Basel II refers to the second set of international banking regulations developed by the Basel Committee on Banking Supervision (BCBS). It was introduced as an update to the original Basel I accord and aimed to enhance the measurement and management of risks in the banking sector. Basel II was officially released in 2004, and its implementation began in various jurisdictions over subsequent years.

Key components of Basel II include:

1. **Three Pillars:** Basel II introduced a three-pillar framework, which expanded on the single focus of capital adequacy in Basel I. The three pillars are:
– **Pillar 1 – Minimum Capital Requirements:** Similar to Basel I, Pillar 1 establishes the minimum capital requirements based on credit, market, and operational risks. However, it introduced more sophisticated methods for calculating these requirements, taking into account credit ratings and internal models.
– **Pillar 2 – Supervisory Review Process:** This pillar focuses on the supervisory review of a bank’s internal capital adequacy assessment and risk management processes. It encourages banks to develop their risk management systems and allows regulators to intervene if a bank’s capital is deemed insufficient.
– **Pillar 3 – Market Discipline:** Basel II promotes transparency by requiring banks to disclose information about their risk exposures, risk assessment processes, and capital adequacy. This disclosure is intended to enable market participants to assess a bank’s risk profile and make more informed investment decisions.

2. **Risk Sensitivity:** Unlike Basel I, Basel II introduced a more risk-sensitive approach to capital requirements. Banks were allowed to use internal models for calculating their capital requirements based on their specific risk profiles.

3. **Credit Risk Mitigation:** Basel II provided more flexibility in recognizing credit risk mitigation techniques, such as collateral and guarantees, allowing banks to reduce their capital requirements for certain exposures.

4. **Operational Risk:** Basel II explicitly addressed operational risk, recognizing it as a distinct risk category and providing methods for banks to measure and manage it.

Despite its improvements, Basel II faced criticism, particularly in the aftermath of the global financial crisis of 2008. Critics argued that the framework did not fully capture the interconnectedness of financial institutions and failed to prevent systemic risks. In response, the Basel Committee introduced further reforms, leading to the development and implementation of Basel III. These reforms aimed to strengthen the global banking system by addressing capital adequacy, liquidity, and leverage ratios.