Basel II - the new Capital Accord
Credit institutions, in their capacity as financial intermediaries, play a special part in modern economies. Confidence in the stability of the banking sector is essential for this. In this context, the solvency of banks is especially relevant.
Credit institutions, in their capacity as financial intermediaries, play a special part in modern economies. Confidence in the stability of the banking sector is essential for this. In this context, the solvency of banks is especially relevant.
One of the most important tasks of financial intermediaries is the professional management of credit, market, liquidity and other risk. These risks must not become a threat to the solvency of the institutions or lead to instabilities in the financial sector. Over and above the institutions' own risk provisioning measures, specific regulatory rules were therefore laid down for credit institutions, primary among which are the capital adequacy requirements.
The 1988 Capital Accord (Basel I), which applied until the end of 2006, concentrated solely on the minimum capital for banks as the decisive factor for limiting the risks and therefore the losses in the case of insolvency of an institution. Basel I included capital requirements that involved only credit and market risk and that were based on a slightly differentiated calculation method for the calculation of the capital requirements for credit risk.
Building on Basel I, the new Basel Framework for the International Convergence of Capital Measurement and Capital Standards (Basel II) aims to improve the stability and soundness of the financial system. The key objective of the new capital adequacy framework is to adjust banks' capital requirements more closely to the actually incurred risk than in the past and to take account of recent innovations in the financial markets as well as in institutions' risk management. Additional focal points of the new framework are basic principles for qualitative banking supervision and the expansion of disclosure requirements in order to enhance market discipline.
In order to achieve this, the Basel Framework is divided into three pillars, the second and third of which are new compared to Basel I.
The three pillars of Basel two Pillar 1: the minimum capital requirements, which include capital requirements for credit risk, market risk and operational risk. To determine the capital requirements for these three risk areas, within the framework of an evolutionary approach various risk measurement methods are available: basic, standardised approaches as well as more advanced and more risk-sensitive approaches that are based on internal methods of banks. The more advanced and more precise risk measurement methods can lead to capital relief. Pillar 1 lays down a flexible framework within which a bank, subject to a supervisory approval, may apply an approach that best suits its complexity and risk profile. The approaches for calculating the required underlying capital for market risks, by which Basel I was extended in 1996, were adopted in the Basel Framework.
Pillar 2: supervisory review process (SRP), which adds a qualitative element to the quantitative minimum capital requirements of pillar 1; the SRP mainly aims at identifying the overall risk of an institution and the main influential factors on its risk situation and to evaluate them from a supervisory perspective.
Pillar 3: market discipline, ie the institutions are to be subject to enhanced disclosure requirements in order to make use of the disciplining forces of the markets as a complement to the regulatory requirements.
Basel II is mainly directed at large, internationally active banks. The basic concept should, however, also be suitable for application to banks of varying levels of complexity and business activities.
During the development of the Basel II Framework, which started in 1998, there was an intensive dialogue between the banking supervisors, the banking industry, policy makers and other interested parties. Three consultation papers and several Basel Committee impact studies contributed to the development of rules that are in line with common practice. With the help of quantitative impact studies (QIS), in which banks made test calculations for the respective current rule proposals, it was possible to estimate the resulting future capital requirements. On this basis, the risk weight formulas were adjusted so that, when institutions change to more advanced measurement approaches, they still have moderate incentives for capital reduction and the previous worldwide capital level stays more or less the same.
The Basel Framework was published in June 2004, extended by trading book aspects and the treatment of the double default effects for guarantees in July 2005 and came into force at the end of 2006.
At a European level, the implementation of Basel II as binding law occurred with the publication of the Banking Directive (2006/48/EC) and the Capital Adequacy Directive (2006/49/EC) in June 2006. In Germany, Basel II was incorporated into national law by means of changes to the Banking Act and by means of additional regulations, in particular the Solvency Regulation (Solvabilitätsverordnung) (currently only available in German) published in mid-December 2006 and the Regulation governing large exposures and loans of €1.5 million or more (Groß- und Millionenkreditverordnung). The Solvency Regulation constitutes the focal point of the implementation of the first pillar of Basel II. Likewise, most of the third pillar of Basel II was incorporated into the Solvency Regulation. The qualitative requirements anchored in the second pillar are given concrete shape in the Minimum Requirements for Risk Management (Mindestanforderungen an das Risikomanagement). The quantitative requirements of the second pillar of Basel and of the European Banking Directive on the interest rate shock were incorporated into Circular 07/2007 (only available in German) of the Federal Financial Supervisory Authority (BaFin) concerning the interest rate risks in the banking book and the determination of the effects of a sudden and unexpected interest rate change.
