BIS2

BIS II is a redevelopment of the original capital accord BIS I. However BIS II encompasses more than just a minimum capital for credit risk. The total structure of the BIS II accord can be graphically presented as follows:

Pillar One
Minimum capital requirements

Credit risk
Standardized approach
Operational risk Market Risk
Credit risk
Internal ratings based approach
Credit risk
Securitisation framework
Pillar two
Supervisory review process
Pillar three
Market discipline

The structure of BIS II consists of three main pillars.

  • Pillar one: Minimum capital requirements
  • Pillar two: Supervisory review process
  • Pillar three: Market discipline

Pillar one
The first pillar is the main part of BIS II. It comprises 192 pages of the total 242 pages (excluding the annexes). The pillar contains the rules for calculating the regulatory capital. The rules for capital requirements are given for three types of risk.

Credit risk is the risk of loss because a customer does not repay the full loan. Operational risk is the risk of loss due to operational issues (bad management decisions, fraud, incorrect administration, etc.). Market risk is the risk of losses due to a decrease in the value of investments (for instance stock or bond investments).

Credit risk is split into three more sections.

In the standardized approach the credit risk is calculated using standard benchmarks. This method is much like the BIS I method. The internal ratings based approach allows a bank to develop and use its own risk models to calculate the credit risk. A bank must choose which method to use. The third section is the securitisation framework. More and more banks sell the risk (and return) associated with a part of their assets (for instance the mortgages). Because in these cases the risk is (partly) not run by the bank the actual credit risk will have to be calculated.

Pillar two
The second pillar considers the method in which banks and central banks should review the implementation and usage of BIS II. This pillar requires banks to develop their risk management beyond the minimum requirements set out in pillar one. Additional risk types such as interest rate risk should be incorporated in this more comprehensive risk management system. Furthermore it dictates that the BIS II framework should be an integral part of the banks activities. This means for instance the banks general management should be aware of BIS II and should be involved in the decisions surrounding BIS II.

Pillar three

The third pillar is the inspiration for this site. It dictates that banks should publish the outcome of their risk calculations and also their methodology. The idea behind this requirement is that the market will guide the banks towards a set of well established methodologies, thereby making the capital requirements stable throughout the banking world.

Author: Muller, J.J.