IMPLEMENTATION ISSUES & CHALLENGES OF BASEL II FACED BY BANKS (IN PAKISTAN)

Abstract

The financial scandals in the last two decades have determined the Basel Committee to improve the risk controls for banks in general, and for operational risk in particular the new capital adequacy framework (Basel II) not only promotes improvements in risk management and regulatory capital allocation but also raises a variety of implementation challenges for both supervisors and banks. A study has been performed taking these issues into account. The objective of this paper is to identify Basel II implementation plans and the issues and challenges that are faced by banks in Pakistan. With regard to the timeframe for adopting the new capital adequacy framework, Basel II appears to be implemented in 2008-10. For Pillar 1 - minimum capital requirements - the foundation internal ratings-based (IRB) approach is envisaged to be the most used methodology for calculating capital requirements for credit risk (in terms of banking assets moving to Basel EQaround the world. The (simplified) standardized approach ranks closely behind the foundation IRB. However in Pakistan, the Standardized approach is to be first implemented, followed closely by the IRB Approaches only after getting approval from the SBP. As regards allocating capital for operational risk, the basic indicator approach is anticipated to be widely employed. Several challenges were identified with respect to the implementation of Pillar1, Pillar 2 - the supervisory review process - and Pillar 3 - market discipline. And a number of suggestions have been offered that can be adapted for use by the banks and central for sound implementation ofBasel EL The goal of credit risk management is to maximize a bank's risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. Banks need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or transactions. There is also operational risk. At the outset, it all seems to suggest the way in which a model should be built to arrive at the required safety capital in the form of tier one and two. The need for creation of a robust mechanism to assess the bank's financial health covering business, operations risks dimensions is vital. It is believed that compared to the current scenario these approaches would have helped banks to not only the better management of risk and capital allocation according to risk exposure but to also improve the way the business is done. It would help the banks to organize their internal systems, people, and processes to ensure that their business is not jeopardized due to failures in operational or credit risk monitoring practices.