In The Name of ALLAH, The Most Merciful, The Most Beneficial.

STATE BANK OF PAKISTAN

Banking Service Corporation (Bank)

Faisalabad

 Aamir Raza
 MBA-08-012
 MBA (Finance)
 University of Sargodha, Sargodha
 REPORT ON

 Basel II & Its Implementation in Pakistan

Banking Sector

Presenting To;

Chief Manager
SBP (BSC) Bank Faisalabad
 Basel Capital Accord

INTRODUCTION
HISTORY
 EVOLUTION OF CAPITAL STANDARD

199 2001 2001

1988 1992 1996 1998
9

1988 Basel Introduction of 1st Consultative Document: Working Paper on

Accord capital charge A New Capital Adequacy Operational Risk
Capital Charge for Market Risk Framework
for Credit Risk Proposed new framework to
replace existing Accord and
introduced capital charge for
operational risk.

Implementation Discussion Paper: 2nd Consultative Package:

of 1988 Accord Operational Risk The New Basel Capital Accord
including capital charge for
Operational
Risks
 BASEL II CAPITAL ACCORD

Introduction
 WEAKNESS OF BASEL CAPITAL ACCORD

Basel I flaws are as under;

 It looks a one size fits for all approach

 Do not discuss capital adequacy in relation to a banks true risk profile

 Broad bushed risk weighting structure

 Created an incentive to take some highest quality assets off the balance sheet

 Cover only credit and market risk

 Does not distinguish among different credit exposures

 Both AAA and BBB assets attract the same capital charge
 Does not allow any capital charge for operational risk
 It was not adequate for modern risk situation
THE OBJECTIVE OF THE NEW BASEL
CAPITAL ACCORD (“BASEL II) IS:

1. To promote safety and soundness in the financial

system
2. To continue to enhance completive equality
3. To constitute a more comprehensive approach to
addressing risks
4. To render capital adequacy more risk-sensitive
5. To provide incentives for banks to enhance their risk
measurement capabilities
 OBJECTIVES OF BASEL II

Are as under;
 To promote safety and soundness in the financial system

 Aligns capital of banks with their basic Risk profiles

 It is elaborate and far superior in terms of its coverage and detail

 To Render Capital Adequacy more risk-sensitive

 To provide incentives for Banks to enhance their Risk measurement capabilities

 Introduce a Capital charge for Operational risk

 To continue to enhance completive equality

 To constitute a more comprehensive approach to addressing risks

 Reform credit risk weightings, making them more risk sensitive and in line with bank
practices
 To cover all essential banking risks with theoretically grounded, flexible and operable
requirements which create incentives for advanced implementation
 COMPARISON OF BASEL I AND BASEL II
Basel I Accord
 Focus on Single Risk Measure
 One Size fits all
 Operational Risk not considered
 Broad Brush Structure
Basel II Accord
 More emphasis on Bank’s internal
methodologies, supervisory review
& market discipline
 Flexibility, menu of approaches.
Provides incentives for better risk
management
 Introduces approaches for Credit
risk & Operational risk in addition to
Market risk introduced earlier
 More Risk Sensitivity
RISK BASED CAPITAL STANDARD
 Why do banks need to hold capital in order to do
business?
 Provides a cushion against unexpected loss that may arise due to
credit/market/operational risk.
 Capital that needs to be maintained as a proportion of risk based
assets is termed as risk based capital – otherwise termed as
capital adequacy ratio (CAR).
 e.g., bank does not maintain any capital towards credit risk
component of GoI bonds as it is non-existent.
 DEVELOPMENT OF A REVISED CAPITAL ADEQUACY
FRAMEWORK COMPONENTS OF BASEL II
Minimum Capital
Requirements
• How is capital adequacy
measured particularly for
Issue
Advanced approaches?
• Better align regulatory capital
with economic risk
• Evolutionary approach to
assessing credit risk
- Standardised (external
Principle
factors)
- Foundation Internal Ratings
Based (IRB)
- Advanced IRB
• Evolutionary approach to
operational risk
- Basic indicator
- Standardised
- Adv. Measurement
Pillar 1
Basel II
Supervisory Review
Process
• How will supervisory
bodies assess, monitor
and ensure capital
adequacy?
• Internal process for
assessing capital in relation
to risk profile
• Supervisors to review and
evaluate banks’ internal
processes
• Supervisors to require
banks to hold capital in
excess of minimum to cover
other risks, e.g. strategic
risk
• Supervisors seek to
intervene and ensure
compliance
Pillar 2
OBJECTIVES
• Continue to promote safety
and soundness in the
Market Disclosure
banking system
• What and how should banks
disclose to external parties?
• Ensure capital adequacy is
sensitive to the level of
• Effective disclosure of:
- Banks’ risk profiles
risks borne by banks
- Adequacy of capital
positions
• Specific qualitative and
quantitative disclosures • Constitute a more
- Scope of application
comprehensive approach to
- Composition of capital
- Risk exposure
addressing risks
assessment
- Capital adequacy
• Continue to enhance
competitive equality
Pillar 3
THE NEW BASEL CAPITAL ACCORD

Total Capital
= Capital Ratio (minimum 8%)

Credit + Market + Operational

Risk Risk Risk

Revised Unchanged New

The new Accord focuses on revising only the denominator (risk-

weighted assets), the definition and requirements for capital are
unchanged from the original Accord.
BASEL I V/S BASEL II
Basel: No Risk Differentiation
Capital Adequacy Ratio = Regulatory Capital / RWAs (Credit + Market)
8% = Regulatory Capital / RWAs
RWAs (Credit Risk) = Risk Weight * Total Credit Outstanding Amount
RWAs = 100 % * 100 M = 100 M
8% = Regulatory Capital / 100 M
Basel II: Risk Sensitive Framework
RWA (PSO) = Risk Weight * Total Outstanding Amount
= 20 % * 10 M =2M
RWA (ABC Textile) = 100 % * 10 M = 10 M
Total RWAs = 2 M + 10 M =12 M
OVERVIEW OF BASEL II APPROACHES (PILLAR I)
Basic Indicator
Approach
Score Card
Operational
Standardized
Risk Approach
Capital Loss Distribution

Advanced
Measurement Internal Modeling
Approach (AMA)

Standardized
Total Credit Approach
Regulatory Risk
Capital Capital Foundation
Internal Ratings
Based (IRB)

Advanced

Standard
Model
Market
Risk
Capital Internal
Model
CREDIT RISK – LINKAGES TO CREDIT PROCESS

Likelihood of borrower default RISK RATING /

Probability of Default
over the time horizon UNDERWRITING

Economic loss or severity of loss in COLLATERAL /

Loss Given Default the event of default WORKOUT
Transaction
Credit Risk
Attributes
Expected amount of loan when LIMIT POLICY /
Exposure at Default default occurs MANAGEMENT

Expected tenor based on pre- MATURITY GUIDELINES

Exposure Term payment, amortization, etc.

Default Correlation Relationship to other assets within INDUSTRY / REGION

the portfolio LIMITS
Portfolio
Credit Risk
Attributes Relative Exposure size relative to the BORROWER LENDING
Concentration portfolio LIMITS

16
OPERATIONAL RISK COMPONENT

 Operational risk is the risk of loss resulting from inadequate

or failed internal processes, people and systems or from
external events.
 Internal fraud
 External fraud
 Employment practices & workplace safety
 Clients, products & business practices
 Damage to physical assets
 Business disruption & system failures
 Execution and delivery
 PILLAR 2ND SUPERVISORY REVIEW PROCESS

Increase the responsibility and levels of

discretion for supervisory reviews and control
covering;
 Process of capital and Risk profile management
 Capital Adequacy Ratio
 Level of capital charge
 Proactive monitoring of capital levels Ensuring Remedial action
 PILLAR 3 MARKET DISCIPLINE

 Comprehensive disclosure is essential for market participants

to understand the relationship between risk profile and capital
of an institution.
 Includes the disclosure of capital structure, capital adequacy,
risk exposure such as market, credit and operational etc.
BASEL II NORMS IN INDIA: AN OVERVIEW
 Credit risk
 Adopts standardized approach
 Operational risk
 Adopts the basic indicator approach
 Market risk
 Banks are allowed to use their internal models to assess the
market risk (i.e., status quo has been maintained in this respect).
 However, RBI’s guideline on Basel II remains silent on the issue of
Tier III capital in Indian context.
 BASEL II NORMS IN PAKISTAN
 Credit Risk
 Adopts Standardized Approach for Credit Risk from January 1,
2008
 Operational Risk
 Adopts Standardized Approach for Operational Risk from January
1, 2008

 Internal Rating Based (IRB) from Jan 1, 2010

 (If commercial Banks have appropriate models of Risk Management)
 STATE BANK OF PAKISTAN ROLE

 Ensure establishment of Basel II unit in each

bank
 Communication of plans to Banks

 Drafting circulars laying down parameters

 Defining the transition period of banks toward

Basel II
BENEFITS ON PAKISTAN BANKING SECTOR
 Paved the way to institutionalize better risk
management practices
 Make them more competitive
 Provide level playing field to robust system which
eventually resulted in improved service standards
 Attract Foreign Bank
 As Supervisor, Its helped us in comparing our Banking
sector with that of other economies of the world
 Facilitated cross border sharing
 ACKNOWLEDGMENT
 At the end, I would like to thank my coordinator
“Mr. Muhammad Rehan” who was always
there to help and guide us when we needed
help… I am thankful to him for his encouraging
and valuable support. Working under him was
an extremely knowledgeable and enriching
experience for me.
 I am very thankful to him for all the value
addition and enhancement done to us.