The Basel Committee on Banking Supervision has published an overview report on the Pillar 2 supervisory review process and on the different practices that regulators and legislators in Basel member jurisdictions have adopted in relation to it.
 
The three 'pillars' under the Basel III Framework are: (i) Pillar 1, which requires banks to have adequate capital to support their business risks over and above minimum requirements; (ii) Pillar 2, which requires national supervisors to evaluate how well banks assess their capital needs and take appropriate steps to hold adequate and potentially additional capital beyond the minimum set under Pillar 1; and (iii) Pillar 3, which imposes disclosure requirements upon banks.
 
The Basel Committee's report focuses on Pillar 2 and identifies four key principles applied by supervisory authorities when reviewing banks' regulatory capital:

1. Banks should have a process for assessing overall capital adequacy in relation to risk profile and a strategy for maintaining capital levels;
2. Supervisors should review banks' internal capital adequacy assessments, strategies and monitoring systems and take action if they are not satisfied with the systems in place;
3. Supervisors should expect banks to operate above minimum capital requirements and be able to mandate that banks hold capital in excess of minimum requirements;
4. Supervisors should intervene early to prevent capital levels falling below minimum requirements and require remedial action if capital is not maintained or restored. 

The report considers the different manners in which national supervisors have put these principles into action, including case studies describing different supervisory approaches. It then reviews four areas of risk that receive particular focus under Pillar 2 supervisory approaches, namely: (i) business model risk; (ii) interest rate risk in the banking book (i.e. the risk arising to banks' book position from adverse movements in interest rates); (iii) concentration risk (i.e. risks arising from a concentration of business in, for instance, a particular geography, sector or products or services provided by banks); and (iv) other risks, including both traditional financial risks, such as credit and market risk and broader reputational, legal, strategic and climate-related risks.
 
The report concludes with an overview of the actions supervisors require banks to take to address deficiencies in their internal frameworks, which include corrective actions (such as strengthening of risk management and limiting lines of business) and capital expectations set under Pillar 2 frameworks.
 
View the report.

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