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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

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Electronic copy available at: http://ssrn.com/abstract=2102059

ABSTRACTBasel 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 Capital2

Electronic copy available at: http://ssrn.com/abstract=2102059

Requirement document issued for Banks and FIs by the State Bank of Pakistan.

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Electronic copy available at: http://ssrn.com/abstract=2102059

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 2 3 4 Abstract Acknowledgements Table of Contents List of Tables & Diagrams

CHAPTER 1 INTRODUCTION 1 2 3 4 5 1.1 Background 1.2 Problem Statement 1.3 Goals of the Research 1.4 Methods and Procedures 1.5 Organization of the Study 1 1.3 1.5 1.6 1.7

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CHAPTER: 2 REVIEW OF BASEL ACCORDS 1 2 3 4 5 6 7 8 9 2.1 Basel I Capital Accord 2.2 Critical Review of the Basel I Accord 2.3 Basel Accord (Revised 2006) 2.4 Criticism of Basel II Accord 2.5 Basel III Accord 2.6 Micro Prudential Capital Rules 2.6.1. Up gradation of Tier I Capital 2.6.2. Regulatory Capital Increase 2.1 2.1 2.3 2.8 2.9 2.9 2.9 2.10

2.6.3. Usage of the Leverage Ratios to Control Exposures of the 2.11 Banks: 2.6.4. Usage of Convertible Capital for Loss Absorbency: 2.7 Macro-prudential Capital Rules 2.7.1. Procyclical Capital Buffers Adjustments 2.7.2. Accounting for the Systemic Risks 2.8 Introduction of Liquidity Ratios 2.8.1. Accounting for the Liquidity Rules 2.8.2. Accounting for the Net Stable Funding Ratio (NSFR) 2.8.3. Study of the Micro Economic Impact of the Capital Accord 2.11 2.12 2.12 2.13 2.13 2.13 2.13 2.14

10 11 12 13 14 15 16 17 18

2.8.4. Study of the Long-term Macro Economic Impact of the 2.14 Capital Accord 2.9 Table of Review of Three Basel Accord 2.15

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CHAPTER: 3 IMPLEMENTATION OF ACCORD 1 2 3 4 5 6 7 3.1 Introduction 3.2 Basel Accord in Developing Countries 3.3 Procyclicality Issue 3.4 Basel Accord: Need of Basel Implementation Resources 3.5 Basel Accord: Adoption of Approaches 3.6 Basel Accord and the Development of Rating Agencies 3.7 Summary 3.1 3.1 3.2 3.3 3.4 3.4 3.4

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1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

CHAPTER:4 COUNTRYWISE COMPARISON OF BASEL ACCORD INSTITUTIONAL ISSUES 4.1 Introduction 4.1 4.2 Basel Accord in South Africa 4.3 Basel Accord in India 4.4 Basel Accord in Switzerland 4.5 Basel Accord in Brazil 4.6 Basel Accord in Jordon 4.7 Basel Accord in United States 4.8 Basel Accord in Pakistan 4.8.1. Feedback Submitted by the Banks 4.8.2. Quantitative Impact Study 4.8.3. General 4.8.4. Pillar 1-Minimum Capital Requirement 4.8.4.1. 4.8.4.2. Standardized Approach Internal Ratings Based Approach 4.1 4.3 4.3 4.4 4.6 4.6 4.9 4.10 4.10 4.10 4.11 4.11 4.11 4.11 4.11 4.12

4.8.5 Pillar 2 - Supervisory Review 4.8.6 Pillar III- Market Discipline 4.9 Conclusion

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1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21

CHAPTER 5 METHODOLOGY AND RESEARCH DESIGN 5.1 Introduction 5.2 The Questionnaire 5.2.1 Why Questionnaire 5.3 Secondary Data 5.4 Study Sample 5.4.1 Respondents 5.5 Questionnaire Response 5.6 Pilot Study of the Questionnaire 5.7 Variables 5.8 Justification of Each Variable 5.8.1 Capital Adequacy Ratio Trend 5.8.2 Type of Bank 5.8.3 Inclination of Bank towards Basel Accord: 5.8.4 Involvement of External Trainer 5.8.5 Competence of Employees in Risk Management Department 5.8.6 Effectiveness of Basel Plan Implementation

5.1 5.1 5.2 5.3 5.3 5.4 5.5 5.5 5.6 5.6 5.6 5.7 5.7 5.7 5.7 5.7

5.8.7 Changes required in the System for Basel Accord Compliance 5.7 5.8.8 Years Covered for Default time Series Data 5.8.9 Compliance with Market Discipline 5.8.10 Basel Customer Awareness 5.7 5.7 5.7

5.8.11 Credit Risk Employees Ratio to Risk Weighted Credit 5.8 Assets: 5.8.12 Total Risk Employees Ratio to Total Risk Weighted Credit 5.89

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Assets 23 24 25 26 27 28 29 5.9 Research Hypothesis 5.10 Methods for Analyzing Data 5.10.1 The Cronbach's Alpha 5.10.2 Radar Diagram 5.10.2.1 Intra Bank Analysis 5.10.2.2 Inter Bank Analysis 5.10.3 Cross Tabulation Analysis 5.8 5.9 5.9 5.9 5.9 5.10 5.10

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CHAPTER 6 DATA ANALYSIS 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 17 18 19 20 21 22 23 6.1 Introduction 6.2 Review of Questionnaire Results 6.3 Primary Data Analysis 6.4 Radar Diagrams 6.4.1-Analysis of KASB Radar Diagram 6.4.2-Analysis of Standard Chartered Bank Radar Diagram 6.4.3-Analysis of Askari Bank Radar Diagram 6.4.4-Analysis of Allied Bank Limited Radar Diagram 6.4.5- Analysis of NIB Bank Radar Diagram 6.4.6- Analysis of MCB Bank Radar Diagram 6.4.7- Analysis of NBP Bank Radar Diagram 6.4.8- Analysis of Bank Alfalah Radar Diagram 6.4.9- Analysis of Faysal Bank Radar Diagram 6.4.10-Analysis of United Bank Radar Diagram 6.4.11-Analysis of the Bank of Punjab Radar Diagram 6.4.12-Analysis of the Habib Bank Limited Radar Diagram 6.4.13-Analysis of the Radar Diagram of an Ideal Bank 6.5 Cross Tabulation: 6.5.1 Relationship between CAR Trend and Bank Type 6.5.2 Relationship between Bank Type and Bank Inclination 6.5.3 Relationship between CAR Trend and Bank Inclination 6.1 6.1 6.30 6.30 6.31 6.32 6.33 6.34 6.35 6.36 6.37 6.38 6.39 6.40 6.41 6.42 6.43 6.44 6.44 6.44 6.45

6.5.4 Relationship between Bank Type and Risk Management Employees 6.45 Expertise11

24 25 26 27 28 29 30 31 32 33 34 35

6.5.5 Relationship between CAR Trend and Risk Management Employees 6.46 Expertise 6.46 6.5.6 Relationship between Bank Type and Basel Plan Effectiveness 6.47 6.5.7 Relationship between CAR Trend and Basel Plan Effectiveness 6.5.8 Relationship between Bank Type and Data Collection Methodologies 6.47 Changes due to Basel Accord 6.5.9 Relationship between CAR Trend and Data Collection Methodologies Changes due to Basel Accord 6.5.10 Relationship between Bank Type and Period covered for Data Collection of Default Time Series 6.5.11 Relationship between CAR Trend and Period cove