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University of Sargodha (State Bank of (Pakistan)
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In The Name of ALLAH, The Most Merciful, The Most Beneficial.
STATE BANK OF PAKISTANBanking 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 ManagerSBP (BSC) Bank Faisalabad
INTRODUCTION
HISTORY
Basel Capital Accord
EVOLUTION OF CAPITAL STANDARD
1988
1988 Basel
Accord
Capital Charge
for Credit Risk
Discussion Paper:
Operational Risk
1998 199
9
1st Consultative Document:
A New Capital Adequacy
Framework
Proposed new framework to
replace existing Accord and
introduced capital charge for
operational risk.
2001
2nd Consultative Package:
The New Basel Capital Accord
including capital charge for
Operational
Risks
1992
Implementation
of 1988 Accord
1996
Introduction of
capital charge
for Market Risk
Working Paper on
Operational Risk
2001
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 Basel II Accord
Focus on Single Risk Measure
One Size fits all
Operational Risk not considered
Broad Brush Structure
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
Pillar 1 Pillar 2 Pillar 3
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
Market Disclosure
• What and how should banks
disclose to external parties?
• 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
Minimum Capital
Requirements
• 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
Issu
eP
rin
cip
le
• Continue to promote safety
and soundness in the
banking system
• Ensure capital adequacy is
sensitive to the level of
risks borne by banks
• Constitute a more
comprehensive approach to
addressing risks
• Continue to enhance
competitive equality
OBJECTIVES
THE NEW BASEL CAPITAL ACCORD
Total Capital
Credit + Market + Operational
Risk Risk Risk
= Capital Ratio (minimum 8%)
The new Accord focuses on revising only the denominator (risk-
weighted assets), the definition and requirements for capital are
unchanged from the original Accord.
NewUnchangedRevised
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 AmountRWAs = 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 = 2 M
RWA (ABC Textile) = 100 % * 10 M = 10 M
Total RWAs = 2 M + 10 M =12 M
OVERVIEW OF BASEL II APPROACHES (PILLAR I)
Total Regulatory
Capital
Operational Risk
Capital
CreditRisk
Capital
MarketRisk
Capital
Basic IndicatorApproach
Standardized Approach
Advanced Measurement
Approach (AMA)
Standardized Approach
Internal Ratings Based (IRB)
Foundation
Advanced
StandardModel
InternalModel
Score Card
Loss Distribution
Internal Modeling
16
CREDIT RISK – LINKAGES TO CREDIT PROCESS
Transaction Credit Risk Attributes
Exposure at Default
Loss Given Default
Probability of Default
Exposure Term
Economic loss or severity of loss in the event of default
Likelihood of borrower defaultover the time horizon
Expected amount of loan when default occurs
Expected tenor based on pre-payment, amortization, etc.
RISK RATING /
UNDERWRITING
COLLATERAL /
WORKOUT
LIMIT POLICY /
MANAGEMENT
MATURITY GUIDELINES
INDUSTRY / REGION
LIMITS
BORROWER LENDING
LIMITS
PortfolioCredit Risk Attributes
Relationship to other assets within the portfolio
Exposure size relative to the portfolio
Default Correlation
Relative
Concentration
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.
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