates to calculating capital necessary for a given level of risks.
Focus areas are: Preventing improper disclosure of information Preventing execution of unauthorised transactions as well as providing means of transmission that will not allow neither modifications nor access to confidential data Preventing system outage and unauthorised changes in the system that would compromise existing security measures It should be noted that banks implement country specific regulations based on Basel II rather than Basel II itself.
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Read more about our banking services. Visit the media centre. In this section:. Basel II: Revised international capital framework The efforts of the Basel Committee on Banking Supervision to revise the standards governing the capital adequacy of internationally active banks achieved a critical milestone in the publication of an agreed text in June Regulatory framework chronology 17 December The Basel Committee announced consultative proposals to strengthen the resilience of the banking sector: Press Release Strengthening the resilience of the banking sector International framework for liquidity risk measurement, standards and monitoring The Committee welcomes comments from the public on all aspects of these consultative papers by 16 April Minimal capital requirements play the most important role in Basel II and obligate banks to maintain minimum capital ratios of regulatory capital over risk-weighted assets.
Because banking regulations significantly varied among countries before the introduction of Basel accords, a unified framework of Basel I and, subsequently, Basel II helped countries alleviate anxiety over regulatory competitiveness and drastically different national capital requirements for banks. Basel II divides the eligible regulatory capital of a bank into three tiers. The higher the tier, the less subordinated securities a bank is allowed to include in it.
Each tier must be of a certain minimum percentage of the total regulatory capital and is used as a numerator in the calculation of regulatory capital ratios. Tier 1 capital is the most strict definition of regulatory capital that is subordinate to all other capital instruments, and includes shareholders' equity, disclosed reserves, retained earnings and certain innovative capital instruments. Tier 2 is Tier 1 instruments plus various other bank reserves, hybrid instruments, and medium- and long-term subordinated loans.
Tier 3 consists of Tier 2 plus short-term subordinated loans. Another important part in Basel II is refining the definition of risk-weighted assets , which are used as a denominator in regulatory capital ratios, and are calculated by using the sum of assets that are multiplied by respective risk weights for each asset type.
The riskier the asset, the higher its weight. The notion of risk-weighted assets is intended to punish banks for holding risky assets, which significantly increases risk-weighted assets and lowers regulatory capital ratios. The main innovation of Basel II in comparison to Basel I is that it takes into account the credit rating of assets in determining risk weights. The higher the credit rating, the lower the risk weight. Regulatory supervision is the second pillar of Basel II that provides the framework for national regulatory bodies to deal with various types of risks, including systemic risk, liquidity risk, and legal risks.
The market discipline pillar provides various disclosure requirements for banks' risk exposures, risk assessment processes, and capital adequacy, which are helpful for users of financial statements.
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