Question

Basel II was a response to shortcomings in the original Basel Accord (Basel I, 1988). In particular, Basel II revised the framework of Basel I to adopt more risk-sensitive minimum capital adequacy requirements that take into account: I. increased credit risk. II. market risk associated with off-balance sheet trading activities. III. operational risk, such as computer failure and fraud. Which of the following is correct?

• II and III only.

• II only.

• III only.

• I only.

• I, II, and III.

Answer 1

Basel 1 was formed with the main objective of specify a minimum capital requirement for banks. This was introduced during 1988 to address the risk management issue from a bank’s capital adequacy angle. During that time, the principal concern was on the Capital Adequacy of the Banks.

Basel II was implemented in early 2008 in most major economies; However, the back ground publishing work started since 2004, with an intention to amend international banking standards., based on the recommendations of the BASEL committee on Banking Supervision;

The main objective of Basel 2 was to introduce a need to conduct a supervisory review of the bank’s capital adequacy, rather than just to specify the minimum capital requirements.

Basel -2 consist of 3 concepts. They are,

- Minimum capital requirements: To develop and expand the standardised rules set out in the Basel 1;

- Supervisory review: of capital adequacy and internal assessment process of a financial institution;

- Market Discipline: Effective use of disclosure as a tool to strengthen market discipline and encourage sound banking practices.

One of the key objectives of Basel 2 is to ensure that the credit risk, operational risk and market risk are quantified based on the data received.

Based on this, all the three: i,ii,iii are correct;

I. increased credit risk. II. market risk associated with off-balance sheet trading activities. III. operational risk, such as computer failure and fraud (this comes under the operational risk defintion covering risks arised due to failed internal process, people or systems, etc) .