State Bank of Pakistan

& Basel-III

Sajid Khan,
Joint Director, SBP

Islamia College Peshawar December 29, 2021

 Today’s Discussions
Introduction to SBP and its History
Functions of SBP
Risk Management at Pakistani Banks
Basel Capital Accord
Intro to Basel-I,II and III
Leverage Ratio & Liquidity Ratio
Career at SBP-Entry Level Positions
Career at SBP-Entry Level Positions
Questions & Answers
 Introduction to SBP

 Inaugurated by Quaid-e-Azam on July

1, 1948.
 Initial legislation, the State Bank of
Pakistan Order 1948.
 Original mandate to issue bank notes,
maintain reserves to secure monetary
stability, operate currency and credit
system to the country’s advantage.`
 State Bank of Pakistan
• Order repealed and replaced by the State
Bank Act of 1956.
• Scope of work widened to regulate the
monetary and credit system and to foster its
growth in the best national interest.
• Governor and Deputy Governors are
appointed by the Federal Government.
 State Bank of Pakistan
• The State Bank of Pakistan an autonomous
institution.
• Governor State Bank of Pakistan is the
Chairman of the Board, which has seven
Members from the private sector and one
from Ministry of Finance.
 The SBP and its Subsidiaries
• The State Bank of Pakistan performing
central banking functions.
• SBP Banking Services Corporation
performing retail banking functions.
• National Institute of Banking & Finance
(NIBAF) performing training for the SBP
staff and international participants.
• PSPC and DPC
 Role of the State Bank
• Regulating and Supervising the
Financial System
• Conducting Monetary Policy
• Exchange Rate Management
• Maintenance of Payments Systems
 Role of the State Bank
• Issue of Currency Notes
• Banker to the Banks
• Banker to the Government
• Lender of the Last Resort
• Public Debt Management
• Developmental role: Agriculture,
Exports, Microfinance, SMEs
Regulating and Supervising the Financial
System
Pro-active supervision and
regulation to ensure soundness
of banking and non-banking
financial institutions
 Conducting Monetary Policy
Qualitative improvement in economic
policy formulation, analysis,
research and data collection for
maintaining price stability with
growth
 Exchange Rate Management
Prudent management of exchange
rate and foreign exchange reserves,
and progressive liberalization of
exchange policy to provide
incentives for production,
investment and trade
 Maintenance of Payments Systems

Strengthening of payments and

settlement system to facilitate
conduct of transactions in the
economy in an efficient manner
 Risk Management at Pakistani Banks

• Optimize risk-reward trade-off rather than

minimize/eliminate risk.
• Risk taking is inherent activity but
– neither engage in business with unnecessary risk
nor absorb risk that can be transferred
 Risk Levels
• Strategic Level
– Encompasses senior management and BOD
• Macro Level
– Within a business area or across business lines
• Micro Level
– ‘On-the-line’ risk management

• Need to have properly structured RM

 Types of Risks for Banks
• Credit Risk
• Market Risk
• Operational Risk
• Strategic Risk
• Business Risks ( Corporate, Consumers, SME
etc)
• ML/FT Risks
• Digital Risks (IS/Cyber Risks etc)
 Risk Management Essentials
1. The individuals who take or manage risks clearly
understand it.
2. The organization’s Risk exposure is within the limits
established by Board of Directors.
3. Risk taking Decisions are in line with the business
strategy and objectives set by BOD.
4. The expected payoffs compensate for the risks
taken
5. Risk taking decisions are explicit and clear.
6. Sufficient capital as a buffer is available to take risk.
 Role of Capital
• “Capital” is the owners’/ sponsors’ stake
in an entity.
• The main function of capital:
– To absorb unanticipated losses/ decline in
assets value
– To finance/ support the growth/ operations
– To provide protection to depositors
– To build and maintain public confidence in
bank

• What are the main sources of capital?

 Reason for Enhanced Regulations for FIs

• Financial institutions are fundamentally

different from other firms.
• The overall effects of failure of say an industrial
corporation are limited to the direct stakeholders
(shareholders, bondholders, & other creditors).
• In contrast, the failure of a financial institution
can be much more harmful and wide spread.
Thus the primary threat is systemic risk.
 Reason for Enhanced Regulations for
FIs
• Systemic risk is the risk of a sudden shock that would
damage the financial system and create ripple effects
throughout the economy.
• Systemic risk can come from two sources i) Panicky behavior
of depositors or investors (bank run), & ii) Interruption in the
payment system.
• Among emerging markets, domestic financial collapse have
often cost more than 10% of a country’s GDP. In each case,
governments have paid for the failure, to avoid collateral
damage to the rest of the economy. The Emergency
Stabilization Act of 2008 of US government allowed
spending upto (bail out) $700 billion on the financial system.
 Reason for Enhanced Regulations for FIs
• During the U.S banking crisis of 1930s, one bank in three
failed, causing a severe contraction of credit. In response,
the U.S established federal deposit insurance in 1933. As
of 1980, all U.S. bank accounts were insured up to a limit
of $100,000. The US temporarily increased the limit to
$250,000 during crisis of 2007.
• The breakdown in the payment system due to failure of
German bank “Bankhaus Herstatt” was another source
of systemic risk. The “Herstatt risk” led to a concerted
effort by bank regulators to try to avoid such situations,
which ultimately gave birth to the Basel Committee on
Banking Supervision (BCBS).
 Regulatory & Economic Capital

• Regulatory capital is the minimum amount of capital

prescribed by the regulator for a financial institution.
(Pillar 1)

• Economic capital is the amount of capital that a financial

institution estimates is needed to achieve a sufficient
level of protection (target solvency standard) against
adverse circumstances (unexpected losses) in the net
asset value. (Pillar 2)
 Regulatory Capital Requirements
• SBP’s capital adequacy framework comprises the
following three standards:
– Capital Adequacy Ratio (CAR) assesses the capital
requirement based on the risks faced by the banks/
DFIs/ MFBs.
– The Minimum Capital Requirement (MCR)
standard sets the nominal amount of capital banks/
DFIs/ MFBs are required to hold.
– Leverage Ratio (LR): A simple, transparent and
independent measure of risk has been introduced
– Liquidity Ratios: LCR and NSFR
 Standard Setters
• Bank for International Settlements
 Based in Basel and created in 1930, the BIS is the
world’s oldest international financial institution
 Its mission is to foster cooperation among central
banks and other agencies in pursuit of monetary
and financial stability
 Fosters regulatory and supervisory convergence
across jurisdictions and financial sectors
 Basel Committee on Banking Supervision
(BCBS)
• Founded
– By Central Bank Governors of G-10
– 1974

• Focus
– Banking Supervision

• Objectives
– Adequate supervision
– No internationally active bank should escape supervision

• Meets 4 times per year

• Around 30 working groups / task forces
• Secretariat: Basel, Switzerland
 Summary of 30 years of Bank Capital
Standards by the BCBS
S. No Date Development
1 07/1988 Basel I issued
2 12/1992 Basel I fully implemented
3 12/1996 Market risk amendment issued
4 12/1997 Market risk amendment implemented
5 06/2004 Basel II issued
6 12/2006 Basel II implemented
7 12/2007 Basel II advanced approaches implemented
Revised securitization & trading book rules
8 07/2009
issued
9 12/2010 Basel III document issued
10 12/2011 Trading book rules implemented
11 01/2013 Basel III implementation begins
12 01/2019 Full implementation of Basel III
Summary of Implementation in Pakistan

S. No Date Development
1 11/1997 Basel I issued

2 12/1997 Basel I implemented

3 08/2004 Market risk amendment issued

4 12/2004 Market risk amendment implemented

5 06/2006 Basel II issued

6 01/2008 Basel II implemented

7 08/2013 Basel III issued

8 12/2013 Basel III implemented in a phased manner

 Basic Structure-Basel I
• Targeted at internationally active banks in G-10
countries.

• Established minimum capital requirements to

cover credit risk (only).

• Broad risk – weighting structure: 0, 20, 50, 100%

Minimum Ratio: ___Capital______ > 8%
Risk weighted assets
 Basel I VS Pillar I of Basel II

Definition
8% Minimum CAR Unchanged
Unchanged

Total Capital
Capital Ratio = .
Credit Risk + Market Risk + Operational Risk.

RWA
Calculatio No New Risk
n Revised Change Capital Charge
 Basel II – the three pillars
Capital
Adequacy
Total Capital
 10%
 Market Risk  Credit Risk  Operational Risk 
PILLAR 1 PILLAR 2 PILLAR 3

Minimum Supervisory Market

Capital Review Discipline
Requirements Process Requirements

Rules Increased Increased

To Calculate Supervisory Disclosure
Required Capital Power Requirements
 Building Blocks of Basel II

Three Mutually Reinforcing Pillars

Pillar 1: Minimum Pillar 2: Supervisory Pillar 3: Market

Capital Requirement Review Process Discipline

Core Capital

Risk Weighted Assets Definition of Capital Supplementary

Capital

Credit Risk Operational Risk Market Risk

Standardized Internal Basic Indicator Standardized Standardized Internal Model

Approach Approach
AMA
Approach Rating Based Approach Based
Implementation Issues of Basel II
• Deduction of significant investment in the
units of mutual funds
• Significant portion of unrated exposures
• Issue of trading and banking book
• Non-availability of more granular data
• No significant ground work made by the
banks for moving toward advance
approaches
 Introduction to Basel III

After the financial crisis , the Basel Committee has revised

Basel II .

Basel III introduced:

 Strengthening the global capital framework ;
 Capital conservation buffer ;
 Countercyclical buffer.
 Leverage ratio;
 Global liquidity standard;
 Risk Coverage;
34
Strengthening the global capital framework
Elements of capital

Total regulatory capital will consist of the sum of the following elements:

1. Tier 1 Capital (going-concern capital)

a.Common Equity Tier 1
b.Additional Tier 1
2. Tier 2 Capital (gone-concern capital)

For each of the three categories above (1a, 1b and 2) there is a single set of
criteria that instruments are required to meet before inclusion in the relevant
category.

 Tier 3 is eliminated.
April 2013 Basel 3- Prof. G. Vento 35
 Improving The Capital Base
• Loss Absorbency Clause: Mandatory write-
down or conversion into common equity will
apply to all Additional Tier 1 and Tier 2 capital
instruments in the event of the institution
becoming non-viable without a bail-out.
• Tier 3 capital has been abolished.
• Deductions from capital (or regulatory
adjustments) will be mainly made from the
common equity Tier 1 component.
Basel III as per BCBS
 Phase-in Arrangement of Basel III as per SBP

Year End (Dec 31)

Sr. # Ratio 2013 2014 2015 2016 2017 2018 2019

1. CET1 5.0% 5.5% 6.0% 6.0% 6.0% 6.0% 6.0%

2. ADL Tier1 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% 1.5%

3. Tier 1 6.5% 7.0% 7.5% 7.5% 7.5% 7.5% 7.5%

4. Total Capital 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0%

Capital
5. Conservation - - 0.25% 0.65% 1.275% 1.90% 2.5%
Buffer (CCB)

Total Capital
6. 10.0% 10.0% 10.25% 10.65% 11.275% 11.90% 12.5%
plus CCB
 Leverage Ratio (LR)
• LR has been introduced to prevent excessive leverage &
supplement CAR measure with a simple, transparent and
independent measure.

• Leverage Ratio = Tier 1 Capital > 3%

Total Exposure
• Total exposure means on-balance sheet assets as well as
off-balance sheet items
• Described as a “backstop” measure, the leverage ratio will
prevent banks from taking on excessive leverage by
holding low risk-weight assets.
• Excessive leverage has been identified as a key factor in the
run up to the financial crisis
• Does not suffer from model risk, and it may be less
susceptible to gaming.
 Global liquidity standard

The Committee has developed two standards

that have separate but complementary
objectives for supervisors to use in liquidity risk
supervision:

 Liquidity Coverage Ratio;

 Net Stable Funding Ratio.

40
 LCR and NSFR
• Liquidity Coverage Ratio

• Net Stable Funding Ratio

 Main Challenges of Basel III

• Deductions
• Lowering of banks’ investment limits
• Raising of ADT1 & T2 capital with loss
absorbency clause.
 Career at SBP-Entry Level Positions
1. SBOTS( State Bank Officials Training Scheme)
General entry level point to SBP.
2. Research Officers( ROs): Economics Degree
and specially for Research/Economic Analysis/
Monetary Policy Department of SBP.
3. Statistical Officers (SOs): Statistics Degree and
specially for Statistics and Data Warehouse
Department of SBP.
 Selection Procedure
Written test for eligible candidates:
i) English composition ii) General Arithmetic
iii) Current Affairs iv) Intelligence Test
v) General Knowledge
Note: For ROs & SOs subject specific test shall be designed
Candidates qualify written test invited to:
1) Group Discussion
2) Interview before the Selection Board
 Pre-Induction Training at NIBAF
Islamabad( 3-6 months)
Package for Selected Candidates:
1) Salary
2) Staff Loans
3) Rest & Recreation Allowance
4) Employee Contributory Provident Fund
5) Employee Gratuity Fund
6) Free Phone Calls
7) Bank Provided Car & Chauffer
8) Medical Facility
THANK YOU