Three Pillars of Basel II
Basel II is a regulatory framework for banks and financial institutions that aims to strengthen the global financial system by improving risk management practices. It consists of three main pillars that provide a comprehensive approach to financial risk management:
Pillar 1: Minimum Capital Requirements
- This pillar focuses on the calculation of minimum capital requirements that financial institutions should maintain to cover their credit, market, and operational risks. The requirements are determined by assessing the risk profile of the institution using various methods, including the standardized approach, internal ratings-based approach, and advanced measurement approach.
Pillar 2: Supervisory Review Process
- Pillar 2 requires banks and financial institutions to establish a comprehensive framework for assessing and managing risks, including stress testing and scenario analysis. The supervisory review process involves regular assessments by regulators to ensure that financial institutions have adequate risk management processes in place.
Pillar 3: Market Discipline
- Pillar 3 aims to promote market discipline by requiring financial institutions to disclose relevant information about their risk profile, capital adequacy, and risk management practices. The disclosure helps stakeholders, including investors and regulators, to make informed decisions and assess the overall risk profile of financial institutions.
Overall, the three pillars of Basel II provide a comprehensive framework for financial institutions to manage their risk exposure and maintain a sound financial position. The framework is intended to enhance the stability of the financial system by promoting prudent risk management practices.
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