BASEL-IIThe Pakistan Perspective

SAYYID MANSOOB HASAN, FCMA

BASEL ACCORDS?

• Banking supervision accords issued by the Basel Committee of Banking Supervision BCBS

• They are called Basel Accords as BSBC maintains its secretariat at the Bank for International Settlement in Basel, Switzerland

• The Basel Accords is a set of Recommendations for Regulations in the banking industry

BCBS

• Initial Committee comprised G10 (IMF Members + Germany and Sweden) now G20

• IMF Members include Belgium, Canada, France, Italy, Japan, the Netherlands, the UK and the USA

• G20 comprises Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Republic of Korea, Mexico, Russian Federation, Saudi Arabia, South Africa, Turkey, United Kingdom, United States and the EU

• Also comprises Singapore and Hong Kong • G20 controls 85% GWP (gross world product) and 80% of

global trade

BASEL-1

BASEL-1

• Dealt mainly with “international convergence of capital measurement and capital standards” to reduce risk in the banking industry

• Set standards to reduce the risk of the banks by finding a common definition of capital, and its division into various categories according to its risk profiles, and by making it mandatory for the banks to maintain a minimum capital ratio against the risks

BASEL-II

BASEL-II

• Provides a new capital adequacy framework• Basel-II is a flexible document and may be modified by

each regulator in accordance with the needs of its sector• Moreover, for each bank, Basel-II accords would only be

minimum standards and would not limit the banks to rely only on Basel-II compliance

• Basel-II is based on three pillars;– Pillar 1 Minimum Capital Requirement– Pillar 2 Supervisory Review Process– Pillar 3 Market Discipline

Pillar-1

• Basel-II suggests that to take greater risk, a bank has to hold greater capital so that it could remain stable. Pillar 1 sets out the minimum capital requirement which must be observed by all banks.

• Minimum Capital Requirement is not the only way to control risk associated with the bank. To mitigate risks, bank should take further actions.

Pillar-2

• The main objective of Pillar 2 is the compliance of banks with the Basel-II requirements. According to Basel-II supervisors have the job to monitor bank’s capital adequacy and ensure that it is in accordance w

• Pillar 2 addresses risks which are either:– Not fully covered in Pillar 1 (i.e. credit concentration)– Not taken into account in Pillar 1 (i.e. interest rate risk,

strategic risk)– External Factors (i.e. business cycle effects)

• There are four principles for central banks under Pillar 2

Principle-1

• Banks should have a process for assessment of capital adequacy and a strategy to maintain their capital. The process must have following features.– Board and Senior Management Oversight– Sound Capital Assessment– Comprehensive Assessment of Risk– Monitoring and Reporting– Internal Control Review

Principle-2

• Central Bank should review and evaluate the internal capital adequacy assessments and strategies, banks’ ability to comply and intervene in case of non-compliance. Review and evaluation may be done through– On site inspection– Offsite supervision– Discussion with bank management– Discussion with bank management– Review of work done by external auditors– Periodic reporting

Principle-3

• Supervisor should make banks operate above minimum level

Principle-4

• Supervisor should intervene at an early stage to prevent capital from falling below minimum level

Pillar-3

• Pillar 3 sets out the risk management disclosure requirement to support Pillar 1 and 2.

• Basel-II committee suggests that disclosure requirements should not conflict with the accounting disclosures requirements which are more broader in scope. Where accounting disclosures fulfill the requirement of Pillar 3, banks are allowed to mention only material differences.

Why comply with Basel?

• International settlements• International requirement/environment• Financial meltdown and failures

Meltdown & Failures

• Barings Bank (Est. 1762 and failed in 1995 suffering losses of US$ 1.3 billion)

• Subprime mortgage – Global financial crisis 2007-8

Reasons

• Derivatives –Futures contracts• Malpractices in lending & investments

Basel Accords’ Implementation in Pakistan

Pakistan’s Status

• Although the State Bank of Pakistan (SBP) is not a member of the BIS and is not bound to implement the new reforms, the SBP did implement the Basel-II reforms in principle in 2005.

• Metrics instituted by Basel-II for the measurement of risk are now in place.

• Instructions for compliance of Basel-III issued on August 15, 2013

MINIMUM CAPITAL REQUIREMENT

HISTORY

• BSD Circular No .05 of 2004 May 22, 2004 Rs. 1b

• BSD Circular No . 12 of 2004 August 25, 2004 1.5b

• BSD Circular No. 6 of 2005 October 28, 2005

Minimum Capital Deadline

a) Rs 3 billion By 31-12-2006

b) Rs 4 billion By 31-12-2007

c) Rs 5 billion By 31-12-2008

d) Rs 6 billion By 31-12-2009

• BSD Circluar 19, 2008

Minimum Capital Deadline

Rs 5 billion 31-12-2008

Rs 6 billion 31-12-2009

Rs 10 billion 31-12-2010

Rs 15 billion 31-12-2011

Rs 19 billion 31-12-2012

Rs 23 billion 31-12-2013

• BSD Circular 07, 2009

Minimum Capital Deadline

Rs 6 billion 31.12.2009

Rs 7 billion 31.12.2010

Rs 8 billion 31.12.2011

Rs 9 billion 31.12.2012

Rs 10 billion 31.12.2013

The Express Tribune September 21, 2013

In line with the Memorandum of Economic and Financial Policies (MEFP) signed with the IMF, the central bank is going to ask all private and public-sector banks that do not currently meet the requirement to raise capital latest by December 2014 to achieve the minimum CAR of 10% of their risk-weighted assets.

Points Ignored

• National interest seriously compromised• National development needs• Equity available for increased capital

requirement

Result

• Mergers and acquisitions of banks• Mostly by foreign investors

Recommendations

• Tier based banking system– Tier 1 – Fully compliant to Basel Accords– Tier 2 – Compliance to Basel Accords voluntary