Question

differentiate between supervisory review (pillar 2) and market discipline (pillar 3) of Basel 2

Answer 1

Answer:

Supervisory review (pillar 2) of Basel 2 is the process whereby national regulators ensure their home country banks are following the rules. The aim of the Pillar 2 processes is to enhance the link between an institution's risk profile, its risk management and risk mitigation systems, and its capital planning. Pillar 2 can be divided into two major components: (i) aimed at institutions, where those are expected to establish sound, effective and complete strategies and processes to assess and maintain, on an ongoing basis, the amounts, types and distribution of internal capital commensurate to their risk profiles (ICAAP), as well as robust governance and internal control arrangements, and (ii) supervisory review and evaluation process (SREP). The key purpose of SREP is to ensure that institutions have adequate arrangements, strategies, processes and mechanisms as well as capital and liquidity to ensure a sound management and coverage of their risks, to which they are or might be exposed, including those revealed by stress testing and risks institution may pose to the financial system,
Whereas, market discipline (pillar 3) of Basel 2 is the Supplement supervision through enhanced market transparency and market discipline and hence lever to strengthen system stability, That allows market participants to obtain key pieces of information on a bank’s capital, risk profile, risk assessment processes and capital adequacy and improve comparability among banks especially for those relying on internal methodologies. Pillar 3 recognises that market discipline has the potential to reinforce minimum capital standards (Pillar 1) and the supervisory review process (Pillar 2), and so promote safety and soundness in banks and financial systems. Market discipline imposes strong incentives on banks to conduct their business in a safe, sound and efficient manner. It can also provide a bank with an incentive to maintain a strong capital base as a cushion against potential future losses arising from its risk exposures.