"BASEL

II"

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October

2011.

Web.

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2011.

http://www.academon.com/Research-Paper-BASEL-II/92235

Basel ii compliance solution framework (pp2-12) Capital Adequacy beyond Basel: Banking, Securities, and Insurance Book by Hal S. Scott; Oxford University Press, 2005

Basel 11 is an global trade standard reserves aimed to envelop

that obligates maintenance of sufficient cash

risks occurred in business .This standard is just a implemented in 1980s ,the

development of Basel

1 which was initially

improvements include introduction of intricate model for determining regulatory capital .The name Basel is a place in Switzerland Where the team that keeps the agreement convene. Basel 11 is built on the foundation of promoting safety and reliability in the

financial sector via allocation of capital to them so as to reflect risk more accurately. Effective management in the bank level together with market discipline and supervision are the only ways of ensuring that its objectives are met. Basel 11 is concerned with security of financial institutions, specifically banks and is aimed at protecting such incidents as bank failure, is argument is that a series of collapsing banks ld lead to the closedown of the whole banking industry.Baset 11 tries to bind together Capital Adequacy ratio while risking the loans it offers to these banks in an effort to reduce the increasing number of bank failures. However there are less chances of the loan going bad if it is directed to the government as opposed to the private sector .The Basel committee for international banking

supervision first tried this attempt in 1988 and employed a system of appraisals to

determine the extend of risk of different loans. In this paper I am going to focus my attention on the key regulatory provisions of Basel II as well as the Consequences of capital adequacy requirements for the banks. Further I am going to do a comparison of external and internal rating procedures together with the consequences and strategic implications for small and medium sized enterprises.( SIRISHA pp1) BASIS OF BASEL 11 Basel 11 is founded on three joint supporting pillars. Minimum capital requirements (pillar 1) Basel 11 is a new move towards the determination of how data and information of an organization is going to be managed .For those financial institutions which act as think tanks on the implications for their funding there is a provision of rewards in

management capacity together with lesser charges on capital .Basel 11 accord concentrates its efforts elaborating credit on bettering risk measurement means such as

risk measurement methods,introducindg

operational risk

measurement methods as well as ensuring that remain constant.

measurements on market risk

Pillar 1 is concerned with minimum capital requirement as regards different types of risks .It is concerned with credit risk, market risk and operational risk .According to Basel committee credit risk is the potential that a banker borrower or a counter

party will fail to meet its obligations in accordance with the agreed time(Aniel 21).Shifts in exchange rates, interest rates and prices of commodities all of which influence the worth of the positions of the ;on and off balance sheets. On the other hand operational risk is described by Basel committee as the direct or indirect

risk that is derived from unsuccessful internal operations , persons and systems as well as from external forces.(Aniel 21) Banks attempt to minimize the capital they hold due to financial resources which can be reinvested .This means that there is a greater possibility that they will not meet their obligation ,it is due to this that the Basel committee developed schemes through which they regulate risk and the amount of capital that a bank can hold t any one time.The scheme developed by the committee is a least capital

requirement of 8% as compared to the risk-weighted assets. However there is a difference between the minimum capital requirement in Basel 1 and 11 and this is on the way solvency ratio is calculated. Supervisory review process (pillar 2) The main aim of pillar 2 is to reinvestigate the capital competence of financial institutions using national regulatory authorities. Through this pillar, banks are stimulated to come up with their own schemes relating to risk identification, assessment and regulation and to calculate capital requirement. Regular audit of the banks is also necessary as this will offer banks a more advanced autonomy in assessing their capital requirement. This pillar is aimed at ensuring that bank management come up with a scheme that sustains the capital assessment process of the bank. Further it should give a room for setting targets that are equal with the banks specific peril outline and the internal control processes,

control setting. The scheme should prop up

regulatory visibility and supervisory evaluation and mediation. Market discipline (pillar 3)

This pillar calls for an advanced approach in

disclosure requirements. This involves

providing information to different users via many links, coming up with a fully integrated system as well as classification of schemes based on their performance. However Basel 11 advocates for compliance with the rules of the three columns

.This means that the only viable manner of the progress is a time bound change . ( Basel ii compliance solution framework (pp2-12).

Through this pillar reliable financial institutions are established as it emphasizes on plainness in financial accounts .According to this pillar access to capital adequacy of the financial

institutions can be made to both regulators as well as other participants in the market.This means that the financial institutions will be eyed at to a greater extend by the entire market and not by regulators only. The presence of these three pillars will ensure that management of risk is improved in the context of banking industry and this will ensure that financial stability is kept high.

CREDIT RISK Credit Risk denotes the peril that a bank is likely to meet incase a borrower is incapable of repaying back the loan he had borrowed. A good credit management system is therefore advocated for by Basel committee and is geared towards maintaining credit risk exposure

within permissible safety limits. Emphasis should be given to the question on how to identify, monitor and regulate credit risk and on how to determine the approximate amount of capital

that can be held up against a certain risk. Basel committee divides the banks capital by riskweighted assets from the credit risk to arrive at the control credit risk. (BASEL II REGULATION, 13) Comparison between external and internal rating procedures

Basel committee has come up with two schemes of determining capital charges ;Firstly is the standardized approach then the internal rating base method . (a) Standardized approach) This method employs the use of assessment from external agencies in determine the risk weights of commercial banks. According to Basel 11 calculation of risk-weighted assets is based on classes such as borrower like sovereigns as well as corporate and financial banks. In scenarios where the is no external agency the committee calculates the weights for the unrated borrowers.

Internal rating based (IRB) Approach This approach is aimed at making banks echo their personal risk profile more precisely. By employing this approach banks will be able to use their own internal means to assess credit risk in an attempt to calculate capital obligation. Banks are therefore required by the committee to classify their exposures into several categories of assets with distinctive credit characteristics. Risk weight function, risk components and minimum requirements are the only three components that are important foe each of the classes. Basel committee further employs this approach to focus on two main types of losses categorized as expected losses(EL) and tell exactly the extend of losses a financial

unexpected losses(U L) .Though it is not possible

institution will incur ,the average level of expected losses can however be forecast by banks as this type of losses are part and parcel in the business. Unexpected losses are not frequent and are very hard to determine since they do not occur on yearly basis and are unpredictable. Pricing and provisions cannot cover these types of losses and therefore capital is in dire need to deal with UN losses. The capital

Basel committee classify capital into 2 categories namely .Tier 1 capital and Tier 2 capital .The central capital of the bank is considered to be Tier 1 since it is the one that is shown as the equity on the financial statement and consists of the owners equity and the profits ploughed back into the business. Tier 2 capital is considered supplementary and includes long term debts as well as certain reserves .The following components are the building blocks of Tier 2 capital;
Undisclosed reserves considered as conceal reserves and are usually accepted by banks

supervisory authority despite the fact that they are not published
General losses reserves that are not related to any particular asset or liability and are

reserves for unexpected ;losses

Hybrid debt instrument that consist of preferred cumulative shares as well as convertible

reserves they posses a characteristic of both equity and debt.

Subordinated debt that are considered as having lesser

status as compared to other

loans

and are placed at the lower level gauged on tier 2 capital.( BASEL II

REGULATION,19-22)

Basel requirements encourage regulatory arbitrage that is not effective.Excessive capital requirements ac even coerce banks to dispose them off through securitization (112-119).At the same time regulations on the extend of capital required to be maintained by financial

institutions selling security on credit derivatives could make those businesses to dodge banks as well as from insurance firms. A notable example is that noted by Herring and schuermann in which E.U companies are excluded from capital despite the fact that insurance firms hold

more tradable securities as compared to banks. Moreover combined capital regulation of any holding firm is burdened with difficulties and this means that banks as well as insurance companies are likely to encounter different capital management.( Hal S. Scott;2006,pp10-11)

Dual gearing crisis has been explained by professor Jackson .He has raised concerns that investment by banks in a secondary financial institution may be a threat with a combined effort to reward this problem via ban the investment bank from counting its finances that is held in a subsidiary as capital .The whole system of banking regulations can be said to be predicted on the foundation of schematic risk as a result of a certain fear that is untold .