Basel Committee on Banking Supervision
International Convergence of Capital Measurement and Capital Standards
A Revised Framework, Comprehensive Version

This document is a compilation of the June 2004 Basel II Framework, the elements of the 1988 Accord that were not revised during the Basel II process, the 1996 Amendment to the Capital Accord to Incorporate Market Risks, and the 2005 paper on the Application of Basel II to Trading Activities and the Treatment of Double Default Effects. No new elements have been introduced in this compilation.

June 2006
Introduction

1. This report presents the outcome of the Basel Committee on Banking Supervision’s (“the Committee”)* work over recent years to secure international convergence on revisions to supervisory regulations governing the capital adequacy of internationally active banks.

Following the publication of the Committee’s first round of proposals for revising the capital adequacy framework in June 1999, an extensive consultative process was set in train in all member countries and the proposals were also circulated to supervisory authorities worldwide.

The Committee subsequently released additional proposals for consultation in January 2001 and April 2003 and furthermore conducted three quantitative impact studies related to its proposals.

As a result of these efforts, many valuable improvements have been made to the original proposals.

The present paper is now a statement of the Committee agreed by all its members.

It sets out the details of the agreed Framework for measuring capital adequacy and the minimum standard to be achieved which the national supervisory authorities represented on the Committee will propose for adoption in their respective countries.

This Framework and the standard it contains have been endorsed by the Central Bank Governors and Heads of Banking Supervision of the Group of Ten countries.

* The Basel Committee on Banking Supervision is a committee of banking supervisory authorities that was established by the central bank governors of the Group of Ten countries in 1975.

It consists of senior representatives of bank supervisory authorities and central banks from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom, and the United States.

It usually meets at the Bank for International Settlements in Basel, where its permanent Secretariat is located.

2. The Committee expects its members to move forward with the appropriate adoption procedures in their respective countries.

In a number of instances, these procedures will include additional impact assessments of the Committee’s Framework as well as further opportunities for comments by interested parties to be provided to national authorities.

The Committee intends the Framework set out here to be available for implementation as of yearend 2006.

However, the Committee feels that one further year of impact studies or parallel calculations will be needed for the most advanced approaches, and these therefore will be available for implementation as of year-end 2007.

More details on the transition to the revised Framework and its relevance to particular approaches are set out in paragraphs 45
to 49.

3. This document is being circulated to supervisory authorities worldwide with a view to encouraging them to consider adopting this revised Framework at such time as they believe is consistent with their broader supervisory priorities.

While the revised Framework has been designed to provide options for banks and banking systems worldwide, the Committee
acknowledges that moving toward its adoption in the near future may not be a first priority for all non-G10 supervisory authorities in terms of what is needed to strengthen their supervision.

Where this is the case, each national supervisor should consider carefully the benefits of the revised Framework in the context of its domestic banking system when developing a timetable and approach to implementation.

4. The fundamental objective of the Committee’s work to revise the 1988 Accord* has been to develop a framework that would further strengthen the soundness and stability of the international banking system while maintaining sufficient consistency that capital adequacy regulation will not be a significant source of competitive inequality among internationally
active banks.

The Committee believes that the revised Framework will promote the adoption of stronger risk management practices by the banking industry, and views this as one of its major benefits.

The Committee notes that, in their comments on the proposals, banks and other interested parties have welcomed the concept and rationale of the three pillars (minimum capital requirements, supervisory review, and market discipline) approach on
which the revised Framework is based.

More generally, they have expressed support for improving capital regulation to take into account changes in banking and risk management practices while at the same time preserving the benefits of a framework that can be applied as uniformly as possible at the national level.

* International Convergence of Capital Measurement and Capital Standards, Basel Committee on Banking Supervision (July 1988), as amended

5. In developing the revised Framework, the Committee has sought to arrive at significantly more risk-sensitive capital requirements that are conceptually sound and at the same time pay due regard to particular features of the present supervisory and accounting systems in individual member countries.

It believes that this objective has been achieved.

The Committee is also retaining key elements of the 1988 capital adequacy framework, including the general requirement for banks to hold total capital equivalent to at least 8% of their risk-weighted assets; the basic structure of the 1996 Market Risk Amendment regarding the treatment of market risk; and the definition of eligible capital.

6. A significant innovation of the revised Framework is the greater use of assessments of risk provided by banks’ internal systems as inputs to capital calculations. In taking this step, the Committee is also putting forward a detailed set of minimum requirements designed to ensure the integrity of these internal risk assessments.

It is not the Committee’s intention to dictate the form or operational detail of banks’ risk management policies and practices.

Each supervisor will develop a set of review procedures for ensuring that banks’ systems and controls are adequate to serve as the basis for the capital calculations.

Supervisors will need to exercise sound judgements when determining a bank’s state of readiness, particularly during the implementation process.

The Committee expects national supervisors will focus on compliance with the minimum requirements as a means of ensuring the overall integrity of a bank’s ability to provide prudential inputs to the capital calculations and not as an end in itself.

7. The revised Framework provides a range of options for determining the capital requirements for credit risk and operational risk to allow banks and supervisors to select approaches that are most appropriate for their operations and their financial market infrastructure.

In addition, the Framework also allows for a limited degree of national discretion in the way in which each of these options may be applied, to adapt the standards to different conditions of national markets.

These features, however, will necessitate substantial efforts by national authorities to ensure sufficient consistency in application.

The Committee intends to monitor and review the application of the Framework in the period ahead with a view to achieving even greater consistency.

In particular, its Accord Implementation Group (AIG) was established to promote consistency in the Framework’s lication by encouraging supervisors to exchange information on implementation approaches.

8. The Committee has also recognised that home country supervisors have an important role in leading the enhanced cooperation between home and host country supervisors that will be required for effective implementation.

The AIG is developing practical arrangements for cooperation and coordination that reduce implementation burden on banks
and conserve supervisory resources.

Based on the work of the AIG, and based on its interactions with supervisors and the industry, the Committee has issued general principles for the cross-border implementation of the revised Framework and more focused principles for the recognition of operational risk capital charges under advanced measurement approaches for home and host supervisors.

9. It should be stressed that the revised Framework is designed to establish minimum levels of capital for internationally active banks.

As under the 1988 Accord, national authorities will be free to adopt arrangements that set higher levels of minimum capital. Moreover, they are free to put in place supplementary measures of capital adequacy for the banking organisations they charter.

National authorities may use a supplementary capital measure as a way to address, for example, the potential uncertainties in the accuracy of the measure of risk exposures inherent in any capital rule or to constrain the extent to which an organisation may fund itself with debt.

Where a jurisdiction employs a supplementary capital measure (such as a leverage ratio or a large exposure limit) in conjunction with the measure set forth in this Framework, in some instances the capital required under the supplementary
measure may be more binding.

More generally, under the second pillar, supervisors should expect banks to operate above minimum regulatory capital levels.

10. The revised Framework is more risk sensitive than the 1988 Accord, but countries where risks in the local banking market are relatively high nonetheless need to consider if banks should be required to hold additional capital over and above the Basel minimum.

This is particularly the case with the more broad brush standardised approach, but, even in the case of the internal ratings-based (IRB) approach, the risk of major loss events may be higher than allowed for in this Framework.

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