The third pillar of the new framework aims to boost market discipline through enhanced disclosure by banks. Basel 2 identifies the disclosure requirements and provides recommendations both on defining methods for calculating capital adequacy, and risk management strategies.
Effective disclosures by banks help market participants understand the bank’s risk profile and adequacy of their capital positions, thereby facilitating market discipline. This strategy plays an important role in maintaining the confidence in a financial institution.
A guidance paper presented in January 2000 has six broad recommendations related to capital, risk exposure and capital adequacy. Based on these recommendations, the committee has laid downmore specific quantitative and qualitative disclosures in key areas. These include the scope of application, composition of capital, risk exposure assessment and management processes, and capital adequacy.
Benefits of the Third Pillar
The third pillar of the Basel 2 framework helps to increase awareness of all the risks in the banking sector through a process of detailed disclosure. It also helps align economic capital data to book and risk capital data. Further, this pillar reveals the annual losses incurred by business lines and asset classes. This helps increase transparency.
