Glossary term
Basel Pillars 1, 2 and 3
Subject: Risk Management, Prudential and Capital Risk
Also known as: Three Pillars, Basel Three Pillars
The Basel pillars are the three parts of the Basel framework: Pillar 1 sets minimum capital, Pillar 2 adds supervisory review and the bank's own assessment, and Pillar 3 requires public disclosure.
Explanation
Pillar 1 fixes the minimum capital a bank must hold against credit, market and operational risk, using standard formulas or approved internal models. Pillar 2 recognises that formulas miss things. Banks run their own internal capital assessment, and supervisors review it and can ask for more capital where risks are not fully captured, such as concentration or interest rate risk in the banking book. Pillar 3 aims at market discipline: banks publish standard information on capital, risk exposures and risk management so that investors and analysts can compare them. The pillars cover for each other: formulas can be gamed, so supervisors apply discretion, and published figures let outsiders check both. In practice, a bank's capital team works to Pillar 1, its supervisory dialogue to Pillar 2 and its published report to Pillar 3.
Example
One bank meets its Pillar 1 ratio comfortably. In its supervisory review, the regulator notes a heavy concentration in commercial property lending that Pillar 1 does not cover, and sets an extra capital requirement. The bank's disclosure report, published each quarter under Pillar 3, then shows investors the capital held and the exposures behind it.
Not to be confused with
- Basel III
- Basel III is a set of reforms. The three pillars are the structure that every version of the framework follows.