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

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
2

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

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

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.

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

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

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

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 5.8
9

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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 Expertise
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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 covered for Data Collection of Default Time Series 6.5.12 Relationship between Bank Type and Compliance with Market Discipline 6.5.13 Relationship between CAR Trend and Compliance with Market Discipline 6.5.14 Relationship between Bank Type CAR Trend and Basel Customer Awareness 6.5.15 Relationship between Bank Type, CAR Trend and C R Employees Ratio to C R Weighted Asset 6.5.16 Analysis of the Results relating to the variable Involvement of External Trainer 6.48 6.48 6.49 6.49 6.50 6.51 6.52 6.53

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CHAPTER 7 SUMMARY FINDINGS CONCLUSIONS AND RECOMMENDATIONS 1 2 3 4 5 6 7 8 9 10 7.1 Introduction 7.2 Summary Findings 7.2.1 Summary Findings of Questionnaire Results 7.1 7.1 7.1

7.2.2 Summary Findings of Radar Diagram and CAR Trend Results 7.3 7.2.2.1 Analysis of Radar Diagrams 7.2.2.2 Analysis of CAR Trend 7.2.3 Summary Findings of Cross Tabulation Results 7.3. Conclusions 7.4 Policy Recommendations 7.5 Areas of Further Study 7.3 7.4 7.5 7.7 7.9 7.10

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LIST OF TABLES AND DIAGRAMS: 1 2 3 4 5 6 7 8 9 10 11 12 13 14 2.5.1-Overview of the New Basel III Capital and Liquidity Rules for Banks 2.9- Table of Review of Three Basel Accord 5.1- Table Key Statistics of our Banks 5.2- Table Capital Adequacy Ratios of Banks in the Sample from 2005-2009 6.2.1-Table and Diagram for the importance of Implementation of Basel II in Pakistan. 6.2.2-Table and Diagram for the significance of Implementation of Basel Accord respective Bank. 6.2.3-Table and Diagram for inclination of respective Bank towards Implementation of Basel Accord. 6.2.4-Table and Diagram for Basel Accord Implementation more Problems than Advantages. 6.2.5-Table and Diagram for Basel Accord improvement in Risk Management Processes. 6.2.6-Table and Diagram for Basel Accord improvement in Corporate Governance. 6.2.7-Table and Diagram for advantages of individual approach to Banks. 6.2.8-Table and Diagram for advantages of internal risk models for capital calculation. 6.2.9-Table and Diagram for effect of Basel Accord on lower the capital requirement for some of the Banks 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. 6.2.11-Table and Diagram for effect of Information Technology, and HR Problems on the implementation of Basel Accord 6.2.12-Table and Diagram knowledge of employees in the bank about standards of Basel Accord 6.2.13-Table and Diagram for delivery of education about the Basel Accord by the Bank to its employees. 6.2.14-Table and Diagram for involvement of external trainer for the training of Bank Staff for Basel Accord. 6.2.15-Table and Diagram involvement proficiency of employees in the risk management process 6.2.16-Table and Diagram for special Basel Accord Implementation Department 6.2.17-Table and Diagram for performance of Basel Accord Implementation Department
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2.9 2.15 5.4 5.4 6.2 6.2 6.3 6.3 6.4 6.4 6.5 6.5 6.6 6.6

15 16 17 18 19 20 21

6.7 6.7 6.8 6.8 6.9 6.9 6.10

22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43

6.2.18-Table and Diagram for performance of staff responsible for the implementation of Basel Accord. 6.2.19-Table and Diagram for effectiveness of Basel Accord implementation plan in respective Bank. 6.2.20-Table and Diagram for attachment of the Banks with any Banking Group and reporting standards. 6.2.21-Table and Diagram for meeting the group capital adequacy standards compliance 6.2.22-Table and Diagram for comparison of IT updation costs to with personnel training and outsourcing: 6.2.23-Table and Diagram for Changes required in system for Basel Accord compliance. 6.2.24-Table and Diagram for collecting sensitive information like personal traits. 6.2.25-Table and Diagram for Bank willing to share data of large customers 6.2.26-Table and Diagram for resolving data protection issue under Basel Accord by taking consent declaration of the customers 6.2.27-Table and Diagram for national legislation on Basel II for data protection. 6.2.28-Table and Diagram for current/drafted (if existing) clarity about national data protection of Basel Accord. 6.2.29-Table and Diagram for compliance of current IT with Basel Accord Requirements for Credit Risk, Operational Risk and Market Risk 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 6.2.31-Table and Diagram for compliance of current database design, internal models, and budgets with Basel Accord 6.2.32-Table and Diagram for approach of the bank for measuring credit risk in your bank 6.2.33-Table and Diagram for internally developed methodology for identifying and measuring credit risk 6.2.34-Table and Diagram for risk categories for ranking of debtors 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 6.2.36-Table and Diagram for methods for measuring economic capital for credit risk 6.2.37-Table and Diagram for market risk measurement in respective bank 6.2.38-Table and Diagram for years covered by time series for market risk assessment 6.2.39-Table and Diagram for methods for developing economic capital for market risk
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6.10 6.11 6.11 6.12 6.12 6.13 6.13 6.14 6.14 6.15 6.15 6.16 6.17 6.18 6.18 6.19 6.19 6.20 6.21 6.22 6.22 6.23

44 45 46 47 48 49 50 51 52 53 54

6.2.40-Table and Diagram for measuring operational risk in the respective bank 6.2.41-Table and Diagram for years covered by time series for operational risk assessment 6.2.42- Table and Diagram for methods for measuring economic capital for operation risk 6.2.43- Table and Diagram for Supervisory Review guidelines 6.2.44-Table and Diagram for availability of resources with the supervisor to comply with the principles of Basel Accord 6.2.45-Table and Diagram for challenging segment of Pillar I to be monitored under supervisory review process 6.2.46-Table and Diagram for requirement for additional legal processes within the national legal regime for appropriate implementation of Basel Accord 6.2.47-Table and Diagram for requirement of additional risks to be captured in Pillar I. 6.2.48-Table and Diagram for Banks compliance of disclosure requirement of Basel Accord Market Discipline 6.2.49-Table and Diagram for possibility of national legislation to be hindrance is meeting disclosure requirements under Basel Accord 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. 6.2.51- Table and Diagram for initiation of any customer awareness for complying with the Market Discipline Requirement of Pillar III 6.4.1-KASB Radar Diagram and CAR Trend 6.4.2-Standard Chartered Bank Radar Diagram and CAR Trend 6.4.3-Askari Bank Radar Diagram and CAR Trend 6.4.4-Allied Bank Limited Radar Diagram and CAR Trend 6.4.5-NIB Bank Radar Diagram and CAR Trend 6.4.6-MCB Bank Radar Diagram and CAR Trend 6.4.7-NBP Bank Radar Diagram and CAR Trend 6.4.8-Bank Alfalah Radar Diagram and CAR Trend 6.4.9-Faysal Bank Radar Diagram and CAR Trend 6.4.10-United Bank Radar Diagram and CAR Trend 6.4.11-Bank of Punjab Radar Diagram and CAR Trend
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6.23 6.24 6.24 6.25 6.25 6.26 6.26 6.27 6.27 6.28 6.28

55 56 57 58 59 60 61 62 63 64 65 66

6.29 6.31 6.32 6.33 6.34 6.35 6.36 6.37 6.38 6.39 6.40 6.41

67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84

6.4.12-Habib Bank Limited Radar Diagram and CAR Trend 6.4.13-Radar Diagram of an Ideal Bank 6.5.1 Table of Relationship between CAR Trend and Bank Type 6.5.2 Table of Relationship between Bank Type and Bank Inclination 6.5.3 Table of Relationship between CAR Trend and Bank Inclination 6.5.4 Table of Relationship between Bank Type and Risk Management Employees Expertise 6.5.5 Table of Relationship between CAR Trend and Risk Management Employees Expertise 6.5.6 Table of Relationship between Bank Type and Basel Plan Effectiveness 6.5.7 Table of Relationship between CAR Trend and Basel Plan Effectiveness 6.5.8 Table of Relationship between Bank Type and Data Collection Methodologies Changes due to Basel Accord 6.5.9 Table of Relationship between CAR Trend and Data Collection Methodologies Changes due to Basel Accord 6.5.10 Table of Relationship between Bank Type and Period covered for Data Collection for Default Time Series 6.5.11 Table of Relationship between CAR Trend and Period covered for Data Collection for Default Time Series 6.5.12 Table of Relationship between Bank Type and Compliance with Market Discipline 6.5.13 Table of Relationship between CAR Trend and Compliance with Market Discipline 6.5.14 Table of Relationship between Bank Type CAR Trend and Basel Customer Awareness 6.5.15 Table of Relationship between Bank Type, CAR Trend and Credit Risk Employees Ratio to Credit Risk Weighted Asset 6.5.16 Table of Analysis of the Results relating to the variable Involvement of External Trainer

6.42 6.43 6.44 6.44 6.45 6.45 6.46 6.46 6.47 6.47 6.48 6.48 6.49 6.49 6.50 6.50 6.51 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
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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).
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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:

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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.

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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.

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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
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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 Cronbachs 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,
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Chapter 7 gives us results, conclusions, recommendations and directions regarding the area of future study.

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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 70s 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

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during the 90s 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
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supervision and bank management with market discipline to ensure security and reliability of the dynamic and intricate banking system.

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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 banks 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 banks capital with underlying risks and a better configured level of capitalization (Makwiramiti, 2008).
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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 RiskWeighted 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 borrowers 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,
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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
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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).
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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:

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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:
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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
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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 Capital Rules- Liquidity Ratios Prudential Macro Prudential A-Own Funds E-Reduction Procyclality of G-Liquidity Coverage Ratio Macroeconomic Impact I-Short Term (during Implementation)

B-Regulatory Capital C-Leverage Ratio D-Convertible Capital

F-Measures against H-Net Stable J-Long Term (After Systemic risks Funding Ratio Implementation)

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
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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

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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.
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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 banks regulatory capital falls below the minimum capital requirement, a situation where hasty corrective measure will be requires; An instance where the a banks 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

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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.

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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.
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2.9 TABLE OF REVIEW OF THREE BASEL ACCORD:

Focus Measures of Risk Sensitivity of Risk Basel I Single Broad brush approach Basel II Broad Enhanced Risk Sensitive Basel III Economy Wide Enhanced Economy and Sector Risk Sensitive Credit Risk Mitigation Limited Recognition Comprehensive Recognition Through The Time Mitigation of Credit Risk Operational Risk Flexibility Excluded One fits for all approach Included Menu approaches Included Menu approaches with comprehensive approach. Supervisory Review Implicit Explicit Explicit with single view of economy and bank regulations. Market Discipline Incentives Not Addressed Not Addressed Addressed Addressed and well defined Addressed 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
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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 risksensitive 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.
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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:

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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
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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

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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
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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
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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
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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
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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
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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

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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
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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
54

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-tovalue 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

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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
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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

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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.
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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
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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
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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.

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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:

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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
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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
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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:
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 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 2005 2006 KASB 9.34 8.95 SCB 6.45 8.14 ACB 11.3 12.37 ABL 12.17 12.8 NIB 11.61 17.44 MCB 12.54 18.65 NIB 11.51 16.5 BALF 8.66 9.48 FBL 12.01 11.42 UBL 9.26 11.1 BOP 12.78 10.09 HBL 9.93 12.81

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2007 2008 2009

12.18 9.45 13.2 10.26 3.33 16.73 18.05 9.85 9.05 9.99 12.1 10.9 19.52 16.28 16.9 8.03 3.53 11.57 13.5 13.47 19.53 19.07 17.23 12.46 *Data Source: expected figure from the last available financial statements

10.27 10.84 12.36

10.32 9.96 13.18

9.69 1.92 7.68*

11.6 12.33 13.07

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
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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.

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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

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Declining Improving

1 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.

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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:

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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 Cronbachs 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:
71

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

72

with Cross Section Data and for the purpose of such data Cross Tabulation gives better analysis than any other Correlation method.

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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:

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6.2.1-Do you perceive the importance of Implementation of Basel II in Pakistan is highly significant:

6.2.2-Do you think that the Implementation of Basel Accord will be highly significant in your Bank.

Pak_Sig Valid Percent 6.7 41.7 30.0 16.7 5.0 100.0 Cumulative Percent 6.7 48.3 78.3 95.0 100.0

Bank_Sig Valid Percent 6.7 48.3 31.7 10.0 3.3 100.0 Cumulative Percent 6.7 55.0 86.7 96.7 100.0

Valid

Strongly Agree Agree Neither Agree Nor Disagree Disagree Strongly Disagree Total

Frequency 4 25 18 10 3 60

Percent 6.7 41.7 30.0 16.7 5.0 100.0

Valid

Strongly Agree Agree Neither Agree Nor Disagree Disagree Strongly Disagree Total

Frequency 4 29 19 6 2 60

Percent 6.7 48.3 31.7 10.0 3.3 100.0

Explanation: Respondents of the Banks do not consider that Basel Accord has very high importance in Pakistan.

Explanation: Majority of the respondents of the Banks agree that Basel Accord has importance for Banks more than for Pakistan.
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6.2.3-Your Bank has very high inclination towards the Implementation of Basel Accord:

6.2.4-Do you think that Basel Accord Implementation will have more Problems than Advantages:

Bank_Incl Frequ ency Vali d Strongly Agree Agree Neither Agree Nor Disagree Disagree Total 3 15 29 13 60 Valid Percent 5.0 25.0 48.3 21.7 100.0 Cumulativ e Percent 5.0 30.0 78.3 100.0

Prob_Vs_Adv Valid Percent 36.7 11.7 51.7 100.0 Cumulative Percent 36.7 48.3 100.0

Percent 5.0 25.0 48.3 21.7 100.0

Valid

Agree Neither Agree Nor Disagree Disagree Total

Frequency 22 7 31 60

Percent 36.7 11.7 51.7 100.0

Explanation: Majority of the respondents opined that their Banks are inclined to Basel Accord Implementation.

Explanation: Majority of the respondents consider that Advantages of Basel Accord will be more than problems. However, the results are not decisive in nature.
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6.2.5-Do you think that Basel Accord will improve Risk Management Processes:

6.2.6-Do you think that Basel Accord will Improve Corporate Governance:

Impr_in_RMP Frequenc y Vali d Strongly Agree Agree Neither Agree Nor Disagree Disagree Total 3 34 20 3 60 Valid Percent 5.0 56.7 33.3 5.0 100.0 Cumulative Percent 5.0 61.7 95.0 100.0

Impr_in_CGov Frequenc y 10 23 27 60 Valid Percent 16.7 38.3 45.0 100.0 Cumulative Percent 16.7 55.0 100.0

Percent 5.0 56.7 33.3 5.0 100.0

Valid

Agree Neither Agree Nor Disagree Disagree Total

Percent 16.7 38.3 45.0 100.0

Explanation: A majority of the respondents agree that Basel Accord will improve Risk Management Processes.

Explanation: The respondents opined that Basel Accord will not improve Corporate Governance.
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Pakistani Banking System. 6.2.7-Do you think that individual approach to Banks will be advantageous to the Banking System as a whole? 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:

Indvapp_Adv Frequen cy Vali d Agree Neither Agree Nor Disagree Disagree Total 33 19 8 60 Valid Percent 55.0 31.7 13.3 100.0 Cumulativ e Percent 55.0 86.7 100.0 Valid Strongly Agree Agree Neither Agree Nor Disagree Disagree Total Frequency 1 34 17 8 60 IntRiskMdl_Adv Valid Percent 1.7 56.7 28.3 13.3 100.0 Cumulative Percent 1.7 58.3 86.7 100.0

Percent 55.0 31.7 13.3 100.0

Percent 1.7 56.7 28.3 13.3 100.0

Explanation: Majority of the respondents agree that Individual Approach will be advantageous to the whole

Explanation: Majority of the respondents agree that

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Internal Risk Model Approach will be advantageous to the whole Pakistani Banking System.

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6.2.9-Do you think that Basel Accord will lead to Lower Capital Requirements for some of the Banks:

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_LCapital Bsl_HCapital Frequenc y Vali d Strongly Agree Agree Neither Agree Nor Disagree Disagree Total 1 34 3 22 60 Percent 1.7 56.7 5.0 36.7 100.0 Valid Percent 1.7 56.7 5.0 36.7 100.0 Cumulative Percent 1.7 58.3 63.3 100.0 Frequency Valid Strongly Agree Agree Neither Agree Nor Disagree Disagree Total 1 44 6 9 60 Percent 1.7 73.3 10.0 15.0 100.0 Valid Percent 1.7 73.3 10.0 15.0 100.0 Cumulative Percent 1.7 75.0 85.0 100.0

Explanation: Majority of the Banks Agree that Basel Accord will lead to Lower Capital Requirements for some

Explanation: Majority of the Banks Agree that Basel Accord will lead to Higher Capital Requirements for some
80

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:

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 IT_HR_Hind Cumulative Percent 8.3 96.7 100.0 Valid Agree Neither Agree Nor Disagree Disagree Strongly Disagree Total Frequency 5 11 43 1 60 Percent 8.3 18.3 71.7 1.7 100.0 Valid Percent 8.3 18.3 71.7 1.7 100.0 Cumulative Percent 8.3 26.7 98.3 100.0

Frequency Valid Strongly Agree Agree Disagree Total 5 53 2 60

Percent 8.3 88.3 3.3 100.0

Valid Percent 8.3 88.3 3.3 100.0

Explanation: A significant majority of the respondents is of the view that IT and HR issues shall be a problem in the

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.
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6.2.13-Do you think that the education about the Basel Accord is being imparted adequately by your Bank to its employees:

6.2.14-Has your Bank involved any external trainer for the training of Bank Staff for Basel Accord:

Bsl_Trng Cumulative Percent 8.3 23.3 100.0 Valid Yes No Total Frequency 50 10 60 Percent 83.3 16.7 100.0 Valid Percent 83.3 16.7 100.0

Valid

Agree Neither Agree Nor Disagree Disagree Total

Frequency 5 9 46 60

Percent 8.3 15.0 76.7 100.0

Valid Percent 8.3 15.0 76.7 100.0

Ext_Trnr_Inv Cumulative Percent 83.3 100.0

Explanation: A significant majority of the respondents is of that the Banks are not imparting Basel Accord training adequately.

Explanation : Most of the Banks respondents have confirmed the involvement of external trainer for the purpose of Basel Accord Implementation.
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6.2.15-Do you think that the employees involved in the risk management process are very proficient:

6.2.16-Has your Bank set-up any special Basel Accord Implementation Department:

RMEmp_Expt Cumulative Percent 23.3 65.0 100.0 Valid Yes No Total BImp_Dept Cumulative Percent 86.7 100.0

Valid

Agree Neither Agree Nor Disagree Disagree Total

Frequency 14 25 21 60

Percent 23.3 41.7 35.0 100.0

Valid Percent 23.3 41.7 35.0 100.0

Frequency 52 8 60

Percent 86.7 13.3 100.0

Valid Percent 86.7 13.3 100.0

Explanation: A significant majority of the respondents are not satisfied with the Risk Management Expertise of their employees involved in Risk Management.

Explanation: Almost all of the Banks have established specialized Basel Accord Implementation Department in their Banks.
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6.2.17-Do you think that the Basel Accord Implementation Department is highly functional in your Bank.

6.2.18-Do you think that the staff responsible for the implementation of Basel Accord possesses highly professional skills to match international standards:

BDept_Per Valid Percent 18.3 21.7 55.0 5.0 100.0 Cumulative Percent 18.3 40.0 95.0 100.0 Valid Strongly Agree Agree Neither Agree Nor Disagree Disagree Total Frequency 1 4 14 41 60 HR_Ab_Bsl Cumulative Percent 1.7 8.3 31.7 100.0

Valid

Agree Neither Agree Nor Disagree Disagree Strongly Disagree Total

Frequency 11 13 33 3 60

Percent 18.3 21.7 55.0 5.0 100.0

Percent 1.7 6.7 23.3 68.3 100.0

Valid Percent 1.7 6.7 23.3 68.3 100.0

Explanation: A majority of the respondents is of the opinion that Basel Accord Implementation is not functional in their Banks.

Explanation: Majority of the respondents are of the view that the Skills of their Basel Accord Staff do not match International Standards.
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6.2.19-Do you think that the plan for the implementation of Basel Accord in your Bank is highly effective:

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:

Bsl_Plan_Effec Cumulative Percent 15.0 43.3 96.7 100.0 Valid Yes No Not Applicable Total System

Valid

Agree Neither Agree Nor Disagree Disagree Strongly Disagree Total

Frequency 9 17 32 2 60

Percent 15.0 28.3 53.3 3.3 100.0

Valid Percent 15.0 28.3 53.3 3.3 100.0

Grp_RComp Valid Percent 20.3 1.7 78.0 100.0 Cumulative Percent 20.3 22.0 100.0

Frequency 12 1 46 59 1 60

Percent 20.0 1.7 76.7 98.3 1.7 100.0

Missing

Explanation: A Significant majority of Respondents do not consider that their banks have an effective Basel Implementation Plan.

Total

Explanation: Most of the Banks in Pakistan are not members of any groups and neither do respondents have
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any significant information about it.

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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:

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 Grp_CAR_Comp Valid Percent 20.0 3.3 76.7 100.0 Cumulative Percent 20.0 23.3 100.0 Frequency 5 51 3 1 60 Percent 8.3 85.0 5.0 1.7 100.0 Valid Percent 8.3 85.0 5.0 1.7 100.0 Cumulative Percent 8.3 93.3 98.3 100.0

Valid

Yes No Not Applicable Total

Frequency 12 2 46 60

Percent 20.0 3.3 76.7 100.0

Valid

Strongly Agree Agree Neither Agree Nor Disagree Disagree Total

Explanation: Most of the Banks in Pakistan are nor members of any groups and neither do respondents have any significant information about it.

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.
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6.2.23-Do you think that Basel Accord changes the method your bank uses to collect data for its Decision making process:

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.

BslAccrd_DCollct Cumulative Percent 5.0 63.3 75.0 100.0 Valid Yes No Not Applicable Total Frequency 8 46 6 60 Percent 13.3 76.7 10.0 100.0 Valid Percent 13.3 76.7 10.0 100.0 Cumulative Percent 13.3 90.0 100.0 Sens_Info

Frequency Valid Strongly Agree Agree Neither Agree Nor Disagree Disagree Total 3 35 7 15 60

Percent 5.0 58.3 11.7 25.0 100.0

Valid Percent 5.0 58.3 11.7 25.0 100.0

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
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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:

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_Sharing Data_Protc_CusCon Frequenc y 8 48 4 60 Percent 13.3 80.0 6.7 100.0 Valid Percent 13.3 80.0 6.7 100.0 Cumulative Percent 13.3 93.3 100.0 Cumulative Percent 85.0 100.0

Valid

Yes No Not Applicable Total

Valid

Yes No Total

Frequency 51 9 60

Percent 85.0 15.0 100.0

Valid Percent 85.0 15.0 100.0

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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.

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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?

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?

Bsl_Accrd_NatReg

NatLeg_DPCl Frequency 49 11 60 Percent 81.7 18.3 100.0 Valid Percent 81.7 18.3 100.0 Cumulative Percent 81.7 100.0 Cumulative Percent 5.0 11.7 36.7 98.3 100.0

Valid

Yes No Total

Valid

Explanation: Majority of the respondents confirmed that there exists national legislation on Basel Accord.

Strongly Agree Agree Neither Agree Nor Disagree Disagree Strongly Disagree Total

Frequency 3 4 15 37 1 60

Percent 5.0 6.7 25.0 61.7 1.7 100.0

Valid Percent 5.0 6.7 25.0 61.7 1.7 100.0

Explanation: Majority of the respondents are of the opinion that the current national legislation on Basel
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Accord is not in agreement about Data Protection Issue on Basel Accord.

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6.2.29-The current IT structure supports Basel Accord Requirements for:

Credit Risk:

Operational Risk:

ITS-CR Freque ncy Vali d Strongly Agree Agree Neither Agree Nor Disagree Disagree Strongly Disagree Total 7 43 8 1 1 60 Valid Percent 11.7 71.7 13.3 1.7 1.7 100.0 Cumulative Percent 11.7 83.3 96.7 98.3 100.0

ITS_OR Frequenc y 5 17 34 4 60 Valid Percent 8.3 28.3 56.7 6.7 100.0 Cumulative Percent 8.3 36.7 93.3 100.0

Percent 11.7 71.7 13.3 1.7 1.7 100.0

Valid

Agree Neither Agree Nor Disagree Disagree Strongly Disagree Total

Percent 8.3 28.3 56.7 6.7 100.0

Explanation: Majority of the respondents are of the opinion that their IT system supports the System Requirements for Credit Risk to Some Extent.

Explanation: Majority of the respondents are of the opinion that their IT systems do not support the System Requirements for Operational Risk.
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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:

ITS_MR Cumulative Percent 35.0 93.3 100.0 Valid Strongly Agree Agree Neither Agree Nor Disagree Disagree Total Frequenc y 1 44 8 7 60

Frequency Valid Neither Agree Nor Disagree Disagree Strongly Disagree Total 21 35 4 60

Percent 35.0 58.3 6.7 100.0

Valid Percent 35.0 58.3 6.7 100.0

Bsl_Accrd_Integration Valid Percent 1.7 73.3 13.3 11.7 100.0 Cumulative Percent 1.7 75.0 88.3 100.0

Percent 1.7 73.3 13.3 11.7 100.0

Explanation: Majority of the respondents are of the opinion that their IT systems do not support the System Requirements for Market Risk.

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.
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6.2.31-Do you think that database design, internal models, and budgets are in close conformity with as required by Basel Accord:

closed conformity with Basel Accord. 6.2.32-Which approach (es) your bank is using for measuring credit risk in your bank?

DD_IM_Budg_Comp Valid Percent 1.7 13.3 20.0 61.7 3.3 100.0 Cumulative Percent 1.7 15.0 35.0 96.7 100.0 CR_Approach Valid Percent 6.7 85.0 3.3 5.0 100.0 Cumulative Percent 6.7 91.7 95.0 100.0

Valid

Strongly Agree Agree Neither Agree Nor Disagree Disagree Strongly Disagree Total

Frequency 1 8 12 37 2 60

Percent 1.7 13.3 20.0 61.7 3.3 100.0

Frequency Vali d Simplied standardized Approach Standardized Approach Foundation Internal Ratings-Based Approach We don't know Yet Total 4 51 2 3 60

Percent 6.7 85.0 3.3 5.0 100.0

Explanation: Majority of the respondents are of the opinion that their existing budgets systems etc., are not in
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Explanation: Most of the Respondents stated that their Banks are on Standardized Approach of Credit Risk.

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6.2.33- Have you developed methodology for identifying and measuring credit risk for your internal needs?

6.2.34-In case you are using internally developed methodology, how many risk categories do you use for ranking of debtors?

CR_IN_Methd Frequenc y Valid No, we are only using methodology prescribed by SBP Yes, we are using internally developed methodology Total 15 Valid Percent 25.0 Cumulative Percent 25.0 Valid 45 60 75.0 100.0 75.0 100.0 Missin g Total 100.0 Upto 7 7 to 10 More than 10 Total System Frequenc y 4 25 28 57 3 60

Percent 25.0

IR_Cat_IDMethd Valid Percent 7.0 43.9 49.1 100.0 Cumulative Percent 7.0 50.9 100.0

Percent 6.7 41.7 46.7 95.0 5.0 100.0

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.

Explanation: A Vast majority is having risk categories of 7 or more in their internally developed credit risk methodologies.
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6.2.35-How many years are covered by time series that you have created for credit risk assessment?

Explanation: Most of the Banks use data of more than three years for their Credit Risk Assessment.
Recovery Model:

Default_TSeries Frequenc y 1 18 24 14 1 58 2 60 Valid Percent 1.7 31.0 41.4 24.1 1.7 100.0 Cumulative Percent 1.7 32.8 74.1 98.3 100.0

Valid

Missin g Total

Less than 1 year 1-3 Years 3-5 Years More than 5 years We have not created time series yet Total System

Percent 1.7 30.0 40.0 23.3 1.7 96.7 3.3 100.0

Recovery_Series Frequenc y 1 17 22 13 7 60 Valid Percent 1.7 28.3 36.7 21.7 11.7 100.0 Cumulative Percent 1.7 30.0 66.7 88.3 100.0

Valid

Less than 1 year 1-3 Years 3-5 Years More than 5 years We have not created time series yet Total

Percent 1.7 28.3 36.7 21.7 11.7 100.0

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Explanation: Most of the Banks use data of more than three years for their Recovery Assessment.
Other time series (specify name)

6.2.36-In case you are using models for measuring economic capital for credit risk, how were these models developed?

AnyOther_Series

Frequency

Percent

Valid Percent

Cumulative Percent

Vali d

Less than 1 year 1-3 Years 3-5 Years We have not created time series yet Total

1 1 1 57 60

1.7 1.7 1.7 95.0 100.0

1.7 1.7 1.7 95.0 100.0

1.7 3.3 5.0 100.0 Frequenc y Valid Locally (Internally)Develope d We are not using the model for that purpose 1 ECap_M_CRisk Valid Percent 1.7 Cumulative Percent 1.7

Percent 1.7

Explanation : Non of the Bank has developed any other time series model for Credit Risk Assessment .
.

59

98.3

98.3

100.0

99

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.

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6.2.37-Which approach (es) and from when are you planning to use for measuring market risk in your bank?

6.2.38-How many years are covered by time series that you have created for market risk assessment?

MR_M_Appr Frequenc y Vali d Standarised Measurement Method We don't know Yet Total 54 6 60 Valid Percent 90.0 10.0 100.0 Cumulative Percent 90.0 100.0 Valid Less than 1 year 1-2 Years 2-3 Years Over 3 years We don't have any time Series Yet Total Frequenc y 36 3 6 8 7 60

MRisk_TSeries Valid Percent 60.0 5.0 10.0 13.3 11.7 100.0 Cumulative Percent 60.0 65.0 75.0 88.3 100.0

Percent 90.0 10.0 100.0

Percent 60.0 5.0 10.0 13.3 11.7 100.0

Explanation: Most of the Banks have adopted Market Risk Measurement Mechanism and they are on Standardized Approach.

Explanation: Market Risk Measurement is in very early stages as the data for the purpose is available for a period of
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only one year at present.

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6.2.39-In case you are using models for measuring economic capital for market risk, how were these models developed?

6.2.40-Which approach (es) and from when are you planning to use for measuring operational risk in your bank?

Ecap_M_MRisk Frequenc y Vali d We are not using the model for that purpose 60 Valid Percent 100.0 Cumulative Percent 100.0 Vali d Basic Indicator Approach Standarized Approach We don't know yet Total Frequenc y 4 55 1 60

OR_M_Appr Valid Percent 6.7 91.7 1.7 100.0 Cumulative Percent 6.7 98.3 100.0

Percent 100.0

Percent 6.7 91.7 1.7 100.0

Explanation: According to the respondents none of the Banks are using Economic Capital Model for Market Risk Measurement and Management.

Explanation: According to the respondents most of the Banks are already using Operational Risk Measurement Mechanism and they are on Standardized Approach.
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6.2.41-How many years are covered by time series that you have created for operational risk assessment?

6.2.42-In case you are using models for measuring economic capital for operation risk, how were these models developed?

OR_T_Series Cumulative Percent 55.0 60.0 73.3 85.0 100.0

Valid

Less than 1 year 1-2 Years 2-3 Years Over 3 years We don't have any time Series Yet Total

Frequency 33 3 8 7 9 60

Percent 55.0 5.0 13.3 11.7 15.0 100.0

Valid Percent 55.0 5.0 13.3 11.7 15.0 100.0

Ecap_OR Frequenc y Vali d We are not using the model for that purpose 60 Valid Percent 100.0 Cumulative Percent 100.0

Percent 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.

Explanation: According to the respondents none of the Banks are using Economic Capital Model for Operational Risk Measurement and Management.

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6.2.43-Supervisory Review guidelines currently formulated by Pillar II are helpful in improving supervisory review regime:

Pakistan. 6.2.44-The supervisor has enough resources to comply with the requirement of four key principles of supervisory review process:

PillarII_Impr_SReview Cumulative Percent 3.3 26.7 73.3 100.0 Valid Yes No Neither Agree Nor Disagree Total Frequency 5 37 18 60 Percent 8.3 61.7 30.0 100.0 Valid Percent 8.3 61.7 30.0 100.0 Adeq_of_SupervRes Cumulative Percent 8.3 70.0 100.0

Frequency Valid Strongly Agree Agree Neither Agree Nor Disagree Disagree Total 2 14 28 16 60

Percent 3.3 23.3 46.7 26.7 100.0

Valid Percent 3.3 23.3 46.7 26.7 100.0

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

Explanation: Majority of the respondents are of the view

105

that the Supervisor in Pakistan do not have adequate resources to supervise the Supervisory Review Process.

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6.2.45-Which segment of Pillar I are challenging to be monitored under supervisory review process:

6.2.46-There is a need for additional legal processes within the national legal regime for appropriate implementation of Basel Accord:

Sig_PI_Seg Valid Percent 6.7 11.7 81.7 100.0 Cumulative Percent 6.7 18.3 100.0 Valid Yes No Neither Agree Nor Disagress Total Frequenc y 45 12 3 60 Need_for_Add_Leg Valid Percent 75.0 20.0 5.0 100.0 Cumulative Percent 75.0 95.0 100.0

Frequency Valid Credit Risk Methodologies Operational Risk Methodologies Market Risk Methodologies Total 4 7 49 60

Percent 6.7 11.7 81.7 100.0

Percent 75.0 20.0 5.0 100.0

Explanation: Majority of the respondents are of the view that the Credit Risk Segment is most Challenging for monitoring.

Explanation: Most of the respondents are of the view that there is a need for additional legislation for Basel Accord
107

Implementation in Pakistan.

108

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:

6.2.48-Do you think that your Bank adequately complies with the disclosure requirement of Basel Accord Market Discipline:

Addl_Risks_in_PI Valid Percent 26.7 63.3 10.0 100.0 Cumulative Percent 26.7 90.0 100.0 Valid Yes No Neither Agree Nor Disagree Total Frequency 14 33 13 60 Percent 23.3 55.0 21.7 100.0 Valid Percent 23.3 55.0 21.7 100.0 Comp_with_Basel_MD Cumulative Percent 23.3 78.3 100.0

Frequency Valid Yes No Neither Agree Nor Disagree Total 16 38 6 60

Percent 26.7 63.3 10.0 100.0

Explanation: A majority of the respondents are of the view that there is no need to add additional risks Pillar I of Basel Accord.

Explanation: Most of the respondents are of the opinion that their bank do not comply with the disclosure requirement of Basel Accord Market Discipline.
109

6.2.49-Do you consider the national legislation to be hindrance is meeting disclosure requirements 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.

Nat_LegHindrance Valid Percent 63.3 13.3 23.3 100.0 Cumulative Percent 63.3 76.7 Valid 14 60 23.3 100.0 100.0 Yes No Neither Agree Nor Disagress Total Propinfo_Disc_ComDisadv Cumulative Percent 76.7 96.7 100.0

Valid

Yes No Neither Agree Nor Disagress Total

Frequency 38 8

Percent 63.3 13.3

Frequency 46 12 2 60

Percent 76.7 20.0 3.3 100.0

Valid Percent 76.7 20.0 3.3 100.0

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.

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.
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6.2.51-Has your bank arranged any customer awareness for complying with the Market Discipline Requirement of Pillar III.

Basel_Cust_Awar Cumulative Percent 3.3 100.0

Frequency Valid Yes No Total 2 58 60

Percent 3.3 96.7 100.0

Valid Percent 3.3 96.7 100.0

Explanation: None of the Banks has started any Basel Accord Customer Awareness Programme.

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6.3 PRIMARY DATA ANALYSIS:

We have used Cronbachs 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 Cronbachs alpha (), 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)
.851

N of Items
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:

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6.4.1-Analysis of KASB Radar Diagram and CAR Trend:

availability of Basel Accord is also very low. The Banks 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: 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
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Explanation: The Capital Adequacy Ratio Trend of KASB Bank for the period 2005 to 2009 is declining.

6.4.2-Analysis of Standard Chartered Bank Radar Diagram and CAR Trend:

availability for Basel Compliance is of a period more than 5 years. The Banks 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: 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
114

Explanation: The Capital Adequacy Ratio Trend of Standard Chartered Bank for the period 2005 to 2009 is improving.

availability of Basel Accord is also acceptable as the data 6.4.3-Analysis of Askari Bank Radar Diagram and CAR Trend: availability for Basel Compliance is of a period about 3 years. The Banks 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: 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
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Explanation: The Capital Adequacy Ratio Trend of Askari Bank for the period 2005 to 2009 is improving.

Compliance requirements. The work done for data 6.4.4-Analysis of Allied Bank Limited Radar Diagram and CAR Trend: availability of Basel Accord is also acceptable as the data availability for Basel Compliance is of a period about 3 years. The Banks 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: 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
116

Explanation: The Capital Adequacy Ratio Trend of Allied Bank for the period 2005 to 2009 is improving.

the Basel Accord requirements. The work done for data availability of Basel Accord is also acceptable as the data 6.4.5- Analysis of NIB Bank Radar Diagram and CAR Trend availability for Basel Compliance is of a period about 3 years. The Banks 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: 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
117

Explanation: The Capital Adequacy Ratio Trend of NIB Bank for the period 2005 to 2009 is improving.

availability of Basel Accord is also acceptable as the data 6.4.6- Analysis of MCB Bank Radar Diagram and CAR Trend: availability for Basel Compliance is of a period about 3 years. The Banks 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: 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
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Explanation: The Capital Adequacy Ratio Trend of MCB Bank for the period 2005 to 2009 is improving.

6.4.7- Analysis of NBP Bank Radar Diagram and CAR Trend:

as the data availability for Basel Compliance is of a period less than 3 years. The Banks 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: 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
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Explanation: The Capital Adequacy Ratio Trend of National Bank of Pakistan for the period 2005 to 2009 is improving.

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 6.4.8- Analysis of Bank Alfalah Radar Diagram and CAR Trend: good as the data availability for Basel Compliance is of a period of more than 3 years. The Banks 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:

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
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Explanation: The Capital Adequacy Ratio Trend of Bank Alfalah Limited for the period 2005 to 2009 is improving.

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

6.4.9- Analysis of Faysal Bank Radar Diagram and CAR Trend:

as the data availability for Basel Compliance is of a period of less than 3 years. The Banks 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:

Explanation: This is a Foreign Owned Private Sector Bank. According to respondents of our questionnaire this bank has good inclination towards Implementation of Basel
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bank has good inclination towards Implementation of Basel Explanation: The Capital Adequacy Ratio Trend of Faysal Bank Limited for the period 2005 to 2009 is declining. 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. 6.4.10- Analysis of United Bank Radar Diagram and CAR Trend: 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 Banks 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:

Explanation: This is a Foreign Owned Private Sector Bank. According to respondents of our questionnaire this
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Explanation: The Capital Adequacy Ratio Trend of United Bank Limited for the period 2005 to 2009 is improving.

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6.4.11-Analysis of the Bank of Punjab Radar Diagram and CAR Trend:

very low quality as the data availability for Basel Compliance is of a period of more than 3 years. The Banks 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: 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
124

Explanation: The Capital Adequacy Ratio Trend of Bank of Punjab for the period 2005 to 2009 is declining.

6.4.12-Analysis of the Habib Bank Limited Radar Diagram and CAR Trend:

Compliance is of a period of more than 5 years. The Banks 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: 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
125

Explanation: The Capital Adequacy Ratio Trend of Habib Bank Limited for the period 2005 to 2009 is improving.

6.4.13 Radar Diagram of an Ideal Bank:

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.

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
126

effectively; has an ideal CREMP to Risk Asset Ratio of 1.5

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 Bank_Type Government Owned Privately Owned Local Ownership Privately Owned Foreign Ownership Total Declining 5 5 5 15 Improving 5 20 20 45 Total Declining 10 25 25 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 Neither Agree Nor Disagree 0 10 15 25 5 10 10 25 Total Disagree 5 5 0 10 Agree 10 25 25 60

Agree Bank_Type Government Owned Privately Owned Local Ownership Privately Owned Foreign Ownership Total

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.

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6.5.3 Relationship between CAR Trend and Bank Inclination:

CAR_Trend * Bank_Incl
Count Bank_Incl Neither Agree Nor Disagree 0 25 25 5 20 25 Total Disagree 10 0 10 Agree 15 45 60

Agree CAR_T rend Total Declining Improving

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 Neither Agree Nor Disagree 0 10 0 10 5 10 10 25 Total Disagree 5 5 15 25 Agree 10 25 25 60

Agree Bank_Type Government Owned Privately Owned Local Ownership Privately Owned Foreign Ownership Total

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.

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6.5.5 Relationship between CAR Trend and Risk Management Employees Expertise:

CAR_Trend * RMEmp_Expt
Count RMEmp_Expt Neither Agree Nor Disagree 0 10 10 5 20 25 Total Disagree 15 10 25 Agree 15 45 60

Agree CAR_T rend Total Declining Improving

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 Neither Agree Nor Disagree 0 0 5 5 0 15 10 25 Total Disagree 10 10 10 30 Agree 10 25 25 60

Agree Bank_Type Government Owned Privately Owned Local Ownership Privately Owned Foreign Ownership Total

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Explanation: Analysis of cross tabulation depicts that Foreign Banks in Pakistan have more Effective Basel Implementation Plan in Pakistan as compared with local Banks.

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6.5.7 Relationship between CAR Trend and Basel Plan Effectiveness:

CAR_Trend * Bsl_Plan_Effec
Crosstab Count Bsl_Plan_Effec Neither Agree Nor Disagree 0 5 5 0 25 25 Total Disagree 15 15 30 Agree 15 45 60

Agree CAR_T rend Total Declining Improving

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 Neither Agree Agree Nor Disagree 0 10 20 15 35 5 10 25 Total Agree 10 25 25 60

Bank_Type

Government Owned Privately Owned Local Ownership Privately Owned Foreign Ownership

Total

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.
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6.5.9 Relationship between CAR Trend and Data Collection Methodologies Changes due to Basel Accord:

CAR_Trend * BslAccrd_DCollct
Count BslAccrd_DCollct Neither Agree Agree Nor Disagree CAR_T rend Total Declining Improving 5 25 30 10 20 30 Total Agree 15 45 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 1-3 Years Bank_Type Government Owned Privately Owned Local Ownership Privately Owned Foreign Ownership Total 0 5 5 10 3-5 Years 10 10 10 30 More than 5 years 0 10 10 20 Total 1-3 Years 10 25 25 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
132

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 1-3 Years CAR_T rend Total Declining Improving 0 5 5 3-5 Years 15 20 35 More than 5 years 0 20 20 Total 1-3 Years 15 45 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 Neither Agree Nor Yes No Disagress 0 10 0 5 0 5 20 20 50 0 5 5 Total

Yes 10 25 25 60

Bank_Type

Government Owned Privately Owned Local Ownership Privately Owned Foreign Ownership

Total

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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.

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6.5.13 Relationship between CAR Trend and Compliance with Market Discipline:

CAR_Trend * Comp_with_Basel_MD
Crosstab Count Comp_with_Basel_MD Neither Agree Nor Yes No Disagress 0 15 0 5 5 35 50 5 5 Total

Yes 15 45 60

CAR_T rend Total

Declining Improving

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.

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6.5.14 Relationship between Bank Type CAR Trend and Basel Customer Awareness:

Bank_Type * Basel_Cust_Awar
Crosstab Count Basel_Cust_Aw ar No Bank_Type Government Owned Privately Owned Local Ownership Privately Owned Foreign Ownership Total 10 25 25 50 Total No 10 25 25 60

CAR_Trend * Basel_Cust_Awar
Crosstab Count Basel_Cust_ Awar No CAR_T rend Total Declining Improving 15 45 60 Total No 15 45 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.

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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 CREMP_to_CRWA .41 0 1 0 1 .45 0 0 1 1 .51 1 0 0 1 .52 0 1 0 1 .56 0 0 1 1 .60 1 0 0 1 .70 0 0 1 1 .73 0 0 1 1 1.08 0 0 1 1 1.13 0 1 0 1 1.33 0 1 0 1 1.50 0 1 0 1 Total

Bank_Type

Government Owned Privately Owned Local Ownership Privately Owned Foreign Ownership

2 5 5 12

Total

CAR_Trend * CREMP_to_CRWA Count CREMP_to_CRWA Total

CAR_ Trend

Declining

.41 1

.45 0

.51 1

.52 0

.56 0

.60 0

.70 0

.73 0

1.08 1

1.13 0

1.33 0

1.50 0

Improving

Total

12

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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.

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6.5.16: Analysis of the Results relating to the variable Involvement of External Trainer:
40.0%

30.0%

Yes

20.0%

10.0%

Ext_Trnr_Inv

Percent

0.0% 40.0%

30.0%

No

20.0%

10.0%

0.0% Group Head Risk Manager Branch Manager

ROR

ROR * Ext_Trnr_Inv Crosstabulation Ext_Trnr_Inv Yes ROR Group Head Count % within ROR % within Ext_Trnr_Inv Risk Manager Count % within ROR % within Ext_Trnr_Inv Branch Manager Count % within ROR % within Ext_Trnr_Inv Total Count % within ROR 20 87.0% 60.6% 11 91.7% 33.3% 2 8.0% 6.1% 33 55.0% No 3 13.0% 11.1% 1 8.3% 3.7% 23 92.0% 85.2% 27 45.0% 23 100.0% 38.3% 12 100.0% 20.0% 25 100.0% 41.7% 60 100.0% Total

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% within Ext_Trnr_Inv

100.0%

100.0%

100.0%

140

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.

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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:

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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.

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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
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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
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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.

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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

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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
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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!

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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:
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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

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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.
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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.

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