Basel II – Rating agencies evaluate Pillar 2 risks

Credit rating agency Standard & Poor's is reported by Reuters as saying that, from January 2008, it will start evaluating the amount of risk capital set aside by banks for the so-called Pillar 2 risks – those risks not covered in Pillar 1 risk capital calculations.

Credit, market and operational risks are covered in Pillar 1 of the Basel Accord and can be calculated in a variety of stimulated approaches. However, various other types of risks, including liquidity risk, interest rate risk and reputational risk are excluded. These risks, covered in the Pillar 2 section of Basel II, have to be identified to regulators but not to other investing institutions or individuals.

Standard & Poor’s have said, from nest year, it will start estimating the amounts of capital that banks should set aside, based on disclosed information, for Pillar 2 risks, in an attempt to better assess overall risk levels. The rating agency has said that it will pay particular attention to single-name concentrations, industry and/or geographic diversification and interest rate risk in the banking book. Standard & Poor's said its aim was to provide investors with better and more transparent capital ratios.

Rival rating agency, Moody’s, is now offering operational quality ratings on hedge funds to supplement its existing operational ratings of other investment vehicles. The rating uses assessments of the fund's valuation process, accounting controls, regulatory compliance processes, risk reporting and control, legal and financial structure, human resources, key service providers and other fund specific issues. The rating includes on-site visits, additional communications with the fund and its service providers, and background checks of key personnel.

Ratings are carried out on request. To date, eight funds from four fund managers have taken advantage of this service to get themselves rated.