BASEL II AT GLANCE : IMPLEMENTATION OF BASEL II IN INDONESIA
:: Improved Standard for Capital Adequacy
A bank provides an intermediation function for funds received from customers. Failure of a bank will result in widespread impact affecting retail and institutional customers who hold funds at the bank. This could trigger multiplier impacts on the domestic and international market. The importance of the banking role demands proper regulation, in which the primary objective is to maintain customer confidence in the banking system. An essential part of the regulatory framework for the banking system involves the regulations governing bank capital, which functions as a buffer against losses.
In view of the importance of capital to banks, BIS issued a capital framework concept more commonly known as the 1988 accord (Basel I). This system was designed as a framework for measurement of credit risk and established a minimum capital standard at 8%. The Basel Committee designed Basel I as a simple standard requiring banks to disaggregate their exposures into broader categories reflecting debtor similarities. Exposures to customers of the same type (such as exposures to all corporate customers) are subject to the same capital requirements without taking account of differences in loan repayment capacity and specific risks associated with the individual customer.
More than a decade later, prompted by the evolution of banking worldwide and the reality that the best method for calculating, managing and mitigating risks would be different from bank to bank, the Basel Committee embarked on the initiative for revision of Accord 1988. The growing diversity and sophistication of products in the banking system led BIS to introduce improvements to the capital framework in the 1988 accord with the launching of a new capital concept known as Basel II. The first proposal was released in 1999 and was slated for implementation at end-2006. The revised capital accord—Basel II—is a comprehensive agreement that establishes a spectrum of more risk-sensitive capital allocation and incentive for improvements in the quality of risk management at banks. This was achieved by adjusting capital requirements to credit risk and operational risk, and introducing changes in calculation of capital to cover exposures to risks of losses caused by operational failures. In addition to the calculation of minimum bank capital, Basel II also provides for a supervisory review process to ensure that banks maintain a level of capital commensurate to their risk profile and promotes market discipline through disclosure requirements.
The objective of Basel II is to strengthen the security and soundness of the financial system by reinforcing the emphasis on risk-based calculation of capital, the supervisory review process and market discipline. The Basel II Framework is based on a forward-looking approach that enables improvements and changes to be made over time. In this way, the Basel II framework is able to keep pace with changes in the marketplace and developments in risk management.
At first glance, Basel II involves various complexities and preconditions that are difficult for banks to meet. However, the extra effort is well justified in view of the benefits to banks from more economic use of capital in covering their risks. Banks also benefit from the international recognition of the Basel II standards, which enables a bank intending to operate globally to be readily accepted on the international market, provided that these standards are met.