In 1988, the Basel Committee decided to introduce a capital measurement system commonly referred to as the Basel Capital Accord. This system provided for the implementation of a credit risk measurement framework with a minimum capital standard of 8% by end-1992. Since 1988, this framework has been progressively introduced in virtually all countries with active international banks.

Basel II

In June 2004 central bank governors and the heads of bank supervisory authorities in the Group of Ten (G10) countries endorsed the publication of International Convergence of Capital Measurement and Capital Standards: a Revised Framework, the new capital adequacy framework commonly known as Basel II that consists of three pillars:

“Pillar 1” revises the 1988 Accord’s guidelines by aligning the minimum capital requirements more closely to each bank’s actual risk of economic loss.
“Pillar 2” recognises the necessity of exercising effective supervisory review of banks’ internal assessments of their overall risks to ensure that bank management is exercising sound judgement and has set aside adequate capital for these risks
“Pillar 3” leverages the ability of market discipline to motivate prudent management by enhancing the degree of transparency in banks’ public reporting. It sets out the public disclosures that banks must make that lend greater insight into the adequacy of their capitalisation.

Operational Risk Requirements

One significant difference between the two Accords is the inclusion, in the new Basel Accord, of capital requirements for operational risk. In Pillar 1, the new Framework establishes an explicit capital charge for a bank’s exposures to the risk of losses caused by failures in systems, processes, or staff or that are caused by external events, such as natural disasters. Similar to the range of options provided for assessing exposures to credit risk, banks will choose one of three approaches for measuring their exposures to operational risk that they and their supervisors agree reflects the quality and sophistication of their internal controls over this particular risk area.

By aligning capital charges more closely to a bank’s own measures of its exposures to credit and operational risk, the Basel II Framework encourages banks to refine those measures. It also provides explicit incentives in the form of lower capital requirements for banks to adopt more comprehensive and accurate measures of risk as well as more effective processes for controlling their exposures to risk.

Imlementation Timeframe

The Basel Committee intends for the new framework to be available for implementation in member jurisdictions as of year-end 2006. The most advanced approaches to risk measurement will be available for implementation as of year-end 2007, in order to allow banks and supervisors to benefit from an additional year of impact analysis or parallel capital calculations under the existing and new rules.