The Three Pillars Of Regulation

Basel II is more complex than Basel I due to:
1. covers an area larger risks;
2. introduced three-tier approach;
using more complex methods of calculating risk.

Basel I → risk of credit and market risk (through the 1996 Market Risk Amendment).
Basel II operational risk → + + 'other risk' to calculate risk-based capital of a bank → (Basel II covers credit, market and operational risk).
Basel II also connects the capital of a bank directly with the risks run by banks

Basel II framework of three concepts developed through regulations known as the Three Pillars are:
Pillar 1 - minimum capital requirement is the development of standardized rules introduced in Basel I.
Pillar 2 - supervisory review of capital adequacy and internal assessment process
Pillar 3 - the implementation of 'market discipline' in an effort to strengthen transparency and encourage safe banking practices (safe) and healthy (sound).

Pillar 1 - Minimum Capital Requirement
Within Pillar 1, banks are required to calculate the minimum capital for credit risk, market risk and operational risk (development of the Basel I). For 'traded market risk' there is no change from the Market Risk Amendment in 1996. Interest rate risk in the banking book are not tercover in Pillar 1.

Pillar 2 - Supervisory Review
Pillar 2 is intended to formalize the practice of supervision by bank supervisors today. The concept of Pillar 2 have been found on the Basel I, and is intended to determine the minimum standards that can be applied according to the bank-by-bank basis. 'Supervisory Review' on Pillar 2 applied the same as that of the Federal Reserve Board (USA) and the Financial Services Authority (UK).
Supervisory reviews arranged to focus on:
Each above the minimum capital requirement according to Pillar 1 level, and
Initial actions needed to overcome the risks that will arise.
Pillar 2 also covers review of the interest rate in the banking book. Basel Committee paper "Principles for the Management and Supervision of Interest Rate Risk" which was published in July 2004 containing details of how to manage interest rate risk in the trading book.

Pillar 3 - Disclosure
Pillar Pillar 3 is about market discipline. The Bank for International Settlements (BIS) defines market discipline as a good corporate governance mechanisms of internal and external to the free market economy without government interference.

Pillar 3 is structured to:
1. help bank shareholders and market analysts;
2. increase transparency on issues such as:
Bank asset portfolios, and
The bank's risk profile

Basel I only includes Pillar 1. In practice Pillar 2 and 3 will be found in all countries, although different approaches and their application far.

Risk Coverage - credit, market, operational and other risks
Basel Committee Pillar 1 focuses on credit risk and operational while the Market Risk Amendment does not change. Pillar 1 marked the first time by dicover operational risk quantitative approach. In addition, the Basel Committee to cover 'other risks' on Pillar 2 and 3.