The Recommendations

In the recent past, there have been calls for stricter regulations in terms of inspection and with child(p) adequacy of the banking sector as a result of increase stakes faced by banks trading internationally. A committee was therefore create Basel Committee on Banking Supervision, to come up with recommendations that would be adopted by banks to mitigate themselves against the jeopardys they face in their operations.The original proposals by the committee were through with(p) in 2001 and 2003 although due to changing financial environment, revisions have had to be do that has led to the live financial proposals which were expected to be adopted by member countries after universe endorsed by the central bank Governors of G10 countries (BIS, 2009). The Recommendations The theoretical account is set out in 3 pillars the first one being the minimal bang-up requirements which touch on the numeration of the marginal slap-up requirements, nifty bump ( apply standardized ap proach, internal ratings approach as advantageously as securitization exemplar), running(a) take a chance and grocery insecurity.The second pillar touches on the supervisory re catch up with process while the third pillar on market discipline (BIS, 2009). 1st Pillar This pillar gives recommendations on the minimum pileus requirements and how it is calculated for purposes of consultation, market and operational encounters. The capital ratio should be lower than 8% with stage 2 capital being bound to deoxycytidine monophosphate% of Tier 1 capital. The capital ratio is calculated using the regulatory capital and risk weighted assets.Regulatory capital theoretical account includes Tier 1 (paid up capital , disclosed reserves), Tier 2 (undisclosed reserves, asset revaluation reserves, general supply, hybrid capital instruments, subordinated debt and Tier 3 (subordinated suddenly term debts). All these Tiers give be included in the capital base provided total of Tier 2 is subject to maximum of 100% of Tier 1, subordinated debt limited to 50% of Tier 1, Tier 3 capital limited to 250% of Tier 1 capital, general provisions on unsung losses limited to 1.25 percentage points and unrealized gains being subject to a discount of 55% (BIS, 2009). The internal ratings approach of calculating credit risk is based on unexpected losses and expected losses. Under this order there is categorization of exposures into asset classes with different underlying risk characteristics. These classes ar corporate, sovereign, bank, retail and equity. The internal ratings approach should be adopted in the banking gathering in a phased manner.Standardized approach measures credit risk in a standard manner, with the help of external assessments (BIS, 2009). The former(a) method of determining credit risk is through the use of securitization approach where exposure is determined on the basis of the economic substance rather than the legal form. Traditional securitization is where hard cash flow from an underlying hookup of exposures is used to service a minimum of two different ranked positions showing different levels of credit risk.Synthetic securitization on the other hand is where at least two different stratified risks reflecting different levels of credit risk where credit risk of an underlying collection of exposures is transferred, partly or wholly through use of funded or unfunded derivatives that mitigate against the credit risk of the portfolio. Operational risk results from insufficient or inadequate internal processes, people and systems or from external events. Operational risk includes legal risk but not strategic or reputational. This risk is measured using standardized and march on measurement approaches.Market risk is risk of losses in on and off balance sheet positions as a result of variety shows in the market prices. The risks include risks associated with interest relate instruments, forex and commodities. 2nd pillar This pil lar of the Basel II provisions touches on supervisory review, risk management as hygienicspring as supervisory responsibility in relation to risks cladding the banks. Supervisory review ensures that banks have seemly capital to manage risks develop internal capital assessment , how well banks are assessing their capital requirements as regarding risks as well as come of capital held against risks.The second pillar also has 4 provisions on banks i. e. banks should have processes of assessing their overall capital adequacy in relation to risk and maintaining capital levels, banks internal capacity and strategies and compliance with capital ratios. , banks operate to a higher place regulatory capital ratios and capital requirements, and intervention by supervisors to avoid capital falling bellow minimum capital requirements. Other issues to be address under this pillar include interest rate risks, credit risks, operational risks, and market risk (BIS, 2009) 3rd pillarThis touche s on the divine revelation requirements under Basel II. The revelation requirements is to complement pillar 1 and 2 thus encouraging market discipline in terms of study access on risk, capital, risk assessment process. The disclosures should be in line with the management of these risks thus in take informing the market on the banks exposure to risks hence enable consistency, understandability and comparability. The info could be made publicly available and in scale of non disclosure, penalties may be enforced. These, though, varies across different countries.The disclosure requirements under the framework should not conflict with the accounting standards which are overall and if conflicts arise, they should be explained. be disclosures should also be complemented with the frameworks disclosure requirements to clarify the disclosures (BIS, 2009). Materiality of the disclosures should also be considered. Materiality is determined by the effect of omission or inclusion body of an item. The disclosures can also be done on a swindle annually, quarterly, or annual basis depending on the nature of information to be disclosed.Confidential and proprietary information should also be considered in disclosing information to the market. Challenges facing Basel II The implementation of the provisions of Basel II has not been smooth sailing. It has presented about apparent challenges to banks across the globe. The new framework has led to the mobilization of the risk, information systems and finance departments of the banks given the fact that far stretch provisions contained in the accord. This in itself give involve the use of resources in terms of hands and money (Accenture, 2007).Banks are also faced with the challenge of implementation of the framework in terms of the change in the product portfolios as well as economic environments. This is in terms of the capital requirements which under the accord, should be in a higher place the minimum limits. The as sessment of capital requirements may also intimation to changes in product portfolios thus leading to introduction and withdrawal of other products. Despite the apparent benefits brought about by the new accord, some banks view Basel II as a regulatory bottle neck in their operations.Other challenges that accompany the implementation of Basel II is that of the be implication. Given the far reaching provisions of the framework, the cost to be incurred in setting up supervisory teams and risk assessment mechanisms may be out of reach of littler banks or even eat into the profits of well established banking institutions. The costs knotty have led to uncertainty among many bank heads (Accenture, 2007). The current information systems in most banks around the globe cannot adequately collide with the requirements of Basel II.This means that banks will have to either improve on their information systems or overhaul them completely. This brings us back to the issue of cost involved in th e implementation of the framework. The need of historical entropy in the calculation of credit risk, advanced internal rating based approach which requires up to 7 years in historical data or advanced measurement approach which requires up to 5 years of historical data will definitely increase the need of databases by banks which also has cost implications attached to it (Accenture, 2007).The implementation of Basel II will lead to the complete change in the existing systems and processes in order to meet the new regulations in risk determination and management as well as capital adequacy. The implementation of the accord will also see the changes in operations of the banks at the same time calling for closer supervision The borrowing of the recommendations of the accord has received widespread acceptance although the level of implementation is varied.The effect of this is that there may be lack of uniformity hence do comparisons difficult between different banks (Accenture, 2007 ). Conclusion Despite all the above mentioned challenges, the benefits brought about by the implementation of Basel II far outweigh the drawbacks. The provisions enable banks to have and develop credit management and assessment systems that will help them to mitigate these risks effectively. The regulatory capital requirements under the accord will also enable the banks to have adequate capital to finance their operations as well as manage any risk arising thereof.The disclosure requirements also ensure that the market is aware of the operations of the banks. References Accenture. (2007, December 10th). Basel II Impacts Challenges and Opportunities. Retrieved March 16th, 2009, from Accenture http//www. accenture. com/xdoc/en/industries/financial/banking/capabilities/BII_Survey_SAP. pdf BIS. (2009, March 10th). Basel IIRevised worldwide Capiatl Frameork. Retrieved March 16th, 2009, from Bank for International Settlements http//www. bis. org/publ/bcbs128. htm