Assignment

Commercial banking

Topic:
Basel Accord II implementation in HBL Pakistan

Basel Accord II
Basel II is the second of the Basel Accords, which are recommendations on banking laws and
regulations issued by the Basel Committee on Banking Supervision. The purpose of Basel II,
which was initially published in June 2004, is to create an international standard that banking
regulators can use when creating regulations about how much capital banks need to put aside to
guard against the types of financial and operational risks banks face. Advocates of Basel II
believe that such an international standard can help protect the international financial system
from the types of problems that might arise should a major bank or a series of banks collapse. In
practice, Basel II attempts to accomplish this by setting up rigorous risk and capital management
requirements designed to ensure that a bank holds capital reserves appropriate to the risk the
bank exposes itself to through its lending and investment practices. Generally speaking, these
rules mean that the greater risk to which the bank is exposed, the greater the amount of capital
the bank needs to hold to safeguard its solvency and overall economic stability.

Objectives
The final version aims at:

 Ensuring that capital allocation is more risk sensitive

 . Separating operational risk from credit risk, and quantifying both

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  Attempting to align economic and regulatory capital more closely to reduce the scope
for regulatory arbitrage.

While the final accord has largely addressed the regulatory arbitrage issue, there are still areas
where regulatory capital requirement will diverge from the economic.

Basel II has largely left unchanged the question of how to actually define bank capital, which
diverges from accounting equity in important respects. The Basel I definition, as modified up to
the present, remains in place.

The accord in operation

Basel II uses a "three pillars" concept to promote greater stability in the financial system.
(1) Minimum capital requirements (addressing risk)
(2) Supervisory review
(3) Market discipline

The Basel I accord dealt with only parts of each of these pillars. For example: with respect to the
first Basel II pillar, only one risk, credit risk, was dealt with in a simple manner while market
risk was an afterthought; operational risk was not dealt with at all

Importance of Basel Accord II for Pakistan Banking Industry

Implementation / adoption of Basel II is essential for Pakistani Banks as it has been initiated by
SBP, and will be in conformity with the international banking standards. SBP has a vital role in
the implementation of Basel II initially as a regulator in terms of dissemination of information
and providing guidelines to all the banks and once it is adopted it will act as a monitor. Pakistani
banks do not operate in isolation. They have considerable interaction with international financial
markets and being compliant with Basel II would facilitate their relationships.

The State Bank of Pakistan (SBP) also issued risk management guidelines for banks in
preparation for implementing the New Basel Capital Accord in Pakistan. The guidelines outline
best practices that banks should follow to assess and manage the risk of their loan portfolios.

The SBP guidelines are intended to give Pakistani banks a framework for managing risk and are
not intended to serve as enforceable regulations at this time. However, banks are expected to
provide twice-yearly progress reports on implementing the guidelines, and the guidelines will
become enforceable after Pakistan adopts the New Basel Capital Accord.

The implementation of Basel II in the local banking system has been initiated by SBP and hence
it becomes mandatory for all banks to follow it. SBP’s approach to implementing Basel II has

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been very appropriate, as it has provided the local banks with sufficient time to understand and
implement it. The impact of Basel II on the banking system would be in the following areas.

Internal Impact: Basel II will enhance focus on economic capital management versus
regulatory capital management because the new accord drives banks to measure their
performance against risk factors other than market share or expected return. Under Basel I most
banks were volume driven; Basel II drives them to become risk-return driven. Once banks can
attribute risk to a potential transaction, product or process, they can ascribe a portion of
economic capital to it (based on the risk it poses), define an expected return on it, consider how
best to price it, consider risk mitigating techniques and thereby decide, e.g. whether to enter a
transaction, engage in a business or pursue an activity or process.

Customer Impact: Improved risk management and data flows should enable banks to identify
clients, evaluate their customers in more thorough way than they might have done in the past,
and determine whether to retain certain customers. Banks will need to request new and timely
information from borrowers to perform the internal rating assessments and the collateral
evaluation that are essential to Basel II’s risk calculation process.

Business Impact: The Basel Accord discriminated only marginally among credit risks providing
banks with no incentive to price high-risk loans adequately. By seeking to enable banks to
achieve a better relationship between risk and required capital, New Accord is designed to
reduce such regulatory arbitrage opportunities. Thus the New Accord encourages banks to
assume a new role as information intermediaries, a role in which they collect and analyze
customer related data using systematic risk appraisal and classification process and tools.
Customers who can supply such information may choose to bypass a bank and go straight to the
capital markets to obtain capital.

Global Impact: The banking industry’s improved risk management, enhanced information flows
and related disclosures could drive parallel improvement in the stability of the financial markets.
New disclosures will provide regulators with “early warnings” that banks or rating agencies
could pass on to the public and investors potentially enhancing trust in the financial markets. For
the individual institution, the challenge will be to determine how to translate internal risk
management to external disclosures.

Benefits Basel II offer:

Implementation of Basel II would benefit the banking sector in three areas:

 Increase focus on risk management, i.e., credit, price and operational risk
 Banks would assess their capital adequacy in relation to their risk profile
 Greater disclosure from banks to make discipline more efficient.

Financial costs of implementation of Basel II:

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The additional financial cost that may arise as a result of implementing Basel accord and Basel II
would be in the areas of

 System / Software for capturing the areas exposed to price and operational risk, and
developing tools to monitor and control.
 Cost of training for development of skill base in the area of Price / Operational risk
measurement and monitoring.
 Creation of reserves for any shortfall in collateralized assets, which will be taken at
forced sale value. The cost of creating the reserve would depend upon the size and quality
of assets portfolio of each bank.

The additional cost will be more than justified by the benefits which will accrue with the
implementation of Basel II.

Basal Accord II and Habib Bank Limited

Introduction:

HBL was the first commercial bank to be established in Pakistan in 1947. Over the years, HBL
has grown its branch network and become the largest private sector bank with over 1,450
branches across the country and a customer base exceeding five million relationships.

The Government of Pakistan privatized HBL in 2004 through which AKFED acquired 51% of
the Bank's shareholding and management control. HBL is majority owned (51%) by the Aga
Khan Fund for Economic Development, 42.5% of the shareholding is retained by the
Government of Pakistan (GOP), whilst 7.5% is owned by the general public i.e. over 170,000
shareholders following the public listing that took place in July 2007.

With a presence in 25 countries, subsidiaries in Hong Kong and the UK, affiliates in Nepal,
Nigeria, Kenya and Kyrgyzstan and rep offices in Iran and China, HBL is also the largest
domestic multinational. The Bank is expanding its presence in principal international markets
including the UK, UAE, South and Central Asia, Africa and the Far East.

Key areas of operations encompass product offerings and services in Retail and Consumer
Banking. HBL has the largest Corporate Banking portfolio in the country with an active

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Investment Banking arm. SME and Agriculture lending programs and banking services are
offered in urban and rural centers.

Pakistan’s Habib Bank’s Profit Rises on Loan Growth:

Habib Bank Ltd., Pakistan’s second- biggest by assets, said full-year profit rose 23 percent
because of growth in loans.

Net income rose to 13.4 billion rupees ($157.8 million), or 14.70 rupees a share in the year ended
Dec. 31, from 10.9 billion rupees, or 11.83 rupees, a year earlier, the Karachi- based bank said in
a statement to the stock exchange today. The bank’s revenue rose to 87.2 billion rupees from
74.7 billion rupees a year ago.

“Growth in interest income worked well,” said Muhammad Farhan, research analyst at Atlas
Capital Markets Ltd., in Karachi, who has a “hold” recommendation for the stock.

Borrowers have taken more loans as the central bank has reduced its benchmark lending rate,
allowing lenders to charge less for loans. The State Bank of Pakistan reduced its benchmark rate
to 12.5 percent in three cuts last year.

Habib Bank’s interest income rose to 76.1 billion rupees, in the year ended Dec. 31, from 63.4
billion rupees.

Shares rose 2.5 percent to 126.95 rupees as of 3:07 p.m. local time close on the Karachi Stock
Exchange. The stock rose 88 percent last year compared with a 60 percent increase in the
benchmark index.

Rating:

HBL is currently rated AA (Long term) and A-1+ (Short term) and has a balance sheet size of
over USD 11 billion. It is the first Pakistani bank to raise Tier II Capital from external sources.

HBL established operations in Pakistan in 1947 and moved its head office to Karachi. Our first
international branch was established in Colombo, Sri Lanka in 1951 and Habib Bank Plaza was
built in 1972 to commemorate the bank’s 25th Anniversary

Data collection stage of Basal Accord II:

As HBL in Pakistan have a vast network of branches, around 1500 branches so they are
collecting data from all those branches for the implementation of this accord. They have just
initiated that process because it’s very time consuming and difficult to assemble all the record so
HBL will take some more time to properly introduce that in its all branches. HBL is in transition
phase as it got privatized in 2004 and currently they are focusing on infrastructure, image and
service. It will take around 1 more year to fully implement it. The basic problems they are facing
are:

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 Data Integrity
 Computer Literacy at regional outlets
 Focus on improving HR and IT processes