body. For the first two years after such approval, the credit risk element of capital allocation cannot be lower than 90% of the allocation calculated under the foundation approach; after two years the BIS propose to review the advanced approach and comment.
EXHIBIT 14.5 Capital
Requirements under Specified PD Bands
Credit Rating PD Band Basel I Standard Approach
IRB Foundation
Operational
Risk
One of the most controversial elements of the Basel II is the new capital charge to cover banks operational risk. The Committee has proposed three different approaches
for calculating
the operational
risk capital charge. These are:
■ the basic
indicator approach,
under which
a 20%
of total
capital would be allocated;
■ a standardized approach, under which different risk indicators will be allocated to different lines of business within a bank; this would be the level
of average assets for a retail bank and assets under management
for a fund manager. The Committee would set the capital charge level
for
each business line in accordance with its perceived level of risk in each national jurisdiction, and the total operational risk would be the sum of the exposures of all business lines;
■ an internal estimation by a bank of the expected losses due to opera- tional risk for each business lines. Operational risk here would be risk
of loss as a result of fraud, IT failures, legal risk, and so on.
Total Minimum
Capital
The sum of the capital calculation
for credit risk exposure, operational risk and the banks trading book will be the total minimum capital requirement. This capital requirement
will be expressed as a 8% risk- asset ratio, identical to the rules under Basel I.
Pillar 2-Supervisory Approach
A new element of the Basel II accord is the requirement for a supervision approach to capital allocation. This is based on three principles. First,
banks must have a procedure for calculating their capital requirements in
accordance with their individual risk profile. This means they are required
to look beyond the minimum capital requirement as provided for under Pillar 1, and assess specific risk areas that reflect their own business activi-
ties. This method would consider for instance, interest rate risk exposure
within the banking book, or prepayment risk as part of mortgage business.
These procedures will be reviewed constantly by banking supervisory
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- body. For the first two years after such approval, the credit risk element of capital allocation cannot be lower than 90%