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There are four
main components to the new framework:
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It is more sensitive
to the risks that firms face: the new framework includes an explicit measure for
operational risk and includes more risk sensitive risk weightings against credit
risk.
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It reflects
improvements in firms' risk management practices, for example by the
introduction of the internal ratings based approach (IRB) that allows firms to
rely to a certain extent on their own estimates of credit risk.
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It provides incentives
for firms to improve their risk management practices, with more risk sensitive
risk weights as firms adopt more sophisticated approaches to risk management.
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The new framework aims
to leave the overall level of capital held by banks collectively broadly
unchanged.
This revised capital adequacy
framework will, the committee hopes, further reduce the probability of consumer
loss or market disruption as a result of prudential failure. It will do so by
seeking to ensure that the financial resources held by a firm are commensurate
with the risks associated with the business profile and the control environment
within the firm. The new Basel Accord will be implemented in the Europe Union
via the Capital Requirements Directive (CRD). It will directly affect banks and
building societies and certain types of investment firms. The new framework
consists of three 'pillars'. Pillar 1 of the new
standards sets out the minimum capital requirements firms will be required to
meet for credit, market and operational risk. Under
Pillar 2, firms and supervisors have to take a view on whether a firm
should hold additional capital against risks not covered in Pillar 1 and must
take action accordingly. The aim of Pillar 3 is
to improve market discipline by requiring firms to publish certain details of
their risks, capital and risk management.
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