Risk management under Basel II and Pillar III disclosure

1. Introduction

Basel II explained

The Basel II banking industry guidelines introduce new capital adequacy requirements for banks. The purpose of the Basel II capital accord is to provide guidelines for banks to determine the minimum capital they have to set aside to cover unexpected losses arising from the financial and operational risks. Basel II was developed by the Basel Committee on Banking Supervision, consisting of representatives of central banks and regulatory authorities of 13 countries, which meets regularly in Basel, Switzerland. The guidelines were adopted in the European Union in the form of the CRD (Capital Requirements Directive), 2006/48/EC and 2006/49/EC. Almost all the EU Member States have now implemented the guidelines in their national legislation. In the Netherlands, this takes the form of the Financial Supervision Act (Wet financieel toezicht or Wft) and subsidiary regulations.

The importance of capital

Banks are exposed to various risks in their day-to-day operations, expressed as the probability of a given event resulting in a loss to a bank. Banks need to hold capital to cover potential losses in the case of an extremely negative scenario so that, when they are faced with such losses, they are still able to pursue their activities.

Three pillars

Basel II is built on three pillars, which banks have to implement in their entirety:

• Pillar I: minimum capital requirements
• Pillar II: supervision
• Pillar III: market discipline

Pillar I provides guidelines for calculating the minimum capital requirement which the regulator requires a bank to meet for credit, market and operational risk. Basel II gives banks the choice of a number of methods for calculating the minimum capital requirement, ranging from the relatively simple to the extremely advanced. Pillar II provides additional guidelines for assessing a bank's capital adequacy on the basis of bank-specific scenarios. The bank is required to calculate the minimum capital that it considers adequate to cover all the risks to which it is exposed, not just the standard risks under Pillar I. This is generally referred to as the 'ICAAP capital' (Internal Capital Adequacy Assessment Process). The ICAAP capital is then compared with the bank's actual capital. Banks are required to hold adequate capital at all times, on the basis of the ICAAP capital. Pillar II also provides guidelines for regulators for assessing a bank's capital management. Pillar III gives guidance for external reporting of the risks to which a bank is exposed and the capital available to the bank to cover unexpected losses arising from those risks.

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Scope and timescale

Basel II is applicable to BinckBank and all its subsidiaries and foreign branches. The guidelines came into effect on 1 January 2007 and were implemented by BinckBank as from 1 January 2008.

What are the implications of Basel II for BinckBank's stakeholders?

Basel II has no direct implications for BinckBank's primary services. Basel II has a beneficial effect on our capital ratios and periodic reporting means that stakeholders are given a better insight into BinckBank's risk exposure and capital position.

What are the financial and strategic implications for BinckBank?

While Basel II has made it more difficult for some banks to meet the requirements, it has benefited BinckBank's solvency ratio (BIS ratio). More capital has to be held to cover operational risk, but the capital requirement is lower for BinckBank's lending to clients against securities (credit risk).

What are the implications for BinckBank's operations?

Basel II has given fresh momentum to the existing initiatives to improve the quality of the risk-management processes within BinckBank. Our capital management models have been further refined and we are working to develop a model to measure operational risk. BinckBank has also set up an infrastructure to provide better reporting to the regulators on the risks presented by specific scenarios and the related minimum capital requirements.

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