How to assess the readiness of your Pillar II Compliance ?
Basel II, with its three pillar model, places increased emphasis on risk management in addition to providing guidelines for the calculation of capital requirements and defining extended disclosure requirements. Banks are thus faced with the challenge of developing internal procedures and systems which will ensure adequate capital resources over the long term and with due attention to all material risks.

The supervisory review process (Pillar II) recognises the responsibility of bank management in developing an internal capital assessment process and setting capital targets that are commensurate with the bank's risk profile and control environment.

To comply with Pillar II guidelines, a bank should adopt the following activities:

Identification of Risks:
The bank should develop an ICAAP which would be comprehensive and include assessment of Pillar I risks, risks not covered under Pillar I, Pillar II Risks (such as Concentration Risk, Interest Rate Risk in Banking Book, Liquidity Risk, Underwriting Risk, Strategic Risk, Reputation Risk and Settlement Risk), and external factors such as the regulatory, economic or business environment.

Quantification of Risks:
Depending on the nature, size and complexity of the bank, it should adopt an appropriate risk quantification methodology. The risk measurement should be forward-looking to incorporate effects of strategic goals and macro-economic factors through appropriate stress tests specific to the jurisdiction and stage of the economic cycle.

Aggregation of Risks:
Risk aggregation needs to be conducted both at bank and group level, using either a simple or VaR-based summation approach at the bank level and correlation-based approaches at the group level.

Allocation of Capital:
Adequate capital should be allocated to cover different risks through a mechanism of ex-ante control, encompassing operational limits, emergency plans to meet extreme scenarios and risk-adjusted pricing. The capital allocation process should be in line with the risk bearing capacity and risk appetite set by the bank.

Monitoring:
The bank should review the ICAAP process regularly to ensure risks are covered adequately and the capital coverage reflects the bank's risk profile on an on-going basis. In addition, the quality of the risk management processes covering data generation to risk measurement and control needs to be independently reviewed.

Integration of Management:
The bank management must ensure that capital planning and management policies and procedures are communicated and implemented bank-wide and supported by sufficient authority and resources. Senior management at the bank should be responsible for the development, review and execution of ICAAP.