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050331
STATE BANK OF PAKISTAN - 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 (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.
Encl As Above:
Yours faithfully,
Sd/-
(JAMEEL AHMAD)
Director
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