Pillar 3 of the Basel Framework

The Basel Committee on Banking Supervision (BCBS) has set internationally accepted measures for enhancing the banking sector's supervision, regulation, and risk management, also known as the Basel Accords with its current version Basel III. One of the pillars, Pillar 3, was created to reinforce the resilience of banks globally by promoting market discipline in the banking sector by ensuring transparent disclosure of vital information such as risk profile, capital adequacy ratio, and risk management practices. This information could be published as a part of the financial report or separately in the so-called Pillar 3 report. This kind of reporting allows stakeholders to monitor and evaluate bank activities effectively. Banks heavily depend on the confidence of their stakeholders. Thus, reputation is a matter of concern to the broader economy. That is why Pillar 3 ensures that banks operate transparently and responsibly to maintain public confidence and establish a form of market discipline. This pillar allows investors and regulators to make informed decisions based on hard data by mandating disclosure requirements related to capital adequacy and risk management practices.

On the EU level, the information to be disclosed in the Pillar 3 reports is defined by implementing technical standards (ITS) of EBA, covering both qualitative and quantitative data via uniform templates and tables. The examples of qualitative data to be reported include risk management framework covering credit, market, operational, liquidity, compliance, and ESG risks, information on the bank's business strategy, capital management policies, details of the bank's governance structure, funding sources, and liquidity management framework. Examples of quantitative data include risk-weighted assets, detailing the level of exposure faced by the balance sheet to various risky credit needs, capital adequacy ratio, the amount of regulatory capital divided by the total risk-weighted assets (capital ratios), leverage ratio, and the detailed exposures to the following risk categories - credit, market, operational, liquidity, interest rate, ESG, and counterparty credit risk.

The ECB is responsible for evaluating banks' adherence to the Pillar 3 disclosure requirements. As part of this evaluation process, the ECB conducts an annual reconciliation exercise, which compares the Pillar 3 data published by banks with the information reported directly to the supervisors. Whenever discrepancies are found between the two datasets, the ECB requests the banks to rectify the information. This exercise helps to enhance the disclosure quality. The contents of this reconciliation exercise may vary each year based on regulation modifications, the risk environment for banks, and the supervisory priorities of European banking supervision.

The Pillar 3 disclosure requirements also come with some costs due to their complexity and potential for creating a competitive disadvantage for institutions and mixed reactions from stakeholders. However, they are still praised for providing transparency, enhancing market discipline, promoting financial stability, and reducing the likelihood of a financial crisis.