First of all, I would like to thank Allah who provided me the strength, ability, and courage to work on this research paper. Afterwards, I would like to thank my parents especially my mother, Kausar Tasnim, whose help, motivation, care, dedication, and hard work has made me the man I am today. I also would like to thank my supervisor, Prof. F. A. Fareedy, who consistently provided guidance, help, and assistance throughout the research project semester. Furthermore, I am thankful to Mr. Asad Ali Shariff Financial Controller Standard Chartered Bank, Mr. Zulfiqar Patel Senior Manager Business Risk Services Ernst & Young, and Mrs. Lubna Farooq Malik Senior Director Risk Supervision State Bank of Pakistan for their time and knowledge which were crucial for the completion of this research. In the end, I am thankful to my friends for their support.
Executive Summary
The study aims to identify the causes behind the failure of banks to fully implement Basel II principles in risk management framework and the impact on banks from complete implementation of Basel II & III. In this regard, the study has analyzed existing literature and interviewed industry leading experts on the subject matter. The study ends with a set of recommendations for implementation of Basel frameworks in local banks' risk management systems.
BASEL I, II, and III accords aims to improve the regulatory capital of the bank according to the risks on banks' balance sheets. Banks have the incentive to follow BASEL accords and use advanced risk management systems because following advanced risk management approaches results in less capital charge than when using simple approaches.
Over the course of last 25 years, three BASEL accords have been introduced called BASEL I, II, and III. BASEL I was introduced in 1989 to set appropriate capital charges against credit risk weighted assets. Afterwards, it was revised in 1996 to accommodate capital charge for market risk weighted assets as well. Than in 2003, BASEL II was introduced to strengthen the existing risk management systems in the banks and is based on three pillars: 1) Minimum Capital Requirements, 2) Supervisory Review Process, and 3) Market Disclosure. Basel Committee on Banking Supervision (2011) revised the Basel framework for the third time and introduced Basel III risk management framework. The need for revision of Basel framework arose as global banks experienced significant liquidity and solvency constraints during global financial crisis of 2008.
State Bank of Pakistan initially mandated compliance to Basel II in 2008 with the introduction of Standardized approach for Credit Risk and Basic Indicator approach for Operational Risk from January 2008. Furthermore, banks are allowed to parallel run standard approach for 1.5 years and internal ratings based approaches for 2 years. However, later the compliance was made discretionary. Currently Basel II is not fully implemented in local banks and only basic standardized approaches are being employed.
Banks in Pakistan are unable to adhere to advanced approaches of Basel II principles in Pakistan due to a number of factors. Banks lack the appropriate support systems, infrastructure, and skilled human resource to incorporate Basel II fully in risk management system. Adding to that, banks are also somewhat unwilling to adopt Basel II because of a number of disadvantages, for example risk based pricing, arising from the complete implementation of Basel II. Also, the existence of imperfect markets and asymmetric information availability are more reasons contributing to the disinclination of banks to adopt Basel II advanced approaches.
In case of implementation of Basel II, several studies have observed a decline in lending to high risk borrowers as banks will require additional capital to lend to these type of borrowers. Furthermore, the implementation can also disturb lending to special sectors e.g. SMEs, Agriculture etc. due to their high risk nature of businesses. However, banks will also get advantages from Basel II & III in the form of stronger capital adequacy, improved liquidity and better loan pricing mechanisms.
Table of Contents
Introduction
Standard Chartered Bank started operations in Pakistan in July 2006 with the acquisition of major stake in Union Bank. The bank paid approximately $487 million in cash for a 95.37% stake in Union Bank. Since then, the bank's balance sheet has grown tremendously over the past few years. Currently it has a nationwide network of 132 branches as of June 30, 2012. The bank, as per State Bank of Pakistan regulations, is listed on all stock exchanges of Pakistan.
Standard Chartered Bank Pakistan is involved in Consumer and Wholesale banking businesses and has over 5000 employees in Pakistan. Standard Chartered is the first bank to get Islamic banking license in Pakistan and has 15 Islamic banking branches. It also has the highest credit rating of AAA/A1+ for any private bank in Pakistan. The bank has been awarded The Best Bank in Pakistan in 2011 by The Asset Triple A.
Standard Chartered Group came into being as a result of the merger of Chartered Bank of India and Standard Bank of South Africa in 1969. It operates in more than 70 markets across the globe with a workforce of more than 87000 employees.
Financial Performance
Despite the contraction in branch network in the last two years, as the bank restructured the pre-merger branch network of acquired Union Bank to improve cost efficiency, the balance sheet expanded by 3% in 2010 and 11% in 2011. The most significant change among assets can be seen in investments portfolio which grew by more than 44% YOY in 2011. Net Advances after provisions shrunk by 5% YOY as the bank avoided any new lending due to poor corporate performance and rising delinquencies. Corporate sector in Pakistan is facing infrastructural deficiencies, e.g. lack of power, which is leading to slim macroeconomic growth. However, SME portfolio in Consumer Banking experienced expansion. By the end of 2011, the balance sheet size of the bank stood at Rs. 364 Billion. Deposits, which fund most of the balance sheet, experienced moderate growth of 7% as the bank focused more on the mobilization of low cost CASA accounts and got rid of the high cost deposits to improve the overall earning spread. CASA accounts now constitute more than 84% of the total deposits. (2010: 79%).
The bank successfully boosted earning spread to 7.98% in 2011 from 7.06% in 2010 by keeping the deposit mobilization cost low and taking full advantage of existing asset base to generate higher interest revenue than previous years. The rising administrative costs were also kept under control. Efficient asset utilization, low cost of deposits, and controlled operational expenses resulted in an impressive bottom line growth for the bank and income before taxes grew by nearly 50% YOY in 2011.
Standard Chartered has a fairly liquid balance sheet as the bank has invested a considerable amount of asset base in short term government securities. Investments constituted approximately 28% of total assets as of end of 2011 compared to 23% at the end of 2010. Since most of the new inflows from deposits were invested in high yield government securities, the Advances to Deposit Ratio suffered and fell to 55%. In 2011, many new loans were classified as Non-Performing as many borrowers defaulted on payments. Therefore, Non-Performing loans increased as a proportion of Gross Advances to 16.36% from 13.79% a year ago which is higher than industry standards. However, the bank has maintained an appropriate coverage level for non-performing loans. Consequently, the loan loss coverage ratio for Standard Chartered Bank Pakistan stood at an adequate level of 83%. The bank has an appropriate Capital Adequacy Ratio (CAR) of 12.90% above the 10% requirement by SBP.
In future, the bank is focused toward prudent lending both in the Consumer and Wholesale segments along with further improvement in deposit and operational costs. However, the bank's spread and profitability is expected to remain under pressure as a result of reduction in discount rate by SBP to 10% as of Oct 2012 from more than 12% in 2011. Therefore, a squeeze in profit margins in expected in 2012.
Comparative and Competitive Analysis
The competitors are selected in terms of balance sheet asset size. Standard Chartered Pakistan had an asset base of nearly Rs.364 billion as of Dec 31, 2011 and is considered a medium sized bank in Pakistan. Askari Bank and Bank Al-Habib can both be considered as competitors of Standard Chartered Pakistan as both of these have a similar balance sheet size. Askari bank had a balance sheet size of approximately Rs.343 Billion and Bank Al-Habib had a balance sheet size of Rs.384 Billion as of Dec 31, 2011.
Balance Sheet Size (Total Assets) Growth
2008
2009
2010
2011
Askari Bank
13%
23%
24%
9%
Bank Al Habib
26%
41%
21%
27%
Standard Chartered Bank Pakistan
4%
20%
3%
11%
All Banks
9%
16%
10%
15%
Net Markup / Interest Income Growth
2008
2009
2010
2011
Askari Bank
20%
17%
11%
0%
Bank Al Habib
57%
38%
19%
31%
Standard Chartered Bank Pakistan
1%
1%
6%
19%
All Banks
18%
17%
4%
20%
2010
2011
Income before Taxation
Total Assets
Staff Strength
Branches
Income before Taxation
Total Assets
Staff Strength
Branches
Askari Bank
Rs. 1.249 Billion
Rs. 315 Billion
7600
235
Rs. 2.454 Billion
Rs. 343 Billion
7300
245
Standard Chartered Bank Pakistan
Rs. 5.757 Billion
Rs. 327 Billion
4900
162
Rs. 8.586 Billion
Rs. 364 Billion
5000
143
Bank Al Habib
Rs. 5.724 Billion
Rs. 302 Billion
5300
303
Rs. 7.158 Billion
Rs. 384 Billion
6100
351
Standard Chartered Bank Pakistan has a better cost structure compared to Askari Bank and Bank Al Habib, as Standard Chartered Bank Pakistan is able to generate more profit per investment in human resource, infrastructure, and compared to balance sheet size. Standard Chartered Bank Pakistan has only 143 branches with a staff of 5000 approximately and a balance sheet size of Rs. 364 billion. But Standard Chartered Bank Pakistan is able to generate more than Rs. 16 Billion of net interest income after provisions. On the other hand, Askari Bank and Bank Al Habib have a branch network of 245 and 290 branches, respectively, and staff strength close to 7400 and 6100, respectively. However, Askari Bank and Bank Al-Habib were only able to generate net interest income after provisions of Rs. 8.2 Billion and Rs. 12.335 Billion in 2011.
Bank Al Habib
Bank Al-Habib is owned by Habib family and has a network of 360 branches/sub branches. The bank has a market share of nearly 5% in the total banking sector assets.
Source: Bank Al Habib
Bank Al-Habib demonstrated strong growth in terms of balance sheet size and profitability in 2011. Balance sheet expanded by nearly 27.4% YOY as a result of strong double digit 62% growth in investments portfolio. Gross advances portfolio contracted by 7% YOY due to slim credit demand from private sector and constraints on credit supply as a result of enormous growth in investment portfolio. The unreasonable growth trend in investments portfolio and shrinkage in lending portfolio is aligned with industry wide trend as banks' are more inclined toward risk-free government lending in current poor national economic environment.
Investment portfolio of the bank nearly doubled in one year with nearly all the growth coming from investment in Government Treasury Bills and Pakistan Investment Bonds. Investment in treasury bills rose nearly fourfold as handsome attractive risk-free returns drove the bank toward these securities in a high interest rate environment.
Gross Advances portfolio contracted in 2011 on account of minimal demand from private sector and deteriorating economic environment. However, growth in non-performing loans was lower at 8% compared to double digit growth in previous years. Furthermore, the bank strengthened the balance sheet by significantly enhancing provisions against advances by 55% YOY in 2011. Non-performing loans constitute a very insignificant part of Bank Al-Habib's lending portfolio and can be seen as a sign of a high quality lending portfolio and prudent risk management practice. Bank Al-Habib's Non-Performing loans are only 2.67% of Gross Advances while the same ratio is higher than 15% for most of the banks in the industry. It may also be because of bank's reluctance to lend and strict risk tolerance policies since the bank has very low advances to deposit ratio of 40% compared to more than 50% for most of the banks in the industry. The advances portfolio is divided between corporates (92%), SME (5%), and Consumer (3%).
In 2011, Bank Al-Habib experienced strong growth in deposits which demonstrates well capitalization of the expansion in branch network and taking advantage of growing inward remittances. The bank had a handsome spread of 3.58% in 2011 higher than private banks' average of 2.77% due to limited lending to only high quality borrowers. As a result, Bank Al-
Habib enjoyed nearly 31% YOY growth in net markup/interest income. Plus, Return on Equity also remained high near 25% compared to only 14% for most of the private banks. In terms of liquidity, the bank has a significant proportion of assets invested in liquid securities such as treasury bills. Lastly, Bank Al-Habib has a sound CAR of 14.8%. Going forward, the bank is expected to perform well as the quality of assets is high and the bank has a significant room to absorb more risk.
Bank Al-Habib has experienced phenomenal growth in terms of balance sheet expansion and income over the last few years when compared with Standard Chartered Bank Pakistan and all the banks in the banking sector of Pakistan. Furthermore, the quality of Bank Al-Habib balance sheet lending portfolio is very high when compared with Standard Chartered Bank Pakistan and All Banks operating in Pakistani Banking Sector. Non-Performing Loans constitute only 2.67% of Gross Advances for Bank Al Habib compared to 16.35% for Standard Chartered Bank Pakistan and 15% for All Banks in Pakistan.
Askari Bank
Askari Bank Limited has a strong brand value among armed forces personnel because of its association with Pakistan Army. The bank started operations in 1992 and the principal shareholder of the bank is Army Welfare Trust with a holding of more than 50%.
Source: Askari Bank
Askari Bank balance sheet size grew exponentially in last few years but the growth slowed down in 2011. The bank faced challenges in mobilizing low cost deposits and borrowed heavily from other financial institutions. As a result, the balance sheet expanded by only 9% in 2011 compared to more than 20% growth in previous years. Bank focused efforts on investing in low risk avenues such as investing in risk free government securities. As a result of declined spread and losses among NPLs, the net interest income growth remained stagnant near zero percent in 2011 compared to 11% in 2010. However, since the bank did not record any major new additions among Non-performing loans portfolio, therefore provisions decreased by 42% and income before taxation rose by more than 96%.
Investment portfolio expanded by nearly 31% in 2011 on the back drop of large investments by the bank in federal government securities incl. Treasury Bills, Pakistan Investment Bonds PIBs, and Sukuk Certificates. As a result, the contribution of investments in the bank's interest income nearly doubled over a year to 50% approximately.
On the other hand, Gross Advances portfolio contracted by 1% YOY as the bank avoided lending to corporations and individuals owing to poor macroeconomic conditions and slim demand of credit. Advances net of provisions portfolio shrank to Rs. 150 billion in 2011 from Rs. 152 billion in 2010.
Askari Bank experienced a decline in spread as the bank struggled to generate income in a worsening economic environment and faced challenges in attracting low cost deposits. Most of the new growth in deposit base came from term deposits which cost more than saving or current accounts. As a result, interest expense rose by nearly 27% compare to interest earned which rose by only 17%; thereby reducing the YOY growth in net interest income to near zero percent in 2011.
The bank is unexpected to encounter any liquidity problems owing to a significant liquid balance sheet with most of the new investments in short term government treasury bills. The bank has adequate capital for risk weighted assets as the CAR of the bank rose to 11.44% in 2011 which is above the minimum prescribed limit of 10% by SBP.
BASEL Risk Management Framework
BASEL I, II, and III accords aims to improve the regulatory capital of the bank according to the risks on banks' balance sheets. Currently, the BASEL risk management framework includes three separate charges for credit, market, and operational risk management. These charges are measured using either the simple or advance internal ratings based approaches.
BASEL Accords are set by BASEL committee consisting of central bank governors from 13 countries: Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Spain, Sweden, Switzerland, UK, and USA.
Banks have the incentive to follow BASEL accords and use advanced risk management systems because following advanced risk management approaches results in less capital charges than when using simple approaches.
Over the course of last 25 years, three BASEL accords have been introduced. BASEL I was introduced in 1989 to set appropriate capital charges against credit risk weighted assets. Afterwards, it was revised in 1996 to accommodate capital charge for market risk weighted assets as well. Than in 2003, BASEL II was introduced to strengthen the existing risk management systems in the banks and is based on three pillars.
Minimum Capital Requirements
Supervisory Review Process
Market Disclosure
Basel Committee on Banking Supervision (2011) revised the Basel framework for the third time and introduced Basel III risk management framework. The need for revision of Basel framework arose as global banks experienced significant liquidity and solvency constraints during global financial crisis of 2008. Many globally banks had excessive on and off -balance sheet leverage exposure. As a result, a slight deterioration in the asset portfolio resulted in erosion of capital and caused severe liquidity problems. To avoid bank runs, governments intervened and provided the required liquidity to keep the financial system from melting. Therefore, Basel committee revised Basel framework in 2010 and introduced several reforms related to capital, liquidity and solvency.
In terms of strengthening the capital base, Tier 1 capital, which is the highest quality capital, must consist of common equity and retained earnings. Capital requirements against counterparty credit risk will be determined under a stressed scenario. Also, to effectively manage liquidity risk, two additional ratios have been introduced in Basel III. Liquidity Coverage Ratio (LCR) measures the bank's ability to maintain liquidity under extreme unfavorable circumstances. Net Stable Funding ratio (NSFR) has been developed to measure the sustainability of the sources of funding for a period of one year. Moreover, a leverage ratio in Basel III prevents banks from excessive risk taking.
The Need for Revision of the Basel Risk Management Framework
Basel accord has been revised twice since its inception in 1988 as the risk management processes evolved and outdated techniques to manage risk became obsolete. Over the past few years development in technology has changed the way banks' used to manage risks in the past. Furthermore, trading of complexly structured financial instruments such as derivatives in today's financial markets have created new avenues for the banks to manage risk. Today, banks are extensively using credit derivatives and securitization techniques in risk management. Therefore, the old risk management framework of 1988, also known as Basel I, needs to be revised. Accordingly, the framework was revised in first half of 2000 and Basel II was introduced with three pillars for risk management. During the financial crisis of 2008, extreme liquidity problems among banks were experienced. Therefore, near the end of 2000, Basel III was introduced which caters to resolve these liquidity problems among banks through maintenance of adequate liquidity reserves.
Current State of Basel Implementation at Banks in Pakistan
State Bank of Pakistan initially mandated compliance to Basel II in 2008 with the introduction of Standardized approach for Credit Risk and Basic Indicator approach for Operational Risk from January 2008. Furthermore, SBP (2006) stated that the banks are allowed to parallel run standard approach for 1.5 years and internal ratings based approaches for 2 years. However, later the compliance was made discretionary. Currently Basel II is not fully implemented in local banks and only standardized approaches are being employed. Except a few foreign banks e.g. Standard Chartered Bank, local banks in Pakistan have not moved to the more advanced internal rating based approaches.
Basel Risk Management Framework at Standard Chartered Bank
Standard Chartered measures the Credit Risk Weighted Assets using the Advanced International Ratings Based approach for both consumer and wholesale banking credit portfolio. Advanced "value at risk" models are being utilized to calculate credit risk weighted assets in wholesale banking. Internal Ratings Based models employ Probability of Default, Loss Given Default, and Exposure at Default techniques.
Standardized approach is in use to measure operational risk weighted assets which uses different risk weights for 8 categories. Value at Risk approach is being employed to calculate market risk weighted assets.
Under BASEL II, banks are required to maintain at least 4% of Tier-I regulatory capital. The total regulatory capital (Capital Adequacy Ratio) should be at a minimum of 8%.
Standard Chartered Bank believes that the Implementation of BASEL Risk Management Framework will be beneficial to the bank in the following ways:
Improved business decision-making, informed by analytical tools and higher quality data
Attention to stress testing
Closer alignment of regulatory and economic capital
Impact of BASEL II on Standard Chartered Bank
Consumer Banking
Mortgage portfolio, because of their secured nature, resulted in reduction in the capital charge. However, Credit Cards, being unsecured in nature, experienced a rise in the capital charge.
Wholesale banking
Capital charges decreased because of increased recognition of collateral and improved credit grading.
Industry Literature Review
Pakistan Economic Review: FY 2012
Pakistan economy performed slightly better than in FY12 compared to FY11 but the real GDP growth rate still missed the targeted 4% and stood at 3.7% compared to 3% a year earlier. Power outages owing to absence of investment in infrastructure, crowded out lending to private sector due to strong governmental borrowing, and weak fiscal fundamentals as a result of slightly improving but still unsatisfactory revenue collection continued to plague the economic growth. Though, strong inflow growth in the form of remittances and low inflation provided some relief to the weak economy in FY12.
State Bank in its recent Monitory Policy Statement observed that the 3.7% real GDP growth in FY12 was consumption driven with a significant fall in Investment and Exports. It is worth noting that the private investment has fallen by 13% in the last four years and now is a small part of economic growth. Inflation, on the other hand, fell in FY12 as a result of slim infrastructure investment and falling oil prices in the year end. Furthermore, weak global economic growth prospects continued to put downward pressure on local exports. On top of that, drastically declined credit flow to private enterprises in FY12 is also deeply concerning.
Private sector enterprises have been badly hurt by energy shortages, fragile political environment, worsening security conditions, and significant budgetary borrowing by the government from local banks. Strong credit demand by the government to meet budgetary deficits has kept the interest rates on the high side and torpedoed SBP's efforts of reducing interest rates to make lending to private sector more affordable. Consequently, the demand and supply of credit has decreased radically. Loans totaling only Rs. 18.3 billion were disbursed to private sector in FY12 compared to Rs. 173 billion in FY11.
On the fiscal side, the government is still facing issues in revenue collection from taxes and foreign aid inflows largely remain dried up. On top of that, mounting circular debt and losses of public enterprises are profoundly pressurizing government expenditure bills. As a result, the fiscal deficit reached 6.4% in FY12 to Rs. 1.328 Trillion. Government continued to borrow heavily from SBP, despite the vows of not borrowing, to finance the shortfall in budgetary receipts. In addition to borrowing from SBP, government also borrowed heavily from commercial banks; thus causing instable short term interest rates and sabotaging SBP efforts to lower lending rates for stimulation of economic activity. Heaving government borrowing from local banks also caused liquidity crunch in the economy and forced SBP to inject more liquidity in the market. According to SBP, government borrowed nearly Rs.847 Billion in FY12 compared to near Rs. 700 Billion in FY11.
Exports fell by 3% in FY12 as a result of weak demand and supply situation. Textiles demand from developed nations most notably Europe fell in FY12 as a result of fragile economic situation and high unemployment prevalent in most of the western developed world. On top of it, local textile industry faced severe constraints in running on optimal capacity because of energy shortages. Import bills, however, rose by nearly 14% in FY12 as a result of increase in the prices of petroleum products. Consequently, trade deficit rose to $15.4 billion in FY12.
Nevertheless, remittances showed impressive growth and reached $13.2 Billion in FY12, thereby limiting the current account deficit to $4.5 billion. Due to slim financial and capital inflows in FY12, the balance of payment ended in negative, and together with IMF loan repayments, eroded $4 billion of SBP's exchange reserves. Overall, the macroeconomic growth environment remained dismal in FY12.
In FY13, infrastructure investment in power projects and efforts to stabilize the volatile security situation are required for stimulating private sector investment. Furthermore, on the fiscal side, reforms are required to improve the tax collection in all provinces. Better revenue collection will reduce government's borrowing from central and local banks; thus improving the availability of credit for private enterprises. Together, both of these factors will result in sound economic growth in the medium term.
Banking Sector Analysis: Year 2011
Performance
The Financial sector is about 5% of the Gross Domestic Product of Pakistan and its sound performance is important for the overall soundness of the economy. Banking Assets displayed an impressive growth of 15% YOY in CY11 on account of a stellar increase in investments. As a result, the balance sheet asset size of Pakistan's banking industry expanded by Rs. 1 Billion to reach Rs. 8,207 by Dec 2011.
Investments Portfolio of the banking sector grew by 42.5% YOY and reached to Rs. 3,053 Billion as a result of high government borrowing. During CY11, Government relied heavily on banks to finance the budget deficits by borrowing from private banks because of poor tax collection and absence of foreign aid inflows. In addition to that, the conversion of Rs. 391 Billion of circular debt in government papers in the second half of CY11 was another factor contributing to the stellar rise in bank's investment portfolio.
The increased government borrowing is having a crowding out effect on Advances as banks' advances fell by 0.2% to Rs. 3,341 Billion as of Dec 2011. Furthermore, banks' also remained risk averse in lending to private sector as a result of worsening business and economic environment. Energy Crisis in CY11 directly had a negative impact on the output of leading industries such as Fertilizer, Cement and Textiles.
As a result of a rising investment portfolio and a declining advances portfolio, the share of investments in total banking assets rose to 37% from 30% and share of Advances fell to 41% from 47in CY11. Though, Share of Advances in Assets fell to 41% from 47% in CY11.
In CY11, Deposits continued to post a double digit growth rate and reached Rs. 6,238 Billion after a 14.5% YOY growth as a result of a record foreign remittances inflow. Because of improved liquidity on account of investments in MTBs, banks' are targeting their efforts to attract low cost CASA deposits instead of focusing their efforts on long term deposits.
The consistent rise in investments along with drop in advances has resulted in a declining ADR over the last 4 years. ADR was highest in CY08 at 75.2% but has a fallen to 53.6% by Dec 2011.
Thanks to high returns on government papers and low provisioning, banks' posted profit before tax of Rs. 170 Billion in CY11 (52% YOY Growth). The share of income from advances in Interest Earned fell from 63% in CY10 to 56% in CY11. The major driver of growth banking sector revenues was interest income from investments. The share of interest income in total interest earned rose to 40% in CY11 from 31% in CY10.
Capital Adequacy of the banking sector improved in CY11 as banks' boosted their T-1 capital with the help of accumulated reserves and also injected capital as required by SBP to have a minimum paid up capital of Rs. 8 Billion by Dec 2011. Consequently, CAR improved from 14% in CY10 to 14.6% in CY11. Still, the current banking system CAR is well above 10% requirement of SBP and demonstrates adequate available cushion against losses.
Risk Analysis
Credit Risk: In spite of placing significant funds in risk free government securities, banks' exposure to credit risk increased in the past year. Credit Risk Weighted Assets (CRWA) grew by 4.7% YOY in 2011 to reach Rs. 3,803 Billion. However, the growth in CRWA was far below the growth in total banking asset which grew by 15% YOY to reach Rs. 8,207 by the end of Dec 2011. As a result, the share of CRWA in total Assets fell to 47% by the end of Dec 2011 compared to 51% a year ago.
Nevertheless the decline of CRWA in the total banking assets, Credit Risk remains significant as NPLs have not shown any signs of slowing in 2011. Instead, NPLs rose by 10.8% YOY despite a trivial YOY growth of 0.9% YOY in Net Advances during Dec 2010 - 2011. As a result, Gross NPL to Gross Loans ratio in the banking sector of Pakistan further deteriorated in 2011 to reach 16.2% by Dec 2011 compared to 14.7% year ago. The rise in NPLs could be attributed to poor corporate performance as a result of severe energy shortages, falling exports, and rising inflation. NPLs rose by Rs. 59.38 Billion YOY and reached Rs. 607 Billion by the end of Dec 2011 compared to Rs. 548 Billion a year ago.
The most significant increase was in the Loss category which added Rs. 55.421 billion NPL Losses in the current year under review. By Dec 2011, 77% of NPLs concentrated in the loss category. Thus, giving rise to the risk of non-recoverability of these assets in future.
The rise in NPLs was contributed by Textile, Agriculture, and Fertilizer, and Cement sectors. Fertilizer and Cement sectors witnessed severe energy shortages which hampered productivity and reduced supply, and as a result deteriorated their ability repay the borrowed funds. Textile Sector, which accounts for 18.16% of total banking advances as of Dec 2011, witnessed severe shocks both on demand and supply side. On supply side, severe energy shortages led to the decrease in capacity utilization and production. On the demand side, weakening economic outlook of EU resulted in a reduction in demand of textile products from EU countries. As a result textile exports have fallen, and many of the Textile Units have been unable to repay the borrowed funds. Thus, Textile NPLR reached 28.5% by Dec 2011 from 24.3% in Dec 2010, and alone contributes 31% of the total banking sector NPLs by the end of 2011. Therefore, any small deterioration in asset quality of Textile Loans can have drastic consequences on the credit soundness of the banking sector of Pakistan.
Consumer and SME Sectors also contributed toward the rising NPLs with SME infection ratio increasing from 28% to 31%, while Consumer infection ratio touching 18.6% from a year ago level of 16.9%. As a result, banks' reduced their exposure in these sectors. The concentration of SME Sector in Advances fell to 8.11% from 9.34%, and the concentration of Consumer loans in total advances fell to 6.47% from 7% in 2011.
Provisioning grew at a similar rate to NPLs and stayed at the same level of 67% till Dec 2011 compared to a year ago. Appropriate levels of provisioning indicate that banks' are well protected against any significant losses due to NPLs.
Going forward, NPLs growth is expected to continue in the short term attributing to poor corporate growth as a result of energy shortages. As a result, banks' are reducing their exposure to the risky corporate sectors and targeting the large creditworthy corporates or risk-free government securities.
Liquidity Risk: Large investments in government papers naturally increased the liquidity profile of the banks in year 2011 with Liquid Asset Ratio rising to 44.4% of total assets from 35.7% in Dec 2010. The Liquid asset ratio at 44.4% is highest in the past five years. Banks added Rs. 752 Billion of liquid assets in their portfolio in year 2011 out of which investments had the largest proportion in the form of government papers. Significant risk aversion toward lending to corporates, and increased concentration in risk-free investments with a marginal rise in deposits resulted in the fall of Advances to Deposit ratio from 61.4% in last year to reach 53.6% by the end of current year under review.
Significant pressures on the liquidity can be observed during the second half of 2011 with overnight rates remaining volatile in the months of August Nov and December on account of significant government borrowing from commercial banks. Therefore, SBP had to inject money a large sum of more than Rs. 5 Trillion (Approx.) through OMOs to maintain liquidity during the second half of year 2011.
Funding structure of the bank remained essentially identical in 2011 compared to last year with marginal changes in deposits and borrowing from financial institutions. The share of deposits slightly fell to reach 76% with the share of borrowing rising to 8.3%. Banks borrowed on cheap rates and invested in investments portfolio offering attractive returns. However, overall increased reliance on low cost deposit funding is a good sign for liquidity of the banks.
During the first half of the year, share of deposits with maturity 1 year and above increased as a result of SBP's policy changes which allow banks to exempt time deposits with maturity of one or more than one year from SLR. The share of Deposits with maturity of less than 1 year fell in the first half of 2011 owing to SBP's revised policy of reporting non-contractual deposits having maturity of less than 1 year on expected maturities.
In March 2011, banks crossed Rs.1 Trillion in terms of excess liquidity held over SLR requirements. By the end of the year, liquidity position improved further and by Dec 2011 banks had Rs. 1.6 trillion in excess liquidity. Overall, the liquidity of the banking sector has shown improvement over the past years as a result of stable growth in liquid investments and long term deposits.
Market Risk: The growing share of investment portfolio of banks is making Market Risk more significant and challenging to manage. Even though the share of Market Risk Weighted Assets (MRWA) in Total Risk Weighted Assets (TRWA) is trivial at 7.2% (Dec 2011), MRWA overall grew by 25% YOY. In 2011, banks added Rs. 70.7 billion worth of MRWA to their portfolios and more than 80% of these MRWA are Government papers.
Yield Curve flattened in 2011 signaling short term tightening of liquidity along with an expectation of low long term inflation and concerns about long term economic growth.
Banks had an increased exposure to yield curve during 2011 owing to increasing investments in government papers, thereby increasing their exposure to market risk. A small change in yield curve can have a significant impact on banks' revenues and expenses as the share of investments in markup earned rose to 39.8% from 31% a year ago. However the flattening of yield curve after 3 year maturity reduced the yield curve risks for banks' as most of their investment portfolios are concentrated in short term government papers.
Most of banks' investments were classified as Available for Sale (AFS) with Market Treasury Bills (MTBs) accumulating the major chunk. Twice cuts of 50 bps and 100 bps in the policy rate by SBP had significant impact on banks revaluation accounts.
KSE100 Index generated a negative return of -5.6% during CY11. Large foreign outflows were observed during CY11 as investors became cautious after weak real sector growth prospects, high inflation, and continuously depreciating rupee. Also, Stock Market remained highly volatile in the second half of the year and shed nearly 1,000 points in the month of August. Equity portfolios of big 5 banks produced a mix performance with some gaining while other losing. However, attractive returns from government papers prevented banks by taking too much risk via equity investments.
In spite of record healthy inflows in the form of home remittances, External Accounts posted a deficit of US$1.8 Billion in CY11 on account of rising imports, falling exports, and weak inflows from financial and capital accounts. As a result, Pakistani Rupee depreciated by 5% in CY11. Fertilizer and Oil import bills constituted the largest part of imports and a rise in oil prices during CY11 put high pressures on the import bill, consequently.
Academic Literature Review
Liebig, Daniel, Weder, & Wedow (2007) investigated the impact of Basel II on bank lending using data from German banks and found out that Basel II will have limited impact on bank lending. Basel II has improved the regulatory capital so that now it accurately reflects the risks on bank's balance sheet; thus bringing it close to economic capital. However, most of the new banks are already using advanced Value at Risk techniques in managing their balance sheet risks, and therefore, are keeping adequate capital close to their economic capital. Therefore, the implementation of Basel II will not have material impact on bank's financial position.
Hakenes & Schnabel (2011) investigated the link between bank size and risk-tolerance of banks under Basel II under the conditions of imperfect competition and moral hazard. The study found out that the implementation of Internal Ratings Based (IRB) Approach reduces the capital requirements for the banks if implemented uniformly across the banking sector with minimum costs. The implementation of IRB approach requires significant investment in risk management department both in terms of human capital and processes. In this case, large banks are at an advantage to adopt IRB approach under Basel II because these banks can more easily make the required investment compared to smaller banks. As a result, large banks enjoy lower capital requirements and have more funds to lend compared to smaller banks; and thus can enjoy better profitability and financial flexibility.
Montgomery (2005) explored the impact of stringent capital requirements on banks' asset portfolios by analyzing banks' balance sheets over the period of 1982 - 1999. The study found out that a change in regulatory capital does not have a material impact on banks' asset portfolios. Though, a change in core tier-I capital does bring a significant change in the asset portfolio of international banks. International banks having low core tier-I capital have a tendency to include less risky government securities in portfolio from high risky corporate loans. It was also found out from the analysis of balance sheets that the shift in the asset portfolios of banks was a post Basel phenomenon. One of the identified limitations of the Basel framework was that the Basel framework gives similar weights to loans of all types of quality. Therefore, banks tend to lend to high risky borrowers to earn higher income. Therefore, a deliberate effort to refine the Basel framework capital rules is needed.
Jacques (2008) observed the effects of Basel II implementation on banks' overall total lending. The study analyzed the impact of using external credit ratings under the standardized approach to gauge credit risk on banks' portfolios. Under this study, (Jacques, 2008) found out that the implementation of Basel II results in reduction of total bank lending and limited lending to high risk borrowers. Basel II implementation results in a larger decrease in total lending and reduction in high risk lending than Basel I.
Mr. Caruana (2004) Governor, Bank of Spain and Chairman of Basel Committee on Banking Supervision, in a Bankers Conference on implementation of Basel II in emerging markets, discussed the impact of using simple or advanced approaches under Basel II. He added that the adoption of advanced approaches does not merely guarantee lower capital. These approaches line up capital requirements in accordance with the risk taken. Also, minimum regulatory capital requirements are directly proportional to the risk taking by the banks in the economic environment.
Macroeconomic Assessment Group, Financial Stability Board and the Basel Committee on Banking Supervision (2010) estimated that the adoption of new stricter capital requirement regulations by the banks laid out in Basel III, will slightly impact the global growth. "GDP is projected to fall by 0.22% below its baseline level in the 35th quarter after the start of implementation". These results will be calculated based on the 8 year transition period given by Basel committee to banks. However, if the transition period is reduced or banks comply with strict capital requirements early, than in that case the impact on GDP and growth will be higher. Some of the macroeconomic factors that were held constant during the simulation were "the ability of banks to alter their business models in response to the new capital regime; the development of nonbank credit channels; and the capacity of markets to absorb new equity offerings by banks".
State Bank of Pakistan (2011) in Financial Stability Review 1H2011 compared the liquidity position of Pakistani banks with the requirements of Basel III. Based on the analysis, the central bank found out that Pakistani Banks meet the liquidity requirements of the new Basel III accord. The liquidity coverage ratio, which deals with the ability of banks to meet liabilities of less than 30 days, is at 103% by June 2011 and above the requirement of 100%. Furthermore, Net Stable Funding ratio, which is related to the ability of bank to meet long term liabilities stable sourcing of funding, is also above the required benchmarks. Net Stable Funding ratio stood at 138% by June 2011, fairly above the Basel III requirement of 100%.
State Bank of Pakistan (2011) arranged a seminar on "SAARCFINANCE Regional Seminar on Basel-III and Policy Response in SAARC Countries". Speaking on the occasion, Deputy Governor SBP, Mr. Yaseen Anwar stated that banks in Pakistan will comfortably meet Basel III capital, solvency and liquidity requirements. In his speech, he also identified 1) lack of IT systems, and 2) Data capturing requirement for internal ratings under new Basel framework, as the two main causes of the banks' inability to fully comply with Basel framework in Pakistan. Advancements in the current IT infrastructure at local banks, and data availability for using Internal Rating Based models of risk management, are a perquisite for the implementation of advanced approaches of Basel framework.
Clerc, et al. (2011) analyzed the long term impact of the new Basel III capital and liquidity requirements and the impact of these new rules on long term economic performance and economic fluctuations using macroeconomic models. They found that a 1% increase in capital requirements will have a 0.09% linear declining effect on steady state output. Also, a 25-50% increase in liquid assets as a percentage of total assets will decrease steady state output by 0.08% and 0.15%, respectively. Furthermore, strict capital requirements are expected to slightly reduce the economic output volatility as well.
Cosimano & Hakura (2011) examined the effects of new capital requirements on bank lending rates and loan growth in developed countries from the period 2001-2009. They found out that capital requirements have a positive linear relationship with bank lending rates, and a negative linear relationship with loan growth. They also estimated that to conform to 7% equity to new risk weighted assets, banks' have to raise interest rates by 0.16%. Also, the following increase in lending rates is expected to reduce loan growth by 1.3%. Cosimano & Hakura (2011) also found out that the resulting increase in lending rates, as a result of 1.3% increase in equity, varies from country to country.
Akhtar (2006) identified six issues and challenges faced by local banks in Pakistan to fully adopt Basel II principles. Banks in Pakistan need to develop effective policies and procedures to strengthen the existing risk management framework. Identification of the need for an improved risk management system will create a strong motive for the bank to adopt advanced Basel risk management framework. Furthermore, reliable and accurate data is required to fully implement the advanced internet rating based approaches in the banks' risk management system which is a major issue for local banks in Pakistan. The quality and accuracy of data along with the quality of controls needs to be improved. Currently, banks in Pakistan lack the required IT infrastructure and support systems in Pakistani banks to fully adopt Basel principles. Another issue faced by financial institutions in Pakistan is the lack of strong coordination between SBP and SECP on Basel implementation. Financial services companies, which fall under SECP jurisdiction, do not face the Basel implementation plan laid out by SBP. As a result, these finance companies are not bound to adhere to Basel risk management principles. Moreover, Akhtar (2006) pointed towards the existence of large players and asymmetric information that has made local markets imperfect and eroded the confidence of small investors on local markets. Therefore, the market data available is expected to be distorted and biased. As a result, the market risk management principles laid out in Basel II cannot be implemented in their true spirit. Additionally, the actual aftereffects of Basel framework adoption are still not clear and the critiques point towards the problems as a result of pro-cyclicality. Banks may restrict lending during economic slumps as the credit worthiness of borrowers deteriorates. In this regard, capital buffers in the Basel III framework has been proposed to alleviate these problems. Lastly, Akhtar (2006) identified a major issue caused by full adoption of Basel risk framework which is the lending to special sectors e.g. Agriculture, SME etc. on discounted and subsidized terms. The borrowers of loans in these sectors usually have poor credit worthiness and banks need to boost capital before lending to these special sectors. As a result, the above phenomenon restricts the banks to provide financing to the deserving and malnourished sectors of the economy.
TONVERONACHI (2009) studied the criticism on the consequences of Basel II, more specifically the negative effects on "financial efficiency and stability" in developing countries, and concluded that "a change of approach is needed, going from Basel regulatory level playing field to a stability level playing field". In other words, TONVERONACHI (2009) proposed that instead of a uniform framework applicable to all countries, the Basel accord framework should be tailored according to developing countries' economic maturity. He added that some of the approaches in Basel II framework specifically require additional guidelines to manage the risk against investment in advanced financial instruments, the practice of which is mostly non-existent or minimal in developing countries. Furthermore, TONVERONACHI (2009) also concluded that the successful implementation of Basel framework in developing countries require independent supervisory authorities with the required knowledgeable human resource and infrastructure. The economic structure in developing countries should be conducive to the Basel framework for effective implementation. TONVERONACHI (2009) proposed, "Allowing the developing countries to have place and voice in international institutions such as Basel Committee on Banking Supervision (BCBS) is often seen as a way to bend rules, standards and codes to their characteristics and interests".
Research design
Research Objectives
This research aims to identify the reasons behind the inability of banks in Pakistan to fully implement Basel II principles in risk management frameworks. In addition, the study also tries to identify the effects of full Basel II and Basel III implementation on Pakistani Banks.
The study will help strategy makers and policy planners in government, central bank, and local banks to 1) identify and address the problems hindering the full adoption of Basel II by banks in Pakistan, and 2) proactively analyze the effects of Basel framework implementation on bank lending and portfolio management to make sound economic decisions.
Research Questions
Why Basel II has not been fully implemented in Pakistani Banks? What are the causes and reasons that are delaying the full implementation of Basel II?
In case of complete implementation of Basel II and III, what is the expected impact on Pakistani Banks?
Justification of Research
The full implementation of Basel principles in the risk management framework of a bank will enable it to closely align its regulatory capital with economic capital; thus helping the bank to improve its risk management and profit making ability. Furthermore, implementation of Basel will educate the risk managers and provide sound guidelines to manage bank's portfolios well under both normal and stress conditions. Basel principles will improve the risk analytics and data collection methodologies necessary for the employment of advanced risk management approaches. Basel risk management framework will help the bank's customers in securing fair rates as loan pricing under Basel principles will reflect the actual risks. Such loan pricing will help low risk customers to get loans at lower rates from banks. The complete implementation of Basel risk management framework across banks will bring up banking risk management practices closer to modern risk management practices as Basel framework incorporates advanced approaches of risk management. Basel II complete implementation will help the local banks in risk management and loan pricing. Therefore, a study needs to be conducted to analyze the existing literature and seek opinions of experts in the industry to identify the reasons behind the inability of banks to fully implement Basel II framework and the possible effects of complete implementation of Basel II and III framework. The study will help policy makers in government and central bank in addressing and identifying the problems behind the inability of banks to implement Basel and also in effective future decision making in relevant matters.
Limitations
A thorough quantitative analysis of Basel framework effects on banks' financial structure, position, and performance requires banks' internal data. Banks treat internal data as confidential and do not share it with outside parties. Therefore, the study was not able to identify the quantitative impact of Basel II and III implementation on banks' financial position, performance, and lending practices.
Research Methodology
Qualitative research, in the form of interviews and analysis of relevant published literature, has been used in the research. Both primary and secondary data is being employed in this research to find the answers to research questions.
In terms of primary research, interviews were conducted from three leading risk management professionals in the industry. The first interviewee, Mr. Zulfiqar Patel, is a senior manager at Ernst & Young and has many years of experience in providing business risk consulting services relating to Basel II & III implementation to banks in Pakistan and Afghanistan. He provided his valuable insight on the subject matter by delivering the opinions from risk consulting services as he is directly involved in the implementation of Basel at many banks. The second interviewee, Mr. Asad Ali Shariff, is Financial Controller at Standard Chartered Bank Pakistan and is the focal person responsible for Basel risk management framework at Standard Chartered Bank Pakistan. He provided the perspective of banks in Pakistan. Third interviewee was Ms. Lubna Farooq Malik, a senior director at State Bank of Pakistan, and one of the senior members of the team responsible for Basel framework implementation and supervision of risk management practices at local banks in Pakistan. Ms. Lubna has been involved in a number of local and international conferences on Basel framework implementation. She provided insight on the challenges faced by Central Bank in implementing Basel framework in local banks.
Secondary data was collected from relevant research published in notable journals, reports by Bank for International Settlements, Central Banks, local banks, Standard Chartered Bank, Accounting Firms, and other published datasets and articles on the subject matter.
Primary Research
Interviews
Interview # 1
Interviewee: Zulfiqar Patel, ACA (ICAEW), CFA, FRM, PRM
Senior Manager
Business Risk Services
Ernst & Young Ford Rhodes Sidat Hyder
Why Basel II has not been fully implemented in Pakistani Banks as yet? What are the causes and reasons that are hindering the full implementation of Basel II?
Response:
Lack of data to implement risk management approaches under Basel II
Lack of expertise to conduct the requisite risk analytics
Lack of funds to undertake the expensive implementation
In case of complete implementation of Basel II and III, what is the expected impact on Pakistani Banks?
Response:
It could lead to a number of advantages:
Better credit/market and operational risk management on account of empirical rating models
Encouraging banks to compute the Internal Capital Adequacy and match it against the risk profile of the bank
Enhancing confidence of the International Correspondents/ Rating Agencies in the organization
Better preparation against stress events/ unforeseen scenarios
Higher amount of capital buffer for risk-averse banks with lower default history in credit risk, lower incident rate with respect to Operational Risk etc.
In my view no material impact on local ratings, I do not think the local rating agencies fully appreciate the Basel II Advanced Approach. However, international ratings may be impaired in the long term (it is unclear how they stand in the short run), however these are already subject to a significant downgrade due to Pakistan's poor country rating.
Interview # 2
Interviewee: Asad Ali Shariff
Financial Controller
Central Finance Team
Standard Chartered Bank
+92 21 32450867
Why Basel II has not been fully implemented in Pakistani Banks? What are the causes and reasons that are hindering the full implementation of Basel II?
Response:
Banks in Pakistan feel that the cost of implementing Basel framework exceeds the benefits derived from the implementation. For example, in current scenario where banks have full discretion to either adopt or not adopt Basel II principles, banks that will adopt Basel framework will price the lending asset portfolio at higher rates for higher risk borrowers compared to banks that have not adopted Basel framework. As a result, the banks' that have adopted Basel framework will be at a disadvantage as other non-complying banks will offer more attractive lower rates to same borrowers. Therefore, banks in Pakistan are reluctant to fully adopt Basel framework in the absence of any directive from the regulatory authority, the State Bank of Pakistan.
Banks in Pakistan lack the appropriate risk quantification and data warehousing infrastructure which are the necessary requirements to adopt advanced approaches of Basel framework. Furthermore, banks along with the regulator lack the necessary expertise to implement Basel framework completely.
In case of complete implementation of Basel II and III, what is the expected impact on Pakistani Banks?
Response:
In case of complete implementation of Basel framework in Pakistan, lending will largely depend on the riskiness of the borrowing party. In such scenario, risk based pricing will give rise to higher lending rates for high risk borrowers. Contrary to the current scenario where banks are willing to lend regardless of the risk and pricing is not based on the risk of loss.
Currently, banks in Pakistan easily comply with Basel III liquidity requirements because of the significant presence of government liquid securities on balance sheets. However, once the lending takes off in the local market and Advances to Deposits rise, the liquidity will fall down. In that case, banks may face problems to comply with Basel III.
I believe the inability of banks to fully comply with Basel framework had a minor impact on the credit rating of banks. Credit ratings of the banks in Pakistan are already quite low due to the low country rating by international credit rating agencies. The credit ratings of banks in a certain country are limited by country credit rating. In other words, credit ratings of banks operating in a country cannot exceed the country credit rating.
Interview # 3
Lubna Farooq Malik
Senior Director, Basel Implementation
Banking Supervision and Surveillance
State Bank of Pakistan
Why Basel II has not been fully implemented in Pakistani Banks? What are the causes and reasons that are hindering the full implementation of Basel II?
Response:
The reasons which are limiting the implementation of Basel II at local banks are quite a few. First of all, Basel II requires the availability of reliable and accurate data, which is currently a major challenge for the banks in the industry. Banks are operating in an environment of minimal data transparency and lack appropriate data support systems. Secondly, Basel II adoption requires significant management dedication and resources, which at the moment, managements of many banks are not willing to spend. Thirdly, in the presence of financial markets manipulation, it is greatly difficult for the banks to adopt advanced credit and market risk approaches which assume the existence of perfect markets and fair pricing. Furthermore, banks in the industry lack the culture, expertise and human resource necessary for a sound risk management structure. Therefore, it has been hard for banks to fully comply with Basel II risk management framework.
In case of complete implementation of Basel II and III, what is the expected impact on Pakistani Banks?
Response:
Basel III was introduced recently to improve the capital adequacy and financial stability of global banks. The framework was restructured with the introduction of several new liquidity, capital, and leverage requirements. To strengthen the capital, the share of common equity in total bank capital was increased with the Core Tier-1 common equity capital increasing to 4.5% of total risk weighted assets (RWA) and total tier-1 capital raised to 6% from existing 4% by 2015. Furthermore, banks are required to hold a capital conversation buffer equal to 2.5% of RWA to deal with capital constraints during stressed out economic cycles. Furthermore, the inclusion of new countercyclical capital buffer in banks' capital during overheated lending periods will help the regulator in keeping the banks from taking on excessive leverage. Therefore, yes, the balance sheets of banks will definitely be affected in case of implementation of Basel III. I guess it has very minimal on no impact on the international credit ratings of local banks. The local credit rating companies does not believe to give credit to implementation of Basel framework in local banks' credit ratings.
Primary Research Analysis
Primary research in the form of interviews of industry leading experts in Basel framework implementation has provided a comprehensive insight about the problems faced by banks in Pakistan to fully implement Basel II framework and the possible impact from the complete implementation of Basel risk management framework in local banks. The information provided in these interviews is both reliable and up to date as the professionals being interviewed are responsible for Basel implementation at different levels in central bank, local banks, and risk consulting services.
The interviewees identified six problems that are hindering the full implementation of Basel II at local banks. These problems namely are 1) non-availability of data, 2) lack of expertise, 3) implementation costs exceeding benefits, 4) disadvantages arising from risk based pricing, 5) market manipulation, and 6) lack of funds to implement Basel II framework.
Risk management approaches under Basel II require the availability of accurate and reliable financial data. Banks currently do not have the required systems and infrastructure to gather data for complete implementation of Basel framework. Furthermore, some data provided by borrowers, e.g. private limited companies, is often distorted and manipulated in Pakistan where data transparency in financial disclosures is observed to be weak.
Moreover, banks in Pakistan still do not have the required trained human resource and knowledge to implement Basel framework especially in areas related to operational risk management. Business education in institutions still lacks appropriat
