Under Pillar 2 of the second Basel accord, a bank must have an Internal Capital Adequacy Assessment Process (ICAAP) in place. ICAAP consists of internal procedures and systems to ensure that the bank will have adequate capital resources in the long-term to cover ALL its material risks. It involves the determination of economic capital as opposed to regulatory capital. It is a process that runs in parallel to the regulatory capital requirement process. Economic capital is the capital required to cover all risks that are estimated using internal risk models of the bank. ICAAP should be an integral part of the bank’s process and must be embedded within the organization. Senior management and the Board of Directors (BOD) should be supportive and fully engaged in the process.
Pillar 2 of the seconds Basel accord also describes the role and duties of the central monetary authority in reviewing and evaluating the member banks within their jurisdiction to ensure compliance with the minimum capital standards requirements.