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

1988

1992

1996

1998

199 9

2001

2001

1988 Basel Accord Capital Charge for Credit Risk

Introduction of capital charge for Market Risk

1st Consultative Document: A New Capital Adequacy Framework Proposed new framework to replace existing Accord and introduced capital charge for operational risk.

Working Paper on Operational Risk

Implementation of 1988 Accord

Discussion Paper: Operational Risk

2nd Consultative Package: 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. 2.
3.

4.
5.

To promote safety and soundness in the financial system To continue to enhance completive equality To constitute a more comprehensive approach to addressing risks To render capital adequacy more risk-sensitive 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

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

 Operational Risk not considered
 Broad Brush Structure

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
OBJECTIVES
Basel II
Minimum Capital Requirements Supervisory Review Process
• How will supervisory bodies assess, monitor and ensure capital adequacy?

Market Disclosure
• What and how should banks disclose to external parties?

• Continue to promote safety and soundness in the banking system

Issue

• How is capital adequacy measured particularly for Advanced approaches?

• Better align regulatory capital with economic risk • Evolutionary approach to assessing credit risk - Standardised (external factors) - Foundation Internal Ratings Based (IRB) - Advanced IRB • Evolutionary approach to operational risk - Basic indicator - Standardised - Adv. Measurement

• 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

• Effective disclosure of: - Banks’ risk profiles - Adequacy of capital positions • Specific qualitative and quantitative disclosures - Scope of application - Composition of capital - Risk exposure assessment - Capital adequacy

• Ensure capital adequacy is sensitive to the level of risks borne by banks

Principle

• Constitute a more comprehensive approach to addressing risks

• Continue to enhance competitive equality
Pillar 3

Pillar 1

Pillar 2

THE NEW BASEL CAPITAL ACCORD
Total Capital Credit + Market + Operational Risk Risk Risk
= Capital Ratio (minimum 8%)

Revised

Unchanged

New

The new Accord focuses on revising only the denominator (riskweighted 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 100 % * 10 M = 10 M

RWA (ABC Textile) =

Total RWAs =

2 M + 10 M

=12 M

OVERVIEW OF BASEL II APPROACHES (PILLAR I)
Basic Indicator Approach

Operational Risk Capital

Score Card
Standardized Approach Advanced Measurement Approach (AMA)

Loss Distribution Internal Modeling

Total Regulatory Capital

Credit Risk Capital

Standardized Approach

Foundation
Internal Ratings Based (IRB)

Advanced
Standard Model

Market Risk Capital

Internal Model

CREDIT RISK – LINKAGES TO CREDIT PROCESS
Probability of Default Likelihood of borrower default over the time horizon RISK RATING / UNDERWRITING COLLATERAL / WORKOUT

Transaction Credit Risk Attributes

Loss Given Default

Economic loss or severity of loss in the event of default

Exposure at Default

Expected amount of loan when default occurs Expected tenor based on prepayment, amortization, etc.

LIMIT POLICY / MANAGEMENT

Exposure Term

MATURITY GUIDELINES

Default Correlation Portfolio Credit Risk Attributes

Relationship to other assets within the portfolio

INDUSTRY / REGION LIMITS

Relative Concentration

Exposure size relative to the portfolio

BORROWER LENDING 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
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.

Market risk

BASEL II NORMS IN PAKISTAN

Credit Risk

Adopts Standardized Approach for Credit Risk from January 1, 2008 Adopts Standardized Approach for Operational Risk from January 1, 2008

Operational Risk


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.

Sign up to vote on this title
UsefulNot useful