INTM267732 | Foreign banks trading in the UK through permanent establishments: The approach in determining an adjustment to funding costs - STEP 2: Risk weighting the assets - the Basel II regulatory regime: The three pillars

Basel II introduced greater use of the assessment of risk provided by the banks’ internal systems as inputs to capital calculations and puts forward a detailed set of minimum requirements designed to ensure the integrity of those internal risk assessments.

It should be noted that Basel II does not alter the basic capital ratio applied to risk weighted assets and this section of guidance does not alter the approach described in Step 3 (INTM267761 to INTM267769). This section does, however, take into account the capital adequacy requirements placed on banks by the directives and the Prudential Regulation Authority (PRA) in respect of operational risk and by virtue of Pillar 2.

Basel II rests on three pillars which are reflected in the PRA “Prudential sourcebook for Banks, Building Societies and Investment Firms” (BIPRU).

Pillar 1 provides for calculation of the capital requirement to support credit, market and operational risk.

Pillar 2 provides for the regulatory review process required to ensure compliance with the Pillar 1 requirement and the identification of risk not covered under Pillar 1 and the provision of capital to support it.

Pillar 3 provides for enhanced disclosure and market discipline.

This section will primarily address PRA requirements under Pillar 1 and Pillar 2 and their effects on the risk weighting of assets. Pillar 3 will not be examined in detail in this Guidance.