Circulars/Notifications - Banking Supervision Department  
 BSD Circular No. 3 of 2005
March 31, 2005 

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 ( 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.

Encl As Above:

Yours faithfully,


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