Basel Committee on Banking Supervision

Introduction

Basel I, II, III are issued by Basel Committee on Banking Supervision (BCBS) under the umbrella of Basel Accord, which contains recommendations on banking supervision and regulations. These recommendations are called "Basel accord" due to the place where meeting for this document took place. Basel is in Switzerland where committee has its head office in the BIS (bank for international Settlements).

Initially, Basel committee had only Ten members countries, but since 2008 almost all G-20 joined Basel. Basel I is the first document issued by Basel Committee (BCBS) in 1988 which contains minimum capital requirements for banks. At that time all ten group countries implemented this document in their banks. Now this document is considered outdated due to changes and advancement in risk management structures of the banks. Therefore, a need for more comprehensive document was identified, which gave birth to Basel- II. Basel-II had not been implemented completely when Financial Crisis emerged during year 2003, so need for more advanced capital emerged for which recommendations from various members countries were incorporated in Basel-II and this new document was given name of Basel-III.

Primary focus of Basel-I was on credit risk. Bank Assets were categorized in five groups according to credit risk profiles, carrying risk weights from 0% to 100%. Member countries banks were required to hold capital (CAR) equal to 10 % of the risk-weighted assets.

Basel II was introduced when Basel-I became outdated, initially it was published in June 2004, it was made with the intention to safeguard bank assets against financial and operational risk. It has guidelines regarding quantity of capital banks should hold against specific risk weights. Basel II also addressed market and operational risk in its document.

Basel II has "three pillars" concept (a) MCR (minimum capital requirement) (b) SRRP( supervisory risk review process) and (c) market discipline approach.

The first pillar

The first pillar dealt with allocation of capital against credit risk, operational risk, and market risk . These three risk areas were considered critical at that point of time and quantification of these were considered highly important. Basel I dealt with only credit risk portion of this pillar.

The second pillar

The second pillar was developed in response of different regulators inputs. This pillar provides comprehensive tools for the minimization of risk and capital allocation against risky areas such as reputational risk, legal risk, systemic risk. It also empowered bank's management to evaluate risk at their own and improve risk mitigation systems.

The third pillar

Pillar three was a refined version of Pillar two, beside all the components contained in Pillar II, banks were further advised to develop a procedure for disclosure requirements, which would help organizations to determine capital allocation requirement of the institution.

BASEL III was the result of continuation of efforts towards financial stability, which added areas such as liquidity risk, capital adequacy and stress testing in Basel document.

Analysis of Pillar II & III of Basel-II.

The Second Pillar - Supervisory Review Process

This pillar discusses need for supervisory review, risk mitigation guidelines and supervisory transparency along with the treatment of different risks such as interest rate, credit, operational, securitization and concentration respectively. This pillar is the foundation of Basel-II.

Need for supervisory review

Supervisory review process emerged in order to provide guidelines to banks for the allocation of enough capital allocation against different risks and also encourage them to build strong internal risk management functions to effectively monitor and manage risk areas proactively.

This review system places great responsibility on the shoulders of the banks in building internal capital assessment process in order to safeguard their assets and nurturing strong control environment. In this system bank's management ensures to allocate certain percentage of capital (as desired by Basel) against risks.

Supervisors have to evaluate level of risk bank is into and corresponding controls. They also have to