The Basel III Guidelines are based upon 3 very important aspects which are called 3 pillars of the Basel II. These 3 pillars are Minimum Capital Requirement, Supervisory review Process and Market Discipline.
First Pillar: Minimum Capital Requirement
The first pillar Minimum Capital Requirement is mainly for total risk including the credit risk, market risk as well as Operational Risk .
Second Pillar: Supervisory Review Process
The second pillar i.e. Supervisory Review Process is basically intended to ensure that the banks have adequate capital to support all the risks associated in their businesses.
In India , the RBI has issued the guidelines to the banks that they should have an internal supervisory process which is called ICAAP or Internal Capital Adequacy Assessment Process. With this tool the banks can assess the capital adequacy in relation to their risk profiles as well as adopt strategies for maintaining the capital levels.
Apart from that, there is another process stipulated by RBI which is actually the Independent assessment of the ICAAP of the Banks. This is called SREP or Supervisory Review and Evaluation Process.
The independent review and evaluation may suggest prudent measures and supervisory actions whatever is needed.
- ICAAPis conducted by Banks themselves and SREP is conducted RBI which is along with the RBI’s Annual Financial Inspection (AFI) of the bank.
Third Pillar: Market Discipline
The idea of the third pillar is to complement the first and second pillar. This is basically a discipline followed by the bank such as disclosing its capital structure, tier-I and Tier –II Capital and approaches to assess the capital adequacy.
In the above discussion, we could understand that the Basel II and forthcoming Basel III are basically guidelines which focus upon adequate capital in the banks and minimize the risk to the customers or depositors. The idea is to make a sound financial system which not only helps the banks and but the entire economy of the country to maintain the trust and faith, as transparency in the business. The centerpieces are “Capital Adequacy” and “Risks“.