Basel II emphasizes the critical role of supervisory authorities through its second pillar, which involves the supervisory review process. It establishes that supervisors should thoroughly review banks' internal assessments of capital adequacy relative to their risk profiles and evaluate the strategies and ability of banks to ensure compliance with regulatory capital requirements. Supervisors are tasked with intervening when they are not satisfied with banks' evaluations and should have the authority to require banks to maintain capital levels above the minimum if necessary . The framework also stipulates that supervisors should promptly intervene to prevent the capital from falling below required levels, and insist on corrective measures if necessary, reinforcing the authority and responsibility of supervisors in maintaining banking stability .

The introduction of operational risk as a distinct category under Basel II has significantly impacted the banking sector's approach to risk management by broadening the scope of risks to be considered. Operational risk is defined as the risk of loss from inadequate or failed internal processes, people, and systems, or from external events, including legal risks, while excluding strategic and reputational risks . Basel II mandates minimum capital requirements for operational risk, pushing banks to develop more advanced methods for quantifying and managing these risks. This has created incentives for banks to continue refining their techniques to better align with the actual activities and underlying risks, driving a cultural shift towards more comprehensive and integrated risk management practices within financial institutions .

Basel II introduced significant changes compared to the previous Basel I agreement, primarily by refining the way capital requirements are calculated to be more sensitive to the risk profile of banks. Under Basel II, capital requirements are determined based on risk-weighted assets with new criteria that better reflect the changes in the risk profile of entities, aiming for greater risk sensitivity . The capital adequacy ratios are expected to be more representative of each entity's risk profile, without altering the overall minimum capital percentage which remains at 8% . Additionally, the Basel II framework is built around three pillars including minimum capital requirements, supervisory review processes, and market discipline, enhancing the scope beyond the singular capital ratio of Basel I .

Basel II aims to improve the accuracy of banks' risk evaluations by allowing banks to use various tailored methodologies such as the Internal Ratings-Based (IRB) approach for credit risk, which requires them to establish internal rating systems that include multiple credit quality grades. This method necessitates that each client has a singular rating, which helps in maintaining a consistent assessment across assets, although exceptions apply for assets held in different currencies or with different guarantees . This framework is intended to make capital ratios more reflective of the true risk profiles of the institutions, thus encouraging banks to develop more comprehensive risk evaluations .

Basel II establishes four key supervisory principles aimed at ensuring that banks operate with adequate capital and maintain regulatory compliance. The first principle mandates banks to have robust processes for assessing capital adequacy relative to their risk profile and maintaining capital levels. The second principle requires supervisors to evaluate banks' internal assessments and strategies, and intervene if they are not satisfied. The third principle sets expectations for banks to operate above the minimum capital requirements, with supervisory authorities having the power to demand additional capital if needed. The fourth principle stresses prompt supervisory intervention to prevent capital from falling below required levels, requiring immediate corrective actions if capital remains insufficient . These principles are designed to enhance the stability and resilience of banks, ensuring they are well-capitalized and capable of managing risks independently while being subject to effective oversight by regulatory bodies .

Basel II addresses the risk of credit securitization by requiring banks to maintain capital buffers against potential losses resulting from these transactions. This involves recognizing the transfer of credit risk associated with securitized assets and ensuring that the retained risk aligns with the bank's capital reserves. The framework encourages transparency and mandates that banks disclose their securitization exposures . The potential benefits of this approach include enhanced risk distribution across the financial system, improved liquidity, and more efficient capital use by enabling banks to offload certain risks. However, it also poses risks such as incentivizing the creation of complex financial products, which may obfuscate true risk levels, and contributing to a disconnect between origination and risk retention, potentially leading to moral hazard if not properly managed .

The implementation of Basel II within the banking systems of Mercosur countries presents considerable challenges due to varying levels of regulatory advancement and compliance among these nations. While the countries are progressing in harmonizing regulations and supervision frameworks to reduce asymmetries, numerous obstacles remain before full implementation can be achieved . The disparities in existing financial systems' sophistication and readiness to adopt complex methodologies like the IRB approach may hinder uniform application. There is also an evident need for enhanced training and capacity building within supervisory bodies to adequately oversee the new, intricate risk models introduced by Basel II . Moreover, addressing the intricacies of international standards against local economic environments and regulations may require significant adjustments and resources, suggesting that practical application could be extensive and demanding .

The market discipline pillar of Basel II has profound implications for financial transparency among banks by mandating the disclosure of risk exposures, capital adequacy, and the risk assessment processes banks use. This heightened transparency allows market participants to better evaluate the risk profile of banks, ultimately increasing market scrutiny and encouraging banks to maintain robust risk management practices. By aligning disclosure requirements with the complex risk estimation methods that depend significantly on internal bank estimates, Basel II promotes consistency and comparability, which can help to identify risky practices and place pressure on banks to improve risk management frameworks. The increased transparency also aims to prevent systemic risks, reduce information asymmetry, and foster trust among stakeholders, including investors and regulators, thereby enhancing stability within the financial system .

To apply the Internal Ratings-Based (IRB) approach under Basel II, banks must meet specific minimum requirements: they should utilize distinct methodologies and rating systems for different asset classes, ensuring that each client is assigned only one credit rating, except for exposures with varied currencies or guarantees. Additionally, for the basic IRB approach, banks must establish credit rating scales comprising at least seven credit quality grades in addition to a default category . These prerequisites aim to standardize risk assessments across banks and encourage thorough internal evaluations, thereby enhancing the accuracy and reliability of capital adequacy measurements .

Basel II proposes to safeguard the integrity of banking capital in international operations by enforcing the application of its new capital adequacy framework in a consolidated manner. This approach ensures that the capital adequacy requirements capture the full spectrum of risks across all subsidiaries and affiliates of a banking group, mitigating the risks of double gearing or dual-leverage, where the same capital is used as a buffer in multiple jurisdictions. By expanding the scope of application to include the holding company of a banking group, Basel II strengthens the capital position and risk management practices throughout the entire entity, ensuring that the risk exposure of international operations is adequately covered and capitalized . This consolidation aims to uphold the integrity and stability of capital across diverse operations and economic environments, particularly important for globally active banks .