Basel II Reporting Achieving Market Discipline

Basel II Reporting Achieving Market Discipline

1. Executive Summary

This whitepaper aims at providing an overview of Basel II reporting requirements and highlights the impact, essence, challenges and the approach to develop Basel II reporting solution.

The underlying aim of Basel II is to promote safety and reliability in the financial system by allocating capital in organizations to reflect risk more accurately. This can be attained only by the combination of effective bank-level management, market discipline and supervision. Basel II Accord addresses the perceived shortcomings and structural weaknesses of Basel I. Basel II Committee proposal is based on three mutually reinforcing pillars that allow banks and supervisors to evaluate properly the various risks that banks face. The first pillar ensures that financial institutions hold enough capital to cover their exposure to credit, market and operational risk, the Second pillar intends to ensure that banks follow rigorous processes, they measure their risk exposures correctly, and they have enough capital to cover all their risks. The third pillar is related to market discipline, which encourages safe and sound banking practices through an effective disclosure mechanism.

By placing market discipline in an equal position, alongside minimum capital standards and the supervisory review process, as one of three pillars in the framework, the Basel committee has underscored the importance if market disclosure in ensuring the financial reliability of banks. We will explore the implications of this further in this paper.

Introduction

The Basel II Accord has had far reaching consequences for the Banking and Financial Services industry necessitating significant
transformation in various critical business processes like Risk management practices, Supervisory approaches, and Capital requirement assessments. The framework aims to put in place a comprehensive risk management process to identify, evaluate, monitor and control or mitigate all material risks and to assess the bank’s overall capital adequacy in relation to their risk profile. The framework also stipulates disclosure of this information as a means of achieving market discipline.

While the Basel II framework is a response to criticism on the short comings of Basel I, it also reflects additional analysis on the role of bank capital management. However the interpretation of the Basel II Accord on banking still remains a moving target for those preparing for its implementation. The reason that banks find compliance to Basel II norms difficult is due to increasing number of customer base of the banks, absence of effective risk management solution and absence of system interfaces between the existing stand alone applications of the banks.

Basel II Accord addresses the perceived shortcomings and structural weaknesses of Basel I. The key differences between Basel I and Basel II make Accord as the landmark regulatory framework.

Accord approach reaches the lowest level of Risk Sensitivity compared to Basel I which is at a broader level Operational risk is included in Accord as it was excluded in Basel I

Market Discipline, well defined incentives, new supervisory techniques, flexibilityapproaches, make Accord more powerful
compliance compared to Basel I

Economic Capital is convergent in Accord whereas in Basel I it is divergent

Newer and comprehensive measures for transaction and counter party specific risk in Basel II Accord

Given the disastrous consequences arising from the failure of banking institutions, Basel II is designed to promote financial stability by making the risk management and reporting systems more robust and responsive.

Banks seeking to implement the Basel II framework have come up against significant read blocks including reconciliation of the different dimensions of risk and capital calculation methods, managing data effectively to support the new measurement methods, and costs related to reengineering IT systems and business processes.

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