SUMMARY

Pillar II complements the ‘black letter’ requirements of Pillar I and is intended to achieve two objectives: to ensure that banks have adequate capital to support all the risks in their business and to encourage them to use better techniques for monitoring and managing their risks.

The second pillar specifically emphasises the need for a qualitative approach to supervising banks. It constitutes an integral part of the new capital accord and ranks equally alongside the minimum capital requirements and the call for market transparency.

Pillar II in the New Basel Accord: The Challenge of Economic Capital takes you through every main strand of Pillar II. It tackles the regulatory framework, shows how to reconcile the various regulatory sources and focuses on the following sequence of questions:

• What additional capital is required to support Pillar I risks where the Basel II models do not adequately reflect the unique circumstances of the particular bank?

• What additional capital is required to support risks not captured under Pillar I at all?

• What reduction in capital should be allowed to account for the fact that individual risks may be less than perfectly correlated?

• What further adjustment should be made to counteract procyclical movements in regulatory capital resulting from the Pillar I calculation?

• How should a banking group’s economic capital be allocated to its business units and legal entities?

• How will supervisors from different countries interact when assessing Pillar II implementation in international banks?

• How will hybrid capital help in preserving and maintaining the capital adequacy levels dictated by Pillar II?

Pillar II in the New Basel Accord is an indispensable book for any financial practitioner affected by the Basel II accord, including chief financial officers, chief operating officers, chief investment officers, risk managers, credit risk managers, senior compliance officers, and also those working in the fields of operational risk, compliance, regulation, credit, and risk management.

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  TABLE OF CONTENTS

About the Editor

About the Authors

Introduction
Andrea Resti
Bocconi University

PART I: THE REGULATORY FRAMEWORK

1 Pillar II in the New Basel Accord and in the New European Directives
Martina Bignami and Andrea Pilati
Bank of Italy

2 The Capital Adequacy Assessment Process: A Supervisory Perspective
Preston Thompson; David Palmer
Federal Reserve Bank of Boston; Federal Reserve Board, Washington

3 The International Coordination of the Supervisory Activity under Pillar II
Andrea Enria, Cécile Meys and Oleg Shmeljov
Committee of European Banking Supervisors

PART II: THE MAIN RISK TYPES TO BE ASSESSED UNDER PILLAR II

4 Concentration Risk in the Credit Portfolio
Andrea Resti
Bocconi University

5 Specification and Calibration Errors in Measures of Portfolio Credit Risk
Nikola Tarashev, Haibin Zhu
Bank for International Settlements

6 Empirical Assessment of Asset Correlations
Ahmet E. Kocagil, Jing Liu
Fitch Solutions

7 Modelling and Measuring Business Risk
Klaus Böcker
UniCredit Group

8 An Introduction to Liquidity Risk
Mario Anolli; Andrea Resti
Università Cattolica del S. Cuore; Bocconi University

9 Portfolio Theory in Illiquid Markets
Carlo Acerbi
Abaxbank

10 Interest Rate Risk on the Banking Book
Andrea Resti
Bocconi University

PART III: RISK INTEGRATION AND CAPITAL MANAGEMENT

11 Principles of Risk Aggregation
Francesco Saita
Bocconi University

12 Aggregation by Risk Type and Inter Risk Correlation
Klaus Böcker
UniCredit Group

13 Risk Aggregation in a Large International Financial Group: A Case Study
Ruben Olieslagers, Patrick Acx
Fortis

14 Compounding Effects between Market and Credit Risk: The Case of Variable-Rate Loans
Thomas Breuer, Martin Jandačaka, Klaus Rheinberger; Martin Summer
PPE Research Centre; Austrian Central Bank

15 Credit Portfolio Stress-Testing and Scenario Analysis
Brian Dvorak
Moody’s KMV

16 Towards Comparable Basel II Ratios: Standard & Poor’s Risk-Adjusted Capital Framework
Bernard de Longevialle, Elie Hériard-Dubreuil, and Thierry Grunspan
Standard & Poor’s

17 Capital Allocation to Business Units and Sub-Portfolios: the Euler Principle
Dirk Tasche
Lloyd’s TSB

18 Capital Management through Hybrid Capital
Laetitia Mouquot
Committee of European Banking Supervisors

Index

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  AUTHOR BIOGRAPHY

Andrea Resti is an associate professor at Bocconi University, Milan, where he teaches financial institutions management and heads the Centre for Applied Research in Finance (CAREFIN). Formerly, he was an officer with one of Italy’s largest banks and the managing director of FinMonitor, a research body on bank mergers. Andrea has acted as a scientific coordinator of a wide array of courses on bank management and risk control themes organised for European bank managers and supervisors by SDA Bocconi, the Bank of Italy and the Italian Bankers’ Association and is a regular speaker at international seminars organised by Incisive Media. In 2002-2004, he was senior rapporteur in the Basel II task force of the Centre for European Policy Studies. He has published in the Journal of Business, Journal of Banking and Finance, Journal of Financial Intermediation and other top journals. Andrea’s research interests include risk regulation, management and measurement, concentration risk, economic capital estimation and risk-adjusted performance measurement, bank strategic management.

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  CONTRIBUTORS

Carlo Acerbi, Patrick Acx, Mario Anolli, Martina Bignami, Klaus Böcker, Thomas Breuer, Bernard de Longevialle, Brian Dvorak, Andrea Enria, Thierry Grunspan, Elie Hériard-Dubreuil, Martin Jandačka, Ahmet E. Kocagil, Jing Liu, Cécile Meys, Laetitia Mouquot, David Palmer, Andrea Pilati, Andrea Resti, Klaus Rheinberger, Francesco Saita , Oleg Shmeljov, Andrea Sironi, Martin Summer, Nikola Tarashev, Dirk Tasche, Preston Thompson, Haibin Zhu
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