The
Presidents/Chief Executives
All Banks/DFIs
Dear
Sirs/Madam,
Implementation
of Basel II in Pakistan
Basel
Committee on Banking Supervision finalized the new capital
adequacy framework commonly known as Basel II on June 26,
2004. It provides a framework for capital allocation that
is more risk sensitive as compared to Basel I. This new
regulatory capital adequacy regime offers a series of approaches
ranging from simple to more complex methodologies for capital
allocation against credit risk and operational risk. Besides,
it requires banks to establish a strong and comprehensive
risk management framework which commensurate with the complexity
and diversification of their business. In this regard, Basel
II prescribes a strong and vigilant role of the supervisory
agency. Further, the accord envisages a detailed disclosure
requirement depending upon the specific approach adopted
by the institution for capital allocation to enhance transparency
and market discipline. This new capital adequacy regime
is expected to be adopted by most of the economies and will
be a benchmark for assessing the capital adequacy of banks.
2.
Keeping in view the foregoing, it has been decided to adopt
the Basel II in Pakistan. For the smooth, realistic and
undisrupted transition from present capital adequacy framework
towards more risk sensitive new capital adequacy framework
– the Basel II, all banks/DFIs are required to designate
one senior officer from their institution who will supervise
all activities relating to Basel II within the bank and
will serve as a point of contact between SBP and that particular
bank. For this purpose, banks may also put in place a support
functionary to assist the person in charge as considered
appropriate. This responsibility may be assigned to Head
of Risk Management or Chief Credit Officer or Chief Financial
Officer. Banks/DFIs are required to establish an adequate
setup and report to SBP the name and other particulars of
the coordinator for Basel II implementation as soon as possible
but not later than 31st May 2005.
3.
While the detailed instructions and rules relating to capital
adequacy requirements under Basel II will be issued in due
course of time, the purpose of this circular is to provide
a broad roadmap and outline which is required to start work
for the adoption of Basel II.
4.
The new framework consists of three mutually reinforcing
pillars; the first pillar relates to Minimum Capital Requirement,
second pillar describes Supervisory Review Process under
the new framework and the third pillar describes the Market
Discipline required to be adopted by the banks. Under pillar
one, the framework offers three distinct options for assessment
of capital requirements for credit risk and three options
for operational risk. The approaches available for assessment
of capital for credit risk are Standardized Approach, Foundation
Internal Rating Based Approach and Advanced Internal Rating
Based Approach. The approaches available for computing capital
charge for operational risk are Basic Indicator Approach,
Standardized Approach and Advance Measurement Approach.
Whereas the capital requirement as to the Market Risks remains
unchanged and banks will continue to assess the capital
charge against the market risk based on the existing instructions
under the Basel-I.
5.
The timeframe for adoption of different approaches under
Basel II is as under: -
i)
Standardized Approach for credit risk and Basic indicator
/ Standardized Approach for operational risk from 1st January
2008.
ii) Internal Ratings Based (IRB) approach from 1st January
2010. Banks interested in adopting Internal Ratings Based
Approach for capital requirement against credit risk before
1st January 2010 may approach SBP for the purpose. Their
request will be considered on case-to-case basis.
Banks/DFIs
will be required to adopt a parallel run of one and a half
year for Standardized Approach and two years for IRB Approach
starting from 1st July 2006 and 1st January 2008 respectively.
The above timeframe has been finalized after consultation
with and with the agreement of the Presidents / CEOs of
all banks/DFIs.
6.
Each bank/DFI is required to formulate their internal plans
specifying the approach they are willing to adopt and the
plans for moving to the particular approach. The plans should
envisage the risk management setup, various risk assessment
methodologies being used for assessment of various risk
categories and the policy and procedures for the capital
allocation. It must highlight what are the gaps for moving
to Basel II implementation and what steps are required to
overcome those gaps. Banks/DFIs should give a time bound
action plan narrating the activities to be done and the
time when it will be accomplished within the overall implementation
timeframe as mentioned above. The internal plans must reach
SBP before 30th June 2005.
7.
As stated earlier, the detailed instructions would be issued
subsequently. Banks/DFIs are, however, advised to thoroughly
review the whole document of New Capital Accord which is
available on the website of Bank for International Settlements
(www.bis.org). The road map for implementation of Basel
II is enclosed. Banks/DFIs are required to ensure completion
of the actions required on their part within the specified
timeframe.
Please acknowledge receipt.