The European path towards a sound Pillar 2 framework for banks

Abstract

Pillar 2 is a cornerstone of prudential regulation for banks. It was introduced in 2004 in the Basel 2 Accord with rather ambitious objectives, i.e. to incentivize financial institutions to better measure and manage risks and to make capital requirements more risk-sensitive than under Basel 1. The underlying key idea was quite simple: to complement the minimum requirements prescribed by regulators (Pillar 1) with tailored supervisory measures based on a comprehensive analysis of the banks’ riskiness, including a review of their self-assessment (Pillar 2). Regulators had recognized that the banking business is so complex and the risks are so heterogeneous that the first line of defence is proper risk quantification and management by the banks themselves. Specific disclosure requirements (Pillar 3) completed the picture, with the aim to promote market discipline.