The Pillars of the Basel II Accord

Abstract

Unlike the Basel I Accord, which had one pillar (minimum capital requirements or capital adequacy), the Basel II Accord has three pillars: (i) minimum regulatory capital requirements, (ii) the supervisory review process, and (iii) market discipline through disclosure requirements. Fischer (2002) argues that the three pillars should be mutually supporting. The effectiveness of the first pillar depends on the supervisor’s ability to regulate and monitor the application of the three approaches to the determination of the minimum regulatory capital, whereas wider public disclosure and market discipline will reinforce the incentives for sound risk management practices. The BCBS (2005b) notes that banks and other interested parties have welcomed the concept and rationale of the three pillars approach on which the Basel II Accord is based. The Committee also notes that it is critical for the minimum capital requirements of the first pillar to be accompanied by a robust implementation of the second and third pillars.