New Basel Capital Accord

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Requirements on Risk Management From Pillar 2The supervisory review process is meantnot only to ensure that banks makeappropriate capital charges to cover theinherent risk of all their businessactivities, but also to encourage them todevelop and apply better risk managementprocesses to monitor and managetheir risk (cf. also Sec. 25a KWG).The supervisory review process shallinclude not only an audit of compliancewith the minimum capital charge asunder Pillar 1 but also a review ofwhether banks are implementingappropriate internal procedures andinstruments for risk management, on thebasis of which their capital adequacymay be judged. The risk managementprocess requires a thorough assessmentof all risk exposures, a valuation ofexisting capital adequacy and a comparisonof the risk strategy with thecurrent risk profile.The Basel Committee has made it clearthat increasing capital should not beviewed as the only option for banks totake in the face of growing risks. Moreto the point, banks are expected tofundamentally address inadequate controland risk management processes andimprove these step by step.Pillar 2 cannot be viewed as a discreteelement of the New Basel CapitalAccord, as compliance with its qualitativestandards is required for theAdvanced Measurement Approaches inPillar 1.Under the supervisory review process,the qualitative standards for risk managementby banks and for supervisorshave been summarized as four key principles:Principle 1:Banks should have a process for assessing their overall capital adequacy in relation totheir risk profile and a strategy for maintaining their capital levels.Principle 2:Supervisors should review and evaluate banks’ internal capital adequacy assessmentsand strategies, as well as their ability to monitor and ensure their compliance withregulatory capital ratios. Supervisors should take appropriate supervisory action if theyare not satisfied with the result of this process.Principle 3:Supervisors should expect banks to operate above the minimum regulatory capitalratios and should have the ability to require banks to hold capital in excess of the minimum.Principle 4:Supervisors should seek to intervene at an early stage to prevent capital from fallingbelow the minimum levels required to support the risk characteristics of a particularbank and should require rapid remedial action if capital is not maintained or restored.Principle 1 calls for banks to have a riskmanagement process. The five mostimportant elements of this process are:• oversight of the risk managementprocess by the board of directorsand senior management• sound capital assessment• comprehensive assessment of risks• monitoring and reporting• internal control review18 ERNST & YOUNG – NEW BASEL CAPITAL ACCORD
REQUIREMENTS ON RISK MANAGEMENT FROM PILLAR 2Level:whole companyLevel:individual risksAdjust andcontinuously improve the measures("self-assessment approach")The Risk Management ProcessSet risk management goals, content and infrastructure• risk policy, risk objectives and limits• risk management processes and responsibilities• tools and systemsmonitor efficacy of measures putinto place(variance analysis and benchmarking)Analyze risks(identify, explain, assessand aggregate)Decision-orientedinformationfor risk managementFormulate risk managementstrategies(avoid, reduce, transfer and accept)Define and implement suitablemeasures(set up early-warming system)Ernst & Young has the methodsand the cross-border expertiseto implement the requirementsof Pillar 2 for opportunity andrisk management. Our integratedapproach to the riskmanagement process gives youan organization-wide solutiontailored to meet your needs. Weprovide all-round support, fromstrategic planning through tooperational implementation.A further important aspect ofPillar 2 is the treatment of interestrate risk in the banking book.Interest rate risk in the banking bookis a significant risk which meritssupport from capital. However, there isconsiderable heterogeneity in terms ofthe nature of the underlying risk and theprocesses for monitoring and managingit. The Basel Committee therefore deemsit appropriate that interest rate risk inthe banking book be treated underPillar 2, and that no specific capitalcharge under Pillar 1 be required.In its guidelines on the management ofinterest rate risk in the banking book,the Basel Committee recognizes banks’internal systems as the principal tool forthe measurement of this risk. Banksmust provide supervisors with the resultsof their internal measurement systemsexpressed in terms of economic valuerelative to capital, using a standardizedinterest rate shock.ERNST & YOUNG – NEW BASEL CAPITAL ACCORD19
Page 1 and 2: G LOBAL F INANCIAL S ERVICESB USINE
Page 3 and 4: Table of ContentsPageThe Effects of
Page 5 and 6: THE EFFECTS OF THE NEW BASEL CAPITA
Page 7 and 8: Basel Milestones1974Basel as the Fo
Page 9 and 10: BASEL MILESTONESJanuary 2001/May 20
Page 11 and 12: Effects of the New Basel Capital Ac
Page 13 and 14: The Conceptual Environment of Risk-
Page 15 and 16: SPECIFIC CAPITAL TREATMENT OF CREDI
Page 17: SEPARATE QUANTIFICATION OF OPERATIO
Page 21 and 22: Bibliography - Selected Current Lit
Page 24: ERNST & YOUNG AGWIRTSCHAFTSPRÜFUNG

New Basel Capital Accord

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