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HMRC internal manual

International Manual

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: Pillar 2

Pillar 2 provides for a supervisory process whereby the amount of capital the bank needs to meet the overall financial adequacy rule is reviewed. One outcome of the process may be that the Financial Services Authority (FSA) gives individual capital guidance to the bank.

Pillar 2 consists of:

  • an internal capital adequacy assessment process (ICAAP) which a bank is obliged to carry out in accordance with ICAAP rules and
  • a supervisory review and evaluation process (SREP) conducted by the FSA.

The ICAAP must include regular assessments of the amounts, types and distribution of financial resources, capital resources and internal capital required to cover risk exposures.

The process will take into account risks not included in Pillar 1 such as:

  • Interest rate risk from non-trading book activities
  • Securitisation risk
  • Residual risk (e.g. risk from ineffective documentation, delay in payment, inability to realise a guarantee on a timely basis)
  • Concentration risk (risk from over-exposure to particular sectors or geographical locations)
  • Liquidity risk
  • General business risk (e.g. fluctuations of business or economic cycles).
  • Pension risk (where the business has a defined benefit scheme).