Presented by

Muhamad Abrar Bahaman 1000400

W. Fatimatul Akmar Md. Hassan 1000407

Corporate Governance and Supervision : Basel Pillar 2

byChizu Nakajima and Barry A.K.

Rider

1. Introduction 2. Key Principles of Supervisory Review3. Pillar 2 and Its Implications for Corporate

Governance4. The Quality of Corporate Governance5. Issues on Governance6. Islamic Finance and Legal Risk7. Conclusion

Content

1. The objective the revised framework for measuring capital adequacy (Basel II ) is to secure international convergence on revisions to supervisory regulations governing the capital adequacy of internationally active bank.

Pillar in Basel II

2. The Basel Committee on Banking Supervision (BCBS) sought to create a more risk sensitive capital adequacy framework by introducing the operational risk.

3. BCBS emphasizes that it is critically important that the minimum capital requirements set by the first pillar be reinforced by banks’ rigorous assessment of their capital adequacy and their supervisors’ review of such assessment under the second pillar.

4. This is provide the senior management with an incentive to put in place systems and control to monitor, measure and mitigate risks.

5. It is responsibility to each bank’s board of directors and senior management to understand the risk profile of the bank and to ensure that capital level adequacy reflect the risk.

Introduction

Pillar I Pillar IIIPillar IIMinimum Capital

Requirements

Establishes minimum standards for management of capital on a more risk sensitive basis

Supervisory review process

Increases the responsibilities and levels of discretion for supervisory reviews and controls

Market Disciplines

Bank will be required to increase their information disclosure, especially on the measurement of credit and operational risks.

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Principle 1: Banks should have a process for assessing their overall capital adequacy

in relation to their risk profile and a strategy for maintaining their capital levels.

Principle 2: Supervisors should review and evaluate banks’ internal capital adequacy

assessments and strategies, as well as their ability to monitor and ensure their

compliance with regulatory capital ratios. Supervisors should take appropriate

supervisory action if they are not satisfied with the result of this process.

Principle 3: Supervisors should expect banks to operate above the minimum

regulatory capital ratios and should have the ability to require banks to hold capital in

excess of the minimum.

Principle 4: Supervisors should seek to intervene at an early stage to prevent capital

from falling below the minimum levels required to support the risk characteristics of a

particular bank and should require rapid remedial action if capital is not maintained or

restored.

Key Principles of Supervisory Review

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It will shift the regulatory regime toward a highly complex, formula based system, a will diminish the important role that is currently played by human judgment.

It is pointed out that banks will need to overhaul their internal risk management and governance process in order to comply with the second pillar which sets standards for internal management and reporting structure equivalent to international best practice. Takes more time and incur high cost

Pillar 2 and Its Implications for Corporate Governance

Under pillar 2’ s key principles, supervisors are expected to review and evaluate banks’ internal capital adequacy assessment and strategies, and their ability to monitor and ensure their compliance with regulatory capital ratios.In case if the supervisors are not satisfied with the result, they can take appropriate supervisory action .Moreover the supervisor should have the discretion to use the tools best suited to the circumstances of the bank and its operating environment.

Continued

1. Essential features of CG is putting in place systems that are capable of demonstrating that generate the general and specific risk to the enterprise are identified and address in a manner that is acceptable in term of law, current business, morality, and good sense.

2. It is the procedures that, if properly complied with, are assumed to produce a good result. One control factor at work supporting the efficacy of the procedures is transparency.

3. There are three roles of transparency ;

1)Disclosure of facts facilitates “enforcement” of some other rule.

2) Disclosure may be used to provide decision makers or those who advise them with sufficient information to reach sensible decisions.

3) There is the use of disclosure to censure.

The Quality of Corporate Governance

Governance issues in the deliberation that led to Basel 11:

-The need to account properly for operational risk

-The assessment of threats and the impact of the risk once it has occurred requires different skills

-Responses to identified threats becomes disproportionate to the risk

Governance Issues

Consequences of overreact to certain types of threats:

-waste resources-cause instability in the developing

and transition economies-foster the development of alternative

and underground financial system

Cont. Governance Issues

Legal risk as part of operational riskThere is a great impact of anti-money

laundering laws and procedures on the way that business is actually done

The imposition of additional procedures-in the case of money laundering- raises threats of legal exposure for non compliance and legal liability

With respect to legal liability in the case of money laundering, it is also the case that a bank may find itself liable at civil law for receiving the proceeds of civil wrong

Cont. Governance Issues

The uncertainty of the law is one of the hurdles facing the development of Islamic Finance

These uncertainties of law at many levels within the legal system are caused by the failure of practitioners to address standardization of documentation in transactional situations, such as murabahah

The failure to have standard documentation increases both interpretational risk and transactional cost

Islamic Finance and Legal Risk

Until there is a greater degree of certainty in this area, the assessments of threats and the impact of risks will remain as distinctly inexact science.

Whether this will lead to further stability of Islamic financial markets is questionable.

Increased discussion and collaboration between academicians and regulatory bodies is to be welcomed.

Conclusion