000042330 BASEL II: AN INTRODUCTION TO THE NEW CAPITAL ACCORD GIỚI THIỆU VỀ HIỆP ĐỊNH VỐN MỚI 000042330 BASEL II: AN INTRODUCTION TO THE NEW CAPITAL ACCORD GIỚI THIỆU VỀ HIỆP ĐỊNH VỐN MỚI
B a c k g ro u n d o v e r v ie w
When comparing two factors often deemed unavoidable in business operations—tax and risk—the latter tends to draw more concern and effort from managers due to its inherent uncertainty of outcomes and its broad range of risk categories Managers grapple with crucial questions: What risks does the organization face, and how can they be anticipated, measured, and controlled effectively and efficiently? This ongoing inquiry highlights the central challenges of enterprise risk management and the priority of developing robust strategies to monitor, mitigate, and respond to risk.
Major crises affecting financial institutions highlight the importance of effective problem solving and timely decision making When answers are delayed or incorrect, the consequences can be severe, potentially pushing an organization toward bankruptcy The stakes are highest in critical sectors like banking, the backbone of a country’s economy Strong risk assessment, rapid response capabilities, and sound governance help protect financial stability and prevent broader systemic damage.
History demonstrates that risk anticipation and robust risk management are essential for navigating financial volatility, including bank runs, speculative bubbles and crashes, and international crises Notable cases such as the U.S savings-and-loan crisis of the 1980s and the European Exchange Rate Mechanism (ERM) crisis in 1992 illustrate the costs of weak controls and policy gaps These events highlight the importance of early warning signals, adequate capital buffers, and coordinated crisis-management frameworks to maintain financial stability in an increasingly interconnected global system.
Basel ¡I: An Introduction to the New Capital Accord
Mechanism crisis o f 1992 and 1993 the 1997-98 Asian financial crisis, the 2000 bursting o f the technology stock bubble, or recently the 2007-09 sub-prime crisis.
Amid severe losses during financial crises, the Basel Committee on Banking Supervision—established by the central bank governors of the G10 countries and meeting in Basel, Switzerland—developed common capital frameworks known as Basel I and Basel II The ultimate objective of these Basel Accords is to enhance the stability of financial markets by focusing on the major banking risks: credit, market, and operational risk Banks are required to hold a minimum capital standard of 8% of their risk-weighted assets.
Up to now, all G 10 members finished Basel I application and are on the way to apply Basel
Basel II requirements: Although the Basel Capital Accords were initially designed for internationally active banks in the G10 group, they have gained recognition as a worldwide standard for capital adequacy in banking Over 100 non-G10 countries volunteered to adopt the Basel I framework, with many already applying Basel II and planning to implement it in the near future (Oesterreichische Nationalbank, n.d.) In the Asia-Pacific region, Hong Kong, Singapore, Korea, Japan and Taiwan emerged as pioneer territories, applying the Basel II framework in banking operations and supervision by 2007–2008, while other countries also planned to follow Basel II in 2009–2010 (Asia Focus).
2009) Vietnam plans to fu lly implement Basel I by 2010 and gradually apply Basel II from
1 G 1 0 c o u n trie s in c lu d e B e lg iu m , C a na da, France G e rm a n y, Ita ly , Japan, th e N e th e rla n d s, S pa in , Sweden,
S w itz e rla n d , th e U n ite d K in g d o m , a n d th e U n ite d States.
S tatem ent o f the p ro b le m
Since January 11, 2007, Vietnam has been the 150th member of the World Trade Organization (WTO), a milestone that opened opportunities for Vietnamese firms to enter foreign markets and for foreign companies to operate in Vietnam The banking sector is no exception, with banks like BIDV and Sacombank pursuing regional expansion by planning to establish branches in neighboring countries such as Cambodia, Laos, and China, according to the Ministry of Foreign Affairs.
At the same time, a large number of foreign banks and their branches entered Vietnam's banking and financial market through joint ventures with Taiwan (Indovina Bank), Malaysia (VID Public Bank), or Thailand (VinaSiam Bank) Investing in Vietnamese banks—such as ANZ buying 10% of Sacombank or HSBC taking a 10% stake in Techcombank—offers another route to access the Vietnamese banking market Larger international banks like ANZ, Standard Chartered, HSBC, Hong Leong Bank Berhad, and Shinhan Bank also established 100% foreign-owned subsidiaries The presence of these well-known foreign banks, with a long history and strong financial strength, poses a challenge to Vietnamese banks in their traditional market Additionally, to participate in regional and international financial markets where risks are higher, more complex, and dynamic, Vietnamese banks must meet strict regulations governing operations, capital requirements, and risk management.
In short, compliance w ith international standards, especially in terms o f risk management is now a M U S T fo r Vietnamese commercial banks to compete and maintain its position in domestic market as w e ll as fin d in g a position in foreign markets A m ong the international
Basel //, An Introduction to the New Capital A ccord
Basel II: An Introduction to the iSew Capital Accord standards on risk management, bank managements pay special attention to the Basel Capital Accord, in particular the latest version (Basel II).
In Vietnam, the State Bank of Vietnam (SBV) has adopted a simplified Basel I framework for banks, with implementation planned for completion in the near term This shift is supported by Decision No 457/2005/QD-NHNN, dated 19 April 2005, which sets out prudential ratios for the operation of credit institutions, and by Decision No 493/2005/QD-NHNN, dated 22 April 2005, which provides regulations on debt classification and the establishment and use of provisions against credit risk in banking activities.
Basel I requirements—even the basic ones—have not been seriously implemented by Vietnamese banks An Ernst & Young assessment of auditing experiences in Vietnamese credit institutions finds that Vietnam's regulatory framework for bank governance does not yet align with international standards; only a small number of banks comply with the regulations, and the information disclosure policy remains insufficient, according to the SBV website Consequently, whether Vietnamese banks can fully apply Basel I and begin implementing Basel II, which is more complex and demanding, by 2010 remains an open question.
Developing a thorough understanding of Basel I and Basel II—their requirements and how the accords mitigate bank risks—helps Vietnamese banks recognize the importance of standards compliance and serves as the first step toward preparing to apply Basel principles.
II in risk management activities.
Base! / / : A n Introduction to the New Capital Accord
V ie tn a m e se b a n ks’ e ffo rt to w a rd s B asel II im p le m e n ta tio n
When Basel II was officially publicized in 2004, it quickly became a hot topic at seminars and conferences aimed at introducing the Basel II regulations to Vietnam’s banking regulators and assessing their potential impact on the economy In April 2004, the State Bank of Vietnam (SBV) and ANZ Bank co-hosted a seminar on Basel II and risk management, as reported by VietBao A subsequent seminar, titled “Basel II Accord and the Possible Impacts on the Development Assistance of the Economy and Vietnamese Banking System,” was organized in January 2005 by the French–Vietnamese Center for Management Education.
After a period of dormancy, Basel II activity resurfaced when, in November 2007, the State Bank of Vietnam (SBV) and Citibank held a seminar introducing Basel II into commercial bank operations and clarifying the SBV’s regulatory role In August 2008, SBV partnered with Ernst & Young for a conference to assess the implementation of security and risk management in Vietnamese financial institutions, identify shortcomings, and propose solutions to effectively apply Basel I and Basel II as well as other international standards.
Besides activities organized by the central bank, commercial banks and other organizations showed growing interest in applying Basel II For example, ACB partnered with Jardine Lloyd Thompson Asia to host a seminar on Basel II and operational risk management at the Sheraton Hotel in Ho Chi Minh City in November 2007 The seminars were designed to help bankers understand the Basel II framework more clearly and to learn from the implementation experiences of Basel II by foreign banks The Basel II framework was advancing as banks and regulators explored enhanced risk management and regulatory compliance.
Basel II: An Introduction to the New Capital Accord, translated into Vietnamese and published by Information and Culture Publisher in 2008, seeks to acquaint Vietnamese academics in finance and banking with the Basel II framework The Vietnamese edition is intended to help raise awareness of Basel II among Vietnam’s scholarly community, but its word-for-word translation of technical terms often makes the material difficult to understand for readers.
As of the study, Vietnamese credit institutions had one year left to complete Basel I implementation by 2010 However, there has been no official announcement from any bank or the Central Bank about the current stage of Basel I implementation or preparations for Basel II The exact timeline for Basel II implementation remains unclear.
T h e Research s ig n ific a n c e s
This study is mainly based on secondary data—documents issued by the Basel Committee on Banking Supervision, books, and scholarly articles—and aims to present a concise overview of Basel II, focusing on its three Pillars, definitions and examples of regulatory capital calculation approaches, and the requirements for supervisory review and information disclosure Building on these standards, the research discusses potential implementation of the Basel Capital Accord in Vietnam After receiving improvement feedback from professors, the study can serve as a reference for individuals and organizations interested in learning about Basel and considering its application.
O v e rv ie w o f the re s e a rc h
This paper is organized into four sections The first section, Literature Review, surveys the Basel Committee, the Basel Capital Accords, and the range of views on their implementation The second and third sections present a summary of the Basel II Accord, with illustrations and discussions on the feasibility of applying Basel II in Vietnam The final section provides a concise synthesis of the key points and outlines opportunities for future research emerging from this study.
Basel II: A n Introduction to the f\rew Capital Accord
Basel II: An Introduction to the New Cqjiiial Accord
B asel C o m m itte e on B a n k in g S u p e rv is io n
Basel Capital Accords are the frameworks for measuring capital adequacy and establishing the minimum standards agreed by the Basel Committee on Banking Supervision The Committee, established in 1975 by the central bank governors of the G10, comprises senior representatives from bank supervisory authorities and central banks from 27 countries worldwide Its key objectives are to strengthen the soundness and stability of the international banking system and to ensure the framework is fair and consistently applied across jurisdictions, with the aim of reducing competitive inequality among international banks (Basel I).
1988) To achieve this，the Comm ittee meets regularly four times per year; and has issued a long series o f documents since its establishment, including Basel I in 1988 and Basel II in 2004.
* 2 7 m em b ers o f th e C o m m itte e in c lu d e A rg e n tin a , A u s tra lia , B e lg iu m , B r a z il, C a na da ，C h in a ，France,
G e rm a n y , H o n g K o n g S A R In d ia , In d o n e s ia Ita ly Japan, K o re a , L u x e m b o u rg , M e x ic o , N e th e rla n d s, Russia,
S audi A ra b ia S in g a p o re ，S o u th A fr ic a , S p a in , S w eden S w itz e rla n d , T u rk e y , U n ite d K in g d o m , U n ite d States.
BaselJI: An Introduction to the New Capital Accord
B asel I A c c o r d
Basel I, introduced in July 1988, reflects the Committee’s years of work through extensive discussion, member-country consultation, and the finalization of common standards and regulations governing capital adequacy for international banks This first Capital Accord was designed for internationally active banks within Committee member states and focuses on assessing capital in relation to credit risk—the risk of counterparty default—while acknowledging that supervisors should also account for other risks, such as interest-rate risk and investment risk in securities.
In January 1996, an amendment to the Basel Accord was published to incorporate market risk arising from trading positions in bonds, equities, foreign exchange, and commodities Compared with the market risk provisions in Basel II, the changes are relatively modest, so the market risk amendment will be covered in the Basel II section.
Basel I Accord divides its e lf in 3 sections The first section, named The constituents o f
Capital reserves define both the types of on-hand capital that count as a bank’s reserve and the maximum amounts permitted for each type The framework organizes reserves into two tiers: Tier 1 Core Capital and Tier 2 Supplementary Capital, with the specific items in each tier detailed in Annex 1 Core Capital consists of published reserves from post-tax retained earnings and equity capital, including issued and fully paid ordinary shares (common stock) and non-cumulative perpetual preferred stock (but excluding cumulative preferred stock) Tier 2 Capital includes undisclosed reserves as supplementary capital. -**Support Pollinations.AI:** -🌸 **Ad** 🌸Powered by Pollinations.AI free text APIs [Support our mission](https://pollinations.ai/redirect/kofi) to keep AI accessible for everyone.
Under the Basel Accord, eligible capital that can be counted toward Tier 1 and Tier 2 includes revaluation reserves, general provisions or general loan-loss reserves, hybrid debt instruments, and subordinated term debt The Accord also specifies which items qualify as capital and clarifies the deductions from capital when calculating the Capital Adequacy Requirement (CAR).
(i) goodw ill, as a deduction from tie r 1 capital elements;
( ii) investments in subsidiaries engaged in banking and financial activities which are not consolidated in national systems.
The second section, Risk Weights, presents the weighting structure applied to both on-balance-sheet assets and off-balance-sheet engagements A simple five-tier framework is used to assign risk weights to on-balance-sheet assets across risk levels, ranging from 0% for risk-free assets to 100% for high-risk assets The following table summarizes the asset types and the corresponding risk weights assigned to each type.
Base! II: An Introduction to the New Capital Accord
Table 1; Risk weights by category o f On-balance-sheet asset
(b) Claims on central governments and central banks denominated in national currency and funded in that currency
0% (c) Other claims on Organization for Economic Co-operation and Development
(OECD) central governments and central banks
(d) Claims collateralized by cash o f OECD central-govemment securities or guaranteed by OECD central governments
Claims on domestic public-sector entities, excluding central government, and loans guaranteed by or collateralized by securities issued by such entities
(a) Claims on multilateral development banks and claims guaranteed by, or collateralized by securities issued by such banks
(b) Claims on banks incorporated in the OECD and claims guaranteed by OECD incorporated Banks
20% (c) Claims on securities firms incorporated in the OECD subject to comparable supervisory and regulatory arrangements, including in particular risk-based capital requirements, and claims guaranteed by these securities firms
Category (d) covers two types of short-term financial claims: claims on banks incorporated in countries outside the OECD with a residual maturity of up to one year, and claims with a residual maturity of up to one year guaranteed by banks incorporated in countries outside the OECD.
Base! II: An Introduction to the Capital Accord
(e) Claims on non-domestic OECD public-sector entities, excluding central government, and claims guaranteed by or collateralized by securities issued by such entities
(0 Cash items in process o f collection
Loans with a 50% loan-to-value ratio that are fully secured by a mortgage on residential property—property that the borrower will occupy or rent—are eligible The framework also covers exposures in two categories: claims on the private sector and claims on banks incorporated outside the OECD with a residual maturity of more than one year.
(c) Claims on central governments outside the OECD (unless denominated in national currency - and funded in that currency - see above)
(d) Claims on commercial companies owned by the public sector (e) Premises, plant and equipment and other fixed assets
(0 Real estate and other investments (including non-consolidated investment participations in other companies) (g) Capital instruments issued by other banks (unless deducted from capital) (h) A ll other assets
The Committee decided to apply a range of credit risk conversion factors to convert all categories of off-balance-sheet engagements into credit risk equivalents This approach addresses limited risk assessment experience in some activities, and the difficulty of justifying complex analytical methods and detailed, frequent reporting systems in certain countries when the volume of business is small, particularly for newer, more innovative instruments The nominal principal amounts of off-balance-sheet engagements will be multiplied by the credit risk conversion factor, and the resulting figures will be weighted according to the nature of the counterparty as described in Table 1.
Basel II: A n Introduction to the N ew Capital Accord
Table 2: C re d it R isk C onversion factors fo r O ff-B alance-Sheet items
Instrum ents C redit conversion factors
1 Direct credit substitutes, e.g general guarantees o f indebtedness
(including standby letters o f credit serving as financial guarantees for loans and securities) and acceptances (including endorsements with the character o f acceptances)
2 Certain transaction-related contingent items (e.g performance bonds, bid bonds, warranties and standby letters o f credit related to particular transactions)
3 Short-term self-liquidating trade-related contingencies (such as documentary credits collateralized by the underlying shipments) 20%
4 Sale and repurchase agreements and asset sales w ith recourse, where the credit risk remains w ith the bank 100%
5 Forward asset purchases, forward deposits and partlv-paid shares and securities, which represent commitments w ith certain drawdown 100%
6 Note issuance facilities and revolving underwriting facilities 50% ᄀ Other commitments (e.g formal standby facilities and credit lines) w ith an original maturity o f over one year 50%
8 Similar commitments w ith an original maturity o f up to one year, or which can be unconditionally cancelled at any time 0%
(N.B Member countries w ill have some limited discretion to allocate particular instruments into items 1 to 8 above according to the characteristics o f the instrument in the national market.) Source: Basel I Capital Accord (1988)
Basel I identifies the target standard ratio of capital to risk-weighted assets: banks must hold 8% of their risk-weighted assets in Tier 1 and Tier 2 capital reserves, with Tier 1 alone accounting for at least 4% This ratio is regarded as minimally adequate to protect against credit risk for international banks across all Basel Committee member countries In practice, it defines the capital cushion banks must maintain against their risk-weighted assets.
Kil _ ^ _ T ie r 1 + Tier 2 Capital nn/
M inim um Tier 1 ratio = ^ ~ ^ [ ier 1 Capital - > 4%
Base! / / : An Introduction to the ISew Capital Accord
C ritic is m s against B asel I and reasons fo r the tra n s itio n to Basel I I
Despite the recognition gained by over 100 countries all over the w o rld as an international standard, Basel I s till receive number o f criticism s o f the academic In the paper ''Basel I ，
Basel II and Emerging Markets: A Nontechnical Analysis (2008) reviews Balin, B.'s critique of Basel I, focusing on the perceived omissions in the Accord Basel I is described as addressing only credit risk, targeting only the G10 countries, and lacking market disciplines As a result, Basel I is viewed as too narrow to ensure adequate financial stability in the international financial system and limited in its ability to influence other countries and banks to follow its guidelines.
Another critical perspective, voiced by the same author, concerns misaligned incentives created by the Accord for banks The Accord's broad scope and the absoluteness of Basel I risk weightings enable regulatory arbitrage, allowing banks to wiggle around Basel's standards and shift risk onto their loan books beyond what the framework's authors intended For example, all else equal, a bank has an incentive to cherry-pick assets with higher returns—such as loans to start-up companies—over lower-yielding assets like loans to large, highly profitable firms, even when the risk weight and capital requirements are the same.
In Basel II: The Duckworth-Lewis of Banking, Chaudhary, Singh, and Prabhat argue that the one-size-fits-all approach—applying a single capital-to-risk-weighted-assets ratio (CRAR)—fails to reflect the actual risk profiles of different banks They critique the norms for relying on a simplified framework with only four broad risk categories, which overlooks bank-specific vulnerabilities and can distort capital adequacy assessments Their analysis calls for a more nuanced, risk-sensitive Basel II implementation that aligns capital requirements with the true risk exposure of individual banks.
Basel II: A n Introduction to the New Capital Accord weights fo r credit risk measurement Consequently, it could not provide enough granularity in risk management，，.
The first and last criticism mentioned above are considered reasons for the review o f Basel
Development of Basel II began in June 1999, eleven years after the Basel I Accord was introduced in 1988 The accompanying table highlights Basel I’s limitations, the reasons for transitioning to Basel II, and how the new Capital Accord overcomes these shortcomings to strengthen risk-based capital requirements.
T ab le 3: C o m pa rison between Basel I and Basel I I
Focus is on single risk measure
More emphasis on the bank's own internal risk management methodologies; supervisory review and market discipline
Flexibility; menu o f approaches; capital incentives for better risk management; granularity in the valuation o f assets and types o f businesses, and in the risk profiles o f their systems and operations
More risk sensitivity by business type and asset class; m ulti dimensional and focused on all the operational components o f a bank
Source: “ The New Basel Accord: An Explanatory Note，'，Bank for International Settlement.
Basel //•• An Introduction to the New Capital Accord
B asel I I d e v e lo p m e n t
Basel II was designed to align regulatory capital requirements with the actual risk profile of banks, improving risk sensitivity and capital adequacy It seeks to cover all essential banking risks with theoretically grounded, flexible, and operable requirements that incentivize banks to adopt more advanced risk management practices The framework also allows banks to use in-house methods and internal models to calculate capital, subject to supervisory scrutiny and validation Together, these goals aim to foster safer banking while enabling more precise capital allocation based on real risk.
Basel II began with the first consultative paper in 1999, followed by the second in 2000 and the third in 2003 By mid-2004, the new Basel Capital Standards were finalized and publicized In July 2005, the framework was extended to include trading book aspects and the treatment of double-default effects for guarantees In June 2006, a comprehensive version of the revised framework was introduced to consolidate all related documents issued by the Committee, including the guidance in the Committee’s July 2005 paper on Basel II for trading activities and the treatment of double-default effects and the amendment to the Capital Accord to incorporate these changes.
This edition brings together Market Risks (January 1996) and the enduring provisions of the 1988 Basel Accord, delivering a comprehensive overview of international solvency standards It is primarily targeted at banks, providing a full view of the current regulatory framework for international solvency and risk management, and it introduces no new elements.
Although the development of the second Accord is intended to amend and refine the shortcomings of the first Capital Framework, it remains questionable whether it truly overcomes those deficiencies The following section will address this question and provide a concise presentation of the 300-plus-page Capital Framework.
BaselJI: An Introduction to the_New Capital Accord
Basel II is a major extension of Basel I, widening the scope of application and offering a range of options for calculating capital requirements, including standardized and internally developed approaches It is more sensitive to different types and levels of risk while maintaining the core elements of Basel I The framework is structured into four main parts, with the first part, Scope of Application (pp 7–11, Basel II), detailing the accord's application scope Building on Basel I’s consolidated-basis approach for banks—including subsidiaries in banking and financial activities—Basel II expands the scope to cover any holding company as well A holding company refers to the parent company within a banking group, and Basel II applies to internationally active banks at every tier on a fully consolidated basis.
Basel I centers on a capital adequacy framework that requires banks to hold capital equal to at least 8% of their risk-weighted assets It also sets out the basic structure of the 1996 Market Risk Amendment, detailing how market risk is treated within the capital calculation Finally, Basel I defines eligible capital, clarifying which instruments count toward regulatory capital and how they qualify Together, these elements establish Basel I's approach to ensuring banks maintain prudent capital buffers against risk.
•’ Banking groups are groups that engage predom inantly in banking and, in some countries a banking group may be registered as a bank.
Basel u : An Inưoducìion to the New Capital Accord
The fo llo w in g illustration presents the new scope o f application o f Basel II
ILLUSTRATION 1: NEW SCOPE OF APPLICATION OF THIS FRAMEWORK
(a), (b ), a n d (c): the Framework is applied at lower levels to all internationally active banks on a consolidated basis.
(d ): Boundary o f predominant banking group The Framework is now to be applied at this level on a consolidated basis, i.e up to holding company level.
T h e F irs t P illa r — M in im u m C a p ita l R e q u ire m e n ts
R e g u la to ry C a p it a l
Under the Basel I framework, the definition of eligible regulatory capital remains largely as stated in the 1988 Accord, with two notable changes: the inclusion of Tier 3 and the modification of how general provisions or general loan-loss reserves are treated to include Tier 2 Specifically, Tier 1 capital continues to consist of equity capital and disclosed reserves Tier 2 capital includes undisclosed reserves, revaluation reserves, hybrid debt capital instruments, subordinated term debt, and general provisions, which are subject to an additional, new regulatory treatment.
Basel II: An Introduction to the New Canital Accord lim it o f 0.6 percentage o f credit risk-weighted assets for banks using the internal ratings- based (IR B ) approach T ie r 3, consisting o f short-term subordinated debt, can be employed only to meet the proportion o f the capital requirements for market risks, which subject to four conditions:
Banks may deploy Tier 3 capital exclusively to cover market risk, while any capital requirement arising from credit and counterparty risk in both the trading and banking books must be satisfied using the existing capital base defined as Tier 1 and Tier 2.
• T ie r 3 capital w ill be lim ited to 250% o f a bank's T ie r 1 capital that is required to support market risks;
Tier 2 elements may be substituted for Tier 3 up to the same 250% limit, as long as eligible Tier 2 capital does not exceed total Tier 1 capital, and long-term subordinated debt does not exceed 50% of Tier 1 capital.
In addition, the decision on whether to use short-term subordinated debt for individual banks or their banking systems generally, and to apply the rule that the sum of Tier 2 plus Tier 3 capital should not exceed total Tier 1 capital, should be a matter of national discretion.
To determine a bank’s eligible capital, the minimum capital requirements for credit risk and operational risk are calculated first, and only then is the market risk requirement assessed This sequencing establishes how much Tier 1 and Tier 2 capital is available to absorb market risk Eligible capital equals the total of the bank’s Tier 1 capital and all of its Tier 2 capital.
Tier 3 capital will be regarded as eligible only if it can be used to support market risk under the above conditions, and the quoted capital ratio will thus represent capital that is available to meet credit risk, operational risk, and market risk Where a bank has Tier 3 capital, which is not at present supporting market risks, it may report that excess as unused but eligible Tier 3 alongside its standard ratio.
Basel ¡1: An Introduction to the New Capital A ccord
For example: A X Y Z bank has tier 1 capital o f 800 tie r 2 capital o f 200, tie r 3 capital o f
Credit risk-weighted assets are 7,500; the operational risk capital charge is 200 and the market risk capital charge is 350, which are multiplied by 12.5 to yield 2,500 and 4,375 risk-weighted assets, respectively, giving a total risk-weighted asset value of 14,375.
After calculating the minimum capital charge, the amount of capital eligible to meet the requirements must be determined, starting with credit risk and operational risk In this example, eligible capital is provided by 600 from Tier 1 capital and 200 from Tier 2 capital, leaving a total of 800 units of eligible capital to meet the requirements.
Two hundred Tier I capital is available to support the bank’s market risk requirements, and due to the 250% rule only 500 of Tier 3 capital is eligible The bank only needs to deploy 100 Tier I capital and 250 Tier 3 capital to meet its market risk capital requirement, leaving 100 Tier I capital and 250 Tier 3 capital unused but eligible for future market risk requirements.
To calculate the capital ratio, excess Tier 1 capital should be taken into account since it can be used to meet credit, operational, and market risk requirements The capital ratio is calculated by dividing eligible capital (excluding unused Tier 3) by total risk-weighted assets, i.e., 1,250 / 14,375 = 8.69% Unused but eligible excess Tier 3 capital can also be expressed as an excess Tier 3 capital ratio, i.e., 250 / 14,375 = 1.74%.
Minimum capital for meeting requirement
Eligible capital (excluding unused Tier 3)
Unused but not eligible capital
그redit risk 7500 operational risk 2500
Basel П: An Introduction to the New Capital Accord
R isk -w eig h ted A s s e t s
In Basel II, the Risk-Weighted Assets (RWA) section is commonly associated with Pillar I, yet it stands as the central element of the Basel II framework For this reason, the author recommends presenting Risk-Weighted Assets as a separate, standalone section distinct from Pillar I to emphasize its pivotal role in risk measurement and capital adequacy.
Total risk-weighted assets (RWA) are calculated by multiplying the capital requirements for market risk and operational risk by 12.5 and then adding the result to the credit risk-weighted assets In other words, RWA equals the credit risk-weighted assets plus 12.5 times the capital requirements for market risk and operational risk.
R is k -w e ig h te d Assets = R W A crcdit + [M R C Market x 12.5] + [ O R C 0 pcrat.onai x 12.5]
R W A crcd it is the credit-risk weighted assets.
MRCMarkct is the market risk capital charge.
ORCopcranonai is the operational risk capital charge.
The fo llo w in g parts w ill describe the risks bank m ight be exposed to ，approaches to measure，as w ell as the calculation o f capital requirement to each.
Credit risk as defined in the former framework is the risk that the counterparty to a transaction would default before the final settlement o f the transaction's cash flows
A ccording to the new capital accord, banks can choose to employ either the standardized o r Internal Ratings-Based (IR B ) approach to calculate credit risk charges.
3.2 1 1 T h e S tan dard ized A pp roach
Under the standardized approach, credit risk-weighted assets equal the exposure amount net of specific provisions multiplied by a risk weight drawn from a table of claim types and the corresponding credit assessment or rating The Committee does not specify which External Credit Assessment Institution (ECAI) is eligible; instead, national supervisors decide eligibility themselves based on six criteria.
Objectivity in credit assessments relies on a rigorous, systematic methodology that is validated against historical experience and continuously reviewed to reflect changes in financial conditions For supervisory recognition, the assessment framework for each market segment, including rigorous backtesting, must be established for at least one year and preferably three years.
• Independence: An ECA1 should be independent and should not be subject to political or economic pressures that may influence the rating The assessment process should be as free as possible from any consưaints that could arise in situations where the composition o f the board o f directors or the shareholder structure o f the assessment institution may be seen as creating a conflict o f interest.
• International access/Trans pa rency: The individual assessments should be available to both domestic and foreign institutions with legitimate interests and at equivalent terms In addition, the general methodology used by the ECAI should be publicly available.
• Disclosure: An ECA1 should disclose the following information: its assessment methodologies, including the definition o f default，the time horizon, and the meaning o f each rating; the actual
Basel II: A n Introduction to the New Capital Accord
Basel / / : An Introduction to the !\ew Capital Accord default rates experienced in each assessment category; and the transitions o f the assessments, e.g the likelihood o f AA ratings becoming A over time.
An External Credit Assessment Institution (ECAI) must have sufficient resources to deliver high-quality credit assessments These resources should enable substantial ongoing engagement with both senior and operational levels within the entities being assessed, thereby adding value to the credit analyses Such assessments should be based on methodologies that combine qualitative and quantitative approaches to ensure a robust and balanced evaluation.
Credibility largely derives from the criteria noted above Moreover, independent parties—such as investors, insurers, and trading partners—relying on an ECAI’s external credit assessments provide evidence of the ECAI’s assessment credibility This credibility is further underpinned by internal procedures that prevent the misuse of confidential information To be eligible for recognition, an ECAI does not need to assess firms in more than one country.
The fo llo w in g table summarizes the risk weights applied to on-balance sheet assets based on different types o f counterparty and th e ir external credit assessments.
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