IT Governance framework Basel

Table of contents:
Executive summary1
Introduction...2
1 BASEL I ....3
1.1 The Purpose of Basel I 3
1.2 Two-Tiered Capital .3
1.3 Limitations of Basel I..4
2 BASEL II ...5
2.1 Objectives of Basel II ..5
2.2 Three pillars of Basel II...5
2.2.1 The First Pillar ..5
2.2.2 The Second Pillar ..6

The Third Pillar6

3 PILLAR III INFORMATION FOR ING BANK.7

3.1 Risk Management at ING Bank.7
3.2 Regulatory Capital Requirements..7
3.3 Credit Risk at ING..8
3.3.1 Pillar 3 Credit Risk in Practice..9
3.4 Risk Rating Methodology.............................................................................10
3.5 Market Risk at ING...12
3.6 Operational Risk12
4 BASEL III.13
4.1 Key points of Basel III accord13
Conclusion ...15
Literature and sources ..16

Index of tables:
Table 1: Regulatory capital requirements 7
Table 2: Exposures (EAD) by PD grade under the AIRB approach ...10
Table 3: Average LGD by PD grade under the AIRB approach .11
Table 4: VaR values for IMA portfolios ..12

Table of pictures
Picture 1: Pillar 3 Credit Risk in Practice .9

EXECUTIVE SUMMERY
The Basel Accords, while extremely influential, are oftentimes too detailed and technical to
be easily accessible to the nontechnical policymaker or interested scholar. This paper looks to
fill that gap by detailing the origin, regulation, implementation, criticism, and results of Basel
I, Basel II and Basel III respectively. Also between explaining this three pillars there is an
example from ING bank on how Basel II framework is used in practice. Findings include in
the first part, the limited scope and general language of Basel wich gives banks excessive
margin in their interpretation of its rules, and in the end, allows financial institutions to take
improper risks and hold unreasonably low capital reserves. The second part gives more
detailed information aboyt Basel II, which seeks to extend the gasp and precision of Basel I,
bringing in factors such as market and operational risk, market-based discipline and

surveillance, and regulatory mandates, but is oftentimes excessively long and complex. The
third part shows how parts of the Basel II framework are used in practice trough example of
ING Bank. In the fourth and final part of this paper includes broader expiation of the
reformed measures in Basel III and their aims. It also notes and briefly explains the key
points of this accord.

INTRODUCTION
The Basel Committee was formed in response to the messy liquidation of a Cologne-based
bank in 1974. On 26 June 1974, a number of banks had released Deutschmark to the Bank
Herstatt in exchange for dollar payments deliverable in New York. On account of differences
in the time zones, there was a lag in the dollar payment to the counter-party banks, and during
this gap, and before the dollar payments could be effected in New York, the Bank Herstatt
was liquidated by German regulators.

This incident prompted the G-10 nations [The Group of Ten is made up of eleven industrial
countries (Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden,

Switzerland, the United Kingdom and the United States] which consult and co-operate on
economic, monetary and financial matters to form towards the end of 1974, the Basel
Committee on Banking Supervision, under the auspices of the Bank of International
Settlements (BIS) located in Basel, Switzerland.

The major impetus for the 1988 Basel Capital Accord was the concern of the Governors of
the G10 central banks that the capital of the world's major banks had become dangerously
low after persistent erosion through competition. Capital is necessary for banks as a cushion
against losses and it provides an incentive for the owners of the business to manage it in a
prudent manner.

1 BASEL I
Basel I represents a set of international banking regulations put forth by the Basel Committee
on Bank Supervision in the year 1988, which set out the minimum capital requirements of
financial institutions with the goal of minimizing credit risk. Banks that operate
internationally are required to maintain a minimum amount (8%) of capital based on a
percent of risk-weighted assets. (http://www.ecb.europa.eu/pub/pdf/scpops/ecbocp42.pdf)

The Purpose of Basel I

In 1988, the Basel I Capital Accord was created. The general purpose was to:
1. Strengthen the stability of international banking system.
2. Set up a fair and a consistent international banking system in order to decrease competitive
inequality among international banks.

The basic achievement of Basel I have been to define bank capital and the so-called bank
capital ratio. In order to set up a minimum risk-based capital adequacy applying to all banks
and governments in the world, a general definition of capital was required. Indeed, before this
international agreement, there was no single definition of bank capital. The first step of the
agreement was thus to define it. (http://www.ecb.europa.eu/pub/pdf/scpops/ecbocp42.pdf)

1.2 Two-Tiered Capital

Basel I defines capital based on two tiers:
1. Tier 1 (Core Capital): Tier 1 capital includes stock issues (or shareholders equity) and
declared reserves, such as loan loss reserves set aside to cushion future losses or for
smoothing out income variations.
2. Tier 2 (Supplementary Capital): Tier 2 capital includes all other capital such as gains on
investment assets, long-term debt with maturity greater than five years and hidden reserves
(i.e. excess allowance for losses on loans and leases). However, short-term unsecured debts
(or debts without guarantees), are not included in the definition of capital.
Credit Risk is defined as the risk weighted asset (RWA) of the bank, which are banks assets
weighted in relation to their relative credit risk levels. According to Basel I, the total capital
should represent at least 8% of the bank's credit risk (RWA). In addition, the Basel agreement
identifies three types of credit risks:
1. The on-balance sheet risk.
2. The trading off-balance sheet risk. These are derivatives, namely interest rates, foreign
exchange, equity derivatives and commodities.
3. The non-trading off-balance sheet risk. These include general guarantees, such as forward
purchase of assets or transaction-related debt assets.
Market risk includes general market risk and specific risk. The general market risk refers to
changes in the market values due to large market movements.
Specific risk refers to changes in the value of an individual asset due to factors related to the
issuer of the security.
There are four types of economic variables that generate market risk. These are
Interest Rates
Foreign Exchanges
Equities
Commodities
(http://www.ecb.europa.eu/pub/pdf/scpops/ecbocp42.pdf)

Limitations of Basel I

Basel I Capital Accord has been criticized on several grounds. The main criticisms include
the following:
Limited differentiation of credit risk: There are four broad risk weightings (0%, 20%,
50% and 100%), as shown in Figure1, based on an 8% minimum capital ratio.

Static measure of default risk: The assumption that a minimum 8% capital ratio is
sufficient to protect banks from failure does not take into account the changing nature of
default risk.
No recognition of term-structure of credit risk: The capital charges are set at the same
level regardless of the maturity of a credit exposure.
Simplified calculation of potential future counterparty risk: The current capital
requirements ignore the different level of risks associated with different currencies and
macroeconomic risk. In other words, it assumes a common market to all actors, which is not
true in reality.
Lack of recognition of portfolio diversification effects: In reality, the sum of individual
risk exposures is not the same as the risk reduction through portfolio diversification.
Therefore, summing all risks might provide incorrect judgment of risk. A remedy would be to
create an internal credit risk model for example, one similar to the model as developed by
the bank to calculate market risk. This remark is also valid for all other weaknesses. These
listed criticisms have led to the creation of a new Basel Capital Accord, known as Basel II,
which added operational risk and also defined new calculations of credit risk. Operational
risk is the risk of loss arising from human error or management failure.
The Basel I Capital Accord aimed to assess capital in relation to credit risk, or the risk that a
loss will occur if a party does not fulfil its obligations. It launched the trend toward increasing
risk modelling research; however, its over-simplified calculations, and classifications have
simultaneously called for its disappearance, paving the way for the Basel II Capital Accord
and further agreements as the symbol of the continuous refinement of risk and capital.
Nevertheless, Basel I, as the first international instrument assessing the importance of risk in
relation to capital, will remain a milestone in the finance and banking history.
(A Guide to Capital Adequacy Standards for Lenders. The United Kingdom
Council of Mortgage Lenders, February 2008.)

2 BASEL II
Measurement and Capital Standards, helps international banks and financial institutions
safeguard themselves against operational and financial risks. It does this by setting up
rigorous risk and capital management requirements designed to ensure that a bank holds
enough capital reserves on hand to offset its risks.
While risk management has always been a core banking function, banks were earlier
permitted to develop their own risk methodologies. For this reason it was very tough to
compare risk position of two different banks. With Basel II, each bank has to follow
minimum risk methodology standards, develop their own risk management framework and
ensure regulatory supervision. This brings the banks under one umbrella to understand risk
position. (http://www.bis.org/publ/bcbs118.htm)

2.1 Objectives of Basel II:

There were four key objectives of the new framework, namely:
1. The Accord should continue to promote safety and soundness of the financial system
2. The Accord should continue to enhance competitive equality
3. The Accord should constitute a more comprehensive approach to addressing risks
4. The Accord should focus on internally active banks, although its underlying principles
should be suitable for application to banks of varying levels of complexity and sophistication.
(http://www.bis.org/publ/bcbs118.htm)
2.2 Three pillars of Basel II:
The Basel II approach to risk is designed to encompass the complexity of information technology and
information management. The enhanced framework, is built on three pillars:

Risk based capital (Pillar 1)

Risk based supervision (Pillar 2)
Risk disclosure to enforce market discipline (Pillar 3)
2.2.1 The First Pillar Minimum Capital Requirements
The first pillar sets out minimum capital requirement. The new framework maintains
minimum capital requirement of 8% of risk assets. Basel II focuses on improvement in
measurement of risks. The revised credit risk measurement methods are more elaborate than
the current accord. It proposes, for the first time, a measure for operational risk, while the
market risk measure remains unchanged.
The first pillar deals with maintenance of regulatory capital calculated for three major
components of risk that a bank faces: credit risk, operational risk, and market risk. Other risks
are not considered fully quantifiable at this stage.
The credit risk component can be calculated in three different ways of varying degree of
sophistication, namely standardized approach, Foundation IRB, Advanced IRB and General
IB2 Restriction. IRB stands for "Internal Rating-Based Approach".
For operational risk, there are three different approaches basic indicator approach or
BIA, standardized approach or STA, and the internal measurement approach (an advanced
form of which is the advanced measurement approach or AMA).
For market risk the preferred approach is VaR (value at risk).
As the Basel II recommendations are phased in by the banking industry it will move from
standardised requirements to more refined and specific requirements that have been
developed for each risk category by each individual bank. The upside for banks that do
develop their own bespoke risk measurement systems is that they will be rewarded with
potentially lower risk capital requirements. In the future there will be closer links between the
concepts of economic and regulatory capital. (http://www.bis.org/publ/bcbs107b.pdf)

2.2.2 The Second Pillar - Supervisory Review Process

Supervisory review process has been introduced to ensure not only that banks have adequate
capital to support all the risks, but also to encourage them to develop and use better risk
management techniques in monitoring and managing their risks.
The process has four key principles
a) Banks should have a process for assessing their overall capital adequacy in relation to their
risk profile and a strategy for monitoring their capital levels.
b) Supervisors should review and evaluate banks internal capital adequacy assessment and
strategies, as well as their ability to monitor and ensure their compliance with regulatory
capital ratios.
c) Supervisors should expect banks to operate above the minimum regulatory capital ratios
and should have the ability to require banks to hold capital in excess of the minimum.
d) Supervisors should seek to intervene at an early stage to prevent capital from falling below
minimum level and should require rapid remedial action if capital is not mentioned or
restored. (http://www.bis.org/publ/bcbs107c.pdf)
2.2.3 The Third Pillar - Risk Disclosure to Enforce Market Discipline
This pillar aims to complement the minimum capital requirements and supervisory review
process by developing a set of disclosure requirements which will allow the market
participants to gauge the capital adequacy of an institution.
Market discipline supplements regulation as sharing of information facilitates assessment of
the bank by others, including investors, analysts, customers, other banks, and rating agencies,
which leads to good corporate governance. The aim of Pillar 3 is to allow market discipline to
operate by requiring institutions to disclose details on the scope of application, capital, risk
exposures, risk assessment processes, and the capital adequacy of the institution. It must be
consistent with how the senior management, including the board, assess and manage the risks
of the institution.
When market participants have a sufficient understanding of a bank's activities and the
controls it has in place to manage its exposures, they are better able to distinguish between
banking organizations so that they can reward those that manage their risks prudently and
penalize those that do not.
These disclosures are required to be made at least twice a year, except qualitative disclosures
providing a summary of the general risk management objectives and policies which can be
made annually. Institutions are also required to create a formal policy on what will be
disclosed and controls around them along with the validation and frequency of these
disclosures. In general, the disclosures under Pillar 3 apply to the top consolidated level of
the banking group to which the Basel II framework applies.
Each of the three pillars are complimentary to each other and are required for supervising
both the overall financial health of the banking industry and that of the individual institution
as well, though it must be highlighted that none can substitute for effective bank
management. The rationale behind adopting the new Accord is that it is believed by the

committee that the new framework has the potential to meet challenges of innovations in
increasingly complex financial markets. (http://www.bis.org/publ/bcbsca10.pdf)

PILLAR III INFORMATION FOR ING BANK

3.1 Risk Management at ING Bank
ING has a group risk management function that is embedded at all levels of the organisation
and operates through a comprehensive risk governance framework.
The primary responsibility of the Bank risk management function lies with the Chief Risk
Officer (CRO), who is a member of the Executive Board. The CRO is responsible for the
management and control of risk on a consolidated level to ensure that INGs bank risk profile
is consistent with its financial resources and the risk appetite defined by the Executive Board.
The CRO has several direct reports who are all responsible for a specific risk management
function within ING Bank.
(http://annualreports.ing.com/2008/additional_information/additional_information_sub/pillar
_info/rm_ing_bank/index.html)

Regulatory Capital Requirements

Table 1: Regulatory capital requirements

Credit risk
Portfolios subject to standardised approach
Portfolios subject to advanced IRB approach
Central governments and central banks
Institutions
Corporate
Residential mortgages
Other retail
Total portfolios subject to advanced IRB approach
Securitisation exposures
Equity portfolios in the banking book under the simple risk weight approach
Other Non-Credit Obligation Assets (ONCOA)
Total credit risk

3,083

309
1,680
9,366
3,062
885
15,302
2,321
194
2,166
23,066

Market risk
Standardised approach
Internal models approach trading book
Total market risk

449
587
1,036

Operational risk
Advanced measurement approach

3,368

Total Basel II required Regulatory Capital

27,470

Basel II floor*
34,369
Additional capital requirement
6,899
Source:http://annualreports.ing.com/2008/additional_information/additional_information_su
b/pillar_info/rm_ing_bank/index.html
Regulatory capital requirements
90% of Basel I required Regulatory Capital. In order to prevent large short term effects on
capital requirements, the regulators introduced transition rules (the capital floor) for
institutions implementing the new capital adequacy reporting. For 2008 and 2009 the capital
requirements should be no less than 90% and 80% respectively of the capital requirements
calculated under Basel I regulations. The additional capital requirements according to the
transition rules are EUR 6,899 million. The required regulatory capital shown in this section
should
be
compared
to
the
available
regulatory
capital.
(http://annualreports.ing.com/2008/additional_information/additional_information_sub/pillar
_info/rm_ing_bank/index.html)
.
3.3 Credit Risk at ING
ING Banks credit policy is to maintain an internationally diversified loan and bond portfolio,
while avoiding large risk concentrations. The emphasis is on managing business
developments within the business lines by means of top-down concentration limits for
countries, individual obligors and obligor groups. The aim is to expand relationship-banking
activities, while maintaining stringent internal risk/return guidelines and controls.
Credit Risk is the risk of loss from the default by debtors or counterparties. Credit risks arise
in ING Banks lending, money market, pre-settlement and investment activities, as well as in
its trading activities. Credit risk management is supported by dedicated credit risk
information systems and internal rating methodologies for debtors and counterparties.
ING Banks credit exposure is mainly related to traditional lending to individuals and
businesses, bonds held in the investment portfolios and financial markets trading activities.
Loans to individuals are mainly mortgage loans secured by residential property. Loans to
businesses are often collateralised, but can be unsecured based on internal analysis of the
obligors creditworthiness. Financial Markets activities include derivatives trading, securities
financing, and Foreign Exchange (FX) transactions, which we collectively refer to as PreSettlement risks. ING uses various market pricing and measurement techniques to determine
the amount of credit risk on pre-settlement activities. These techniques estimate INGs
potential future exposure on individual and portfolios of trades. Master agreements and
collateral agreements are frequently entered into to reduce these credit risks.
(http://annualreports.ing.com/2008/additional_information/additional_information_sub/pillar_info/cre
dit_risk/index.html)

3.3.1 Pillar 3 Credit Risk in Practice

The Basel II Accord not only changes the way ING reports its credit risk for regulatory
purposes; it also affects the daily operations and practices of all types of risk management at

all levels within ING Bank. It has no effect on ING Insurance or Asset Management
operations.
One of the key elements of the Basel II Accord is the Use Test, which requires ING to use
Basel concepts in its day-to-day activities. The diagram below illustrates where ING has
incorporated the Basel II concepts into its daily activities, both globally and locally:
(http://annualreports.ing.com/2008/additional_information/additional_information_sub/pillar_info/cre
dit_risk/pillar3_credit_risk.html)
Picture 1: Pillar 3 Credit Risk in Practice

Source:http://annualreports.ing.com/2008/additional_information/additional_information_sub/pillar_info/credi
t_risk/pillar3_credit_risk.html

3.4 Risk Rating Methodology

In principle all Risk Ratings are based on a Risk Rating (PD) Model that complies with the
minimum requirements detailed the CRD, the DNB Supervisory Rules and CEBS guidelines.
This concerns all Obligor Types and Segments, including Countries.
INGs Probability of Default (PD) rating models are based on a 1-22 scale, which roughly
corresponds to the same rating grades that are assigned by external rating agencies, such as
Standard & Poors and Fitch. For example, an ING rating of 1 would correspond to an
S&P/Fitch rating of AAA; an ING rating of 2 would correspond to an S&P/Fitch rating of
AA+, and so on.
Table 2: Exposures (EAD) by PD grade under the AIRB approach
Central
Institutions Corporate Residential Other
governments
mortgages retail
and central
banks

Total

1 (AAA)
28,745
1,857
7,698
181
38,481
2 (AA+)
26,271
2,185
1,553
1,859
146
32,014
3 (AA)
3,321
19,158
5,142
1,990
100
29,711
4 (AA-)
11,463
43,761
6,352
1,046
84
62,706
5 (A+)
618
23,075
9,156
4,761
2,638 40,248
6 (A)
314
10,589
12,181
1,571
311
24,966
7 (A-)
865
9,357
14,793
18,839
1,086 44,940
8 (BBB+)
948
5,441
24,173
19,238
2,481 52,281
9 (BBB)
129
1,950
30,589
40,149
4,067 76,884
10 (BBB-)
848
3,792
39,143
45,809
3,523 93,115
11 (BB+)
116
1,636
35,671
66,961
6,085 110,469
12 (BB)
1,969
1,329
30,210
30,016
2,558 66,082
13 (BB-)
42
1,121
23,890
6,088
2,036 33,177
14 (B+)
151
432
14,343
1,501
1,139 17,566
15 (B)
53
415
4,993
7,396
1,089 13,946
16 (B-)
403
2,289
855
347
3,894
17 (CCC-C)
9
1,011
3,771
2,776
481
8,048
18
(Special
52
2,183
311
488
3,034
Mention)
19
3
43
567
1,566
271
2,450
(Substandard)
20 (Doubtful) 4
181
3,359
1,466
679
5,689
21
182
1,346
79
1,607
(Liquidation
no loss)
22
9
407
23
110
549
(Liquidation
with loss)
Total
75,869
127,797
272,645
255,567
29,979 761,857
Source:http://annualreports.ing.com/2008/additional_information/additional_information_su
b/pillar_info/credit_risk/credit_risk_exposures.html
The figures presented above are based on EAD and as such differ from those presented in the
annual accounts due to different measurement methodology.
Over 95% of INGs credit risks have been rated using one of the in-house developed PD
rating models. Within the AIRB Portfolio, the level of Basel II ratings exceeds 99% coverage
by exposure. Bank wide, ING has implemented approximately 90 PD models, including
various sub models that may be applicable. Some of these models are universal in nature,
such as models for Large Corporate, Commercial Banks, Insurance Companies, Central
Governments, Local Governments, Funds, Fund Managers, Project Finance, and Leveraged
Companies.
Under Basel II rules, the nominal exposures are weighted to determine the RWA (and
regulatory capital) of a portfolio, under a risk-based approach. This approach dictates that
less capital is required for credit risks which are well-rated, while progressively more capital
is required as an obligors risk (rating) deteriorates. This effect can cause RWA assets to
increase or decrease together with risk rating migration without a significant change in the
size of the underlying financial assets, in terms of financial accounting. As such, rating

migrations
are
closely
monitored
within
ING.
(http://annualreports.ing.com/2008/additional_information/additional_information_sub/pillar
_info/credit_risk/credit_risk_exposures.html)
Table 3: Average LGD by PD grade under the AIRB approach IRB approach
Central
Institutions Corporate Residential Other Total
governments
mortgages retail
and
central
banks
1 (AAA)
20%
16%
34%
10%
53%
23%
2 (AA+)
20%
22%
34%
10%
46%
20%
3 (AA)
20%
21%
37%
10%
42%
23%
4 (AA-)
20%
22%
41%
10%
37%
23%
5 (A+)
20%
24%
35%
12%
55%
27%
6 (A)
21%
24%
28%
10%
52%
25%
7 (A-)
24%
27%
31%
21%
40%
26%
8 (BBB+)
55%
27%
34%
18%
22%
27%
9 (BBB)
18%
37%
29%
16%
33%
23%
10 (BBB-)
41%
29%
25%
14%
26%
19%
11 (BB+)
22%
38%
20%
13%
37%
17%
12 (BB)
37%
42%
22%
16%
38%
20%
13 (BB-)
49%
43%
18%
16%
40%
20%
14 (B+)
8%
36%
23%
15%
39%
23%
15 (B)
8%
43%
26%
13%
45%
21%
16 (B-)
52%
74%
20%
14%
33%
25%
17 (CCC-C)
17%
33%
30%
12%
37%
24%
18
(Special 20%
24%
16%
19%
19%
17%
Mention)
19
33%
48%
18%
14%
35%
18%
(Substandard)
20 (Doubtful)
28%
30%
25%
24%
44%
27%
21
1%
15%
14%
57%
16%
(Liquidation
no loss)
22
15%
27%
14%
73%
36%
(Liquidation
with loss)
Total
21%
24%
26%
15%
36%
22%
Sorce:http://annualreports.ing.com/2008/additional_information/additional_information_sub/
pillar_info/credit_risk/credit_risk_exposures.html
The table above represents the weighted average LGD for each of the represented
combination of PD Grade and Exposure Class. For example, the weighted average LGD for
an AAA rated corporate is 34%, while the weighted average LGD for a BBB rated corporate
is 29%. LGD percentages are influenced by the transactional structure of the financial
obligation, the related collateral or covers provided, and the country in which the collateral (if
any) would have to be recovered.

In certain cases, the portfolio size is relatively small, which can also have an effect on the
weighted average LGD in a given PD Grade and Exposure Class. Therefore, this table should
be read in conjunction with the previous table (Exposures (EAD) by PD grade).
(http://annualreports.ing.com/2008/additional_information/additional_information_sub/pillar
_info/credit_risk/credit_risk_exposures.html)
3.5 Market Risk at ING
According to the Dutch regulation, regulatory capital for trading portfolios can be calculated
using the standardised approach (CAD1) or an internal model approach (CAD2). In 1998,
ING received approval from the Dutch Central Bank (DNB) to use an internal Value-at-Risk
(VAR) model to determine the regulatory capital for the market risk in the trading book of
ING Bank. Market risk capital of CAD2 trading books is calculated according to the internal
VaR model, where correlations and volatilities are taken into account. On the other hand,
market risk capital of CAD1 books is calculated using standardised fixed risk weights.

Table 4: VaR values for IMA portfolios

Interest rate risk
Equity position risk
Foreign exchange risk
Diversification effect
Total

High
50
11
8

Mean
37
7
5
5
44

Low
22
4
2

Period-end
40
7
6
3
50

For a summary of the Value-at-Risk measurement applicable to the internal model approach
please refer to the Market Risk segment in the Risk Management section. It should be noted
that the VaR figures in the above table only relate to the CAD2 trading books for which the
internal model approach is applied. The VaR figures reported in the Risk management section
relate to all books under trading governance.
(http://annualreports.ing.com/2008/additional_information/financial_information/pillar_info/
msarket_risk/index.html)
3.6 Operational Risk
The Operational Risk Capital model of ING is based on a Loss Distribution Approach
(LDA). The Loss Distribution is based on both external and internal loss data exceeding EUR
1 million. The model is adjusted for the scorecard results, taking into account the specific
quality of control in a business line and the occurrence of large incidents (bonus/malus).
This provides an incentive to local (operational risk) management to better manage
operational risk. Originally, the model was designed for Economic Capital (99.95%
confidence level) and the Financial Risk Dashboard (90% confidence level). From 2008
onwards, the model is used for regulatory capital reporting purposes as well (AMA

approach). Insurance reduction because of risk mitigation by insurance has not been applied
to the AMA capital of 2008.
The Operational Risk Capital using AMA significantly increased to EUR 3,368 million in
(as stated in the operational risk part of the risk management section) due the periodic update
of the external loss data, which reflected the increased uncertainty/turmoil in the financial
market. Two acquisitions took place that impacted capital and the related diversification
benefit

as

well:

ING

Turkey

and

ING

Direct

Interhyp.

(http://annualreports.ing.com/2008/additional_information/additional_information_sub/pillar
_info/operational_risk.html)

4 BASEL III
After the current global financial crisis the Basel committee feels the importance to improve
the current Basel II accord and start to work for developing a new capital framework known
as the Basel III.
Basel III is a comprehensive set of reform measures, developed by the Basel Committee on
Banking Supervision, to strengthen the regulation, supervision and risk management of the
banking sector. These measures aim to:
Improve the banking sector's ability to absorb shocks arising from financial and economic
stress, whatever the source.
Improve risk management and governance.
Strengthen banks' transparency and disclosures.
(http://www.bis.org/bcbs/basel3.htm)
4.1 Key points of Basel III accord:
Banks will have to increase their core tier-one capital ratio to 4.5% by 2015. In addition, they
will have to carry a further "counter-cyclical" capital conservation buffer of 2.5% by 2019.
Any bank that fails to meet the new requirements is expected to be banned from paying
dividends to shareholders until it has improved its balance sheet.
Financial supervision: The G20 wants closer supervision of systemic risk at local and
international levels.
Derivatives: The G20 has called for greater standardization and central clearing of privately
arranged, over-the-counter contracts by the end of 2012.
Hedge funds: US reforms are in line with the G20 pledge that funds above a certain size
should be authorized and obliged to report data to supervisors. A draft EU law includes
private equity groups and restrictions on non-EU fund managers seeking European investors.
Accounting: The G20 wants common global accounting rules by mid-2011.

Credit rating agencies: The G20 wants them registered and supervised by the end of 2009.
The EU has adopted a law mandating registration and direct supervision that takes effect this
year. US legislation passed this year includes similar provisions.
Pay: The G20 has endorsed principles designed to stop bonus schemes in banks from
encouraging too much short-term risk-taking.
(http://www.theguardian.com/business/2010/sep/13/basel-iii-the-main-points)

CONCLUSION

One very important fact to assess is the achievements and limitations of each Basel Accord.
The first Basel Accord, Basel I, was a groundbreaking accord in its time, and did much to
promote regulatory harmony and the growth of international banking across the borders of
the G-10 and the world alike. On the other hand, its limited scope and rather general language
gives banks 16 excessive leeway in their interpretation of its rules, and in the end, allows
financial institutions to take improper risks and hold unduly low capital reserves. Basel II, on
the other hand, seeks to extend the breath and precision of Basel I, bringing in factors such as
market and operational risk, market based discipline and surveillance, and regulatory
mandates. The drawbacks of both accords, interestingly enough, are remarkably similar. Put
simply, both effectively ignore the implications of their rules on emerging market banks.
Although each states that its positions are not recommended for application in emerging
market economies, the use of Basel I and II by most private and public organizations as truly
international banking standards predicates the inclusion of emerging markets in each accord.
As a result of this drawbacks and the current global financial crisis the Basel committee
decides to improve the current Basel II accord and start to work for developing a new capital
framework known as the Basel III. The key points of this new accord will include financial
supervision, derivatives, hedge funds and accounting and are expected to overcome the
limitations and week points of the previous two pillars.

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