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Title[ Part 3: The Second Pillar - Supervisory Review Process

Section[ II. Four key principles of supervisory review

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725.     The  Committee  has  identified  four  key  principles  of  supervisory  review,  which complement those outlined in the extensive supervisory guidance that has been developed by  the  Committee,  the  keystone  of  which  is  the  Core  Principles  for  Effective  Banking Supervision and the Core Principles Methodology. ¹¹⁶ A list of the specific guidance relating to the management of banking risks is provided at the end of this Part of the Framework.

Principle 1: Banks should have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital levels.

726.     Banks must be able  to demonstrate that chosen internal  capital targets are well founded and that these targets are consistent with their overall risk profile and current operating  environment.  In  assessing  capital  adequacy,  bank  management  needs  to  be mindful of the particular stage of the business cycle in which the bank is operating. Rigorous, forward-looking stress testing that identifies possible events or changes in market conditions that could adversely impact the bank should be performed. Bank management clearly bears primary responsibility for ensuring that the bank has adequate capital to support its risks.

727.     The five main features of a rigorous process are as follows:

w Board and senior management oversight;

w Sound capital assessment;

w Comprehensive assessment of risks;

w Monitoring and reporting; and

w Internal control review.

116 Core Principles for Effective Banking Supervision,  Basel Committee on Banking Supervision (September 1997), and Core Principles Methodology, Basel Committee on Banking Supervision (October 1999).

117 This section of the paper refers to a management  structure composed  of a board  of directors  and senior management. The Committee is  aware that there  are significant differences in legislative  and  regulatory frameworks across countries as regards the functions of the board of directors and senior management. In some countries, the board has the main, if not exclusive, function of supervising the executive body (senior management, general management) so as to ensure that the latter fulfils its tasks. For this reason, in some cases, it is known as a supervisory board.  This means that the board  has no  executive functions. In other countries, by contrast, the board has a broader competence in that it lays down the general framework for the management  of the  bank.  Owing to these differences,  the notions of the  board  of directors and senior management are used in this section not to identify legal constructs but rather to label two decision-making functions within a bank.

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