Financial Stability Institute: Proportionality under Pillar 2 of the Basel framework

Pillar 2 of the Basel framework aims to ensure that the minimum Pillar 1 capital and liquidity requirements are better aligned with a bank’s overall risk profile. Pillar 2 accommodates a range of banks and banking systems and it needs to be applied proportionately. This paper outlines the Pillar 2 implementation approaches in 16 jurisdictions, focusing on whether and how they apply proportionality. We also take stock of the post-crisis evolution of bank rating systems, given their fundamental role in shaping supervisory outcomes. While all surveyed jurisdictions have a process that incorporates the key elements of Pillar 2, their implementation approaches vary. Differences include variations in the methods used to determine Pillar 2 capital add-ons and what these add-ons are intended to cover. Diverging Pillar 2 approaches can also be attributed to the role of supervisory judgment in applying proportionality and in assessing an institution’s risk profile. We find that some authorities provide explicit guidance to support the judgments of supervisors, while others allow greater discretion to supervisory teams to fulfill their Pillar 2 responsibilities.

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