Basel II defined

The purpose of the new capital accord Basel II is to create guidelines that banks can use to determine the minimum amount of capital that they need to put aside to offset unexpected losses associated with financial and operational risks that they face.

It replaces the current, outdated, guidelines called Basel I. Both guidelines have been developed by the Basel Committee on Banking Supervision, which is a committee consisting of representatives from central banks and regulatory authorities from 13 countries who periodically meet in Basel, Switzerland.

The guidelines have been implemented in the European Union through the Capital Requirements Directive. Almost all EU Member States have by now finalised the incorporation of the Directive in their national laws. In the Netherlands, for example, the Directive has been incorporated in the “Wet financieel toezicht” (Wft) and lower-level regulation. A number of non-EU countries, including Switzerland, Canada and Australia, have also incorporated Basel II in their national laws. It is currently (September 2007) uncertain when the US will follow suit.

As a result of their day-to-day activities, banks are exposed to different types of risk. Risk is the likelihood that an event will cause a bank to suffer losses. Banks hold capital to absorb losses that occur in a very bad scenario so that they can continue their operations when confronted by these losses.

Basel II consists of three “pillars,” which banks must implement as a whole: minimum capital requirements, supervisory review and market discipline.

Basel II applies to ING Bank NV and its legal entities and to ING Investment Management BV and its legal entities. ING has asked its home supervisor De Nederlandsche Bank (DNB) for approval to use its own models to calculate minimum capital for credit and operational risk. DNB is expected to pass its judgment in the fourth quarter of 2007. ING will start reporting under Basel II as per 31 March 2008.

Basel II will only indirectly affect our customers. ING has already used risk-based pricing for large groups of Wholesale and Retail customers for years. Basel II models for credit risk enable ING to determine loan pricing even more sharply. Investors, analysts and rating agencies will notice the favourable impact of Basel II on our capital ratios. Furthermore, they will gain more insight into ING’s risks and capital position through our periodical disclosures.

ING has performed a number of test calculations. The results are favourable: minimum regulatory capital is expected to decrease by more than 20%. That said, the decrease will be more limited in 2008 and 2009 because the Dutch central bank has established floors above which minimum regulatory capital must be maintained during those two years. This decrease is mainly thanks to ING’s substantial residential mortgage portfolio, which requires a lower level of minimum regulatory capital. This has a favourable impact on the Tier-1 and BIS ratios that ING discloses each quarter. Under Basel II, ING will have enough available capital to finance organic growth, do bolt-on acquisitions and to execute the EUR 5 billion share buyback program we announced in May 2007.

Basel II reinforced existing initiatives to improve the quality of ING’s risk management processes. ING developed more than 90 credit risk models and stores credit risk data in one central data warehouse. It implemented a model to measure operational risk. ING improved the documentation of economic capital calculations and capital management policies. Finally, ING developed the infrastructure to report its minimum regulatory capital to its supervisors. The use of sophisticated internal models ties in with ING’s objective of operational excellence: better measurement of risk leads to better management of risk.

http://www.bis.org/publ/bcbsca.htm

http://eur-lex.europa.eu/LexUriServ/site/en/oj/2006/l_177/l_17720060630en00010200.pdf

http://www.globalriskregulator.com/