Following are excerpts from a recent address made by Nout Wellink, Chairman of the Basel Committee on Banking Supervision and President of the Netherlands Bank onthe subject.

The Basel II framework helps firms and financial systems to become more resilient to a rapidly changing financial landscape.

“It is essential to have robust and resilient core firms at the centre of the financial system operating on safe and sound risk management practices. A sound global capital adequacy framework is critical to ensure the robustness and resilience of these firms”, said Mr Wellink. He noted that “innovation has led to new techniques and tools for managing credit portfolios and this has been accompanied by increased complexity. The Basel Committee’s response has been to capitalise on the improvements in banks’ risk management systems to better address the complexity and innovation we see today.”

Mr Wellink underscored that Basel II will help strengthen risk management practices in areas such as operational risk measurement and management, firm-wide stress testing, and the measurement of increasingly complex counterparty exposures. He said that “Basel II also establishes benchmarks for recognising risk transfer and mitigation in securitisation and credit derivative structures.” In highlighting the central role that Pillar 2 plays in the Basel II framework, Mr Wellink said “This is not a compliance exercise! Senior management and boards of directors need to lead the process and ensure that their institutions establish robust internal systems that capture all material risks for their institution in a rigorous manner.” He noted that “the better banks measure and manage their risks, the more comfortable supervisors and the market will become with respect to their Pillar 1 processes, as well as the amount of overall capital that Pillar 2 indicates is appropriate.”
Mr Wellink also emphasised the growing importance of Pillar 3 and that in the light of rapid financial innovation, state of the art dislosure needs to keep up. “Basel II seeks to raise the bar on the quality of disclosures, especially related to more complex credit risk intermediation activities, covering areas such as counterparty risk, securitisations, and credit risk mitigants.”

Mr Wellink noted that while the move to the Basel II framework entails transition costs, “both banks and supervisors need to take a long term perspective when considering the benefits of Basel II.” Regulatory capital, risk management and risk based supervision will be aligned in a more consistent manner to better accommodate financial innovation. “This capital framework is a long term investment that if done properly will lay the foundation for further evolution.”