Basel Accords Literature review

The Basel Accords refers to the banking supervision Accords (recommendations on banking regulations)—Basel I, Basel II and Basel III —issued by the Basel Committee on Banking Supervision (BCBS). They are called the Basel Accords as the BCBS maintains its secretariat at the Bank for International Settlements in Basel, Switzerland and the committee normally meets there. Formerly, the Basel Committee consisted of representatives from central banks and regulatory authorities of the Group of Ten countries plus Luxembourg and Spain. Since 2009, all of the other G-20 major economies are represented, as well as some other major banking locales such as Hong Kong and Singapore. The committee does not have any power to enforce its recommendations. The committee just formulates its recommendations and then they are enforced through the national laws. Background The Committee was formed in response to the messy liquidation of a Cologne-based bank (Herstatt Bank) in 1974. On 26 June 1974, a number of banks had released Deutsche Mark (German Mark) to the Bank Herstatt in exchange for dollar payments deliverable in New York. On account of differences in the time zones, there was a lag in the dollar payment to the counter-party banks, and during this gap, and before the dollar payments could be effected in New York, the Bank Herstatt was liquidated by German regulators. This incident prompted the G-10 nations to form towards the end of 1974, the Basel Committee on Banking Supervision, under the auspices of the Bank of International Settlements (BIS) located in Basel, Switzerland. The first meeting took place in February 1975 and meetings have been held regularly three or four times a year since The Committee's members come from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain,1 Sweden, Switzerland, United Kingdom and United States. Countries are represented

by their central bank and also by the authority with formal responsibility for the prudential supervision of banking business where this is not the central bank. The present Chairman of the Committee is Mr. Nout Wellink, President of the Netherlands Bank. The topic to which most of the Committee's time has been devoted in recent years is capital adequacy. In the early 1980s, the Committee became concerned that the capital ratios of the main international banks were deteriorating just at the time that international risks, notably those vis-à-vis heavily-indebted countries, were growing. Backed by the Group of Ten Governors, the members of the Committee resolved to halt the erosion of capital standards in their banking systems and to work towards greater convergence in the measurement of capital adequacy. This resulted in the emergence of a broad consensus on a weighted approach to the measurement of risk, both on and off the balance sheet. One important objective of the Committee's work has been to close gaps in international supervisory coverage in pursuit of two basic principles: that no foreign banking establishment should escape supervision; and that supervision should be adequate. In May 1983 the Committee finalized a document Principles for the Supervision of Banks' Foreign Establishments which set down the principles for sharing supervisory responsibility for banks' foreign branches, subsidiaries and joint ventures between host and parent (or home) supervisory authorities. This document is a revised version of a paper originally issued in 1975 which came to be known as the "Concordat". The text of the earlier paper was expanded and reformulated to take account of changes in the market and to incorporate the principle of consolidated supervision of international banking groups (which had been adopted in 1978). In April 1990, a Supplement to the 1983 Concordat was issued with the intention of improving the flow of prudential information between banking supervisors in different countries. In June 1992 certain of the principles of the Concordat were reformulated as Minimum Standards. These Standards were communicated to other banking supervisory authorities who were invited to endorse them, and in July 1992 the Standards were published. In April 1995, the Committee issued an amendment to the Capital Accord, to recognize the effects of bilateral netting of banks' credit exposures in derivative products. In April 1996, a further document was issued explaining how Committee members intended to recognise the effects

the Committee issued a proposal for a new capital adequacy framework to replace the 1988 Accord. The publication of the Framework in June 2004 represents the culmination of nearly six years of challenging work. which was the focus of the 1988 Accord. commodities and options. subject to strict quantitative and qualitative standards. To achieve its aims. During those years. designed to incorporate within the Accord a capital requirements for the market risks arising from banks' open positions in foreign exchange. The Committee believes that. effective end-1997 at the latest. which seek to develop and expand on the standardised rules set forth in the 1988 Accord. and this has been refined in the intervening years. by asset securitisation structures. these three elements are the essential pillars of an effective capital framework. culminating in the release of the New Capital Framework on 26 June 2004. traded debt securities. In January 1996. At the same time. as an alternative to a standardised measurement method. supervisory review of an institution's capital adequacy and internal assessment process. following two consultative processes. the Committee considered the characteristics and needs of markets and supervisory systems in numerous countries. Much of the preparatory work for the market risk package was undertaken jointly with securities regulators and the Committee believes it is capable of application to non-bank financial institutions. the Basel Committee consulted extensively with banks and industry groups in an attempt to develop significantly more risk-sensitive capital requirements that are conceptually sound. An important aspect of this amendment is that. the Committee undertook a careful review of the existing rules and of the recent advances attained in the industry. The new Framework is designed to improve the way regulatory capital requirements reflect underlying risks and to better address the financial innovation that has occurred in recent years. The changes aim at rewarding the improvements in risk measurement and control that have occurred and providing incentives for such improvements to continue. and effective use of disclosure as a lever to strengthen market discipline and encourage safe and sound banking practices. The new Framework consists of three pillars: minimum capital requirements.of multilateral netting. equities. the Committee issued the so-called Market Risk Amendment to the Capital Accord. for example. banks are permitted. In June 1999. The Committee has also undertaken work to refine the framework to address risks other than credit risk. It . as shown. to use internal value-at-risk models as a basis for measuring their market risk capital requirements. taken together.

Assets of banks were classified and grouped in five categories according to credit risk. supervisory agencies. the international body of securities supervisors who monitor the activities of securities firms and investment houses. and in 1988. published a set of minimal capital requirements for banks. twenty. market and operational risk. This is also known as the 1988 Basel Accord. primarily focused on credit risk. central banks. Following the June 2004 release. most corporate debt). In close cooperation with the International Organization of Securities Commissions (IOSCO). the Committee turned its attention to the trading book. Basel 1 and credit risk: Basel I is the round of deliberations by central bankers from around the world. that is. risk weighted assets and the minimum ratio of capital to risk weighted assets. carrying risk weights of zero (for example home country sovereign debt). and outside observers. the Committee published in July 2005 a consensus document governing the treatment of banks’ trading books under the new Framework. Basel I. this new text was integrated with the June 2004 text in a document released in June 2006. and up to one hundred percent (this category has. the 1988 Basel Accord. For ease of reference.consulted widely and publicly with industry representatives. Switzerland. a definition of regulatory capital. the Basel Committee (BCBS) in Basel. ten. MATHODOLOGY: . The minimum capital requirements are composed of three fundamental elements. Banks with international presence are required to hold capital equal to 8 % of the riskweighted assets. which focused primarily on the banking book. as an example. fifty. THE FIRST PILLAR MINIMUM REQUIREMENTS AND THE CREDIT RISK: CAPITAL This section discusses the calculation of the total minimum capital requirements for credit. and was enforced by law in the Group of Ten (G-10) countries in 1992.

THE STANDARDISED APPROACH – GENERAL RULES 1) INDIVIDUAL CLAIMS Claims on sovereigns Claims on sovereigns and their central banks has been risk weighted as follows: Credit Assessment RISK WEIGHTS AAA+ to AAA+ to ABBB+ to BBBBelow BUnrated 0% 20% 50% 150% 100% Claims on the Bank for International Settlements. the alternative methodology.. Claims on non-central government public sector entities (PSEs) Claims on domestic PSEs are being treated as claims on the sovereigns in whose jurisdictions the PSEs are established. the European Central Bank and the European Community will receive a 0% risk weight. using regulatory capital as the numerator. The ratio must be no lower than 8% for total capital. the International Monetary Fund.In calculating the capital ratio.e.5 (i. the denominator or total risk weighted assets will be determined by multiplying the capital requirements for market risks and operational risk by12. . which is subject to the explicit approval of the bank’s supervisor.Instruments eligible for inclusion in Tier 1 capital. The definition of eligible regulatory capital will remain the same as outlined in the 1988 Accord and clarified in the 27 October 1998 press release on . Credit risk – the standardised approach The Committee proposes to permit banks a choice between two broad methodologies for calculating their capital requirements for credit risk. Tier 2 capital will continue to be limited to 100% of Tier 1 capital. the reciprocal of the minimum capital ratio of 8%) and adding the resulting figures to the sum of risk-weighted assets compiled for credit risk. One alternative will be to measure credit risk in a standardized manner. The ratio will be calculated in relation to the denominator. In this project we are using the standardized approach.

Claims on multilateral development banks (MDBs): The risk weights applied to MDBs is based on external credit assessments. The loans have been divided into two categories. short term and long term. sector. and continued capital contributions and new pledges from sovereign shareholders. internal creditworthiness and risk concentration limits (per country.e. status review process. the amount of callable capital the MDBs have the right to call. • Adequate level of capital and liquidity (a case-by-case approach is necessary in order to assess whether each institution’s capital and liquidity are adequate). which would Include among other conditions a structured approval process. • Shareholder structure comprised of a significant proportion of high quality sovereigns with long term issuer credit assessments of AA or better. Short term claims are those which have a maturity 03 or less than 03 months. large exposures approval by the board or a committee of the board. effective monitoring of use of proceeds. to repay their liabilities. Claims on banks We are using here option 02 for calculation of the risk weighted claims on banks. and individual exposure and credit category). and strict statutory lending requirements and conservative financial policies.s external assessments must be AAA. subject to a floor of 20%. The eligibility criteria for MDBs risk weighted at 0% are: • Very high quality long-term issuer ratings. if required. and rigorous assessment of risk and provisioning to loan loss reserve. i. Credit Assessment AAA+ to AAA+ to ABBB+ to BBBBB+ to BBelow BUnrated Risk weights 20% under Option 2 Risk weights 20% for short-term claims 50% 20% 50% 20% 100% 50% 150% 150% 50% 20% . A 0% risk weight will be applied to claims on highly rated MDBs. fixed repayment schedules. a majority of MDB. • Strong shareholder support demonstrated by the amount of paid-in capital Contributed by the shareholders.

banks/DFIs are required to initially adopt Standardized Approach of the New Accord. SBP guidelines and External Credit Assessment Institutions (ECAIs) We have used external credit assessment in view of the Roadmap for the implementation of Basel II in Pakistan issued by the State Bank in March 2005. . (viii) Claims secured on commercial real estate .Claims on securities firms Claims on securities firms may be treated as claims on banks provided they are subject to supervisory and regulatory arrangements comparable to those under the New Basel Capital Accord (including. the Committee holds to the view that mortgages on commercial real estate do not. risk-based capital requirements13). including claims on insurance companies. or that is rented. in particular.Lending In view of the experience in numerous countries that commercial property lending has been a recurring cause of troubled assets in the banking industry over the past few decades. Credit Assessment RISK WEIGHTS AAA+ to AAA+ to ABBB+ to BBBBelow BUnrated 20% 50% 100% 150% 100% Claims secured by residential property fully secured by mortgages on residential property that is or will be occupied by the borrower. in principle. The standard risk weight for unrated claims on corporates will be 100%. Under this approach the capital requirement against credit risk is determined on the basis of risk profile assessed by the External Credit Assessment . Claims on corporates: The table provided below illustrates the risk weighting of rated corporate claims. will be risk weighted at 50%. justify other than a 100% weighting of the loans secured.

Types of exposures and ECAIs used For domestic claims. Moody’s. In addition. Type of exposures for which each agency is used in the year ended 2010 is presented below: . Foreign exposures not rated by any of the aforementioned rating agencies were categorized as unrated. For foreign currency claims on sovereigns. the exposures are treated as unrated and relevant risk weights applied. and Fitch Ratings were used. risk weights were assigned on the basis of the credit ratings assigned by Moody’s. where available. rating of S&P. For claims on foreign entities. External ratings for assets. are applied using the assessments by various External Credit Assessment Institutions (ECAIs) and aligned with appropriate risk buckets. there are fixed risk weights for certain types of exposures such as retail portfolio and residential mortgage finance for which external ratings are not applicable. namely Pakistan Credit Rating Agency Limited (PACRA) and JCR-VIS Credit Rating Company Limited (JCR-VIS) were used.Institutions (rating agencies) duly recognized by the supervisory authority. ECAIs recommended by the State Bank of Pakistan (SBP). Otherwise.

Capital adequacy ratio as at December 31. calculated in accordance with the State Bank of Pakistan’s guidelines on capital adequacy. The total of Tier II and Tier III capital has to be limited to Tier I capital. General provisions for loan losses and capital reserves originated by restructuring of facilities (up to a maximum of 1.25% of total risk weighted assets). Askari bank CAPITAL ADEQUACY Scope of Applications The Bank has two subsidiaries. The total risk-weighted exposures comprise the credit risk. Askari Investment Management Limited (AIML) and Askari Securities Limited (ASL). 50% of other deductions noted above are also made from Tier II capital. TierIII supplementary capital. reserves on the revaluation of fixed assets and equity investments after deduction of deficit on available for sale investments (up to a maximum of 45 percent). which consists of short term sub-ordinate debt solely for the purpose of meeting a proportion of the capital requirements for market risks. AIML is the wholly-owned subsidiary of the Bank while ASL is 74% owned by the Bank. In Askari bank standardized approach is used for calculating the Capital Adequacy for Credit risk.Results and findings: We have done analysis of different banks of the banking industry of paksitan the light of guidelines provided by in the Basel accord II by bcbs and sbp recommendations. market risk and operational risk. Banking operations are categorized as either trading book or banking book and riskweighted assets are determined according to specified requirements of the State Bank of Pakistan that seek to reflect the varying levels of risk attached to on-balance sheet and off-balance sheet exposures. using Basel II standardized approaches for credit and market risks and basic indicator approach for operational risk is presented below: . Both these entities are included while calculating Capital Adequacy for the Bank using full consolidation method. 2010 The capital to risk weighted assets ratio. foreign exchange translation reserve etc. The bank currently does not have any Tier III capital.

Risk weighted exposures .

deposits. contingencies and commitments. .Segment information: Segmental Information is presented in respect of the class of business and geographical distribution of advances.

Segment by sector s Credit exposures subject to standardized approach .


Credit rating data for advances is obtained from recognized External Credit Assessment Institutions and then mapped to State Bank of Pakistan’s Rating Grades. Fitch.Muslim Commercial Bank Ltd. The Bank has adopted standardized approach to measure Credit risk regulatory charge in compliance with Basel–II requirements. Bank utilizes. The Bank has adopted Standardized approach of Basel II for calculation of capital charge against credit risk in line with State Bank requirements. Type of Exposures for which the ratings from the External Credit Rating Agencies are used by the Bank: . Moody’s and Standard & Poors . the capital requirement is based on the credit rating assigned to the counterparties by the External Credit Assessment Institutions (ECAIs) duly recognized by SBP for capital adequacy purposes. The approach is reliant upon the assessment of external credit rating agencies. viz. wherever available. JCR–VIS (Japan Credit Rating Company– Vital Information Systems). the credit ratings assigned by the SBP recognized ECAIs. PACRA (Pakistan Credit Rating Agency). Credit Risk: Disclosures for portfolio subject to the Standardized Approach under standardized approach.

.Segmental information Segmental Information is presented in respect of the class of business and geographical distribution of advances (gross). contingencies and commitments. deposits.


Credit Exposures subject to Standardized approach .


National Bank of Pakistan CAPITAL ASSESSMENT AND ADEQUACY BASEL II Statutory minimum capital requirement and management of capital The bank uses reputable and SBP approved rating agencies for deriving risk weight to specific credit exposures. These are applied consistently across the bank credit portfolio for both on . .balance sheet and off-balance sheet exposures. The methodology applied for using External Credit Assessment Institutions (ECAI's) inclusive of the alignment of alpha numerical scale of each agency used with risk bucket is as per SBP Basel II guidelines .


This capital is solely for the purpose of meeting a proportion of the capital requirements for market risk. In addition the bank has maintained minimum Capital Adequacy Ratio (CAR) of 16.13. Tier II capital. A similar treatment is adopted for off balance sheet exposures. There is also restriction on the amount of general reserve for loan losses up to 1. with some adjustments to reflect more contingent nature of potential losses.25% of total risk weighted assets. market and other risks associated with each asset and counterparty. general reserves and inappropriate profits (net of accumulated losses. which ultimately determine the regulatory capital required to be maintained by Banks and other DFIs. which comprises of highest quality capital element and include fully paid up capital. Risk weighted assets are measured according to the nature of and reflecting an estimate of credit. taking into account any eligible collateral or guarantees. Subordinated debts cannot exceed 50% of tier I capital.93%. Qualifying tier II and tier III capital cannot exceed the tier I capital. if any). investor. The Bank monitors and reports its capital ratios under SBP rules. among other measures. The State Bank of Pakistan's regulatory capital as managed by the bank is analyzed into following tiers: Tier I capital. exchange translation reserves and subordinated debts.454 billion and is in compliance with the SBP requirement for the said year. Further tier III capital cannot exceed 250% of tier I capital. Revaluation reserves are eligible up to 45% for treatment as tier II capital. 2010 stood at Rs. Tier III capital. reserve for issue of bonus shares. balance in share premium account. revaluation reserves. which includes general reserve for loan losses. the rules and ratios established by the State Bank of Pakistan. which includes short term sub-ordinate debts. The adequacy of the Bank's capital is monitored using. creditor and market confidence and to sustain future development of the business. . The ratios compare the amount of eligible capital with the total of risk-weighted assets. Bank's policy is to maintain strong capital base so as to maintain. Various limits are applied to elements of the capital base.The paid-up capital of the bank for the year ended December 31.

.There have been no material changes in the Bank's management of capital during the year.

This would also maintain long term sustainable growth of National Bank and ensure that it continues to retain the role of the market leader.balance sheet and off-balance sheet exposures. National Bank of Pakistan. So 8% of the risk weighted is 14.e.461.RISK MANAGEMENT The bank uses reputable and SBP approved rating agencies for deriving risk weight to specific credit exposures. technological advancement. A significant milestone towards achieving this objective was the hiring of external consultancy services of one of the most reputed and experienced consultant for Bank wide implementation of the Basel II Accord.000. The total risk wieghted assets of the askari bank are 179.000.So as basel says that capital atleast must be equal to the 8% of the risk weighted assets.603.688.000. changing regulatory environment etc.30 which is slightly grater than 10% bench mark set by the the regulatoy capital is excess by 4.124. The Bank is therefore committed to the establishment of a robust Risk Management system that caters to the full range of activities that can potentially impact its risk profile i. This consultancy will align National Bank to international Best Practices and the requirements of the Basel II Accord. especially the depositors. . the capital adequacy ratio of Askari Bank is 10.000 while the regualatory capital of the askari bank is 18. innovative new financial products. These are applied consistently across the bank credit portfolio for both on .308.436. The methodology applied for using External Credit Assessment Institutions (ECAI's) inclusive of the alignment of alpha numerical scale of each agency used with risk bucket is as per SBP Basel II guidelines as is given below: National Bank in its capacity of being the largest bank in the country is fully aware of its critical and leading role in the sustainable economic growth of Pakistan. volatility of the global/local markets. This would cater to the interest of all the stakeholders. Muslim Commercial Bank. Comparative analysis of Askari Bank.116.344.

360 112.000 while the regualatory capital of the muslim commercial bank is 72.856.367.000. Bank name Total risk weighted assets (‘000) 179.93 √ √ √ . the capital adequacy ratio of national bank of pakistan is 16.147 Basel requirement for CA for credit risk fulfill (‘000) Askari bank Muslim commercial bank National bank of pakistan 10.829. 26.07 16.000 while the regualatory capital of the national bank of pakistan is 112. So 8% of the risk weighted is 53.135.760.426.367 663.160.426.07 which is higher than 10% bench mark set by the the regulatoy capital is excess by 46.000.360.410.603 330.000.124 72.856. The total risk wieghted assets of national bank of pakistan 663.829 53.000.344.297.074.30 22.So as basel says that capital atleast must be equal to the 8% of the risk weighted assets.847 Total regulatory capital (‘000) which is higher than 10% bench mark set by the sbp.410.160 Capital adequacy raio 8% of the total risk weighted assets (‘000) 14.308.445. So 8% of the risk weighted is the regulatoy capital is excess by 59.135.847.240.the capital adequacy ratio of muslim commercial bank is 22.So as basel says that capital atleast must be equal to the 8% of the risk weighted assets.531.461. The total risk wieghted assets of the muslim commercial bank are 330.

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