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Basel Ii

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The Basel II was proposed in 1999 as a more comprehensive capital adequacy accord, formally known as A Revised Framework on International Convergence of Capital Measurement and Capital Standards, and informally as “Basel II”. Each Pillar of Basil I was expanded to cover new approaches.

A. Pillar I
Known as Minimum Capital Requirements, Basel II creates a more sensitive measurement of a bank’s risk-weighted assets. It broadens the scope of regulation to include assets of the holding company of an internationally active bank to avoid the risk that a bank will “hide” risk-taking by transferring its assets to other subsidiaries.

Basel II proposes three mutually exclusive methods. The first method, known as the Basic Indicator Approach, recommends that banks hold capital equal to fifteen percent of the average gross income earned by a bank in the past three years. Regulators are allowed to adjust the 15% number according to their risk assessment of each bank. The second method, known as the Standardized Approach, divides a bank by its business lines to determine the amount of cash it must have on hand to protect itself against operational risk. Each line is weighted by its relative size within the company to create the percentage of assets the bank must hold. The third method, the Advanced Measurement Approach is much more demanding for regulators and banks alike: it allows banks to develop their own reserve calculations for operational risks. Regulators, of course, must approve the final results of these models. In its evaluation of market risk, Basel II makes a clear distinction between fixed income and other products such as equity, commodity, and foreign exchange vehicles and also separates the two principal risks that contribute to overall market risk: interest rate and volatility risk.

B. Pillars II and III
Pillar II primarily addresses regulator-bank interaction, extending the rights of the regulator in bank supervision and dissolution. While Pillar III looks to increase market discipline within a country’s banking sector. In sum, disclosures of a bank’s capital and risk-taking positions that were once only available to regulators are recommended to be released to the general public in the Basel II Accord.

C. Implementation
Basel II underwent seven years of deliberation and two revisions before a final agreement was agreed upon by all G-10 nations and representatives. The only major country outside the G-10 that has not announced its intentions to adopt Basel II’s standards is China: it asserts that its own domestic regulation and the adoption of Basel I standards will be sufficient to ensure the stability of its banking system.

D. Criticisms Related to Emerging Market Economies
The principle criticism of Basel II is that the Basel Committee has expressly stated that its recommendations are for its G-10 member states and not for developing economies. Next, Basel II is criticized for its retention of the “sovereign ceiling” in its estimation of bank asset risk. Finally with the addition of internal risk measurements in the calculation of a bank’s capital reserves, Basel II may cause banks to function in a way that is pro-cyclical to the business cycle

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