Basel II

Pillar 3: Enhanced disclosure (discipline of market)

The minimum capital requirements (Pillar 1) and the supervisory review process (Pillar 2) are being reinforced by transparency requirements (Pillar 3) which are designed to facilitate a complementary use of market mechanisms for prudential purposes. This is based on the assumption that well informed market participants will reward a risk-conscious management strategy and effective risk control by credit institutions in their investment and credit decisions and will correspondingly penalise riskier behaviour. This gives credit institutions a greater incentive to monitor and efficiently manage their risks.

A flexible concept was devised in order to achieve such market discipline and concurrently to accommodate the interests both of credit institutions and of market participants. Thus when determining the disclosure practice of individual banks, due heed can be paid to the principles of substantiality and of the protection of confidential information in relation to the scope and frequency of the disclosure.

The disclosure proposals are framed primarily as recommendations, as in many cases the banking supervisory authorities do not have responsibility for issuing disclosure regulations. But where disclosure concerns the application of certain internal procedures – such as the use of internal ratings, asset securitisation or the recognition of collateral when calculating the capital charge needed to back credit risk – they have the status of rules. This is because by using the aforementioned procedures an institution may achieve a lower capital requirement. A precondition for prudential recognition of capital-reducing internal procedures and instruments is compliance with the associated transparency requirements so as to ensure some public control over the discretion which such internal systems give to institutions.

The transparency requirements relate to the following areas:

• application of the capital rules,
• capital (amount and structure)
• quantitative and qualitative capturing of the risks incurred.