Three Pillars of the Basel II Accord

The second pillar, Supervisory Committee, sets regulating guidelines based on the response to the first pillar. In addition to providing regulators with these guidelines, the second pillar deals with other risks not addressed under the first pillar (credit risk, market risk and operational risk), such as systemic risk, pension risk, strategic risk, concentration risk, reputation risk, legal risk and liquidity risk, these being combined under residual risk. The second pillar, therefore, provides a framework within which banks can review, and revise where necessary, their risk management systems.

The third pillar, Market Discipline, encourages prudent management and a high degree of transparency with regard to reporting to shareholders and customers, particularly when it comes to revealing their compliancy with Minimum Capital Requirements (pillar one).

It is anticipated that the implementation of Basel II will enable all parties concerned to discern whether a banking organization is managing their risk adequately. This could lead to a bank being rewarded for managing their risks well, while those that don’t are likely to face penalties. At the very least, it will give investors more insight into which bank to add to their investment portfolios.