SSRN-id2102059
161
Electronic copy available at: http://ssrn.com/abstract=2102059 1 WHY PAKISTANI BANKS FAILED TO ADOPT ADVANCED APPROACHES OF BASEL ACCORD ACCORDING TO ROAD MAP OF STATE BANK OF PAKISTAN SYED ALAMDAR ALI Student No: MSCF-10019 A thesis submitted in partial fulfillment of the requirements for the degree of M.PHIL COMMERCE & FINANCE DEPARTMENT OF ECONOMICS SUPERIOR UNIVERSITY LAHORE, PAKISTAN Supervisor: PROFESSOR DR. OMAR MASOOD AUGUST 2011
Transcript of SSRN-id2102059
Electronic copy available at: http://ssrn.com/abstract=2102059
1
WHY PAKISTANI BANKS FAILED TO ADOPT ADVANCED
APPROACHES OF BASEL ACCORD ACCORDING TO ROAD MAP
OF STATE BANK OF PAKISTAN
SYED ALAMDAR ALI
Student No: MSCF-10019
A thesis submitted in partial fulfillment of the requirements for the
degree of
M.PHIL COMMERCE & FINANCE
DEPARTMENT OF ECONOMICS
SUPERIOR UNIVERSITY LAHORE, PAKISTAN
Supervisor: PROFESSOR DR. OMAR MASOOD
AUGUST 2011
Electronic copy available at: http://ssrn.com/abstract=2102059
2
ABSTRACT
Basel Accord has gained much importance all over the world through implementation of
its different versions since 1988. Its different approaches have been adopted depending
upon banking structures, riskiness of banking structures, development of financial
structures and economic development in respective geographic territories. Developing
risk environment in banks therefore has long term impact on their assurance and
reliability of operations and their ultimate results. The adoptability of accord largely
depends upon amongst others the availability of human and technological resources as
well as the national culture of financial liberalization and accountability. Evidences from
around the world suggest that even advanced countries failed to implement the Accord in
true letter and spirit despite having adequate resources due to several domestic and
international reasons. Pakistan started implementing Basel environment in the year 2005
with the deadline of full fledged adoptability up to December 2009 which was latter
extended for indefinite period of time. In this thesis we have endeavored to find out
technical and human resource availability analysis of banks regarding their existing risk
management and Basel Accord structures using mixed method approaches on primary
and secondary data collected through questionnaires and annual reports of the banks to
arrive at any conclusion. The purpose of our thesis is to find out the resource availability
and capacities of Banks in Pakistan for moving on to the advanced stages of Basel
Accord by reviewing their capacities under III Pillars of the Accord as well relating their
capacities to the trends of their respective capital adequacy ratios and a newly developed
ratio used in this analysis showing relationship between Credit Risk Employees to Risk
Weighted Credit Assets. The results show that Pakistani Banks lack the required technical
and human resources for risk management under Basel Accord as well as they are also
reluctant to adopt the accord. Also the results show that the banks with the higher CR
Employees to RWCA ratio have higher inclination towards Basel Accord and have better
Basel Accord implementation resources than others. Also there is a lot of work required
to be done in the field of Supervisory Review as well. Therefore additional legislation is
required for improving implementation of all the three pillars in Pakistani banking
environment incorporating the provisions of Basel III in the additional Minimum Capital
Electronic copy available at: http://ssrn.com/abstract=2102059
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Requirement document issued for Banks and FI’s by the State Bank of Pakistan.
4
ACKNOWLEDGEMENTS
With thanks to Almighty Allah I am highly indebted to my supervisor Professor Dr.
Omar Masood for his guidance; understanding and graciousness that made me complete
my thesis. I would like to thank Chairman Superior Group of Colleges Prof. Dr. Ch.
Abdul Rehman, as it is because his initiative that instigated us move ahead in pursuit of
our research goal. I am also thankful to my family and especially my wife Yvee for her
moral support and patience during the whole of my thesis; and bearing with the burden of
research by lending me some precious moments out of her time with me! May God richly
bless you!
I would also thank my friends Rizwan Ali, Usman Darr and Imran Bhatti for their
encouragement, and moral support which helped me a lot in pursuing my goals. Thank
you very much all.
In the end I would like to thank the rest of the Economics Department staff members
especially Miss Ayesha and Mr. Ilyas for extending me whatever support whenever I
needed. Last by not least, thanks goes to everyone I did not manage to mention by name.
Always remember that I appreciate your help and guidance. I love you all.
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TABLE OF CONTENTS
1 Abstract
2 Acknowledgements
3 Table of Contents
4 List of Tables & Diagrams
CHAPTER 1
INTRODUCTION
1 1.1 Background 1
2 1.2 Problem Statement 1.3
3 1.3 Goals of the Research 1.5
4 1.4 Methods and Procedures 1.6
5 1.5 Organization of the Study 1.7
6
CHAPTER: 2
REVIEW OF BASEL ACCORDS
1 2.1 Basel I Capital Accord 2.1
2 2.2 Critical Review of the Basel I Accord 2.1
3 2.3 Basel Accord (Revised 2006) 2.3
4 2.4 Criticism of Basel II Accord 2.8
5 2.5 Basel III Accord 2.9
6 2.6 Micro Prudential Capital Rules 2.9
7 2.6.1. Up gradation of Tier I Capital 2.9
8 2.6.2. Regulatory Capital Increase 2.10
9 2.6.3. Usage of the Leverage Ratios to Control Exposures of the
Banks:
2.11
10 2.6.4. Usage of Convertible Capital for Loss Absorbency: 2.11
11 2.7 Macro-prudential Capital Rules 2.12
12 2.7.1. Procyclical Capital Buffers Adjustments 2.12
13 2.7.2. Accounting for the Systemic Risks 2.13
14 2.8 Introduction of Liquidity Ratios 2.13
15 2.8.1. Accounting for the Liquidity Rules 2.13
16 2.8.2. Accounting for the Net Stable Funding Ratio (NSFR) 2.13
17 2.8.3. Study of the Micro Economic Impact of the Capital Accord 2.14
18 2.8.4. Study of the Long-term Macro Economic Impact of the
Capital Accord
2.14
19 2.9 Table of Review of Three Basel Accord 2.15
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CHAPTER: 3
IMPLEMENTATION OF ACCORD
1 3.1 Introduction 3.1
2 3.2 Basel Accord in Developing Countries 3.1
3 3.3 Procyclicality Issue 3.2
4 3.4 Basel Accord: Need of Basel Implementation Resources 3.3
5 3.5 Basel Accord: Adoption of Approaches 3.4
6 3.6 Basel Accord and the Development of Rating Agencies 3.4
7 3.7 Summary 3.4
8
CHAPTER:4
COUNTRYWISE COMPARISON OF BASEL ACCORD INSTITUTIONAL
ISSUES
1 4.1 Introduction 4.1
2 4.2 Basel Accord in South Africa 4.1
3 4.3 Basel Accord in India 4.3
4 4.4 Basel Accord in Switzerland 4.3
5 4.5 Basel Accord in Brazil 4.4
6 4.6 Basel Accord in Jordon 4.6
7 4.7 Basel Accord in United States 4.6
8 4.8 Basel Accord in Pakistan 4.9
9 4.8.1. Feedback Submitted by the Banks 4.10
10 4.8.2. Quantitative Impact Study 4.10
11 4.8.3. General 4.10
12 4.8.4. Pillar 1-Minimum Capital Requirement 4.11
13 4.8.4.1. Standardized Approach 4.11
14 4.8.4.2. Internal Ratings Based Approach 4.11
15 4.8.5 Pillar 2 - Supervisory Review 4.11
16 4.8.6 Pillar III- Market Discipline 4.11
17 4.9 Conclusion 4.12
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CHAPTER 5
METHODOLOGY AND RESEARCH DESIGN
1 5.1 Introduction 5.1
2 5.2 The Questionnaire 5.1
3 5.2.1 Why Questionnaire 5.2
4 5.3 Secondary Data 5.3
5 5.4 Study Sample 5.3
6 5.4.1 Respondents 5.4
7 5.5 Questionnaire Response 5.5
8 5.6 Pilot Study of the Questionnaire 5.5
9 5.7 Variables 5.6
10 5.8 Justification of Each Variable 5.6
11 5.8.1 Capital Adequacy Ratio Trend 5.6
12 5.8.2 Type of Bank 5.7
13 5.8.3 Inclination of Bank towards Basel Accord: 5.7
14 5.8.4 Involvement of External Trainer 5.7
15 5.8.5 Competence of Employees in Risk Management Department 5.7
16 5.8.6 Effectiveness of Basel Plan Implementation 5.7
17 5.8.7 Changes required in the System for Basel Accord Compliance 5.7
18 5.8.8 Years Covered for Default time Series Data 5.7
19 5.8.9 Compliance with Market Discipline 5.7
20 5.8.10 Basel Customer Awareness 5.7
21 5.8.11 Credit Risk Employees Ratio to Risk Weighted Credit
Assets:
5.8
22 5.8.12 Total Risk Employees Ratio to Total Risk Weighted Credit 5.8
10
Assets
23 5.9 Research Hypothesis 5.8
24 5.10 Methods for Analyzing Data 5.9
25 5.10.1 The Cronbach's Alpha 5.9
26 5.10.2 Radar Diagram 5.9
27 5.10.2.1 Intra Bank Analysis 5.9
28 5.10.2.2 Inter Bank Analysis 5.10
29 5.10.3 Cross Tabulation Analysis 5.10
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CHAPTER 6
DATA ANALYSIS
1 6.1 Introduction 6.1
2 6.2 Review of Questionnaire Results 6.1
3 6.3 Primary Data Analysis 6.30
4 6.4 Radar Diagrams 6.30
5 6.4.1-Analysis of KASB Radar Diagram 6.31
6 6.4.2-Analysis of Standard Chartered Bank Radar Diagram 6.32
7 6.4.3-Analysis of Askari Bank Radar Diagram 6.33
8 6.4.4-Analysis of Allied Bank Limited Radar Diagram 6.34
9 6.4.5- Analysis of NIB Bank Radar Diagram 6.35
10 6.4.6- Analysis of MCB Bank Radar Diagram 6.36
11 6.4.7- Analysis of NBP Bank Radar Diagram 6.37
12 6.4.8- Analysis of Bank Alfalah Radar Diagram 6.38
13 6.4.9- Analysis of Faysal Bank Radar Diagram 6.39
14 6.4.10-Analysis of United Bank Radar Diagram 6.40
15 6.4.11-Analysis of the Bank of Punjab Radar Diagram 6.41
17 6.4.12-Analysis of the Habib Bank Limited Radar Diagram 6.42
18 6.4.13-Analysis of the Radar Diagram of an Ideal Bank 6.43
19 6.5 Cross Tabulation: 6.44
20 6.5.1 Relationship between CAR Trend and Bank Type 6.44
21 6.5.2 Relationship between Bank Type and Bank Inclination 6.44
22 6.5.3 Relationship between CAR Trend and Bank Inclination 6.45
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6.5.4 Relationship between Bank Type and Risk Management Employees
Expertise
6.45
12
24 6.5.5 Relationship between CAR Trend and Risk Management Employees
Expertise
6.46
25 6.5.6 Relationship between Bank Type and Basel Plan Effectiveness 6.46
26 6.5.7 Relationship between CAR Trend and Basel Plan Effectiveness
6.47
27
6.5.8 Relationship between Bank Type and Data Collection Methodologies
Changes due to Basel Accord
6.47
28
6.5.9 Relationship between CAR Trend and Data Collection Methodologies
Changes due to Basel Accord
6.48
29
6.5.10 Relationship between Bank Type and Period covered for Data Collection of
Default Time Series
6.48
30
6.5.11 Relationship between CAR Trend and Period covered for Data Collection of
Default Time Series
6.49
31 6.5.12 Relationship between Bank Type and Compliance with Market Discipline 6.49
32
6.5.13 Relationship between CAR Trend and Compliance with Market
Discipline
6.50
33
6.5.14 Relationship between Bank Type CAR Trend and Basel Customer
Awareness
6.51
34
6.5.15 Relationship between Bank Type, CAR Trend and C R Employees Ratio to
C R Weighted Asset
6.52
35
6.5.16 Analysis of the Results relating to the variable Involvement of External
Trainer
6.53
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CHAPTER 7
SUMMARY FINDINGS CONCLUSIONS AND RECOMMENDATIONS
1 7.1 Introduction 7.1
2 7.2 Summary Findings 7.1
3 7.2.1 Summary Findings of Questionnaire Results 7.1
4 7.2.2 Summary Findings of Radar Diagram and CAR Trend Results 7.3
5 7.2.2.1 Analysis of Radar Diagrams 7.3
6 7.2.2.2 Analysis of CAR Trend 7.4
7 7.2.3 Summary Findings of Cross Tabulation Results 7.5
8 7.3. Conclusions 7.7
9 7.4 Policy Recommendations 7.9
10 7.5 Areas of Further Study 7.10
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LIST OF TABLES AND DIAGRAMS:
1 2.5.1-Overview of the New Basel III Capital and Liquidity Rules for Banks 2.9
2 2.9- Table of Review of Three Basel Accord 2.15
3 5.1- Table Key Statistics of our Banks 5.4
4 5.2- Table Capital Adequacy Ratios of Banks in the Sample from 2005-2009 5.4
5 6.2.1-Table and Diagram for the importance of Implementation of Basel II in
Pakistan.
6.2
6 6.2.2-Table and Diagram for the significance of Implementation of Basel Accord
respective Bank.
6.2
7 6.2.3-Table and Diagram for inclination of respective Bank towards Implementation
of Basel Accord.
6.3
8 6.2.4-Table and Diagram for Basel Accord Implementation more Problems than
Advantages.
6.3
9 6.2.5-Table and Diagram for Basel Accord improvement in Risk Management
Processes.
6.4
10 6.2.6-Table and Diagram for Basel Accord improvement in Corporate Governance. 6.4
11 6.2.7-Table and Diagram for advantages of individual approach to Banks. 6.5
12 6.2.8-Table and Diagram for advantages of internal risk models for capital
calculation.
6.5
13 6.2.9-Table and Diagram for effect of Basel Accord on lower the capital requirement
for some of the Banks
6.6
14 6.2.10-Table and Diagram for effect of Basel Accord on Higher Capital Requirements
for some of the Banks which might eventually be a problem in the implementation of
Basel Accord.
6.6
15 6.2.11-Table and Diagram for effect of Information Technology, and HR Problems on
the implementation of Basel Accord
6.7
16 6.2.12-Table and Diagram knowledge of employees in the bank about standards of
Basel Accord
6.7
17 6.2.13-Table and Diagram for delivery of education about the Basel Accord by the
Bank to its employees.
6.8
18 6.2.14-Table and Diagram for involvement of external trainer for the training of Bank
Staff for Basel Accord.
6.8
19 6.2.15-Table and Diagram involvement proficiency of employees in the risk
management process
6.9
20 6.2.16-Table and Diagram for special Basel Accord Implementation Department 6.9
21 6.2.17-Table and Diagram for performance of Basel Accord Implementation
Department
6.10
15
22 6.2.18-Table and Diagram for performance of staff responsible for the
implementation of Basel Accord.
6.10
23 6.2.19-Table and Diagram for effectiveness of Basel Accord implementation plan in
respective Bank.
6.11
24 6.2.20-Table and Diagram for attachment of the Banks with any Banking Group and
reporting standards.
6.11
25 6.2.21-Table and Diagram for meeting the group capital adequacy standards
compliance
6.12
26 6.2.22-Table and Diagram for comparison of IT updation costs to with personnel
training and outsourcing:
6.12
27 6.2.23-Table and Diagram for Changes required in system for Basel Accord
compliance.
6.13
28 6.2.24-Table and Diagram for collecting sensitive information like “personal traits”. 6.13
29 6.2.25-Table and Diagram for Bank willing to share data of large customers 6.14
30 6.2.26-Table and Diagram for resolving data protection issue under Basel Accord by
taking consent declaration of the customers
6.14
31 6.2.27-Table and Diagram for national legislation on Basel II for data protection. 6.15
32 6.2.28-Table and Diagram for current/drafted (if existing) clarity about national data
protection of Basel Accord.
6.15
33 6.2.29-Table and Diagram for compliance of current IT with Basel Accord
Requirements for Credit Risk, Operational Risk and Market Risk
6.16
34
6.2.30-Table and Diagram for problems in integrating the systems required for Basel
Accord Implementation into the main stream system of your Bank
6.17
35
6.2.31-Table and Diagram for compliance of current database design, internal
models, and budgets with Basel Accord
6.18
36 6.2.32-Table and Diagram for approach of the bank for measuring credit risk in your
bank
6.18
37 6.2.33-Table and Diagram for internally developed methodology for identifying and
measuring credit risk
6.19
38 6.2.34-Table and Diagram for risk categories for ranking of debtors 6.19
39
6.2.35- Table and Diagram for years covered by time series for credit risk assessment
for Default Model; Recovery Model; or any Other Model
6.20
40 6.2.36-Table and Diagram for methods for measuring economic capital for credit risk 6.21
41 6.2.37-Table and Diagram for market risk measurement in respective bank 6.22
42 6.2.38-Table and Diagram for years covered by time series for market risk
assessment
6.22
43 6.2.39-Table and Diagram for methods for developing economic capital for
market risk
6.23
16
44 6.2.40-Table and Diagram for measuring operational risk in the respective bank 6.23
45 6.2.41-Table and Diagram for years covered by time series for operational risk
assessment
6.24
46 6.2.42- Table and Diagram for methods for measuring economic capital for
operation risk
6.24
47 6.2.43- Table and Diagram for Supervisory Review guidelines 6.25
48
6.2.44-Table and Diagram for availability of resources with the supervisor to
comply with the principles of Basel Accord
6.25
49
6.2.45-Table and Diagram for challenging segment of Pillar I to be monitored
under supervisory review process
6.26
50
6.2.46-Table and Diagram for requirement for additional legal processes within the
national legal regime for appropriate implementation of Basel Accord
6.26
51 6.2.47-Table and Diagram for requirement of additional risks to be captured in
Pillar I.
6.27
52
6.2.48-Table and Diagram for Bank’s compliance of disclosure requirement of
Basel Accord Market Discipline
6.27
53
6.2.49-Table and Diagram for possibility of national legislation to be hindrance is
meeting disclosure requirements under Basel Accord
6.28
54
6.2.50-Table and Diagram for possibility that the disclosure requirements under
Basel Accord regarding proprietary information can lead the Bank to comparative
disadvantage.
6.28
55
6.2.51- Table and Diagram for initiation of any customer awareness for complying
with the Market Discipline Requirement of Pillar III
6.29
56 6.4.1-KASB Radar Diagram and CAR Trend 6.31
57 6.4.2-Standard Chartered Bank Radar Diagram and CAR Trend 6.32
58 6.4.3-Askari Bank Radar Diagram and CAR Trend 6.33
59 6.4.4-Allied Bank Limited Radar Diagram and CAR Trend 6.34
60 6.4.5-NIB Bank Radar Diagram and CAR Trend 6.35
61 6.4.6-MCB Bank Radar Diagram and CAR Trend 6.36
62 6.4.7-NBP Bank Radar Diagram and CAR Trend 6.37
63 6.4.8-Bank Alfalah Radar Diagram and CAR Trend 6.38
64 6.4.9-Faysal Bank Radar Diagram and CAR Trend 6.39
65 6.4.10-United Bank Radar Diagram and CAR Trend 6.40
66 6.4.11-Bank of Punjab Radar Diagram and CAR Trend 6.41
17
67 6.4.12-Habib Bank Limited Radar Diagram and CAR Trend 6.42
68 6.4.13-Radar Diagram of an Ideal Bank 6.43
69 6.5.1 Table of Relationship between CAR Trend and Bank Type 6.44
70 6.5.2 Table of Relationship between Bank Type and Bank Inclination 6.44
71 6.5.3 Table of Relationship between CAR Trend and Bank Inclination 6.45
72 6.5.4 Table of Relationship between Bank Type and Risk Management
Employees Expertise
6.45
73 6.5.5 Table of Relationship between CAR Trend and Risk Management
Employees Expertise
6.46
74 6.5.6 Table of Relationship between Bank Type and Basel Plan Effectiveness 6.46
75 6.5.7 Table of Relationship between CAR Trend and Basel Plan Effectiveness 6.47
76
6.5.8 Table of Relationship between Bank Type and Data Collection
Methodologies Changes due to Basel Accord
6.47
77
6.5.9 Table of Relationship between CAR Trend and Data Collection
Methodologies Changes due to Basel Accord
6.48
78
6.5.10 Table of Relationship between Bank Type and Period covered for Data
Collection for Default Time Series
6.48
79
6.5.11 Table of Relationship between CAR Trend and Period covered for Data
Collection for Default Time Series
6.49
80 6.5.12 Table of Relationship between Bank Type and Compliance with Market
Discipline
6.49
81 6.5.13 Table of Relationship between CAR Trend and Compliance with Market
Discipline
6.50
82 6.5.14 Table of Relationship between Bank Type CAR Trend and Basel Customer
Awareness
6.50
83
6.5.15 Table of Relationship between Bank Type, CAR Trend and Credit Risk
Employees Ratio to Credit Risk Weighted Asset
6.51
84 6.5.16 Table of Analysis of the Results relating to the variable Involvement of
External Trainer
6.52
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CHAPTER 1
INTRODUCTION
1.1 BACKGROUND:
Banking is becoming more and more complex and risky around the world. Main causes
for such leveraged banking are attributed to international financial deregulation, product
and technological innovation and above all integration of global financial markets
(Sahajwala and Van den Bergh, 2000, Makwiramiti, 2008). Such accelerations among
others have upgraded the methodologies and procedures banks use to gauge and
administer their risks (Carauana, 2004, Makwiramiti, 2008). This has leaded the way to
secure stability in financial systems and structures by using a set of rules which are
acceptable in all global financial hubs. Such mechanisms have been adopted to secure
stability in the banking sector as well.
Being major players in the financial system of the world, banks also face some
requirements relating to minimum capital in addition to complying with the rules. Such a
requirement is advantageous to the economy as it adds cushions to the banks against
losses resulting from credit, operational and market risk exposures which eventually
enable banks ensure availability of capital in the economy throughout business cycles
(BIS, 2004; Hassan Al-Tamimi, 2008).Furthermore, capital levels in Banks make
foundation for smoother capital growth which itself is a cover to the bank against bank
failures (Accord Implementation Forum (AIF): Disclosure Subcommittee, 2004). Another
important thing is to examine business activities of the banks under the prescribed rules
and regulations against the prescribed capital limits to protect against stemming risks
(Amidu, 2007).
The formation of Basel Committee on Banking Supervision (BCBS) commonly known as
“The Committee” takes its roots back to the initiative of G10 central bank governors after
the collapse of Bankhaus Herstatt in Germany and Franklin National Bank in the United
States in 1974. (BIS, 2008; Klaus, 2001). The committee came up with its first Basel
19
Accord known as Basel I in 1988, the main purpose of which was to enhance the
resilience of the global banking systems against financial crisis. The landmark
achievement of this Accord was the acceptance of the definition and minimum criteria for
capital requirement for banks (Makwiramiti, 2008). This act among other inconsistencies
in the banking environment also addressed the bank capitalization.
Basel I Accord was required to be implemented by all banks for ensuring a minimum
capital of 8% before 31st of December 1992 (AIF: Disclosure Subcommittee, 2004). The
purpose of this Accord was to enhance the resilience of global banking by enhancing their
capital holdings and accordingly curtailing their competitive inequalities (Cumming and Nel,
2005). This was done through linking the required capital with the portfolios of risks thereby
introducing the incentives for the banks to reduce their risks to free up their capital (BCBS,
2001, Makwiramiti, 2008).
The revisions to this Accord were proposed after June 1999 with a newer framework of
risk sensitivity. It was necessary because Basel I Accord was losing its effectiveness
against the dynamics of new financial system at that time which included enhanced
globalization; technological and financial innovations among others (AIF: Disclosure
Subcommittee, 2004). This initiated requirement for an enhanced version of capital adequacy
framework.
In the year 2004 Basel Committee on Banking Supervision publicized “International
Convergence of Capital Measurement and Capital Standards: a Revised Framework‖,
which is known as Basel II framework (BCBS, 2004). It had the primary objective to
stabilize and regulate the consistencies in the capital structures of the banks all over the
world (BCBS, 2004). This framework outlined the intricacies of promulgating the
regulatory capital requirements by setting minimum capital standards for institutions in
banking sector and simultaneously reinforced them by enabling the respective supervisors
for stringent assessment of Risk Weighted Assets and related Tier I, II and III capitals to
cover the banking sectors against Systemic and Non Systemic Risks stemming from
economic environment (BCBS, 2004, Makwiramiti, 2008).
20
Conservative Risk Management is the hallmark of the Basel II framework for mobilizing
financial stability across baking sectors around the world (BCBS, 2006). This framework
stemmed on the basic premise of capital management as was suggested by 1988 Accord
way back in 1988 and provided improved parameters that reflect clearer formations of
risks occurring to the banking sector and mechanism for protecting banks against the
same in more methodical and scientific manner. The objective was achieved in two parts:
firstly, by improving the 1988 alignment of capital Accord with credit risk and secondly
it proposed a capital charge for operational risk “exposures” (BCBS, 2006; AIF:
Disclosure Subcommittee, 2004). Although it was primarily meant for G10 countries
however, it was structured in such a way that it could be applied across the world
equivalently in developed and developing countries (Mboweni, 2004). It was made
possible for the reason that it had the quality to align capital adequacy of the banks with
the range of risks stemming from its assets and also the potential of risk generation of
such assets. This enabled the Basel Accord to manage the developments in the banking
field relating to the financial instruments and financial technologies (Mboweni, 2004).
Basel Accord had the reengineered organizational structures and processes of the
supervisors and the banking sectors all around the world (Mboweni, 2004). The key to
the effective and improved risk management under the Accord is its proper
implementation (AIF: Disclosure Subcommittee, 2004). Accordingly, in order to have
effective implementation around the world Basel Accord cooperation between global
supervisors and the respective institutions play a pivotal role. (Global Risk Regulator,
2005). The primary purpose of the Basel Accord is therefore to promulgate three pillars
of Basel Accord by instigating the behavior of developing firm capital structures among
the banks in order to rationalize their risk appetite according to their residual resources to
which is actually the basis of sound banking structure.
1.2 PROBLEM STATEMENT:
21
In Pakistan Banks are regulated by the Banking Supervision Department of State Bank of
Pakistan. It has set-up its road map for the implementation of Basel Accord which
attempts to comply with Basel Accord Implementation guidelines issued by the BCBS.
With the growth of international banking and entrance of multinational banks in Pakistani
Banking Sector the diversity of domestic Banking Sector has been increased which has
also improved the availability of banking services to the masses matching international
standards. This development has enhanced among other things the versions of risks which
has initiated the basis of promulgating Basel Accord in the Pakistani banking structure
like it has been adopted in most of the countries. However, multiple stage system of Basel
Accord and different levels of adoption all around the world crates myth and anxieties
across global banking sectors which hampers their reliabilities.
In Pakistani Banking sector the Basel Accord was supposed to be implemented in full
letter and spirit before 31st of December 2009. However, State Bank of Pakistan extended
the dates for implementation for varieties of anomalies that Pakistani Banking Sector has
faced. There is a need to investigate the reasons behind this delay in the local perspective
over and above the international reasons which have stemmed after the international
banking crisis. In this regard a research needs to be undertaken focusing on the following
issues:
The compliance to the timetable introduced by the Supervisory Authorities;
Problems faced by the State Bank of Pakistan and Banks;
The present and proposed infrastructure available with the Basel Accord for
smooth and successful implementation;
HR capabilities;
Impact the Basel Accord has and will have on bank exposures in credit, market
and operational risks.
22
Such study will explore various concerns of Basel Accord Implementation in Pakistan
which will magnify behind the scene facts of the inability of Pakistani Banks to adopt
advanced techniques of Basel Accord.
Many countries including United States, Brazil, Switzerland, India, Lebanon and South
Africa have under taken such academic studies so far for gauging the impact of Basel
Accord implementation (Jacobsohn, 2004; Cumming and Nel, 2005) but no such study
has been conduct in Pakistan. Further, even in the respective countries most of these
studies are were conducted prior to the Second Accord, the main purpose of which was to
gauge the likely impact of Basel Accord on the respective Banking Systems. It is
therefore quite pertinent to initiate a fresh study in Pakistan that investigates into the
statics and dynamics of Basel Accord Implementation in Pakistan.
In a similar study in South Africa Jacobsohn (2004) studied the impact of Basel Accord
on South African Banking System via incorporating possible alterations in the conduct of
banking, merely focusing on Pillar I. The research concluded that the Banks in South
Africa will have to change their banking methodologies due to enhanced risk
management requirement of banking procedures under the Basel Accord and also due to
enhanced competition in the exposure taking market (Jacobsohn, 2004). The pivotal
feature of this as well as other researches was that even internationally very few works
are available which have accounted for the successful or unsuccessful implementation of
Basel Accord, therefore most of the problems highlight only the perceived hindrances in
the implementation of Basel Accord. Furthermore, this study is important because Basel
is under continuous improvement phase which requires higher and higher level of
resource availability with the banks and with the supervisors; and accordingly in the
Pakistani environment the failure to meet first time schedule on the part of the banks
indicates that the banks have also suffered from similar problems among others things
that might have disturbed the smoother transitions towards the Basel Accord. In the
coming section we have highlighted the goals of this study.
23
1.3 GOALS OF THE RESEARCH: The primary objective of this study is to conduct a research that encompasses various
issues regarding the implementation of Basel Accord in Pakistan. These issues include
both the qualitative and quantitative aspects of implementation concerning the following:
Behavior of the Banks regarding the Implementation of Basel Accord;
Availability of HR resources with the Banks regarding the implementation of
Basel Accord;
Availability of Technological resources with the banks regarding the
implementation of Basel Accord;
Analysis of Capital Adequacy Ratios and their Trends;
Focus of the Banks on the Risks they facing and any enhanced area of focus;
Response of the Banks regarding the Capabilities of the Supervisor regarding
implementation of Basel Accord
1.4 METHODS AND PROCEDURES:
For the purpose of understanding Basel I, II, III and related rules and regulations behind
their implementation we have undertaken a detailed literature review comprising of
analysis of all the three Basel Accord and their deficiencies. Further we have also
reviewed the critical factors arisen during the implementation of Basel in South Africa,
Brazil, United States, Switzerland, India and Lebanon for building a strong infrastructure
for the construction of our study. The study has been conducted to find out principles,
viewpoints, methodologies, interrelationships and interpretations of various findings on
Basel Accord implementation studies in the respective countries. We have also
supplemented our literature review with quantitative impact studies, consultative
documents, and other miscellaneous documents available on the Basel Accord
implementation issue to get a deeper insight into our proposed area of research. We have
generated primary data from questionnaires distributed to the executives, risk managers
and branch managers of various banks in our study and have collected secondary data
24
from Annual Reports of various Banks and various reports of State Bank of Pakistan to
find out the progress made by the respective Banks on the implementation of Basel
Accord. As the secondary data has been collected from the Published Annual reports of
various Banks in the study therefore it has high standard of validity and reliability. The
Cronbach’s Alpha has been used for the validity of the primary data and to narrow down
the variables to be used for the purpose of our study. As the Basel Accord
implementation started in Pakistan since 2005 therefore we have taken the Capital
Adequacy Ratios only for a five year period from 2005 to 2009 for the purpose of our
analysis. Apart from Capital Adequacy Ratios we have also collected data regarding
Total Assets, Risk Weighted Credit Assets, Total Deposit, and Total Employees for more
comprehensive review of progress made by the Banks on Basel Accord implementation
progress made by the respective Pakistani Banks. For the purpose of analysis of data we
have used Radar Diagrams which shows the impact of multiple variables on a single
object in graphical form; supplemented by Cross tabulation analysis which identifies the
relationship between two unique variables in a unique way. This helped us establish how
banks in Pakistan responded and approached the implementation of Basel II rules.
1.5 ORGANISATION OF THE STUDY:
In order to have better understanding of the reasons behind the delays in the
implementation of Basel Accord and to form conclusions, this research has been arranged
in the following order: Chapter 2 gives the Review of all Basel Accords. This chapter
critically analyses the dynamics behind the transitions from Basel I to III. Chapter 3 this
gives a brief review of the technical issues in the implementation of Basel Accord.
Chapter 4 provides review of the issues as discussed in Chapter 3 in country specific
scenarios and progress made by the respective countries in implementing Basel Accord
which included among others details about regulatory structures, time schedules and
planning matters. Chapter 5 focuses on data analysis using multiple techniques and
Chapter 6 Analyses the data we have collected for the purpose of our study. Finally,
25
Chapter 7 gives us results, conclusions, recommendations and directions regarding the
area of future study.
26
CHAPTER: 2
REVIEW OF BASEL ACCORDS
2.1 BASEL I CAPITAL ACCORD:
Basel Accord was first introduced in the year 1988 at which time the minimum capital
requirement was set at 8% of risk adjusted assets. The said Accord was accepted all over
the world by over 100 countries (Makwiramiti, 2008). This Accord primarily focused on
credit risk where the exposures were classified generally thereby portraying akin types of
risks and borrowers. Accordingly Klaus (2001) claims its general acceptability by most of
the banks globally since 1988. For the purpose of our study we take a brief review of the
potency and drawbacks that urged the need of the transition to improved Basel Accords
in the form of Basel II and onwards.
The adoption of Basel I Accord in a significant number of countries all over the world
improved the resilience of international banking system through improved capital
standards (Rime, 2001; Cumming and Nel, 2005). Amongst the need of Banking
supervision that urged international authorities to move towards the convergence of
capital standards the Basel Accord also drew lessons from the 70’s financial crisis that
appropriate capital levels would help reduce the systematic bank failure risk (Dobson and
Hufbauer, 2001). Such appropriate levels were set to guarantee that the individual
financial institutions can withstand all losses in general and credit loss in particular
(Dobson and Hufbauer ,2001).
2.2 CRITICAL REVIEW OF THE BASEL I ACCORD:
(Ong, 2004) pointed that despite providing stability to financial sector the Basel Accord
had quite a few considerable deficiencies that initiated the need for fundamental reforms
in its structure. Concurrently in the (BCBS , 2001) it was pointed that due to enhanced
risk management and customer oriented practices adopted by the financial institutions
27
during the 90’s decade it was almost became necessary to upgrade the Accord to
encompass the current issues as well.
The deficiencies included:
“One size fit all” to risk management (Ong, 2004).
Distortions in Credit Risk in Banking initiated Capital Arbitrage opportunities
through the use of asset securitization vehicles (Ong, 2004).
The Basel I Accord was insensitive towards distinction of credit risk and other
risks (Hai et al. ,2007).
Non accounting for the new complex financial products as are prevailing in the
modern era (Makwiramiti, 2008).
Decline in traditional banking which was primarily the subject of Basel I Accord
due to financial derivatives and securitizations (Hai et al., 2007).
No incentives to the Financial Institutions to improve their risk management
systems (Makwiramiti, 2008).
(Cumming and Nel, 2005) pointed that categories of risk were not in strongly
correlation with actual banking risks. For instance, all exposures from corporate
sector were given risk weighting of 100% regardless of their risk ratings.
The banks started “cherry picking” practices which provided leverage to banks to
adopt high risk carrying portfolios assets within a particular risk category
(Cumming and Nel, 2005).
The globalization and integration of world financial markets also exposed banks
to diversified structure of risks which also necessitated the need of a revised Basel
Accord (Hai et al., 2007).
In a nutshell the above important factors substantiated the need for initiation of and
promulgation of a new Accord that would be more risk sensitive (Pagia and Phlegar,
2002). The trademark of the new Basel was therefore appears to combine good bank
28
supervision and bank management with market discipline to ensure security and
reliability of the dynamic and intricate banking system.
29
2.3 BASEL ACCORD (REVISED 2006):
The revised Accord focused on the reconciliation of regulatory capital with the quantum
and types of risks faced by the banks BIS (2007). This follows as pointed by (Caruana,
2003) that the focus is not only on capital, but a systematic risk management system with
focus on ensuring a level playing field and strengthening incentives is the primary
objective. Accordingly, Pillar I of this Accord further supplemented the 1988 Accord by
introducing new minimum capital requirements while Pillar II and III introduced
innovations in Banking Supervision. In short this Accord introduced a new premise for
the banks that they should maintain at least a required minimum amount of capital against
some internal factors such as unfruitful credit decisions and external factors such as
economic crisis and twin crisis etc. (Dobson and Hufbauer, 2001) leading to higher and
lower capital requirements for the banks According to their risk profiles.
The prime objective of this Accord was to inculcate solidity of the financial system by
ensuring that banks are appropriately and proportionately capitalized with respect to the
risk, risk management control structure and risk management techniques. In this regard
the first pillar maintained definitions relating to the minimum capital requirements setting
minimum capital to atleast 8% of total risk weighted assets. However, it was also directed
to make sure that any such capital be maintained keeping in view the close alignment
with the actual risks of the bank’s economic loss (BCBS, 2001). This activity improved
the risk measurement by calculating the risk exposure resources which comprised
converting banking assets into risk resources by getting a figure of risk based assets based
upon credit, market and operational risk. In the word of Bailey, 2005 the core objective of
the first pillar is the alignment of risks of the banks with regulatory capital. The purpose
was achieved by linking the risk-weights to the credit ratings. This resulted into
accounting for the individual credit worthiness of the counterparty rather than assigning a
credit-weight to the group of counterparties (Bailey, 2005). This ensured better alignment
of bank’s capital with underlying risks and a better configured level of capitalization
(Makwiramiti, 2008).
30
The approaches for measuring the credit risk are primarily divided into two groups, i.e.,
the Standardized Approach (SA) and the Internal Rating Based (IRB) approach.
However, for the purpose of promulgation of Basel environment the first step of
Standardized Approach was termed as “Simplified Standardized Approach” whereas the
first step of IRB Approach was termed as Foundation internal Ratings Basel Approach. In
this regard BCBS (2001) states that SA formulated the procedure to derive total Risk-
Weighted Assets by applying certain risk weights to its own on and off balance sheet
assets. Meaning thereby, application of 100% risk weight leads to the full value
recognition of an exposure into Risk Weighted Assets and corresponding amount of
capital of 8% (Makwiramiti, 2008).
The Basel I Accord assignment of risk weights to individual borrowers was actually
dependent upon broader risk categories for instance, sovereigns, and banks or corporate.
However in the Basel II Accord all such risk weights were refined with reference to some
ratings criterias specified by some rating agencies as specified by the Financial
Authorities of respective geographic boundaries under the standardized approach.
Resultantly Basel II provided risk-weightings, 0%, 20%, 50% 100% and 150% (BCBS,
2006; Cumming and Nel, 2005). Furthermore, Basel I specified only one risk category for
corporate exposures that was 100% whereas there are four risk categories available under
Basel II environment (20%, 50%, 100% and 150%) (BCBS, 2006).
At the same time Basel II introduced an internal ratings based approach (IRB) which
allowed the banks to use their internal estimates of the borrower’s individual
creditworthiness to gauge the probable future losses. This provided an opportunity to
establish a basis of minimum capital requirements under more methodical, objective and
stringent disclosure requirements (BCBS, 2006). According to (Makwiramiti, 2008) this
provided unique and different analytical frameworks for loan exposures, with varying
loss characteristics. Under the IRB approach, banks are required to categorize the
“banking-book” exposures into broad asset groups based upon the nature of exposure
customers. The classes of assets introduced in the Basel II Accord were: corporate,
31
sovereign, bank, retail and equity16 (BCBS, 2006). BCBS, (2006) bifurcated IRB
approach in the foundation and advanced methodologies for corporate, sovereign and
bank exposures, to allow account for a bigger area of risk-weights in comparison with all
those which have been established by the standardized approach. This effort on the part
of BCBS enhanced the position of banks toward a leveraged level of exposure and
volatility towards risks (BCBS, 2006). There is only the difference of complexities with
respect to application of quantification methodologies in the Foundation IRB (FIRB)
approach and the Advanced IRB (AIRB) approaches. While applying the FIRB
methodology, banks compute estimates of the probability of default (PD) of respective
borrowers and in the next step their supervisors of the respective regions complement
their estimate with other appropriate inputs. On the other hand while applying the AIRB
methodology, banks which are using advanced internal capital allocation processes have
been permitted to complement their estimates with other inputs from their own as well
(BIS, 2004). In this regard the probability of default (PD), loss given default (LGD),
exposure at default (EAD), and maturity (M) are the four factors used to compute the
required credit risk when the IRB approaches are applied(BCBS, 2006). Basel II also
established that banks should also innovate to find out a proportionate allocation of
capital for operational risk, which was a new promulgation under this Accord. This
enhanced the scope of Basel II because banks needed to gauage the probable losses from
failed or inadequate internal processes, systems, and employee errors in comparison to
external disruptions. For capturing operational risk three unique approaches were
introduced with the aim to quantity the effect operational risk i.e. the basic indicator,
standardized and internal measurement.
For market risk, Basel II Accord also specified capital charges for banks’ Market risk
exposures based upon their risk of loss stemming from on and off balance positions
coming out from volatility in market prices. Such risks include risks relating to the
interest rate related instruments and equities in the trading book; and risks of dealing or
using international currencies other than the respective domestic currencies (Foreign
exchange risk) of the respective bank and risks of dealing in or using commodities
(commodities risk) throughout the bank. For accomplishing the purpose Basel II Accord
32
also specified prudent guidelines for valuation of positions in the trading book. These
consist of provision of adequate systems and control; valuation methodologies of marking
to market and marking to model; independent price verifications; and valuation
adjustment and reserves. The second step involves actual measurement of market risk
using either “The Standardized Measurement Method” or “The Internal Models
Approach”.
The Basel II Accord also introduced Supervisory review using a second pillar. The
purpose of this pillar was to ensure that the banks have sufficient resources to gauge their
internal risk assessment (BCBS, 2006). Basel Accord made it mandatory that all banks
under their jurisdiction have systems and processes available for their capital adequacy
assessment (BCBS, 2001). In doing so this Accord suggested the banks to develop their
assessment procedures and calculation of capital targets that are upgraded within the
system and also stay in line with their capital adequacy requirements (BCBS, 2001). The
supervisors were also given powers to decide if any/all of the banks in the banking
system are to hold higher capital levels over and above 8% as prescribed in Pillar I.
Furthermore, supervisors were also possessed with the authority to intervene in the risk
management procedures, and/or revise and upgrade the procedure and processes as and
when they it deemed it necessary (BCBS, 2001).
The third pillar of market discipline emphasized the improvement of bank management
by ensuring full disclosure, lucidity and clarity in public reporting. The main focus of
this pillar is to increase the disclosure of capital adequacy of the banks in their public
reports (BCBS, 2006). Actually, this pillar elaborated the issue already raised in (BCBS,
2001) which pointed that the participants of the market can only comprehend the capital
adequacy risk profiles of the banks only if the reporting banks comply with the enhanced
levels of market discipline (BCBS, 2001). In this way by comprehending the activities of
the banks and the willingness and potential to administer its exposure the market
participants will gain a position to honor such banks that conservatively administer their
risks and simultaneously penalize those that fail to do so (Makwiramiti, 2008).
33
In the beginning Basel Accord was developed for the internationally participating banks,
however it could equivalently be applied to all banks with different levels of complexity
(BCBS, 2001). For doing so it gave a combination of approaches for every kind of risk
with the availability of a supervisor to review it all, which enhanced its elasticity in the
calculation of risk and respective capital. Therefore, in a way it has also contributed
towards improvement in corporate governance and transparency (Makwiramiti, 2008).
Another very important factor added by Basel Accord was improved regulatory
framework, applications, and processes. The advantages of Basel II can be categorized in
loan, portfolio, and at organizational level (Skosana Risk Management Company, 2006).
Loan level advantages of Basel Accord aided in the following ways:
Demarcation between high risk and low risk borrowers keeping in view their
probability of default (PD).
Demarcating the risk of the facility on the basis of Loss Given Default (LGD).
Improvement in the pricing and provisioning of financial products.
Portfolio Level Advantages of Basel II Include:
Recognition of the power of diversification: that the banks were able to assign risk
weights to the each individual loan in portfolios and maintaining the capital
Accordingly.
Probing into the concentrations and gauging impact on the overall capital,
profitability and risk structures.
Adjusting Risk Weighted Credit Assets and Capital limits in comparison with
each other.
Organizational Level Advantages of Basel II include:
34
The Basel II Accord helped banks justify their large profiles keeping in view their
capital and risk profiles.
The Basel II Accord encouraged banks to appoint fund managers to keep close
watch of their investments, capital and risk profiles.
By appointing fund managers and making large risk profile investments the banks
enabled themselves to take risks in smart way and leveraging their pure risk based
return.
All the above organizational benefits combining with enhanced supervision and
market discipline amongst others added transparency and corporate governance in
the banking sector at an enhanced level.
It has been narrated over time that the main emphasis of Basel I Accord was on
maintaining the Banks’ capital and reducing the likelihood of insolvencies (BIS, 2004).
With this background Basel II Accord elevated the soundness and security of the
financial system by ensuring the adherence to the requirements of three dimensional three
pillars introduced (BCBS, 2001, Bauerle, 2001). Resultantly, the Basel II helped in
improving the regulatory levels of capital in all respect which provided better and secured
banking mechanism, with better responsive and exhaustive approaches to as compared
with Basel I Accord (BCBS, 2001). This Accord therefore portrayed itself as a landmark
change in the methods of capital calculation and sharing the financial responsibilities of
the economic society between the bank and the regulator to a greater extent (Bailey,
2005; Caruana, 2004).
2.4 CRITICISM OF BASEL II ACCORD:
The Basel II Accord lived a very short life in comparison to the earlier Accord as it was
promulgated during the cultivating season of a big financial crisis! The perceptions of the
regulators and participants of the banking sector fell short of what was required and
resultantly the following areas were identified where more work was sought. This was
primarily meant for fundamental strengthening and “partial radical overhaul” of the
international standards of capital:
35
The enhanced level and quality of capital are basically part and parcel of one and
another. Even though under Basel II environment certain items of assets of
questionable quality are already deducted from Tier I and Tier II Capital, still
under Basel III Capital regime such deductions are proposed to be directly applied
to the common equity to derive more meaningful status of the equity.
Simultaneously with the quality of capital the Financial Crisis taught a lesson of
higher quantity of capital as well.
Under the Basel II regime the common equity was prescribed as minimum 2% of
the risk weighted assets which are effectively equivalent to 1% under the new
definitions of capital under Basel III. There was also no protection available to the
equity under the Basel II Accord as it was available to absorb losses directly in
case of need.
For Trading Book Exposures there was no distinction made between the quantum
and quality of capital required for simple and complex positions.
There was also no limit for the banks to take leverage, i.e., the banks could take
whatever amount of leverage without taking into account their leverage ratios.
Basel II Accord does not state anything about macro prudential stability, i.e., the
impact the banks have on the financial system as a whole.
Basel II Accord does not provide for the systemic risks that arise from
interlinkage and common exposures across financial institutions.
2.5 BASEL III ACCORD:
Keeping in view all the above the revisions to the Basel II Accord were the crying need
of time. Therefore in an effort to revamp the banking regulations first document of the
36
new Accord titled “Strengthening the resilience of the banking sector and international
framework for liquidity risk measurement, standards and monitoring” was issued by the
Basel committee in December 2009 as the first document of Basel III Accord.
Marco Folpmers, 2010, presented the grouping of Basel III rules in the following four
categories:
Table: 2.5.1: Overview of the New Basel III Capital and Liquidity Rules for Banks
Capital Rules-Micro
Prudential
Capital Rules-
Macro Prudential
Liquidity Ratios Macroeconomic
Impact
A-Own Funds E-Reduction of
Procyclality
G-Liquidity
Coverage Ratio
I-Short Term (during
Implementation)
B-Regulatory
Capital
F-Measures against
Systemic risks
H-Net Stable
Funding Ratio
J-Long Term (After
Implementation)
C-Leverage Ratio
D-Convertible
Capital
2.6 MICRO PRUDENTIAL CAPITAL RULES:
2.6.1. Up gradation of Tier I Capital: Here the definition of Tier I capital has been
narrowed down to include only the common shares, retained earnings, perpetual loans
evergreen maturityless loans and a fully discretionary dividend. The corresponding
deductions are such investments that have been made in the capital of other banks and
therefore required to be deducted from the similar capital type at the balance sheet. The
major objective of introducing such deductions is to ensure injection of outside capital in
the banking sector rather than following mutual capital support approach that has been
proved fatal during the latest financial crisis.
Further more a newer brand of capital under the name Tangible Common Equity (TCE)
has been introduced as a buffer capital. Its role would be to evaporate the losses as soon
37
as they appear. This TCE has been referred as the sum of commom equity and retianed
earnings after taking reduction effect of the amount of goodwill (Folpmers, 2010).
In the case of Tier III capital that was previously available for market risk, the Basel III
Accord has eliminated its recognition for loss aborbing purpose. However, the scope of
Tier 2 capital for the purpose of “gone concern” has been simplified and reduced to a
debt with an subordination agreement with atleast maturity of 5 years. Where the term
“gone cocern” means that the Tier 2 capital should be available to absord losses before
the occurrence of default (Folpmers, 2010).
The common equity ratio under Basel III has also been increased to 4.5% which will be
in the first phase enhanced to 3.5% of Risk Weighted Assets from January 2013. For all
such banks which are having problems in maintaining their common equity ratios it has
been proposed that in case of failure to attract new equity through public subscription,
their asset side exposures be reduced by increasing lending spread and/or credit
containment (Folpmers, 2010).
2.6.2. Regulatory Capital Increase: Increases in the levels of regulatory capital will be
promulgated by adopting more steeper rules. Such rules include newer rules for (1)
management of capital and counterparty credit risk exposures relating to derivatives,
repos and securities financing; and (2) for “A higher asset return correlation in Advanced
IRB Credit Risk Calculation for exposures to financial institutions” (Folpmers, 2010).
The Basel III Accord has also introduced rules for the recognition of central
counterparties as distinct bilateral counterparties. Accordingly the central counterparties
have been assigned more secured position by assigning a zero weight to it in the case of
any exposure arising from it, while at the same time strengthening the exposure
requirement of bilateral exposure. The prime purpose of all this activity is to move
derivative counterparties exposures from bilateral to central counterparty positions for
38
spreading the benefits of diversified derivative exposure amongst protection seekers
through central counterparty exchanges!
Addressing the asset value correlation is another landmark achievement of the Basel III
Accord as it has been increased by 1.25 in the case of credit exposures to financial.
2.6.3. Usage of the Leverage Ratios to Control Exposures of the Banks: The purpose
of the leverage ratios is to put a limit on the total assets of a bank upto the maximum of
an explicit multiple of the amount of Tier I Capital. For the moment this number of
multiple has been set at 33 for all countries all across the world. This has been set due to
an observation by the Basel Committee where they explained that the Banks created
“excessive on-and off-balance sheet leverage” before the credit crisis. There was also a
very key observation about the Banking behavior that the banks manipulated the risk
based Basel II system in their own favor (Folpmers,2010). In this context a universal
solution over and above the rating system was required that can safeguard the usage of
Basel II rating system by the banks in their own favor. Therefore a universal requirement
of 33 times leverage was considered sufficient for the purpose for the moment.
2.6.4. Usage of Convertible Capital for Loss Absorbency: In August 2010 in their
paper titled “Proposal to ensure the loss absorbency of regulatory capital at the point of
non-viability” the Basel Committee of Banking Supervision (BCBS) enhanced the scope
of the application of Tier II Capital of the Banks to ensure that it is available for
absorbing losses in case of need by their conversion into common shares upon a
triggering event before default. Such a decision has been based on the premise that in the
recent financial crisis such a capital was not available to absorb losses and the public
funds were required to be injected for salvation of individual institutions. In this regard
the BCBS has also indicated a level of moral hazard existent for such a capital as on one
side they are protected by a form of government bailout and on the other hand a
preferential rate of return is provided (Folpmers,2010). Therefore in order to remove this
anomaly such capital has been enabled to absorb losses in certain circumstances.
39
2.7 MACRO-PRUDENTIAL CAPITAL RULES:
2.7.1. Procyclical Capital Buffers Adjustments: After witnessing the procyclical
application of Basel II Accord during recessionary period through reduced PDs and
LGDs and increased buffers, the creation of capital buffers have been ruled out by the
BCBS in the Basel III during the periods of expanding economy. Practically speaking this
is a reduction in distribution of earnings for the purpose of the benefit of the economy as
a whole rather than the benefits of the bank executives and stockholders (Folpmers,
2010). For accomplishment of this purpose a range specific for such buffer has been
defined i.e., when banks will operate within this buffer, they will have to reduce their
distribution of earnings (Folpmers, 2010).
In this way the bank has three layers of loss absorbing regulatory capital:
An instance where a bank’s regulatory capital falls below the minimum capital
requirement, a situation where hasty corrective measure will be requires;
An instance where the a bank’s regulatory is above the stage as described above
but is within the “buffer zone”, in which case a phase of contractionary
discretionary distributed earnings will set-in;
The regulatory capital is higher than the above buffer zone.
However, this requirement will set in from January 2016 from 0.625% and will raise upto
2.5% as of January 2019.
Over and above the buffer as described above an additional similar buffer upto 2.5% will
be at the discretion of national supervisors which will alongside the promotion of
through-the-time PD and LGD approaches amongst the banks, will also most likely to aid
40
the Monetary Policies of the regulators of the respective countries in the “excessive credit
growth” (Folpmers,2010).
In short the results of such rules will primarily affect the Banks in the following three
ways:
o There will be no liberal bonuses/dividends available to the Banks once the
capital adequacy is disturbed in awkward direction;
o PDs and LGDs will be more justifiable and streamlined which will aid the
economic cycle in a positive manner;
o The credit expansion and bank regulations could both be gauged within
the same framework rather than handling them separately under Bank
Regulations and Monetary Policies.
2.7.2. Accounting for the Systemic Risks: The Basel Committee stated that “The crisis
was amplified by a procyclical deleveraging process and by the interconnectedness of
systemic institutions through an array of complex transaction.” Therefore the objectives
of Basel III were to contract the external affects of systemic repercussions. For
accomplishing the purpose a capital add-on has been introduced for reducing such
systemic repercussions with the results expected amongst others “the increased costs of
capital for large institutions”.
2.8 INTRODUCTION OF LIQUIDITY RATIOS:
2.8.1. Accounting for the Liquidity Rules: Considering the liquidity as the lifeline of
the banks the Basel committee of banking supervision has introduced a liquidity coverage
ratio based upon a 30-Day liquidity coverage ratio for countering the efforts of such
banks that were involved in building excessive leverage without sufficient liquidity
cushions. In the explanation of the LCR rule the Basel committee stated that the banks
should hold an amount equal to the sum of quantum of cash, central bank reserves, and
government bonds.
41
2.8.2. Accounting for the Net Stable Funding Ratio (NSFR): This ratio exhibits the
relation between the stable funding amount and stable funding required amount, where
stable funding is a weighted sum of assets, with the quantum of weights ranging from 0%
allocated to cash to 100% assigned to retail etc., exposures with maturity of more than a
year.
For both the above ratios the Basel Committee will start observing the impact of above
ratios from 2011 and 2012 respectively. The minimum threshold for the above ratios will
be promulgated from 2015 and 2018 respectively.
2.8.3. Study of the Micro Economic Impact of the Capital Accord: The study of the
impact of Basel III Accord on the overall economy is very difficult to gauge as the
occurrence of economic event is difficult to predict. Commenting on the reason behind
this trivia the Basel committee on banking supervision states that since it is very difficult
to measure the level of interconnectedness between the banking system, capital markets
and payment systems and their multiplier effects on themselves and the economy
therefore in the current scenario the exact percentage change in the response variable
GDP as result of such interconnectedness is beyond the scope of current economic
models (BCBS, 2010d).
2.8.4. Study of the Long-term Macro Economic Impact of the Capital Accord: The
Macro Economic Assessment Group in their report titled “Assessing the Macroeconomic
impact of the Transition to Stronger Capital and Liquidity Requirements” published in
August 2010 narrated that the benefits of the rules relating to liquidity and capital have
been probed into by the Basel Committee. Such benefits have been analyzed with respect
to sensitivity analysis of an environment with and without the effect of Basel Accord on
the financial crisis. According to the Basel committee the new rules have net favorable
effect with the projection that the financial crisis will reduce over time. But still such
results are not reliable after the year 2018 as the future is uncertain in the observing and
implementation.
42
2.9 TABLE OF REVIEW OF THREE BASEL ACCORD:
Focus Basel I Basel II Basel III
Measures of Risk Single Broad Economy Wide
Sensitivity of Risk Broad brush
approach
Enhanced Risk
Sensitive
Enhanced Economy
and Sector Risk
Sensitive
Credit Risk
Mitigation
Limited
Recognition
Comprehensive
Recognition
Through The Time
Mitigation of Credit
Risk
Operational Risk Excluded Included Included
Flexibility One fits for all
approach
Menu approaches Menu approaches
with comprehensive
approach.
Supervisory Review Implicit Explicit Explicit with single
view of economy
and bank
regulations.
Market Discipline Not Addressed Addressed Addressed
Incentives Not Addressed Addressed and well
defined
Well defined
incentives of
transition and
outcome.
Economic Capital Divergence Convergence Extended
Convergence-Based
upon time based
results
The above table is an extended version of table of comparison of Mr. Oothuzien of South
Africa Reserve Bank as published in his paper “Basel II: Introduction to Nuts and Bolts”
43
in the year 2005 wherein the comparison was made only of Basel I and Basel II. The
table has been extracted from the Master of Commerce Thesis of Mr. Makwiramiti, 2008.
CHAPTER: 3
IMPLEMENTATION OF ACCORD 3.1 INTRODUCTION:
The latest up gradations in the Basel Accord has received stringent commentaries with
regard to its implementation on the whole banking system and the economy. Therefore it
becomes quite imperative to have insight into the common concerns about the latest Basel
Accord. About the earlier Basel II Accord there was a majority opinion that it would
bring financial stabilization into the financial system as it provided advanced risk-
sensitive methodologies (BIS, 1999; BCBS, 2004; Cumming and Nel, 2005; van Rixtel,
Alexopoulou and Harada, 2003; Jacobsohn, 2004). At the same time the Basel Accord
also had to deal with issues relating to the support to sounder banking environment,
volatility, and consequences for emerging and developing economies (Makwiramiti, 2008
). In the case of Basel III Accord the scope of these observations has been enhanced
through Good-Bad time connectivity concept of “Through the Cycle” measures. It is
therefore important to probe into these issues to form a basis for the implementation of
the new Accord in emerging countries and especially in Pakistan.
3.2 BASEL ACCORD IN DEVELOPING COUNTRIES:
There has always been a debate about the influence of Basel Accord on developing
countries. The practitioners of the banking industry state that the introduction of IRB
approaches earlier (Griffith-Jones and Spratt, 2001) and capital and liquidity ratios
introduced in the Accord at present shall considerably reduce the quantum, cost, and
volatility of lending to the developing countries. Keeping in view this phenomena Bailey
(2005) argued that such investments will yield lower results as the Accord was not
originally designed for developing countries, neither do it has accounted for the financial
crisis of such countries of the world. Bailey (2005) further added that in such a scenario
local banks of developing countries may face capital evaporation problem which will
make them more susceptible in the case of acquisitions by international banks.
44
Commenting on the similar issue Dupuis (2006) argued that Basel Accord unjustifiably
favors mega banking institutions because of their abundant capital and human
institutions. This will favor the international mega banking institutions in dominating the
local banking sectors which might eventually peril the domestic supervision and
regulatory structures (Bailey, 2005).
There are multiple similar opinions regarding the increase and decrease in capital
requirements as a result of Basel Accord however, the conclusion of Bailey (2005) seems
the most contradictory that “Basel Implementation in developed countries holds no
serious implication for developing country lending because costs will not be affected as
international banks price using economic capital, not regulatory capital”. Furthermore
Basel Accord will not intensify the business cycles effects in developing countries as
additional anti-procyclical rules set in Basel Accord along with the requirements of Pillar
II and Pillar III will preclude such behavior of international banks due to the following
three reasons (Bailey. 2005):
The scope of Basel Accord for Regulatory tolerance and sleaze will be increase
through Pillar II;
The underdeveloped capital markets will keep the Pillar III ineffective; and,
Poor environment of data will keep the Pillar I less effective.
However, IMF (2005) discusses that the risk sensitivity of the Basel Accord is likely to
keep higher capital charges on loans to developing and emerging economies due to their
higher operational and credit risks. Resultantly, there will be less capital inflows and
borrowing costs for such high-risk destinations (IMF, 2005). The resource availability is
also a constraint in the implementation of Basel Accord therefore it is argued that new
rules will definitely hinder the provision of capital in a significant number of developing
countries (Dupuis, 2006).
3.3 PROCYCLICALITY ISSUE:
45
Cumming and Nel (2005) argued that the largest threat Basel Accord might have to the
banking system is the procyclicality as capital charges have positive causality with the
probability of default (PD). That is, under the depression the capital charges will rise and
vice versa. Furthermore in terms of risk weights, the banks assign higher risk weights
during a depression which increase the cost of capital and in turn contracts the lending of
the Banks (IMF, 2005). It can therefore be concluded that the Basel II Accord was
inducing procyclical lending behavior amongst the banks which might eventually
aggravate the instability in the banking system. Heid (2007) stated that such a scenario
will enhance the variation of regulatory capital which will also hamper the ability of the
banks to lend. However, in such a scenario there always exists a danger of exacerbation
of economic distress which can be transferred on to the real sector of the economy
(Jacobsohn, 2004; Heid, 2003). In this way the banks shift the overcapitalization
incidence created during recession to borrowers. This evaporation of capital by banks
forces companies to reduce their investment spending which exaggerates the economic
downturn, in the absence of any other source of finance. Heid (2007) pointed that this
slowing down impact can ever turnout to be devastating if banks start recovering their
loans premature. Keeping in view this problem the capital buffers as supposed by Basel
III play very pivotal roles in the stabilization of the overall financial systems by virtue of
absorbing the impact of capital volatility. Similarly, the procyclical effects may also
appear when the eminence of assets of the banks is correlated with business cycles, in
case there also prevails high risk volatility of capital charges (Jacobsohn, 2004).
Resultantly, the prime objectives of capital regulations are distorted from being stemming
stability in the financial system (Heid, 2003). The developing countries are also more
affected by the procyclicality by virtue of their co-existence with economic cycles
(Griffith-Jones and Spratt, 2001; Reisen, 2001; Ward, 2002).
3.4 Basel Accord: Need of Basel Implementation Resources:
The updation of systems and resources in order to nurture the results as required by the
Basel Accord is a challenge to banks because such up gradations are required in terms of
staffing, processes and systems (Dupuis, 2006). IMF (2005) also stated that the
46
infrastructural systems of the banks must be compatible for reporting data, and its
continuous verification and validation should also be put in for smooth and correct
transition and adoption of modern methodologies. However, it is still expected that the
Basel Accord will not be adopted all over the world at the same time because banks in
developing and emerging economies have to put extra efforts to meet best international
practices and procedures (Dupuis, 2006:8). Similarly high caliber practitioners of risk
based supervision are required all over the world which is a challenge for supervisors in
respective emerging economies (IMF, 2005). The Cornford (2005) correctly stated that
the speed to implement Basel Accord is heavily influenced by resource availability
constraint of the supervisors all over the world. This proves that the banks are required to
cautiously and are also required to put away resources specifically for this purpose in
order to make the process of implementation successful.
3.5 BASEL ACCORD: ADOPTION OF APPROACHES:
Meeting the minimum supervisory conditions regarding adoption of Basel Accord is
mandatory for all participants of Basel Accord. These requirements include amongst
others the requirements of internal control and risk management. The adoption of
advanced approaches is permitted only in case of meeting all the requirements of Basel
Accord (Cornford, 2005). However, sometimes different rules are applied in case of
internationally active Banks. This case arises where the home country of a bank requires
higher IRB approaches whereas the host country prescribes standardized approach due to
limitations in the supervisory capacity. Such cases can complicate the implementation of
Basel Accord globally (Makwiramiti, 2008).
3.6 BASEL ACCORD AND THE DEVELOPMENT OF RATING
AGENCIES:
IMF (2005) pointed that rating agencies can manipulate the Credit Risk Management in
developing countries as such companies can come up with the risk-weights of the assets
that can provide biased incentives for standardized approach in Pillar I. There is therefore
47
a strong need on the part of the supervisors of the respective countries to ensure that the
work of Rating Agencies stays within tolerable limits of acceptability.
3.7 SUMMARY:
We have taken a review of the Basel Accord Implementation by taking their strengths
and weaknesses in this chapter. It has been analyzed that the failure of Basel I and II
Accords led way for the Basel III Accord to creep in. Basel II had many drawbacks
relating to emerging and developing economies, that included procyclicality, selection of
methodologies, selection and availability of required resources for setting up rating
agencies. This stems the need to explore the implantation issues in some major
developing countries and then in Pakistan in order to understand that how the questions
relating to extent of implementation, timetable, resources and overall planning, as well as
the trends in banking sector variables are dealt with, in the light of the framework set in
this chapter.
CHAPTER:4
COUNTRYWISE COMPARISON OF BASEL
ACCORD INSTITUTIONAL ISSUES
4.1 INTRODUCTION:
It is a prerequisite for any country around the world to have a culture of risk management
and supervisory authority for implementation of Basel Accord for Kruger (2005). In the
next step it is required for the supervisory authority to assess the integrity of management
of capital by the banks. Last but not the least there should also be strong culture of
disclosure of information of financial and risk positions in the financial markets of such
countries. As there exists huge chances that there might a great degree of variation in
adaptability of these measures therefore it is pertinent to probe into the issues that include
48
structures of banking and regulations, extent of implementation, time required for
transition and the planning for overall integration. To accomplish our purpose we
therefore take a review of such measures in South Africa, India, Switzerland, Brazil,
Jordan, USA and Pakistan. In our study we have taken account of governmental and
regulatory changes introduced by the respective governments for Basel Accord
Implementation.
4.2 BASEL ACCORD IN SOUTH AFRICA:
South Africa is working for the Basel Accord Adoption for the about 11 years. They met
the following preconditions before their transition to Basel Accord:
Stabilization, transparency and discipline in fiscal and macroeconomic policies.
Adoption of IFRS and IAS standards for Financial Disclosures and audits of
financial disclosures.
Enhancing the level of Banking Supervision in Accordance with the core
principles of effective supervision as prescribed by Basel.
Enhanced level of corporate governance in conformity with the “Enhanced
Corporate Governance for Banking Organizations” of Basel Committee, and
local standards.
Continuous management of risk in compliance with Basel I, Core Principles and
other applicable guidelines.
The above measures in particular and many others in general with regard to banks,
companies, insolvency, money laundering, bank supervision, accounting and the legal
environment, has made South more compliant with International Standards
(Makwiramiti, 2008).
However, in order to more formally comply with the International Standards in 2007,
South African parliament approved a Banks Amendment Bill. The purpose of this bill
was to enforce South African Banks to hold their risk weighted assets in proportion to
49
their capital (Manuel, 2007). This was the benchmark measure taken by the government
which put the whole Basel Accord process on its way.
Basel II Accord was chosen to be implemented in South Africa from January 2008 all
across banking sector uniformly (Neville, 2005; SARB, 2004). The glaring feature of the
Accord was that, “Basel II would be adopted in its letter and spirit as an absolute
minimum standard, and no sub-Basel II deviations would be permitted, although
enhancements to Basel II that set a higher standard were, and in future may be
incorporated into the regulatory and supervisory framework” (Bank Supervision
Department, 2007). It means that all Basel II all measures are available to all banks in
South Africa subject to meeting certain requirements (Bank Supervision Department,
2007). The Basel II Accord is feasible for most of the Banks in South Africa as it offers a
range of approaches to different authorities in the Banks and the Banking Sector
(Makwiramiti, 2008).
The integration of Basel Accord into the Banking System of South Africa is an ongoing
process (Makwiramiti, 2008). It started its way in the period 2001-2002 with the
appointment of the Head of BSD for the purpose, followed by appointment of analysts for
the implementation of advanced techniques in Banks (Bank Supervision Department,
2007).
The Basel II framework was initiated in South Africa soon after its announcement by the
Basel Committee of Banking Supervision in the year 2004-2005 (Kruger, 2005). Some of
the Banks adopted Advanced Internal Risk Based Approach while the others adopted
Foundation Internal Risk Based Approach (Makwirmaiti, 2008). The pioneer run of Basel
II Accord was initiated in 2006 in order to gauge its dimensions (Makwirmaiti, 2008).
Year 2007 was the year of major development with the aim to collect information of the
impact of Basel Accord on a single member of South African Banking System and its
preparation about it (Bank Supervision Department, 2007).
After the parallel run of Basel I and Basel II South African Banks switched to Basel II
from 1st of January 2008. Since there are a number of approaches under Pillar 1 per risk
50
type available; a bank can only use what it has been allowed by the regulator. Therefore,
after this date all banks in South Africa were either on Basel II Standardized Approach
and simultaneously discussing their way to move on to IRB Approach or they are on the
IRB Approach. South Africa is a member of the group of Basel Committee for taking
Quantitative Impact Study and therefore carrying out the studies relating to
implementation of Basel III for implementation into their system.
4.3 BASEL ACCORD IN INDIA:
As regards the Implementation of Basel Accord, although the banks and regulators give it
very high importance yet the pace of transition is very slow (Mehra, 2010). The Reserve
Bank of India articulated the roadmap for implementation of Basel Accord in India in the
year 2009 (RBI, 2007a, 2009). The works done by the regulatory authority is in the very
primary stage because the initial approaches for all the risks categories in the First Pillar
were required to adopted from March 2009. Until December 2010 the Banks in India
were still following the initial approaches as more advanced approaches were supposed to
be followed by the Indian Banking System from the year 2013 RBI (Notification) 2009.
4.4 BASEL ACCORD IN SWITZERLAND:
The banking industry in Switzerland has although achieved the preconditions yet they
have not given it legislative importance through enactment (Makwirmiti, 2008).
Alternatively they have set the required standards by an Ordinance of “Swiss Federal
Banking Commission 2005). This helped in facilitating the transition from earlier Basel I
to IInd and ultimately the III Accord. Switzerland is under moral obligation to apply
Basel Accord (Swiss Federal Banking Commission, 2005). Being the host country of the
Accord the implementation adopted is very much similar to the one as adopted by the
Basel Committee (Swiss Federal Banking Commission, 2005). Although all major banks
started to apply approaches by the year 2006, it was only the large internationally active
banks that had resources to apply methodologies like IRB and AMA (Swiss Federal
Banking Commission, 2005). Just like South Africa, Switzerland opted to integrate all the
elements of the three pillars into its regulatory system and adopt all the approaches
available in the Basel II framework. There were no alterations made to the methodologies
51
for credit, operational and market risks (Swiss Federal Banking Commission, 2005). The
easier approaches were taken up by January 2007 while the advanced approaches were
taken up by January 2008. This double paced time schedule allowed banks to have
enough time for smooth transition (Makwirmaiti, 2008). There are two approaches of
Credit Risk in Switzerland as distinct from other countries (Swiss Federal Banking
Commission, 2006):
The Swiss standard approach (SA-CH) is peculiarly designed for domestic banks
and is also updated quite regularly to make it compatible According to the
standards of Basel Accord.
The international standard approach (SA-BIS) is designed for implementation on
in International Banks Only.
Such flexible transitional provisions offered relaxation which was helpful to the banks to
switch the framework in 2007 (Swiss Federal Banking Commission, 2006).
In the words of Makwirmiti (2008) “Switzerland has been exemplary among the Basel
Committee member countries, by remaining committed to the BCBS proposed timetable.
As the host of the BCBS, in Basel it is imperative that Switzerland acts as a measuring
rod for other countries.” The Basel III environment under Impact Study in Basel Banks
therefore Basel has also played a significant role in this regard as well.
4.5 BASEL ACCORD IN BRAZIL:
In order to implement the Basel Accord the Central Bank of Brazil has issued a number
of prudential regulations. The most popular amongst it was the communication resolution
no. 2682 that introduced credit ratings and provisions for doubtful debts. The Brazilian
authorities also have the honor of being the first amongst the emerging economies to
pursue compliance towards Basel Accord after the announcement of Basel I Accord in
the year 2004. Communication rule no. 12746 is a bench mark for implementation of
52
transition table in Brazil. The advanced methodologies are proposed to be implemented
till the year 2012 (Banco do Brasil 2008) which is expected to extend further in the wake
of Basel III requirements.
In Brazil the framework for the implementation was outlined in the year 2004, where the
details of three pillars to be implemented in Brazilian environment were explained. The
document stated that in Brazil there would be the difference in application of rules of risk
management in domestic and foreign countries (Focus BCB, 2005). However, like all
other countries that we have discussed smaller banks were given the leverage of adopting
the easier approaches like Standardized Approach standardized approaches to credit risk
while other larger banks had the opportunity to embrace FIRB and AIRB approaches
sequentially. The banks in Brazil which adopted advanced approaches in credit risk were
also allowed to adopt advanced measurement approaches (AMA) for operational risk
(Focus BCB, 2005).
The schedule of implementation of Basel Accord was firstly advised to be started from
2004, which later was delayed and started from the year 2007. This whole process of
implementation is expected to be completed till 2013 when all the approaches are
expected to be applied. The time schedule for Implementation of Basel Accord in Brazil
is very much detailed as compared with other timetable that we have studied as it is
holistic in nature. All the three pillars are expected to be applied concurrently with prime
attention on capital requirement for operational risk (criteria and methodology). All this is
in addition to the promulgation of a credit risk measurement approach by the banks in
Brazil (Central Bank of Brazil, 2008). Evaluation of the results of validation commenced
at the end of the year 2009 whereas by the end of 2010 the authorization process for
FIRB approach for credit risk capital requirement initiated. The process of authorization
for AIRB approach for similar is about to commence in 2011. The end of 2011 marks the
commencement of validation of internal models for operational risk. By the end of 2012
the process of authorization for use of internal models for operational risk shall
53
commence (Central Bank of Brazil, 2008). In a nutshell the implementation of the
methodologies shall take place in following chronological order:
2010-2011, market risk methodologies,
2012-2013, credit risk methodologies
2013, operational risk methodologies.
Meaning thereby the whole Basel II Accord is expected to be implemented in Brazil till
2013. Apart from the above Brazil is also taking part in the quantitative impact studies of
Basel Committees to examine the possibilities of its adoption in Brazilian Banking
System.
4.6 BASEL ACCORD IN JORDON:
In a study conducted by Barakat (2009) on Banks in Jordon it was revealed that Banks in
Jordon have met the preconditions of implementing the Basel Accord in the following
dimensions: Supervising Administration, Culture of Control, up gradation in the
definitions of risks and evaluations, separation and control of activities and tasks,
communication and information, following separation, and correction of imperfect
information. However, the existence of supervisory Authority is questionable as there do
not exist any mechanism of external rating of credit exposures which shakes the integrity
of the whole process (Barakat, 2009). It therefore appears that implementation of Basel
Accord in Jordon is a long way to do.
4.7 BASEL ACCORD IN UNITED STATES:
In terms of adoption of Basel Accord the United States formed a two-step ladder for its
financial institutions. It opted Basel I Accord for some of the Banks for not meeting a
specific criteria and Basel II Accord for other Banks coming up to a specific criterion.
However, it is responsibility of the supervisor to decide as to which banks may opt for
Basel I and which will opt for Basel II Accord based upon specific criteria (Federal
Reserve Board, 2007). Accordingly in the USA all such banks which opt for Basel II
54
Accord are obligated to promulgate advanced approached for capital allocations in their
banks (Federal Reserve Board, 2007; Gordon-Hart, 2004). However, the crept-in
financial crisis disturbed the Basel II implementation path and many attempts to even out
the two-step ladder approach gone out of the way. Currently, Basel III does not pose
more threats to US Banks as they are more cushioned in terms of liquidity, leverage and
buffer requirements (Folpmers, 2010). However there are still deliberations under process
to phase out the implementation of Basel III Accord in line with the international
standards.
In USA Basel II Accord was adopted three years after its release in December 2007
(Federal Reserve Board, 2007). It allowed all banks that were qualified for adopting this
rule to embrace IRB approaches for credit risk and AMA for operational risk for
calculating their capital requirements based on risk assessment their capital profile.
Kroszner (2008) pointed that advanced rules took effect in USA in the beginning of
second quarter of the year 2008 and henceforth it became an official regulation with no
timeline for the implementation of the full rules under the Basel Accord. USA is therefore
is an exception amongst the Basel committee member countries where Basel II adoption
was sluggish. As the Basel Accord rules were a prerequisite for core banks therefore all
such banks had to improve their credit and operational risk measurement mechanism to
come at par for using advanced methodologies (Federal Reserve Board, 2007).
The criterion for qualification of any bank for adopting advanced Basel Accord was laid
down in the interagency statement (Federal Reserve Board, 2008a). The Federal Reserve
Board (2007) stated that the Basel II rules in USA were consistent with international
approaches and defense boundaries called prudentials. The qualification period in this
regard consisted of completing a parallel run equal to four quarter and three periods off
floor prior to fully boarding on to the Basel II, while the analysis was assigned to
agencies for successful transition to Basel II Accord (Federal Reserve Board, 2007).
The plans for all core banks were approved by their Board of Directors either by October
2008 or within six months of becoming a core bank during this period (Federal Reserve
55
Board, 2008). On the contrary banks were also give liberty to opt in at anytime they
regard themselves suitable for the purpose. The implementation plans were submitted
before 2nd
of March 2008 that is to say within sixty days of the start of Basel II
implementation to the Federal supervisors for approval. Consequently Banks started their
parallel run in 2008 and were eligible to commence their floor transitional period in 2009.
The core banks were also expected to express their strategy about transitional floor to the
maximum of not more than 36 months later than effective date of the rule i.e., from 1st of
April 2011) (Federal Reserve Board, 2008). All the banks during the period of parallel
run must show that their Internal Ratings Based Assessment, Advanced Measurement
Approach, general methodologies and internal capital adequacy assessment are working
in harmony progressively (Federal Reserve Board, 2008a). All banks were required to
complete a parallel run period before the adoption of advanced methodologies. The
Banks were to be notified of their qualification on to the first floor transitional period
once the primary supervisor is satisfied of their parallel run. It therefore appeared that the
Basel Accord in USA was started from January 2009 as amended from 2007 (Bies, 2005;
Gnevko, 2006).
All Banks, holding companies for banks on savings institutions that were outside the
ambit of Basel II as described above were proposed the standardized framework by the
Federal Reserve Board from June 2008 which introduced simple approaches included in
Basel II to calculating the risk-based capital requirements (Federal Reserve Board, 2008).
The salient features of this framework included:
Risk-weights for credit exposures were increased.
Residential mortgages were also assigned risk-weighting based upon their loan-to-
value ratios
Basic Indicator Approach was adopted for determining capital charge for
operational risk.
Banks were also forced to assess their risk profiles at regular intervals
56
The focus of the standardized framework seems towards streamlining risk and regulatory
capital requirement and therefore promoting advancements in risk management practices.
In a banking structure like that of USA it was important for the banks to have a positive
balance between capital rules and regulatory burden. The purpose of this was to ensure
that a standardized framework would illicit stabilization and aggressive equity between
the institutions that were not adopting advanced methodologies of Basel Accord (Federal
Reserve Board, 2008).
The Basel Accord in USA therefore appears as their own tale. According to Yetis (2008)
“At one point non-core banks were allowed to adopt a Basel 1A, which was a fusion of
the Basel I and Basel II standardized approach for credit risk” which was lately
withdrawn and replaced with standardized approach of Basel Accord for non-core banks
as discussed above.
4.8 BASEL ACCORD IN PAKISTAN:
In Pakistan the State Bank of Pakistan (SBP) has taken rigorous steps in the
implementation of Basel Accords. On 31st of March 2005 SBP issued a Road Map for the
implementation of Basel Accord in Pakistan through their BSD Circular No. 5 of 2005.
In this circular SBP directed Banks to set-up a Basel Coordination upto May 2005. The
following is the schedule given by the SBP regarding implementation of Basel Accord:
Standardized Approach for credit risk and Basic indicator / Standardized
Approach for operational risk from 1st January 2008.
Internal Ratings Based (IRB) approach from 1st January 2010. Banks interested in
adopting Internal Ratings Based Approach for capital requirement against credit
57
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.
A review of the SBP Road Map is hereunder:
SBP Road Map for Basel Accord Implementation in Pakistan acknowledged that
Implementation of Basel Accord would not be an easy task because of infancy of risk
management techniques. Therefore SBP prepared its plan on the basis of:
Feedback submitted by the Banks
Appraisal of Financial impact derived from quantitative Impact Study carried out
by Banking Supervision Department.
Implementation of Basel Accord in various countries.
As the third point is the criteria that we have already accounted for in our discussion
earlier therefore we shall review the first two points only.
4.8.1.Feedback Submitted by the Banks: In order to accomplish the purpose SBP
conducted a survey in the July 2004 where representatives from all banks in Pakistan
were invited to express their views through a detailed questionnaire. Regarding start of
implementation the larger Banks argued for the start of implementation from the year
2008 whereas the smaller banks agreed from 2007. However, regarding the adoption of
approaches available in Pillar I almost all of the banks agreed for the standardized
approach initially.
Discussing about the prerequisites of the most of the banks agreed to possess robust risk
management techniques for major risks. However, the area considered to be lacking was
58
operational risk management function. Further at that time Basel Accord was available in
the Banks’ policies only in their next operating plan.
4.8.2.Quantitative Impact Study: Apart from the survey SBP also conducted a
Quantitative Impact Study of the Basel Accord on the basis of data submitted by the
Banks as of 31.12.2003. The premise of the study was a hypothesis that in the absence of
external ratings most of the banks would not suffer a major variation in their capital
requirements, as in that case all of the claims would fall under the unrated category and
would therefore fetch 100% risk weight. The requirement of capital under Basel Accord
in case of individual banks was calculated by adding capital allocations for operational
and market risk. The results did not show any major variation as most of the banks were
capital compliant According to new Basel rules. The document further states that “It may
be worth mentioning here that the study did not take into account the impact of increased
Paid-up Capital requirement of Rs 2 billion in compliance of which some of the banks
have to increase their paid-up capital”.
Keeping in view the results of the above studies SBP developed a Road Map for the
Implementation of the Basel Accord as already indicated hereinabove with the following
responsibilities on their own part:
4.8.3. General:
1) Promulgation of Basel Accord implementation across all banks.
2) Informing the Banks about the Basel Accord Implementation Plan.
3) Developing a mechanism regarding the release of circulars for time to time updation of
procedures and parameters.
4.8.4 Pillar 1-Minimum Capital Requirement:
4.8.4.1. Standardized Approach:
1) Establishing the criteria for recognition of rules and regulations regarding the
acceptance of External Credit Rating Institutions.
59
2) After recognition of External Credit Rating Institutions, mapping of ratings with the
appropriate risk weights in Accordance with the criteria laid down.
4.8.4.2 Internal Ratings Based Approach:
3) Working out procedure regarding the design of Internal Rating System and also to
establish minimum for the banks which opt for this approach.
4) Validation of Systems of the Bank with the Basel Accord implementation.
4.8.5 Pillar 2 - Supervisory Review:
1. Encouraging Banks regarding capacity building and doing the same at SBP as well.
2. In case a bank is not meeting a certain criteria or only partially meeting certain criteria,
devising alternative range of actions and ensuring their uniformity across banks and
segments.
3. Ensuring through carrying out the simulation exercises that whether there exists
sufficient capabilities on the part banks regarding their assessment of overall capital
adequacy, risk profiles and maintaining minimum economic and regulatory capital.
4.8.6 Pillar III- Market Discipline
1. Reviewing and revising (if required) the formats of disclosure According to the
requirements of Basel Accord.
2. From time to time introducing new formats for disclosure by Banks in order to meet
the changing requirements of Basel Accord.
Above all directions and guidelines relate to Basel II Accord. No circular has been issued
by State Bank of Pakistan to date regarding the treatment and promulgation of Basel III
Accord in Pakistan.
4.9 CONCLUSION: The successful implementation of Basel Accord depends highly
upon the requirements of individual countries. It is quite clear from the above discussion
60
that different countries are at different levels in terms of adoption of Basel Accord as it
takes them time to prepare for capital adequacy rules in terms of their own domestic
legislation.
The above country wise analysis of the Basel Accord suggest that all countries as we
have discussed have implemented the Basel Accord in their own way according to the
specific requirement of their country. However, due to global financial crisis and newly
emerging Basel III Accord the compliance to the Basel II and III has become stagnant to
a greater extent. All the countries have done comprehensive Quantitative Impact Studies
along with feasibility and compatibility studies while doing planning for the
implementation of Basel Accords in their respective countries. These countries have also
introduced appropriate legislations in their national legal regime wherever it was required
for the smooth compliance to the procedures of Basel Accords. Therefore, the quantum
and quality of legislation very much depends upon the already prevailing legal structures
and frameworks applicable in these respective countries.
As prescribed by the Basel Committee for Banking Supervision all countries submitted
their plans for the implementation of Basel Accords in their respective countries to
compare the progress of Basel Accord across countries. These timetables also helped the
respective country supervisors to keep an eye on the institutions of banking regarding the
meeting of Basel Accord compliance deadlines. All these timetables have variations
based upon specific country requirements and financial circumstances prevailing in the
respective country based upon structure of the banking industry, nature and progress of
economic development, complexity and advancement of banking industry, preparation of
the banks and the respective supervisors. It is quite clear from the country wise analysis
as discussed that strong regulatory authorities exist in all countries to supervise the Basel
II compliance in their territories which are also responsible for the appropriate
functioning of financial systems.
According to Annual reports submitted by the Banks in Pakistan all Banks none of the
Banks have yet adopted Advanced Internal Ratings Based Approaches which were
61
supposed to be implemented by the Banking sector from the 1st of January 2010. It means
that to date Pakistan has already lagged behind by more than 1-1/2 years in the
implantation of Basel Accord. After establishing that Pakistan has lagged behind in terms
of implantation of Basel Accord as compared with other countries which started Basel
Accord Implementation in almost the similar period it becomes necessary to investigate
the trends in the Pakistani banking sector regarding the causes of this failure to comply
with the time schedule. Next chapter discusses the analysis of the banks operating in the
Pakistani Banking Industry with the respect to their capital adequacy trends, ownership
structure, resource availability, Risk Weighted Credit Assets and total assets variations,
and performance of Risk Management Divisions of various Banks which will be helpful
in determining the underlying causes of failure to meet the time schedule.
62
CHAPTER 5
METHODOLOGY AND RESEARCH DESIGN
5.1 INTRODUCTION:
This study has been conducted to find out the gaps in the implementation of Basel Accord
in Pakistan. To accomplish our purpose we have followed a mixed method approach
wherein we collected data from the secondary sources and from the primary sources as
well. According to the Basel Accord Road Maps issued by the State Bank of Pakistan all
Banks were required to upgrade to Advanced Internal Ratings Based Approach from 1st
of January 2010, however it was at the end of the year 2010 banks disclosed in their
Annual Financial Statements that they are still on the Standardized Approach and could
not move on to the Advanced Approach as it was laid down in the time schedule issued
by the State Bank of Pakistan and also they did not disclose any reason for such inability.
In such a situation where facts from multiple sources are incomplete and therefore
becomes a myth themselves, it becomes very difficult to analyze different parts to look
for any discrepancy (Bazeley, 2002). Therefore, mixed methods analysis is like
compiling pieces of information and making a meaning picture out of it like in a jigsaw
puzzle (Jick, 1979; Mark, Feller & Button, 1997).
In order to complete our research we have also collected various secondary data to
supplement and as well as confirm our results as obtained from primary resources. This
data has been collected from various Published Annual Statements of Banks in our study
and also from State Bank of Pakistan. The variables constructed for the purpose of our
study are therefore based upon primary data, secondary data and their combined effects
that we have used to construct new variables derived from multiplier or division effects
of some of the variables extracted from primary and secondary data.
5.2 THE QUESTIONNAIRE:
63
The questionnaire used for our study has been adopted from the Basel Accord
Implementation of Bank of Serbia and has been amended for the purpose of our study.
The amended Questionnaire has about 51 questions regarding the following areas:
Questions about the risk profile of bank and the functional profile of respondent;
Questions about aptitude of the respective bank and their IT and HR resource
availability regarding the implementation of Basel Accord;
Questions about the Risks covered in First Pillar and efforts put in by the Bank
regarding the progress made by the Bank to adopt advanced approaches to cover
those risks and its results.
Questions about the Second Pillar of Basel Accord titled “Supervisory Review”;
Questions about the Third Pillar of Basel Accord titled “Market Discipline”
The questionnaire also had a segment of “Comment” at the end of each question to illicit
response about the question that might not be included in the question or answer of the
respective question. This segment enhanced the scope of our study and accordingly
helped us include personal judgments of the practitioners of the banking sector to form
better conclusions.
5.2.1 Why Questionnaire: Questionnaires are required in such studies which involve
eliciting information about a phenomenon where patterns, frequency and success of
adoption are not known (Taylor, 1998;Taylor, 2000). Therefore based upon needs of
researcher and their expectation about results and other relevant priorities questionnaires
are designed in such a way that are helpful in collecting relevant information which
account for the changing attitudes and opinions of the respondent about the research
phenomena (Taylor, 1998;Taylor, 2000).
As our research study involves a contemporary phenomenon of inability of Banks to
move on to Advanced Methodology of Basel Accord for which no reason stated in the
Annual Reports of the respective institutions therefore we require a questionnaire to
acquire inputs from the representatives of the institutions for the purpose of study. Apart
from the above there are certain advantages of Questionnaire base studies in the words of
64
John Milne of Centre for CBL in Land Use and Environmental Sciences, Aberdeen
University which are also relevant to our studies:
“The responses are gathered in a standardized way, so questionnaires are more
objective, certainly more so than interviews.
Generally it is relatively quick to collect information using a questionnaire.
Potentially information can be collected from a large portion of a group. This
potential is not often realized, as returns from questionnaires are usually low.”
In order to address the third issue as pointed by John we have personally visited all the
respondents to get our questionnaires filled. Therefore, in a way we have also conducted
small interviews which helped us in getting information about aspects of our questions
not addressed in the questionnaire and also personal opinion of Bank Employees about
the Basel Accord.
5.3 SECONDARY DATA:
Apart from the data collected from respondents we have also collected data regarding
Total Assets, Risk Weighted Credit Assets, Total Deposit, Total Employees and Capital
Adequacy Ratios of the respective Banks and total Banking Industry. All such data has
been collected from Annual Financial Statements for the Year 2009 as published by all
Banks and also from the Economic Data as available from the State Banks of Pakistan.
The data of the year 2009 has been used for the purpose of our calculation for the reason
that we intend to gauge the preparation of banks before moving on to the Advanced
Internal Ratings.
5.4 STUDY SAMPLE:
There are about 38 Banks working in Pakistan at the moment out of which we have
collected data from about 5 key personnel of 12 out of the total 38 banks. These 12 banks
own about 70% of the market share both in Deposit and Asset categories. Further the
Banks in our study have been selected which have different ownership types and different
65
Trends of Capital Adequacy Ratios. Key Statistics of our Banks in the sample have been
given in the table 4.1 as under:
This classification helped us find out if there any difference exists in the implementation
of Basel Accord in the local as well as in the foreign banks and whether there is any
difference in the availability of resources in the foreign, local and government owned
banks. This aspect also helped us address the question raised in the international literature
about the confrontation between the foreign and the local supervisors about the adoption
of methodologies in case foreign bank is in advanced stage of Basel Accord in home
country and elementary stage in host country and vice versa.
Table 5.1 Key Statistics of our Banks in the sample are as under:
Data Source: *Annual Financial Statements are Available on the Website of State Bank of
Pakistan.
: **Average of the response of all respondents in each bank collected using
Questionnaire of this Research Study
***Bank of Punjab has not been issuing its Annual reports for the last two years
due Capital Adequacy problems with Permission of State Bank of
Pakistan. The figures used in this thesis are expected figures as inquired from our
respondents in the sample.
Table 5.2 Capital Adequacy Ratios of Banks in the Sample from 2005-2009:
Year KASB SCB ACB ABL NIB MCB NIB BALF FBL UBL BOP HBL
2005 9.34 6.45 11.3 12.17 11.61 12.54 11.51 8.66 12.01 9.26 12.78 9.93
2006 8.95 8.14 12.37 12.8 17.44 18.65 16.5 9.48 11.42 11.1 10.09 12.81
Name of the Bank Ownership
Type
Total Emp* Risk
Division
Emp*
Credit Risk
Employees**
Total Risk
Weighted
Assets*
Total Risk
Weighted
Credit Assets
Total
Deposits*
KASB Bank Local 1321 16 12 45.745 42.492 43.807
SC Bank Foreign 5042 148 91 180.268 136.300 206.958
Askari Bank Local 7270 69 58 165.596 144.793 205.970
Allied Bank Local 11690 351 315 238.437 193.031 328.875
NIB Bank Foreign 6385 47 38 101.957 86.115 93.920
MCB Bank Local 9397 410 380 337.417 243.712 367.604
National Bank Government 16248 308 286 624.881 459.755 726.465
Bank Alfalah Foreign 7462 130 106 213.840 185.162 324.760
Faysal Bank Foreign 2042 117 99 103.420 83.013 123.655
United Bank Foreign 8738 185 163 485.958 386.466 503.832
B of Punjab*** Government 4811 100 85 172.345*** 151.000*** 195.073
Habib Bank Local 13122 524 490 586.894 471.902 653.452
66
2007 12.18 9.45 13.2 10.26 3.33 16.73 18.05 9.85 10.27 10.32 9.69 11.6
2008 9.05 9.99 12.1 10.9 19.52 16.28 16.9 8.03 10.84 9.96 1.92 12.33
2009 3.53 11.57 13.5 13.47 19.53 19.07 17.23 12.46 12.36 13.18 7.68* 13.07
*Data Source: expected figure from the last available financial statements
The banks were also selected on the basis of their CAR Trends. The CARs are calculated
by all the banks and published in their annual accounts. The CARs of the selected Banks
were either rising or declining.
5.4.1 Respondents: The respondents from our respondent banks have also been selected
According to the following predefined criteria:
Two questionnaires have been got filled from the senior executives to see the
extent of Basel Accord awareness at the high level of management.
One Questionnaire has been got filled from one executive of the Risk
Management Division to have a closer view of the Basel Accord Implementation
in the respective bank.
Two questionnaires have been filled by the Branch Manager of each respective
bank to see the extent of Basel Accord awareness at the lower management levels.
Based upon the above we can state that for the purpose of our study we have carefully
selected a sample that is fairly representative of all Banking Sector and also meets our
study purpose of analyzing the extent of Basel Accord Implementation in the Pakistani
Banking Sector.
5.5 QUESTIONNAIRE RESPONSE:
Most of the questionnaires have been filled by the author himself by giving personal visit
to the interviewees. This was necessary because firstly, bankers are often considered very
overt in giving their opinions which was an inherent requirement for research study.
Secondly, there is also much information that needs to be explained to the interviewee to
get appropriate answer depending upon the functional profile of the employee. Thirdly, as
most of the bankers are often short of time to involve in research activities due to their
official commitments, therefore the response of questionnaires is often very low in most
of the studies. Considering all these constraints and forced nature of our sample and also
67
to reduce bank and respondent quantity bias from our study we targeted the respondent
individually. Therefore in a way we have obtained 40 direct interviews from top and
lower management of banks for the purpose of our study. 20 Questionnaires have been
filled on the telephonic interviews 5 have been filled on e-mails and 5 have been received
by post. Therefore we can conclude that we have obtained 100% response of our
questionnaires.
5.6 PILOT STUDY OF THE QUESTIONNAIRE:
Before proceeding with our research study we conducted a pilot study of our
questionnaire results by getting some preliminary response from three banks in sample.
Accordingly, we got our questionnaire filled from three key personnel each from our
three banks in the pilot study. The three personnel were an executive, a risk manager and
a branch manager. Three banks for our sample study were owned by Government, owned
by local private sector and owned by foreign private sector, with improving and declining
CAR Trend. As our research involved use of a variable that has never been used before
for doing research on banks therefore it was after the validation of results from our pilot
study we elected to proceed with our proposed research.
68
5.7 VARIABLES:
On the basis of results as derived from the questionnaire as described above and review
of annual financial statements for the year 2009 we have identified the following 11
variables for the purpose of our study:
Capital Adequacy Ratio Trend
Type of Bank
Inclination of Bank towards Basel Accord
Involvement of External Trainer
Competence of Employees in Risk Management
Effectiveness of Basel Plan Implementation
Changes Required in the System for Basel Accord Compliance
Years Covered for Default time Series Data
Compliance with Market Discipline
Basel Customer Awareness
Credit Risk Employees to Credit Risk Weighted Credit Assets Ratio
Total Risk Employees to Total Risk Weighted Credit Assets Ratio
5.8 JUSTIFICATION OF EACH VARIABLE:
This section provides theoretical justification, reliability Index, and use for each variable
used in our research study:
5.8.1 Capital Adequacy Ratio Trend: The Trend of Capital Adequacy has been
computed from the Capital Adequacy Ratios published by all Banks in our study in their
study. We have used Capital Adequacy Ratio Trend instead of Capital Adequacy Ratio
itself for the reason that it catches a longer period of analysis instead of a single ratio of
one period. In order to depict CAR trend we have used the following proxies to show last
five year trend of CAR ratios:
Trend Proxy Used
69
Declining 1
Improving 2
5.8.2 Type of Bank: We have categorized Banks in the following three segments to see if
there exists any difference in the implementation of Basel Accord in Public and Private
Sector Banks in Pakistan.
5.8.3 Inclination of Bank towards Basel Accord: This variable represents the opinion
of the respective respondent about the Inclination of the Bank towards Basel Accord.
This is necessary because the there might be policies and procedure defined to fulfill
regulatory requirements, yet it is their implementation that describes how far bank is
inclined to adopting it. Therefore the opinion of the Bank is critical in this regard.
5.8.4 Involvement of External Trainer: This variable represents if the Bank has
involved external trainer or not. The response is captured in simple “Yes” or “No”
5.8.5 Competence of Employees in Risk Management Department: This variable
represented the opinion of all respondent about the expertise of Employees in their Risk
Management Department. This variable is the base variable of “Credit Risk Employees
Ratio to Risk Weighted Credit Assets”. This variable will help us in accepting or
rejecting the results of the variable “Credit Risk Employees Ratio to Risk Weighted
Credit Assets”.
5.8.6 Effectiveness of Basel Plan Implementation: This variable represents the opinion
of the respondent regarding the effectiveness of Basel Plan Implementation in the
respective Bank.
5.8.7 Changes required in the System for Basel Accord Compliance: This variable
has been used to assess the compatibility of existing systems with Basel Accord.
5.8.8 Years Covered for Default time Series Data: The longer the period of time the
data is available it represents the compliance and inclination of the Bank towards Basel
Accord and related standards.
70
5.8.9 Compliance with Market Discipline: This variable represents the extent of
compliance with disclosure requirements as per International Financial Reporting
Standards and other disclosure requirements of Basel Accord.
5.8.10 Basel Customer Awareness: Whether Banks are introducing any awareness
among its customer regarding Basel Accord Compliance. It is necessary in the preview of
Data Sharing and other international experiences of financial crisis.
5.8.11 Credit Risk Employees Ratio to Risk Weighted Credit Assets: This ratio has
been specifically introduced in our thesis to assess the performance of the Credit Risk
related Employees of Risk Management Division. This ratio will depict the number of
employees each bank is having for every Rs. 1 Billion of its Risk Weighted Credit Assets.
This ratio shall be assessed all across banks in our sample to compare the performance of
all banks. Also this ratio shall be compared with the Trend of Capital Adequacy Ratios to
form any conclusion in this regard. The only problem that arises for computation of this
variable is the relating the current data with the annual statement figures of the year 2009.
For addressing this question we added another variable in our questionnaire regarding the
any significant change in the number of employees in Risk Management Department
during the year 2010 where respondents from almost all of our respondents responded
that there has not been any significant change in the number of employees in their
department during the year 2010. Therefore the information about the number of
employees given by the respondents in our questionnaire is also comparable with the
results of the period 2009.
5.8.12 Total Risk Employees Ratio to Total Risk Weighted Credit Assets: We have
also introduced this ratio to judge overall performance of Risk Management Division.
However, due to very much inclination of Pakistani Banks towards Credit Risk
Management this ratio is not very much applicable at present and we can get our desired
results from the ratio given at 5.8.11 above. This ratio is not used in the present study.
5.9 RESEARCH HYPOTHESIS:
71
Based upon our research to collect primary data we have developed the following
Hypothesis for analyzing the deviations in the Banking Sector from Road Map for Basel
Accord Implementation in Pakistan:
H1: Pakistani Banks are very much Inclined to Basel Accord Implementation and they
have taken a number of steps regarding, policy making, up gradation of employee skills
and technology for achieving the results.
H2: Progress on Basel Accord Implantation is Uniform all Across Banking Sector and
the steps taken by Public and Private Sector Banks are almost similar in nature.
With the help of combining primary and secondary data and developing additional
variable we have developed the following alternative Hypothesis to check the effects of
the steps taken by the Pakistani Banks and also the gauge any difference if any existent in
Public and Private Sector Banks regarding Basel Accord Implementation.
H3: The steps taken by the Pakistani Banks are not enough to keep the banking sector on
the road map of the Basel Accord Implementation and also there exits differences in its
implementation in Public and Private Sector Banks.
5.10 Methods for Analyzing Data:
As our research involves primary cross section and secondary panel data to compare
results across Pakistani Sector in different dimensions therefore we have applied various
graphical and statistical techniques to infer our results.
5.10.1 The Cronbach's Alpha: The Cronbach’s alpha describes how much variability in
the results of different research variables can be assigned to chance or random errors
(Selltiz et al., 1976). In this regard a general rule for acceptability is 0.7 which is
considered acceptable for reliability of construct (Nunnally, 1978). It has been applied to
check the overall reliability for the 11 variables selected from our questionnaire for
primary data as explained in the section 4.8 hereinabove.
5.10.2 Radar Diagram: These diagrams have been used for the following two purposes:
72
For comparing the performance of different banks in Basel Accord
implementation by simultaneously analyzing the application of multiple variables
in graphical environment;
For comparing the performance of Risk Management Divisions
These diagrams show the effect of more than three variables at the same time on a single
phenomenon which helps us visualize the multiple effects of different variables at the
same time. For comparison among banks we have used these diagrams in two steps:
5.10.2.1 Intra Bank Analysis: Firstly, these diagrams show the effect of different
variables on a single organization.
5.10.2.2 Inter Bank Analysis: In the second step we have produced similar diagrams for
all the twelve banks of selected for the purpose of study to make and interbank
comparison. This helped us in analyzing the Basel Implementation Performance of
different Banks at a particular point in time.
For comparison the Performance of Risk Management Divisions three diagrams have
been used showing relationship among the following two diagrams in the following
manner:
Relationship between CAR Ratio Trend and Risk Weighted Credit Assets
Relationship between CAR Ratio Trend and Ratio of Credit Risk Employees to
Risk Weighted Credit Assets
Relationship between Risk Weighted Credit Assets and Credit Risk Employees
5.10.3 Cross Tabulation Analysis: In order to analyze the relationship of various factors
of Basel Accord Implementation on Public, Private and Foreign Owned Private Sector
Banks on one part and the effect of similar variables on the Improving and Declining
Trend of Capital Adequacy Ratio (CAR) on the other part we have conducted cross
tabulation analysis of each individual variable with the Type of Banks and also with the
CAR Trend. This is necessary because for the purpose of our this research we are dealing
73
with Cross Section Data and for the purpose of such data Cross Tabulation gives better
analysis than any other Correlation method.
74
CHAPTER 6
DATA ANALYSIS 6.1 INTRODUCTION: The analysis of our Data used for the purpose of our research has been conducted in two
phases. Firstly, we have analyzed the results of our questionnaire and the variables
derived on the basis of questionnaire. In the second step we have observed the
relationship among different variables through diagrams and statistics to form our opinion
to answer the hypothesis.
6.2 REVIEW OF QUESTIONNAIRE RESULTS:
We have developed a cumulative frequency distribution and a BAR Chart against the
response of each question. A detailed explanation of the response of each question from
our respondent has been given on the next page:
75
6.2.1-Do you perceive the importance of Implementation of
Basel II in Pakistan is highly significant:
Pak_Sig
Frequency Percent
Valid
Percent
Cumulative
Percent
Valid Strongly Agree 4 6.7 6.7 6.7
Agree 25 41.7 41.7 48.3
Neither Agree
Nor Disagree 18 30.0 30.0 78.3
Disagree 10 16.7 16.7 95.0
Strongly
Disagree 3 5.0 5.0 100.0
Total 60 100.0 100.0
Explanation: Respondents of the Banks do not consider
that Basel Accord has very high importance in Pakistan.
6.2.2-Do you think that the Implementation of Basel
Accord will be highly significant in your Bank.
Bank_Sig
Frequency Percent
Valid
Percent
Cumulative
Percent
Valid Strongly Agree 4 6.7 6.7 6.7
Agree 29 48.3 48.3 55.0
Neither Agree
Nor Disagree 19 31.7 31.7 86.7
Disagree 6 10.0 10.0 96.7
Strongly
Disagree 2 3.3 3.3 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents of the Banks
agree that Basel Accord has importance for Banks more
than for Pakistan.
76
6.2.3-Your Bank has very high inclination towards the
Implementation of Basel Accord:
Bank_Incl
Frequ
ency Percent
Valid
Percent
Cumulativ
e Percent
Vali
d
Strongly
Agree 3 5.0 5.0 5.0
Agree 15 25.0 25.0 30.0
Neither
Agree Nor
Disagree
29 48.3 48.3 78.3
Disagree 13 21.7 21.7 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents opined that their
Banks are inclined to Basel Accord Implementation.
6.2.4-Do you think that Basel Accord Implementation will
have more Problems than Advantages:
Prob_Vs_Adv
Frequency Percent
Valid
Percent
Cumulative
Percent
Valid Agree 22 36.7 36.7 36.7
Neither
Agree Nor
Disagree
7 11.7 11.7 48.3
Disagree 31 51.7 51.7 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents consider that
Advantages of Basel Accord will be more than problems.
However, the results are not decisive in nature.
77
6.2.5-Do you think that Basel Accord will improve Risk
Management Processes:
Impr_in_RMP
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Vali
d
Strongly
Agree 3 5.0 5.0 5.0
Agree 34 56.7 56.7 61.7
Neither
Agree Nor
Disagree
20 33.3 33.3 95.0
Disagree 3 5.0 5.0 100.0
Total 60 100.0 100.0
Explanation: A majority of the respondents agree that
Basel Accord will improve Risk Management Processes.
6.2.6-Do you think that Basel Accord will Improve
Corporate Governance:
Impr_in_CGov
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Valid Agree 10 16.7 16.7 16.7
Neither
Agree Nor
Disagree
23 38.3 38.3 55.0
Disagree 27 45.0 45.0 100.0
Total 60 100.0 100.0
Explanation: The respondents opined that Basel Accord
will not improve Corporate Governance.
78
6.2.7-Do you think that individual approach to Banks will
be advantageous to the Banking System as a whole?
Indvapp_Adv
Frequen
cy Percent
Valid
Percent
Cumulativ
e Percent
Vali
d
Agree 33 55.0 55.0 55.0
Neither Agree
Nor Disagree 19 31.7 31.7 86.7
Disagree 8 13.3 13.3 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents agree that
Individual Approach will be advantageous to the whole
Pakistani Banking System.
6.2.8-Do you think that use of internal risk models for
capital calculation will be advantageous to the Banking
System as a whole:
IntRiskMdl_Adv
Frequency Percent
Valid
Percent
Cumulative
Percent
Valid Strongly
Agree 1 1.7 1.7 1.7
Agree 34 56.7 56.7 58.3
Neither Agree
Nor Disagree 17 28.3 28.3 86.7
Disagree 8 13.3 13.3 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents agree that
79
Internal Risk Model Approach will be advantageous to the
whole Pakistani Banking System.
80
6.2.9-Do you think that Basel Accord will lead to Lower
Capital Requirements for some of the Banks:
Bsl_LCapital
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Vali
d
Strongly
Agree 1 1.7 1.7 1.7
Agree 34 56.7 56.7 58.3
Neither
Agree Nor
Disagree
3 5.0 5.0 63.3
Disagree 22 36.7 36.7 100.0
Total 60 100.0 100.0
Explanation: Majority of the Banks Agree that Basel
Accord will lead to Lower Capital Requirements for some
of the Banks.
6.2.10-Do you think that Basel Accord will lead to Higher
Capital 10-Requirements for some of the Banks which
might eventually be a problem in the implementation of
Basel Accord:
Bsl_HCapital
Frequency Percent
Valid
Percent
Cumulative
Percent
Valid Strongly
Agree 1 1.7 1.7 1.7
Agree 44 73.3 73.3 75.0
Neither Agree
Nor Disagree 6 10.0 10.0 85.0
Disagree 9 15.0 15.0 100.0
Total 60 100.0 100.0
Explanation: Majority of the Banks Agree that Basel
Accord will lead to Higher Capital Requirements for some
81
of the Banks. However, most respondents are in favor of
High Capital in case of Basel Accord Implementation.
6.2.11-Do you think Information Technology, and HR
Problems might be hindrances in the implementation of
Basel Accord:
IT_HR_Hind
Frequency Percent Valid Percent
Cumulative
Percent
Valid Strongly
Agree 5 8.3 8.3 8.3
Agree 53 88.3 88.3 96.7
Disagree 2 3.3 3.3 100.0
Total 60 100.0 100.0
Explanation: A significant majority of the respondents is
of the view that IT and HR issues shall be a problem in the
implementation of Basel Accord.
6.2.12-Do you think that the employees in your Bank have
adequate knowledge of the standards of Basel Accord.
Emp_Knw
Frequency Percent
Valid
Percent
Cumulative
Percent
Valid Agree 5 8.3 8.3 8.3
Neither Agree
Nor Disagree 11 18.3 18.3 26.7
Disagree 43 71.7 71.7 98.3
Strongly Disagree 1 1.7 1.7 100.0
Total 60 100.0 100.0
Explanation: A significant majority of the respondents are
of the view that employees of the Banks do not have
adequate know how of the Basel Accord.
82
6.2.13-Do you think that the education about the Basel
Accord is being imparted adequately by your Bank to its
employees:
Bsl_Trng
Frequency Percent Valid Percent
Cumulative
Percent
Valid Agree 5 8.3 8.3 8.3
Neither Agree
Nor Disagree 9 15.0 15.0 23.3
Disagree 46 76.7 76.7 100.0
Total 60 100.0 100.0
Explanation: A significant majority of the respondents is
of that the Banks are not imparting Basel Accord training
adequately.
6.2.14-Has your Bank involved any external trainer for the
training of Bank Staff for Basel Accord:
Ext_Trnr_Inv
Frequency Percent Valid Percent
Cumulative
Percent
Valid Yes 50 83.3 83.3 83.3
No 10 16.7 16.7 100.0
Total 60 100.0 100.0
Explanation : Most of the Banks respondents have
confirmed the involvement of external trainer for the
purpose of Basel Accord Implementation.
83
6.2.15-Do you think that the employees involved in the risk
management process are very proficient:
RMEmp_Expt
Frequency Percent Valid Percent
Cumulative
Percent
Valid Agree 14 23.3 23.3 23.3
Neither Agree
Nor Disagree 25 41.7 41.7 65.0
Disagree 21 35.0 35.0 100.0
Total 60 100.0 100.0
Explanation: A significant majority of the respondents are
not satisfied with the Risk Management Expertise of their
employees involved in Risk Management.
6.2.16-Has your Bank set-up any special Basel Accord
Implementation Department:
BImp_Dept
Frequency Percent Valid Percent
Cumulative
Percent
Valid Yes 52 86.7 86.7 86.7
No 8 13.3 13.3 100.0
Total 60 100.0 100.0
Explanation: Almost all of the Banks have established
specialized Basel Accord Implementation Department in
their Banks.
84
6.2.17-Do you think that the Basel Accord Implementation
Department is highly functional in your Bank.
BDept_Per
Frequency Percent
Valid
Percent
Cumulative
Percent
Valid Agree 11 18.3 18.3 18.3
Neither Agree
Nor Disagree 13 21.7 21.7 40.0
Disagree 33 55.0 55.0 95.0
Strongly
Disagree 3 5.0 5.0 100.0
Total 60 100.0 100.0
Explanation: A majority of the respondents is of the
opinion that Basel Accord Implementation is not functional
in their Banks.
6.2.18-Do you think that the staff responsible for the
implementation of Basel Accord possesses highly
professional skills to match international standards:
HR_Ab_Bsl
Frequency Percent Valid Percent
Cumulative
Percent
Valid Strongly Agree 1 1.7 1.7 1.7
Agree 4 6.7 6.7 8.3
Neither Agree
Nor Disagree 14 23.3 23.3 31.7
Disagree 41 68.3 68.3 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents are of the view
that the Skills of their Basel Accord Staff do not match
International Standards.
85
6.2.19-Do you think that the plan for the implementation of
Basel Accord in your Bank is highly effective:
Bsl_Plan_Effec
Frequency Percent Valid Percent
Cumulative
Percent
Valid Agree 9 15.0 15.0 15.0
Neither Agree
Nor Disagree 17 28.3 28.3 43.3
Disagree 32 53.3 53.3 96.7
Strongly Disagree 2 3.3 3.3 100.0
Total 60 100.0 100.0
Explanation: A Significant majority of Respondents do
not consider that their banks have an effective Basel
Implementation Plan.
6.2.20-If your Bank is the member of Banking Group do
you think that the reports being submitted in this regard
comply with Basel Accord:
Grp_RComp
Frequency Percent
Valid
Percent
Cumulative
Percent
Valid Yes 12 20.0 20.3 20.3
No 1 1.7 1.7 22.0
Not Applicable 46 76.7 78.0 100.0
Total 59 98.3 100.0
Missing System 1 1.7
Total 60 100.0
Explanation: Most of the Banks in Pakistan are not
members of any groups and neither do respondents have
86
any significant information about it.
87
6.2.21-If your Bank is the member of a Banking Group do
you think that capital adequacy standards at an aggregate
level comply with the requirements of Basel Accord:
Grp_CAR_Comp
Frequency Percent
Valid
Percent
Cumulative
Percent
Valid Yes 12 20.0 20.0 20.0
No 2 3.3 3.3 23.3
Not
Applicable 46 76.7 76.7 100.0
Total 60 100.0 100.0
Explanation: Most of the Banks in Pakistan are nor
members of any groups and neither do respondents have
any significant information about it.
6.2.22-Do you think that IT updation would require higher
costs to comply with Basel Accord in comparison with
personnel training and outsourcing:
ITCost_Vs_HRCost
Frequency Percent Valid Percent
Cumulative
Percent
Valid Strongly Agree 5 8.3 8.3 8.3
Agree 51 85.0 85.0 93.3
Neither Agree
Nor Disagree 3 5.0 5.0 98.3
Disagree 1 1.7 1.7 100.0
Total 60 100.0 100.0
Explanation : Majority of the respondents consider that the
Banks do not have proper IT resources and therefore IT
costs to comply with Basel Accord would be higher than
any other costs.
88
6.2.23-Do you think that Basel Accord changes the method
your bank uses to collect data for its Decision making
process:
BslAccrd_DCollct
Frequency Percent Valid Percent
Cumulative
Percent
Valid Strongly
Agree 3 5.0 5.0 5.0
Agree 35 58.3 58.3 63.3
Neither Agree
Nor Disagree 7 11.7 11.7 75.0
Disagree 15 25.0 25.0 100.0
Total 60 100.0 100.0
Explanation : Most of respondents are of the view that
their current systems would require significant changes to
collect data According to the requirements of Basel
Accord.
6.2.24-Do you think that your Bank is collecting sensitive
information like “personal traits” of its corporate and
individual customers to meet the requirements of Core
Principles of Basel Accord.
Sens_Info
Frequency Percent Valid Percent
Cumulative
Percent
Valid Yes 8 13.3 13.3 13.3
No 46 76.7 76.7 90.0
Not Applicable 6 10.0 10.0 100.0
Total 60 100.0 100.0
89
Explanation: Majority of the respondents are of the view
that they are not collecting sensitive information about their
borrowers as required by Basel Accord.
6.2.25-Is your Bank willing to share data of large
customers to share settle their credit limits within banks or
with other third parties if it will be allowed by Banking
Laws of your country:
Data_Sharing
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Valid Yes 8 13.3 13.3 13.3
No 48 80.0 80.0 93.3
Not
Applicable 4 6.7 6.7 100.0
Total 60 100.0 100.0
Explanation: Majority of the Banks are not willing to
share data to settle large customer limits.
6.2.26-Do you think that your Bank should plan to resolve
data protection issue under Basel Accord by taking consent
declaration of its customers.
Data_Protc_CusCon
Frequency Percent Valid Percent
Cumulative
Percent
Valid Yes 51 85.0 85.0 85.0
No 9 15.0 15.0 100.0
Total 60 100.0 100.0
90
Explanation: Most of the respondents are of the view that
data protection issue under Basel Accord should be settled
by taking consent of the customers.
91
6.2.27-Does your national legislation contain any specific
provisions on Basel II and data protection or do you know
about projects/drafts to do so?
Bsl_Accrd_NatReg
Frequency Percent Valid Percent
Cumulative
Percent
Valid Yes 49 81.7 81.7 81.7
No 11 18.3 18.3 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents confirmed that
there exists national legislation on Basel Accord.
6.2.28-Do you think that the current/drafted (if existing)
national data protection legislation and banking legislation
in your country is clear enough to make it certain to your
bank how to solve data protection issues raised by Basel
Accord?
NatLeg_DPCl
Frequency Percent Valid Percent
Cumulative
Percent
Valid Strongly Agree 3 5.0 5.0 5.0
Agree 4 6.7 6.7 11.7
Neither Agree Nor
Disagree 15 25.0 25.0 36.7
Disagree 37 61.7 61.7 98.3
Strongly Disagree 1 1.7 1.7 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents are of the
opinion that the current national legislation on Basel
92
Accord is not in agreement about Data Protection Issue on
Basel Accord.
93
6.2.29-The current IT structure supports Basel Accord
Requirements for:
Credit Risk:
ITS-CR
Freque
ncy Percent
Valid
Percent
Cumulative
Percent
Vali
d
Strongly Agree 7 11.7 11.7 11.7
Agree 43 71.7 71.7 83.3
Neither Agree
Nor Disagree 8 13.3 13.3 96.7
Disagree 1 1.7 1.7 98.3
Strongly Disagree 1 1.7 1.7 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents are of the
opinion that their IT system supports the System
Requirements for Credit Risk to Some Extent.
Operational Risk:
ITS_OR
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Valid Agree 5 8.3 8.3 8.3
Neither Agree
Nor Disagree 17 28.3 28.3 36.7
Disagree 34 56.7 56.7 93.3
Strongly
Disagree 4 6.7 6.7 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents are of the
opinion that their IT systems do not support the System
Requirements for Operational Risk.
94
Market Risk:
ITS_MR
Frequency Percent Valid Percent
Cumulative
Percent
Valid Neither Agree
Nor Disagree 21 35.0 35.0 35.0
Disagree 35 58.3 58.3 93.3
Strongly Disagree 4 6.7 6.7 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents are of the
opinion that their IT systems do not support the System
Requirements for Market Risk.
6.2.30-Do you think that there would be problems in
integrating the systems required for Basel Accord
Implementation into the main stream system of your Bank:
Bsl_Accrd_Integration
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Valid Strongly
Agree 1 1.7 1.7 1.7
Agree 44 73.3 73.3 75.0
Neither
Agree Nor
Disagree
8 13.3 13.3 88.3
Disagree 7 11.7 11.7 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents are of the
opinion that there would be problems in integrating the
systems required for Basel Accord with the Main stream
systems.
95
6.2.31-Do you think that database design, internal models,
and budgets are in close conformity with as required by
Basel Accord:
DD_IM_Budg_Comp
Frequency Percent
Valid
Percent
Cumulative
Percent
Valid Strongly Agree 1 1.7 1.7 1.7
Agree 8 13.3 13.3 15.0
Neither Agree
Nor Disagree 12 20.0 20.0 35.0
Disagree 37 61.7 61.7 96.7
Strongly
Disagree 2 3.3 3.3 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents are of the
opinion that their existing budgets systems etc., are not in
closed conformity with Basel Accord.
6.2.32-Which approach (es) your bank is using for
measuring credit risk in your bank?
CR_Approach
Frequency Percent
Valid
Percent
Cumulative
Percent
Vali
d
Simplied standardized
Approach 4 6.7 6.7 6.7
Standardized Approach 51 85.0 85.0 91.7
Foundation Internal
Ratings-Based Approach 2 3.3 3.3 95.0
We don't know Yet 3 5.0 5.0 100.0
Total 60 100.0 100.0
96
Explanation: Most of the Respondents stated that their
Banks are on Standardized Approach of Credit Risk.
97
6.2.33- Have you developed methodology for identifying
and measuring credit risk for your internal needs?
CR_IN_Methd
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Valid No, we are only
using methodology
prescribed by SBP 15 25.0 25.0 25.0
Yes, we are using
internally
developed
methodology
45 75.0 75.0 100.0
Total 60 100.0 100.0
Explanation: Most of the respondents are of the opinion
that their banks have developed techniques for identifying
and measuring Credit Risk for their Internal Needs.
6.2.34-In case you are using internally developed
methodology, how many risk categories do you use for
ranking of debtors?
IR_Cat_IDMethd
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Valid Upto 7 4 6.7 7.0 7.0
7 to 10 25 41.7 43.9 50.9
More than
10 28 46.7 49.1 100.0
Total 57 95.0 100.0
Missin
g
System 3 5.0
Total 60 100.0
Explanation: A Vast majority is having risk categories of
7 or more in their internally developed credit risk
methodologies.
98
6.2.35-How many years are covered by time series that you
have created for credit risk assessment?
Default_TSeries
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Valid Less than 1 year 1 1.7 1.7 1.7
1-3 Years 18 30.0 31.0 32.8
3-5 Years 24 40.0 41.4 74.1
More than 5 years 14 23.3 24.1 98.3
We have not
created time series
yet
1 1.7 1.7 100.0
Total 58 96.7 100.0
Missin
g
System 2 3.3
Total 60 100.0
Explanation: Most of the Banks use data of more than
three years for their Credit Risk Assessment.
Recovery Model:
Recovery_Series
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Valid Less than 1 year 1 1.7 1.7 1.7
1-3 Years 17 28.3 28.3 30.0
3-5 Years 22 36.7 36.7 66.7
More than 5 years 13 21.7 21.7 88.3
We have not
created time series
yet
7 11.7 11.7 100.0
Total 60 100.0 100.0
99
Explanation: Most of the Banks use data of more than
three years for their Recovery Assessment.
Other time series (specify name)
AnyOther_Series
Frequency Percent Valid Percent
Cumulative
Percent
Vali
d
Less than 1 year 1 1.7 1.7 1.7
1-3 Years 1 1.7 1.7 3.3
3-5 Years 1 1.7 1.7 5.0
We have not created
time series yet 57 95.0 95.0 100.0
Total 60 100.0 100.0
Explanation : Non of the Bank has developed any other
time series model for Credit Risk Assessment . .
6.2.36-In case you are using models for measuring
economic capital for credit risk, how were these models
developed?
ECap_M_CRisk
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Valid Locally
(Internally)Develope
d
1 1.7 1.7 1.7
We are not using the
model for that
purpose
59 98.3 98.3 100.0
100
Total 60 100.0 100.0
Explanation : According to the respondents none of the
Banks are using Economic Capital Model for Credit Risk
Measurement and Management.
101
6.2.37-Which approach (es) and from when are you
planning to use for measuring market risk in your bank?
MR_M_Appr
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Vali
d
Standarised
Measurement
Method
54 90.0 90.0 90.0
We don't know Yet 6 10.0 10.0 100.0
Total 60 100.0 100.0
Explanation: Most of the Banks have adopted Market Risk
Measurement Mechanism and they are on Standardized
Approach.
6.2.38-How many years are covered by time series that you
have created for market risk assessment?
MRisk_TSeries
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Valid Less than 1 year 36 60.0 60.0 60.0
1-2 Years 3 5.0 5.0 65.0
2-3 Years 6 10.0 10.0 75.0
Over 3 years 8 13.3 13.3 88.3
We don't have
any time Series
Yet
7 11.7 11.7 100.0
Total 60 100.0 100.0
Explanation: Market Risk Measurement is in very early
stages as the data for the purpose is available for a period of
102
only one year at present.
103
6.2.39-In case you are using models for measuring
economic capital for market risk, how were these models
developed?
Ecap_M_MRisk
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Vali
d
We are not using the
model for that
purpose
60 100.0 100.0 100.0
Explanation: According to the respondents none of the
Banks are using Economic Capital Model for Market Risk
Measurement and Management.
6.2.40-Which approach (es) and from when are you
planning to use for measuring operational risk in your
bank?
OR_M_Appr
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Vali
d
Basic Indicator
Approach 4 6.7 6.7 6.7
Standarized Approach 55 91.7 91.7 98.3
We don't know yet 1 1.7 1.7 100.0
Total 60 100.0 100.0
Explanation: According to the respondents most of the
Banks are already using Operational Risk Measurement
Mechanism and they are on Standardized Approach.
104
6.2.41-How many years are covered by time series that you
have created for operational risk assessment?
OR_T_Series
Frequency Percent Valid Percent
Cumulative
Percent
Valid Less than 1 year 33 55.0 55.0 55.0
1-2 Years 3 5.0 5.0 60.0
2-3 Years 8 13.3 13.3 73.3
Over 3 years 7 11.7 11.7 85.0
We don't have any
time Series Yet 9 15.0 15.0 100.0
Total 60 100.0 100.0
Explanation: Operational Risk Measurement is in very
early stages as the data for the purpose is available for a
period of only one year at present.
6.2.42-In case you are using models for measuring
economic capital for operation risk, how were these models
developed?
Ecap_OR
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Vali
d
We are not using the
model for that
purpose
60 100.0 100.0 100.0
Explanation: According to the respondents none of the
Banks are using Economic Capital Model for Operational
Risk Measurement and Management.
105
6.2.43-Supervisory Review guidelines currently formulated
by Pillar II are helpful in improving supervisory review
regime:
PillarII_Impr_SReview
Frequency Percent Valid Percent
Cumulative
Percent
Valid Strongly
Agree 2 3.3 3.3 3.3
Agree 14 23.3 23.3 26.7
Neither Agree
Nor Disagree 28 46.7 46.7 73.3
Disagree 16 26.7 26.7 100.0
Total 60 100.0 100.0
Explanation: Majority of the Respondents are of the view
that Supervisory Review Guidelines of Basel II are not
helpful in improving supervisory review regime in
Pakistan.
6.2.44-The supervisor has enough resources to comply with
the requirement of four key principles of supervisory
review process:
Adeq_of_SupervRes
Frequency Percent Valid Percent
Cumulative
Percent
Valid Yes 5 8.3 8.3 8.3
No 37 61.7 61.7 70.0
Neither Agree
Nor Disagree 18 30.0 30.0 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents are of the view
106
that the Supervisor in Pakistan do not have adequate
resources to supervise the Supervisory Review Process.
107
6.2.45-Which segment of Pillar I are challenging to be
monitored under supervisory review process:
Sig_PI_Seg
Frequency Percent
Valid
Percent
Cumulative
Percent
Valid Credit Risk
Methodologies 4 6.7 6.7 6.7
Operational Risk
Methodologies 7 11.7 11.7 18.3
Market Risk
Methodologies 49 81.7 81.7 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents are of the view
that the Credit Risk Segment is most Challenging for
monitoring.
6.2.46-There is a need for additional legal processes within
the national legal regime for appropriate implementation of
Basel Accord:
Need_for_Add_Leg
Frequenc
y Percent
Valid
Percent
Cumulative
Percent
Valid Yes 45 75.0 75.0 75.0
No 12 20.0 20.0 95.0
Neither Agree
Nor Disagress 3 5.0 5.0 100.0
Total 60 100.0 100.0
Explanation: Most of the respondents are of the view that
there is a need for additional legislation for Basel Accord
108
Implementation in Pakistan.
109
6.2.47-There are additional risks to be captured in Pillar I
for capital adequacy requirement in order for more
effective implementation of Supervisory Review Process:
Addl_Risks_in_PI
Frequency Percent
Valid
Percent
Cumulative
Percent
Valid Yes 16 26.7 26.7 26.7
No 38 63.3 63.3 90.0
Neither Agree
Nor Disagree 6 10.0 10.0 100.0
Total 60 100.0 100.0
Explanation: A majority of the respondents are of the view
that there is no need to add additional risks Pillar I of Basel
Accord.
6.2.48-Do you think that your Bank adequately complies
with the disclosure requirement of Basel Accord Market
Discipline:
Comp_with_Basel_MD
Frequency Percent Valid Percent
Cumulative
Percent
Valid Yes 14 23.3 23.3 23.3
No 33 55.0 55.0 78.3
Neither Agree
Nor Disagree 13 21.7 21.7 100.0
Total 60 100.0 100.0
Explanation: Most of the respondents are of the opinion
that their bank do not comply with the disclosure
requirement of Basel Accord Market Discipline.
110
6.2.49-Do you consider the national legislation to be
hindrance is meeting disclosure requirements under Basel
Accord.
Nat_LegHindrance
Frequency Percent
Valid
Percent
Cumulative
Percent
Valid Yes 38 63.3 63.3 63.3
No 8 13.3 13.3 76.7
Neither Agree
Nor Disagress 14 23.3 23.3 100.0
Total 60 100.0 100.0
Explanation: Majority of the Respondents are of the
Opinion that National Legislation about Banking in
Pakistan is a hindrance in meeting disclosure requirement
under Basel Accord.
6.2.50-Do you consider that disclosure requirements under
Basel Accord regarding proprietary information can lead
the Bank to comparative disadvantage.
Propinfo_Disc_ComDisadv
Frequency Percent Valid Percent
Cumulative
Percent
Valid Yes 46 76.7 76.7 76.7
No 12 20.0 20.0 96.7
Neither Agree
Nor Disagress 2 3.3 3.3 100.0
Total 60 100.0 100.0
Explanation: Majority of the respondents are of the
opinion that disclosure requirements under Basel Accord
regarding Proprietary Information can lead the Bank to
comparative disadvantage.
111
6.2.51-Has your bank arranged any customer awareness for
complying with the Market Discipline Requirement of
Pillar III.
Basel_Cust_Awar
Frequency Percent Valid Percent
Cumulative
Percent
Valid Yes 2 3.3 3.3 3.3
No 58 96.7 96.7 100.0
Total 60 100.0 100.0
Explanation: None of the Banks has started any Basel
Accord Customer Awareness Programme.
112
6.3 PRIMARY DATA ANALYSIS:
We have used Cronbach’s alpha for evaluation of the variable scales used in our
questionnaire, which helped us in measuring the validity of our variables. The
respondents gave their opinions about 52 questions raised which also have certain sub
questions. The nature of questions has already been explained in section 4.2 above. The
overall Cronbach’s alpha (α), for the eleven variables of research is 0.851 as shown in
table 5.1 below meaning thereby that there exists acceptability in responses against each
item.
Table 5.1: Overall Reliability Statistics for our variables:
Cronbach's Alpha N of Items
Cronbach's
Alpha(a) N of Items
.851 11
6.4 RADAR DIAGRAMS:
The Radar Diagrams have been used for simultaneously the effect of multiple variables
on one object and then comparing the object with other objects to form any conclusion.
For the purpose of our analysis we have applied these diagrams to show the effect of
eleven variables as selected above in each Bank available in our sample. The bank wise
diagrams and their results are shown hereunder:
113
6.4.1-Analysis of KASB Radar Diagram and CAR
Trend:
Explanation: This is a locally owned private sector Bank.
According to respondents of our questionnaire this bank
has least inclination towards Implementation of Basel
Accord. They have although involved external trainer yet
the competence of their employees is low. Also their plan
for Basel Accord Implementation is least effective and their
System requires thorough changes to meet Basel Accord
Compliance requirements. The work done for data
availability of Basel Accord is also very low. The Bank’s
compliance with Market Discipline is also very low. The
Bank has done nothing to initiate any customer awareness
programme regarding Basel Accord. The Credit Risk
Employees to Risk Assets Ratio is 0.41.
Trend of Capital Adequacy Ratio:
Explanation: The Capital Adequacy Ratio Trend of KASB
Bank for the period 2005 to 2009 is declining.
114
6.4.2-Analysis of Standard Chartered Bank Radar
Diagram and CAR Trend:
Explanation: This is a foreign owned private sector Bank.
According to respondents of our questionnaire this bank
has good inclination towards Implementation of Basel
Accord. They have although involved external trainer yet
the competence of their employees is low. Also their plan
for Basel Accord Implementation is moderately effective
and their System requires thorough changes to meet Basel
Accord Compliance requirements. The work done for data
availability of Basel Accord is also very good as the data
availability for Basel Compliance is of a period more than 5
years. The Bank’s compliance with Market Discipline is
very low. The Bank has done very little to initiate any
customer awareness programme regarding Basel Accord.
The Credit Risk Employees to Risk Assets Ratio is 0.7.
Trend of Capital Adequacy Ratio:
Explanation: The Capital Adequacy Ratio Trend of
Standard Chartered Bank for the period 2005 to 2009 is
improving.
115
6.4.3-Analysis of Askari Bank Radar Diagram and CAR
Trend:
Explanation: This is a locally owned private sector Bank.
According to respondents of our questionnaire this bank
has low inclination towards Implementation of Basel
Accord. They have although involved external trainer yet
the competence of their employees is low. Also their plan
for Basel Accord Implementation is least effective and their
System requires moderate changes to meet Basel Accord
Compliance requirements. The work done for data
availability of Basel Accord is also acceptable as the data
availability for Basel Compliance is of a period about 3
years. The Bank’s compliance with Market Discipline is
very low. The Bank has done very little to initiate any
customer awareness programme regarding Basel Accord.
The Credit Risk Employees to Risk Assets Ratio is 0.51.
Trend of Capital Adequacy Ratio:
Explanation: The Capital Adequacy Ratio Trend of Askari
Bank for the period 2005 to 2009 is improving.
116
6.4.4-Analysis of Allied Bank Limited Radar Diagram
and CAR Trend:
Explanation: This is a locally owned private sector Bank.
According to respondents of our questionnaire this bank
has moderate inclination towards Implementation of Basel
Accord. They have also involved external trainer and the
competence of their employees is moderate. Although their
plan for the Basel Accord Implementation is good yet their
System requires moderate changes to meet Basel Accord
Compliance requirements. The work done for data
availability of Basel Accord is also acceptable as the data
availability for Basel Compliance is of a period about 3
years. The Bank’s compliance with Market Discipline is
very low. The Bank has done very little to initiate any
customer awareness programme regarding Basel Accord.
The Credit Risk Employees to Risk Assets Ratio is 1.33.
Trend of Capital Adequacy Ratio:
Explanation: The Capital Adequacy Ratio Trend of Allied
Bank for the period 2005 to 2009 is improving.
117
6.4.5- Analysis of NIB Bank Radar Diagram and CAR
Trend
Explanation: This is a Foreign owned private sector Bank.
According to respondents of our questionnaire this bank
has moderate inclination towards Implementation of Basel
Accord. They have also involved external trainer and the
competence of their employees is moderate. The plan of the
Bank for Basel Accord Implementation is not effective yet
their Systems are quite up to the mark for complying with
the Basel Accord requirements. The work done for data
availability of Basel Accord is also acceptable as the data
availability for Basel Compliance is of a period about 3
years. The Bank’s compliance with Market Discipline is
very low. The Bank has done very little to initiate any
customer awareness programme regarding Basel Accord.
The Credit Risk Employees to Risk Assets Ratio is 0.45.
Trend of Capital Adequacy Ratio:
Explanation: The Capital Adequacy Ratio Trend of NIB
Bank for the period 2005 to 2009 is improving.
118
6.4.6- Analysis of MCB Bank Radar Diagram and CAR
Trend:
Explanation: This is a locally owned private sector Bank.
According to respondents of our questionnaire this bank
has good inclination towards Implementation of Basel
Accord. They have also involved external trainer and the
competence of their employees is good. The plan of the
Bank for Basel Accord Implementation is not effective yet
their Systems are quite up to the mark for complying with
the Basel Accord requirements. The work done for data
availability of Basel Accord is also acceptable as the data
availability for Basel Compliance is of a period about 3
years. The Bank’s compliance with Market Discipline is
very low. The Bank has done very little to initiate any
customer awareness programme regarding Basel Accord.
The Credit Risk Employees to Risk Assets Ratio is 1.50.
Trend of Capital Adequacy Ratio:
Explanation: The Capital Adequacy Ratio Trend of MCB
Bank for the period 2005 to 2009 is improving.
119
6.4.7- Analysis of NBP Bank Radar Diagram and CAR
Trend:
Explanation: This is a Government Owned Bank.
According to respondents of our questionnaire this bank
has moderate inclination towards Implementation of Basel
Accord. They have also involved external trainer and the
competence of their employees is moderate. The plan of the
Bank for Basel Accord Implementation is ineffective
neither their Systems are quite up to the mark for
complying with the Basel Accord requirements. The work
done for data availability of Basel Accord is very minimal
as the data availability for Basel Compliance is of a period
less than 3 years. The Bank’s compliance with Market
Discipline is very low. The Bank has done very little to
initiate any customer awareness programme regarding
Basel Accord. The Credit Risk Employees to Risk Assets
Ratio is 0.60.
Trend of Capital Adequacy Ratio:
Explanation: The Capital Adequacy Ratio Trend of
National Bank of Pakistan for the period 2005 to 2009 is
improving.
120
6.4.8- Analysis of Bank Alfalah Radar Diagram and
CAR Trend:
Explanation: This is a Foreign Owned Private Sector
Bank. According to respondents of our questionnaire this
bank has moderate inclination towards Implementation of
Basel Accord. They have also involved external trainer and
the competence of their employees is not upto the mark.
The plan of the Bank for Basel Accord Implementation is
ineffective Systems but their systems are quite up to the
mark for complying with the Basel Accord requirements.
The work done for data availability of Basel Accord is
good as the data availability for Basel Compliance is of a
period of more than 3 years. The Bank’s compliance with
Market Discipline is very low. The Bank has done very
little to initiate any customer awareness programme
regarding Basel Accord. The Credit Risk Employees to
Risk Assets Ratio is 0.56.
Trend of Capital Adequacy Ratio:
121
Explanation: The Capital Adequacy Ratio Trend of Bank
Alfalah Limited for the period 2005 to 2009 is improving.
6.4.9- Analysis of Faysal Bank Radar Diagram and
CAR Trend:
Explanation: This is a Foreign Owned Private Sector
Bank. According to respondents of our questionnaire this
bank has good inclination towards Implementation of Basel
Accord. They have also involved external trainer and the
competence of their employees is quite upto the mark. The
plan of the Bank for Basel Accord Implementation is not
satisfactory and their systems are not quite upto the mark to
meet the system requirements for Basel Accord. The work
done for data availability of Basel Accord is also below par
as the data availability for Basel Compliance is of a period
of less than 3 years. The Bank’s compliance with Market
Discipline is very low. The Bank has done very little to
initiate any customer awareness programme regarding
Basel Accord. The Credit Risk Employees to Risk Assets
Ratio is 1.08.
Trend of Capital Adequacy Ratio:
122
Explanation: The Capital Adequacy Ratio Trend of Faysal
Bank Limited for the period 2005 to 2009 is declining.
6.4.10- Analysis of United Bank Radar Diagram and
CAR Trend:
Explanation: This is a Foreign Owned Private Sector
Bank. According to respondents of our questionnaire this
bank has good inclination towards Implementation of Basel
Accord. They have also involved external trainer and the
competence of their employees is not quite upto the mark.
The plan of the Bank for Basel Accord Implementation is
quite satisfactory and their systems are also quite upto the
mark to meet the system requirements for Basel Accord.
The work done for data availability of Basel Accord is also
remarkable as the data availability for Basel Compliance is
of a period of more than 5 years. The Bank’s compliance
with Market Discipline is on the lower side. The Bank has
done very little to initiate any customer awareness
programme regarding Basel Accord. The Credit Risk
Employees to Risk Assets Ratio is 0.73.
Trend of Capital Adequacy Ratio:
123
Explanation: The Capital Adequacy Ratio Trend of United
Bank Limited for the period 2005 to 2009 is improving.
124
6.4.11-Analysis of the Bank of Punjab Radar Diagram
and CAR Trend:
Explanation: This is a Government Owned Bank.
According to respondents of our questionnaire this bank
has very low inclination towards Implementation of Basel
Accord. They have also involved external trainer and the
competence of their employees is not quite upto the mark.
The plan of the Bank for Basel Accord Implementation is
not satisfactory and their systems are also not upto the mark
to meet the system requirements for Basel Accord. The
work done for data availability of Basel Accord is also of
very low quality as the data availability for Basel
Compliance is of a period of more than 3 years. The Bank’s
compliance with Market Discipline is on the lower side.
The Bank has done very little to initiate any customer
awareness programme regarding Basel Accord. The Credit
Risk Employees to Risk Assets Ratio is 0.51.
Trend of Capital Adequacy Ratio:
Explanation: The Capital Adequacy Ratio Trend of Bank
of Punjab for the period 2005 to 2009 is declining.
125
6.4.12-Analysis of the Habib Bank Limited Radar
Diagram and CAR Trend:
Explanation: This is locally owned private bank.
According to respondents of our questionnaire this bank
has moderate inclination towards Implementation of Basel
Accord. They have also involved external trainer and the
competence of their employees is not quite upto the mark.
The plan of the Bank for Basel Accord Implementation is
not satisfactory and their systems are also not upto the mark
to meet the system requirements for Basel Accord. The
work done for data availability of Basel Accord is also of
very good quality as the data availability for Basel
Compliance is of a period of more than 5 years. The Bank’s
compliance with Market Discipline is on the lower side.
The Bank has done very little to initiate any customer
awareness programme regarding Basel Accord. The Credit
Risk Employees to Risk Assets Ratio is 1.13.
Trend of Capital Adequacy Ratio:
Explanation: The Capital Adequacy Ratio Trend of Habib
Bank Limited for the period 2005 to 2009 is improving.
126
6.4.13 Radar Diagram of an Ideal Bank:
Explanation: The above diagram is the ideal diagram of an
imaginative Bank. This imaginative Bank has all the
trained staff available for it for Basel Accord
implementation; has very high inclination towards Basel
Accord implementation;has very effective Basel Accord
Implementation Plan; has the data for internal modelling
for a period of more than five years; complies with Market
discipline; has initiatited customer awareness plan
effectively; has an ideal CREMP to Risk Asset Ratio of 1.5
and also has improving trend of Capital Adequacy. We
have developed this diagram with artificial ideal data
developed on the basis of our questionnaire results and data
obtained from Annual Reports of the respective Banks. The
main purpose of this ideal diagram is to identify the bank
which most closely complies with the ideal values of the
variables developed from our research and make and
effective comparison of our results Accordingly.
127
6.5 CROSS TABULATION:
In order to comment on our hypothesis we have augmented our analysis hereunder with
the help of analysis of Cross Tabulation. The results of our test are hereunder:
6.5.1 Relationship between CAR Trend and Bank Type:
Count
CAR_Trend Total
Declining Improving Declining
Bank_Type Government Owned 5 5 10
Privately Owned Local
Ownership 5 20 25
Privately Owned
Foreign Ownership 5 20 25
Total 15 45 60
Explanation: The Cross tabulation results depict that local and foreign Banks have better
CAR Ratio Trend while the government sector banks are at the lowest Rank among CAR
relationship analysis.
6.5.2 Relationship between Bank Type and Bank Inclination:
Count
Bank_Incl Total
Agree
Neither Agree
Nor Disagree Disagree Agree
Bank_Type Government Owned 0 5 5 10
Privately Owned Local
Ownership 10 10 5 25
Privately Owned
Foreign Ownership 15 10 0 25
Total 25 25 10 60
Explanation: The analysis of the results in cross tabulation depict that Foreign Owned
Banks in private sector are more inclined towards Basel Accord Implementation while
the Govt., Owned Banks are less inclined toward towards such implementation.
128
6.5.3 Relationship between CAR Trend and Bank Inclination:
CAR_Trend * Bank_Incl
Count
Bank_Incl Total
Agree
Neither Agree
Nor Disagree Disagree Agree
CAR_T
rend
Declining 0 5 10 15
Improving 25 20 0 45
Total 25 25 10 60
Explanation: Results of Cross Tabulation depict that Banks with Improving CAR Trend
are more inclined towards implementation of Basel Accord.
6.5.4 Relationship between Bank Type and Risk Management Employees Expertise:
Bank_Type * RMEmp_Expt
Count
RMEmp_Expt Total
Agree
Neither Agree
Nor Disagree Disagree Agree
Bank_Type Government Owned 0 5 5 10
Privately Owned Local
Ownership 10 10 5 25
Privately Owned
Foreign Ownership 0 10 15 25
Total 10 25 25 60
Explanation: Analysis of cross tabulation suggests that respondents of the local private
banks consider their employees more expert than the Foreign Banks and Government
Banks.
129
6.5.5 Relationship between CAR Trend and Risk Management Employees
Expertise:
CAR_Trend * RMEmp_Expt
Count
RMEmp_Expt Total
Agree
Neither Agree
Nor Disagree Disagree Agree
CAR_T
rend
Declining 0 5 15 15
Improving 10 20 10 45
Total 10 25 25 60
Explanation: The results about Expertise of Risk Management Employees in CAR
improving and declining banks suggest that very few banks consider their employees
having required level of expertise however, the results are better in banks which have
improving CAR Trend in comparison with declining CAR Trend. However, the results
still depict that the respondents are not satisfied with the expertise of their employees in
Risk Management Department as very low proportion of respondents “Agreed” with the
statement.
6.5.6 Relationship between Bank Type and Basel Plan Effectiveness:
Bank_Type * Bsl_Plan_Effec
Count
Bsl_Plan_Effec Total
Agree
Neither Agree
Nor Disagree Disagree Agree
Bank_Type Government Owned 0 0 10 10
Privately Owned Local
Ownership 0 15 10 25
Privately Owned
Foreign Ownership 5 10 10 25
Total 5 25 30 60
130
Explanation: Analysis of cross tabulation depicts that Foreign Banks in Pakistan have
more Effective Basel Implementation Plan in Pakistan as compared with local Banks.
131
6.5.7 Relationship between CAR Trend and Basel Plan Effectiveness:
CAR_Trend * Bsl_Plan_Effec
Crosstab Count
Bsl_Plan_Effec Total
Agree
Neither Agree
Nor Disagree Disagree Agree
CAR_T
rend
Declining 0 0 15 15
Improving 5 25 15 45
Total 5 25 30 60
Explanation: Analysis of cross tabulation depicts that CAR Trend has little relationship
with Basel Accord effectiveness as only a few respondents of the banks even with
increasing CAR trend responded that their banks have effective Basel Accord Plan.
6.5.8 Relationship between Bank Type and Data Collection Methodologies Changes
due to Basel Accord:
Bank_Type * BslAccrd_DCollct
Count
BslAccrd_DCollct Total
Agree
Neither Agree
Nor Disagree Agree
Bank_Type Government Owned 0 10 10
Privately Owned Local
Ownership 20 5 25
Privately Owned
Foreign Ownership 15 10 25
Total 35 25 60
Explanation: Analysis of cross tabulation depicts that none of our respondents responded
that Basel Accord will not change the data collection methodologies. This suggests the
systems of most of the banks require upgradations for implementation of Basel Accord
which is still under progress.
132
6.5.9 Relationship between CAR Trend and Data Collection Methodologies Changes
due to Basel Accord:
CAR_Trend * BslAccrd_DCollct
Count
BslAccrd_DCollct Total
Agree
Neither Agree
Nor Disagree Agree
CAR_T
rend
Declining 5 10 15
Improving 25 20 45
Total 30 30 60
Explanation: The Cross tabulation analysis suggests that all Banks whether their CAR
Trend is improving or declining shall have to upgrade their systems to meet Basel Accord
requirements of Data Collection in their systems.
6.5.10 Relationship between Bank Type and Period covered for Data Collection for
Default Time Series:
Bank_Type * Default_TSeries
Crosstab Count
Default_TSeries Total
1-3 Years 3-5 Years
More than 5
years 1-3 Years
Bank_Type Government Owned 0 10 0 10
Privately Owned Local
Ownership 5 10 10 25
Privately Owned
Foreign Ownership 5 10 10 25
Total 10 30 20 60
Explanation : The cross tabulation suggest that although the data available with foreign
banks covers a longer period of time as compared with local Banks yet the overall results
133
suggest that for most of the banks in all categories the data available is between 3 to 5
years.
6.5.11 Relationship between CAR Trend and Period covered for Data Collection for
Default Time Series:
CAR_Trend * Default_TSeries
Crosstab Count
Default_TSeries Total
1-3 Years 3-5 Years
More than 5
years 1-3 Years
CAR_T
rend
Declining 0 15 0 15
Improving 5 20 20 45
Total 5 35 20 60
Explanation: The cross tabulation results suggest that the Banks with improving CAR
Trend possess data for a longer period of time for their default time series than other
Banks.
6.5.12 Relationship between Bank Type and Compliance with Market Discipline:
Bank_Type * Comp_with_Basel_MD
Crosstab Count
Comp_with_Basel_MD Total
Yes No
Neither
Agree Nor
Disagress Yes
Bank_Type Government Owned 0 10 0 10
Privately Owned Local
Ownership 5 20 0 25
Privately Owned
Foreign Ownership 0 20 5 25
Total 5 50 5 60
134
Explanation: The Cross tabulation results suggest Compliance with Basel Accord
requirements of Market Discipline is very low in Pakistan as most of the respondents
denied the compliance of their banks with such discipline in this regard.
135
6.5.13 Relationship between CAR Trend and Compliance with Market Discipline:
CAR_Trend * Comp_with_Basel_MD
Crosstab Count
Comp_with_Basel_MD Total
Yes No
Neither
Agree Nor
Disagress Yes
CAR_T
rend
Declining 0 15 0 15
Improving 5 35 5 45
Total 5 50 5 60
Explanation: The Cross tabulation results suggest Compliance with Basel Accord
requirements of Market Discipline is very low in Pakistan as most of the respondents
denied the compliance of their banks with such discipline in this regard.
136
6.5.14 Relationship between Bank Type CAR Trend and Basel Customer
Awareness:
Bank_Type * Basel_Cust_Awar
Crosstab Count
Basel_Cust_Aw
ar Total
No No
Bank_Type Government Owned 10 10
Privately Owned Local
Ownership 25 25
Privately Owned
Foreign Ownership 25 25
Total 50 60
CAR_Trend * Basel_Cust_Awar
Crosstab Count
Basel_Cust_
Awar Total
No No
CAR_T
rend
Declining 15 15
Improving 45 45
Total 60 60
Explanation: The cross tabulation analysis of the above tables depict that none of the
Banks has initiated any customer awareness programme regarding Basel Accord
Implementation. Whether it is from public or private sector or the bank has improving or
declining CAR Trend.
137
6.5.15 Relationship between Bank Type, CAR Trend and Credit Risk Employees Ratio to Credit Risk Weighted Asset:
Bank_Type * CREMP_to_CRWA
Count
CAR_Trend * CREMP_to_CRWA
Count
CREMP_to_CRWA Total
.41 .45
.51
.52 .56 .60 .70
.73 1.08 1.13 1.33 1.50
Bank_Type Government Owned 0 0 1 0 0 1 0 0 0 0 0 0 2
Privately Owned
Local Ownership
1
0
0
1
0
0
0
0
0
1
1
1
5
Privately Owned
Foreign Ownership 0 1 0 0 1 0 1 1 1 0 0 0 5
Total 1 1 1 1 1 1 1 1 1 1 1 1 12
CREMP_to_CRWA Total
.41 .45 .51 .52 .56 .60 .70 .73 1.08 1.13
1.33 1.50
CAR_ Declining
Trend
Improving
Total
1
0
1
0
1
1
1
0
1
0
1
1
0
1
1
0
1
1
0
1
1
0
1
1
1
0
1
0
1
1
0
1
1
0
1
1
3
9
12
138
Explanation: The analysis of the cross section tables above depict that Banks in Private
Sector have higher Credit Risk Employees to Credit Risk Weighted Assets Ratios as
compared with Banks in Public Sector. Furthermore Banks with higher Credit Risk
Employees to Credit Risk Weighted Assets Ratio have CAR Trend better than the other
ones.
139
6.5.16: Analysis of the Results relating to the variable Involvement of External Trainer:
Perc
ent
40.0%
30.0%
20.0%
10.0%
0.0%
ROR
Branch ManagerRisk ManagerGroup Head
40.0%
30.0%
20.0%
10.0%
0.0%
Ext_Trnr_Inv
YesNo
ROR * Ext_Trnr_Inv Crosstabulation
Ext_Trnr_Inv Total
Yes No
ROR Group Head Count 20 3 23
% within ROR 87.0% 13.0% 100.0%
% within Ext_Trnr_Inv 60.6% 11.1% 38.3%
Risk Manager Count 11 1 12
% within ROR 91.7% 8.3% 100.0%
% within Ext_Trnr_Inv 33.3% 3.7% 20.0%
Branch Manager Count 2 23 25
% within ROR 8.0% 92.0% 100.0%
% within Ext_Trnr_Inv 6.1% 85.2% 41.7%
Total Count 33 27 60
% within ROR 55.0% 45.0% 100.0%
140
% within Ext_Trnr_Inv 100.0% 100.0% 100.0%
141
Explanation: The analysis of the diagram relating to the variable Involvement of
External variable suggests that most of the Banks have involved external trainners but
only at the higher management and risk management department level, and very little has
been done to train the staff working at branches. As the diagram and cross section tables
above suggests as the Rank of the Respondent as above lowers down the igonorance of
the staff about the involvmenet of exteranl trainner increases meaning thereby staff
posted at the lower ranks is not involved in Basel Accord Implementation ass across
banking sector.
142
CHAPTER 7
SUMMARY FINDINGS CONCLUSIONS AND
RECOMMENDATIONS
7. 1 INTRODUCTION
We have conducted this study to find out the reasons of the inability of Pakistani Banks
to adopt the advanced techniques of Basel Accord. It was required to investigate into this
phenomenon after the wide spread global acknowledgement and acceptance of advanced
methodologies relating to Capital Adequacy rules, risk environment and its measurement
relating to Basel Accord and the recognition of Pakistani banks in such dynamic
environment. Notwithstanding, the fact that there exists different timelines for
adoptability of rules of the Accord in different geographic locations of the world
depending upon quantum of economic development and complexity of banking
structures; and extensions allowed by the regulator in the domestic structures as well, an
in depth study in this regard can further highlight the attitude of banks towards
adoptability of advanced methodologies and quality and availability of resources to
accomplish the purpose available with the banks and with the supervisors. In this regard
we have already stated our data analysis in chapter 6 above and based upon data analysis
our summary findings, conclusions, recommendations and areas of further study are
discussed hereunder.
7.2 SUMMARY FINDINGS
As we have adopted different research methods for the purpose of our research therefore
summary findings from every research method has been firstly discussed individually to
form a major conclusion for our research.
7.2.1 Summary Findings of Questionnaire Results:
143
The results obtained on the five aspect of the Basel Accord Implementation as explained
in the section 4.2 have been depicted in the graphical form. We present hereunder the
results on seven aspects our questionnaire:
The results of the first ten questions depict a very interesting relationship that
although the banks consider the significance of Basel Accord in Pakistan and their
banks very high yet they are of the opinion that its implementation will have more
problems than advantages and the inclination of their respective banks towards its
implementation is low.
Questions from eleven to twenty one deal with the availability of resources and
the quality of resources with the bank for the Basel Accord implementation. The
review of frequencies distributions and diagrams of these questions depict that
although banks have made Basel Accord Implementation set-ups and has also
arranged staff training programs, yet the quality of resources available are still
very low and are not coming up to the required mark in terms system and human
resource availability as well.
Questions from 22 to 31 deal with the problems being faced by the Banks
regarding the implementation of Basel Accord; national and international
legislations available in the country and their compliance. A review of the
diagrams and frequency distributions of the response data available regarding
these questions suggest that there do exist national legislation regarding the
implementation of Basel Accord but banks are expected to face higher costs in
complying with these regulations as their existing setups require quite a few up
gradations in this regard. Also there are many international regulations of the
Basel Accord that are causing fear amongst the Banks for compliance like data
protection and data sharing.
144
Questions from 32 to 36 deal with Credit Risk Measurement as prescribed in
Basel Accord. A review of the related frequency distributions and related
diagrams suggest that most of the banks in Pakistan are on Standardized
Approach of Credit Risk Measurement and most of them are using their default
and recovery data up to 5 years for the purpose. Further, they have not made any
progress on the model based economic capital determination or any other model
for beyond measuring credit risk in this regard.
Questions from 37 to 42 deal with Operational and Market Risk. A review of the
frequency distributions and diagrams of the results of these questions suggest that
there is very little or no progress made by the banks in these two areas of Pillar I
Risk Measurement.
Questions from 43 to 47 deal with the Supervisory Review Pillar II of the Basel
Accord. A review of the diagrams and frequency distributions of the results of
these questions suggest that the banks consider that the supervisor do not have
adequate resources to monitor Basel Accord progress in the country. Also they
consider that there is a need for additional legislation for compliance to Basel
Accord in the country.
Questions from 48 to 51 deal with the Market Discipline Pillar III of the Basel
Accord. A review of the diagrams and frequency distributions of the results of
these questions suggest that the banks are not yet fully meeting the disclosure
requirements under Basel Accord as they consider that it might lead them to
comparative disadvantage in the absence of any legislation in this regard. Also
none of the Bank has yet arranged any customer awareness programme under the
Basel Accord.
7.2.2 Summary Findings of Radar Diagram and CAR Trend Results:
For the purpose of better understanding we have performed the analysis of Radar
Diagrams of each bank by making a comparison with a standard Radar Diagram of an
145
ideal bank as depicted in figure 6.4.13. Our primary finding is that there is a not single
bank in our entire sample whose Radar diagram exactly matches with our standard
Diagram of an ideal bank. However, the following conclusions are derived for the
purpose of our analysis:
7.2.2.1 Analysis of Radar Diagrams:
The diagrams of most of the banks have right arm but still it is above the scale of
2 which does not match very with the standard diagram of our ideal banks. This
exhibits that most of the banks have low inclination towards implementation of
Basel Accord. However, the diagrams of foreign owned private sector Banks
shows that only these banks have better inclination towards implementing the
Accord. Also this depicts that most of the Foreign Banks and Government owned
banks have not shown their inclination towards Basel Accord which needs to
investigated as well before reaching an overall conclusion.
The diagrams of most of the banks have right long leg which depicts that
According to respondents of our questionnaire the plan of the Basel Accord
implementation is not effective and also the employees in the risk management
departments of the banks in our sample are not competent enough to match with
the international requirement of Basel Accord.
The left leg of the radar diagram depicts the period of time for which the data is
held by the bank and the up gradations required in the system of the respective
banks for internal modeling purpose of Basel Accord compliance. An analysis of
all the diagrams suggests that the value remains close to 2 and 3 on the scale,
which is an indication of upgradation required in the systems of all the banks for
Basel compliance. As regards the availability of data only the diagrams of
Standard Chartered Bank, MCB Bank, United Bank, and Habib Bank suggests
that they have the data with them for longer period than all other Banks. This
146
depicts that none of the government owned banks have the required data of
required lengths also the data possessed by most of the banks including most of
the foreign banks is within 3 to 5 years.
Over and above the findings as discussed hereinabove our analysis of radar
diagrams suggests that the compliance with market discipline is not quite upto the
mark also none of the banks has initiated any customer awareness program of
Basel Accord amongst its customers.
7.2.2.2 Analysis of CAR Trend:
The analysis of CAR Trend diagram suggests that out of 12 Banks in our sample only
KASB Bank, Faysal Bank and BOP have declining Capital adequacy ratios; while the
CARs of all other banks have non declining or improving trend.
7.2.3 Summary Findings of Cross Tabulation Results:
The cross tabulation results have supplemented our radar diagram results to find more
objective conclusions regarding Type of Bank and CAR Adequacy Trends of different
banks in our sample. Our summary findings in this regard are hereunder:
The cross tabulation results of Bank Type, CAR Trend and Bank Inclination
suggest that Foreign Banks with improving CAR trend are more inclined towards
Basel Accord implementation in Pakistan.
The cross tabulation results of Bank Type, CAR Trend and Risk Management
Employees Expertise suggests that the expertise of Risk Management employees
is generally lower in all Pakistani Banks however, only the employees of banks
with improving CAR trend have good expertise in risk management According to
our survey results.
147
The cross tabulation results of Bank Type, CAR Trend and Effective Basel Plan
suggests that although Banks do not have effective Basel Accord Implementation
Plan but still only one foreign Bank that improving CAR Trend has effective
Basal Accord Implementation Plan.
The cross tabulation results of Bank Type, CAR Trend and Basel Accord Data
Collection Methodologies suggest that systems of almost all of the banks require
significant changes to meet Basel Accord data collection requirements.
The cross tabulation results of Bank Type, CAR Trend and duration of default
time series suggest that only the private sector banks with improving CAR Trend
have more than 5 years data to make an internal model of default as required by
the Basel Accord.
The cross tabulation results of Bank Type, CAR Trend and Compliance with
Market discipline suggests that compliance with market discipline requirement of
Basel Accord is generally weak among the Banks functioning in Pakistan.
The cross tabulation results of Bank Type, CAR Trend and Customer Awareness
programs suggests that none of the banks whether with improving or declining
CAR trend or from public or private sector has done much work regarding
spreading awareness among customers regarding awareness of Basel Accord.
The cross tabulation results of Bank Type, CAR Trend and Credit Risk
Management Employees to Credit Risk Weighted Assets ratio (CREMP to
CRWA ratio) suggest that we have three categories of our results:
o The Banks having their CREMP to CRWA below 0.5
o The Banks having their CREMP to CRWA ratio above 0.5 to less than 1
o The Banks having their CREMP to CRWA ratio over 1
148
The ratios of banks with declining CAR trend have their ratio under 0.5. All banks
with ratios significantly above 0.5 have improving CAR trend while the banks
with the required ratio over 1 are the stronger Banks in Pakistani sector. The only
exception appears in this regard is Faysal Bank with the CREMP to CRWA ratio
of 1.08 with declining trend and NIB Bank with CREMP to CRWA ratio of 0.45.
The analysis of CAR trends of both Banks reveals that this Bank also has
improving CAR Trend for the last three years, however, due to even higher capital
adequacy ratio in the year 2005 the relationship appears declining whereas for
NIB Bank the Bank had severe declining trend until 2007 and then it had to inject
fresh equity which has raised our ratio. The table also reveals that the minimum
CREMP to CRWA ratio a Pakistani should maintain is 0.5.
Apart from the above, the findings about the involvement of External trainer and
as discussed in section 6.5.16 are also very significant and shall be discussed for
the purpose of making our final conclusion of this research study.
7.3 CONCLUSIONS:
Despite the fact that Pakistan is a developing country, still far away even from its take off
stage, yet it took the initiative of reforming its financial sector through implementing the
Basel Accord. Based on our key summary findings on twelve banks of our research study
we can conclude that apart from planning and completing the policy documentation
regarding implementation of Basel Accord; availability of resources, dedication and
willingness to stick with the road map in letter and spirit are the key factors in the
implementation which seem to have lacked in Pakistani environment. This argument also
stems from our literature review that even big countries like USA with advanced
technologies and resources although do have an edge towards promulgating the Basel
Accord but the country like South Africa moves ahead of them in meeting the timelines
149
and ensuring full compliance to Basel Accord implementation in its financial sector
which is attributed to dedication of resources, planning and willingness to stick with the
timeframe (Makwiramiti, 2008).
In order to have an insight of the extent of planning and willingness in Pakistani
environment our research results identify that even after the lapse of more than 1 and half
year of the deadline of implementing the Basel Accord, most of the work is still in its
adolescent stages. The questionnaire results suggest that the Bankers themselves are
scared of the Accord as they perceive more problems due to Basel Accord. Main reasons
for this reluctance According to our findings are the facts that firstly, even the trainings
extended to the bank staff for the purpose has not produced desired results because the
quality of Risk Management Employees is not considered good by most of the
respondents and secondly, the cost of converting the existing systems into more
compliant Basel Accord systems are expected to be on higher side.
Over and above major up gradations required in the resource structures of the Banks,
there are also major follow-ups and revisions required at the level of the supervisors as
well, as the Banks perceive that the supervisory process has flaws due to inadequate
resources and room for additional legislation. Accordingly, market discipline also appears
weak as none of the banks are creating awareness among its customers neither are they
properly disclosing the results of Basel compliance in their annual statements. Apart from
the above, most of the respondents are also of the view that their banks do not have very
effective Basel Accord implementation plans. This further complements our earlier
conclusion of reluctance among Pakistani Bankers for adopting the Basel Accord. These
results also match with the findings of Khliji, 2003, where she concluded that there exists
a huge gap between policy and practice in Pakistani Banks; and it is even more alarming
situation that even after the lapse of eight years the situations has not improved
significantly!
150
In addition to above our bank wise analysis based on radar diagrams further complements
our conclusion where only few banks in our sample depict that they have required level
of human, technological and data resources. Further only four banks, two foreign and two
large domestic banks, seem performing only marginally well than all other banks in the
sample which also depicts that the Basel Accord Implementation is quite low in Pakistan.
There are other numbers of subsidiary conclusions that are relevant for the purpose
of our conclusion:
There is an urgent need to assess the performance of Risk Management Units in
the Banks which are responsible for executing the implementation of Basel
Accord. For the purpose of our analysis we have introduced a new Credit Risk
Management Employees to Risk Weighted Credit Assets Ratio. This ratio tells us
how much human resources a bank is having for every Rs. 1 Billion of its Risk
Weighted Credit Assets. The ratio is also very interesting as only four banks in
our sample have more than 1 employee for every Rs. 1 Billion, which given the
technological requirement of the system for Basel Accord needs to improved.
Although, our results partly depict that 0.5 value of this ratio is sufficient for
maintaining improving trend of Capital Adequacy Ratio; but still due to very
elementary risk management mechanism, this ratio cannot be considered as safe
and needs to further investigated into. This ratio is also better in private sector
banks and in large commercial banks, while needs improvement in Government
Owned Banks.
The acknowledgement of involvement of external level at the higher executive
level and denial at the lower level suggests that the Banks have failed to introduce
Basel environment across their respective organizations.
7.4 POLICY RECOMMENDATIONS:
The Banks and the supervisory authority need the following enhancement in their Basel
Accord Implementation policies:
151
After the lapse of first Basel Accord Implementation Road no other road map has
yet been announced by State Bank of Pakistan. This needs to be announced at
earliest as no deadline for implementation means Banks can infinitely defer their
efforts to improve their Risk Management processes which are harmful for the
Banking industry itself.
The Minimum Capital Requirements document released by State Bank of
Pakistan requires significant improvement. For instance, the definitions of all
types of capital, and capital deduction need to be updated along with their
respective usages in determination of minimum capital According to the new
guidelines set by the BCBS. The “Unexpected Loss” (UEL) term although used in
the document has not been defined anywhere in the document which requires
clarification; also all other default terms require mathematical clarifications for
their better and objective usage.
An analysis of Annual Reports of the banks in our sample reveals that they are not
disclosing their risk reports and Capital Adequacy Ratios (CARs) data in any
methodical manner. For instance, some banks are showing CARs of only two
years while others depict more than five years. This makes over the year
comparison very difficult. Particularly there exists a problem in the year 2007
after which date most of the banks started depicting Basel compliant CARs. There
are only few banks which have shown their revised Basel compliant CARs for the
period from 2005 to 2007 in their annual reports which makes comparison very
difficult across banking sector. Also banks should disclose in their annual reports
the HR costs and number of employees in their Risk Management Divisions to
better assess their performance. Therefore there is a huge gap existent in the
compliance with Market Discipline and needs urgent improvement.
Banks need to inculcate Basel compliance environment in their organizations and
152
also among their customers to address data quality and protection issue which will
also help improve the compliance with Market Discipline.
7.5 AREAS FOR FURTHER STUDY:
As there was no study available in this area in Pakistan therefore we have done a
pioneering effort to find the causes in delays in Basel Accord implementation in Pakistan
using the post implementation phases data. This opens a range of future areas of study in
this regard which include the following:
This study has been conducted only on twelve Pakistani conventional banks
therefore; a comprehensive study encompassing all banks can be helpful in getting
more meaningful results.
A study can be conducted on Islamic and investment banks as well to get an
overall picture of Basel Accord implementation in Pakistan.
Similar studies can be conducted in other countries lagging behind in the Basel
Accord implementation to explore further dynamics of Basel Accord
Implementation.
The CREMP to CRWA ratio used in this study explores the performance of Risk
Management Divisions. As we have used only credit risk weighted assets because
of their dominance in Pakistani Banking sectors therefore, similar ratios can be
computed for Operational and Market Risks in other parts of the world to have
better idea of the relevance of this ratio. Furthermore, studies can be conducted to
establish minimum bench mark ratios for risk segment and banking sector as well.
Similar relationships can also be discovered from using Risk Management HR
Cost to Risk Weighted Assets ratio which requires further data disclosure from
Banks.
153
A more relevant use of this ratio will be on the crisis affected and survived banks
before and after the recent global financial crisis which might be helpful in
indicating any symptom in this regard.
154
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