Basel II

The New Basel Capital Accord prepared by the Basel Committee on Banking Supervision. Basically, ´Basel II´ will result in the adjustment of a bank´s regulatory capital to its economic capital. Instead of assessing risk in general, each loan commitment will be analyzed individually. The Accord is based on three mutually reinforcing pillars that allow banks and supervisors to evaluate properly the various risks that banks face. These three pillars are: minimum capital requirements, which seek to refine the present measurement framework; supervisory review of an institution´s capital adequacy and internal assessment process; and market discipline through effective disclosure to encourage safe and sound banking practices.
The Basel Accord can have two approaches either the Foundation or IRB Advanced approach to using Internal Ratings for Regulatory calculations. The IRB Advanced approach is a significantly refined approach to calculating Credit Risks.
The key refinements to the Foundation Approach calculation are: a company will use its own internal estimates of EAD and LGD together with the treatment of guarantees and credit derivatives, rather than the parameterised method under the Foundation approach; effective maturity is used in addition to EAD, PD, and LGD in calculating Regulatory Capital (in order to more accurately reflect the impact of transaction maturity on default risk).Many financial companies will intend to use the Advanced Approach for Corporate exposures as soon as possible after the Basel II Implementation date (and may decide to use the Advanced approach immediately for Specialised Lending). As a result, data will be calculated and captured using both the Foundation and Advanced Approach for each exposure. Although the inputs to the Advanced Approach differ from the Foundation Approach, the same models for GAE, EAD, PD and LGD will commonly be used.