SBP Asks Banks to Undertake Basel III Reforms

The State Bank of Pakistan (SBP) has directed commercial banks to undertake Phase II of the Basel III reforms, aiming to address shortcomings of the pre-crisis regime and strengthen the resilience of the banking sector under a robust regulatory framework. The Basel III framework was introduced by the Basel Committee on Banking Supervision (BCBS) after the Global Financial Crisis (GFC) in 2008 exposed critical weaknesses in the financial system, prompting global regulatory reforms. BCBS reforms are broadly divided into two phases. Phase I focused on enhancing capital adequacy, introducing liquidity and leverage ratios, and establishing the D-SIB framework. Phase II emphasizes revisions to the risk-weighting regime, leverage ratio, and other enhancements. The SBP has already implemented Phase I reforms. As a first step toward adopting Phase II reforms in a smooth and timely manner, and in line with BCBS guidance, the SBP has developed revised instructions on the Standardized Approach for Credit Risk. Banks are required to utilize credit ratings exclusively from those credit rating agencies (CRAs) that have been duly recognized by the State Bank of Pakistan for capital adequacy purposes. Moreover, banks must use the chosen External Credit Assessment Institutions (ECAIs) recognized by the SBP and their credit ratings consistently for all types of claims, for both risk weighting and risk management purposes. Banks will not be allowed to “cherry-pick” ratings provided by different ECAIs or arbitrarily change the use of ECAIs. Banks must disclose the ECAIs they use for risk weighting purposes by type of claim, the risk weights associated with particular rating grades through the mapping process, as well as aggregated risk-weighted assets for each risk weight based on the assessments of each eligible ECAI. A 0% risk weight will be applied to the stock of cash owned and held at the bank or in transit (domestic and foreign currency); gold bullion held at banks or in another bank on an allocated basis; and cash equivalents, including national prize bonds. Cash items in the process of collection will be risk-weighted at 20%. Claims on the Government of Pakistan (federal or provincial) and the SBP, denominated and funded in PKR, will be assigned a risk weight of 0%. Foreign currency claims on sovereigns (domestic or foreign) will attract a risk weight as per the relevant credit ratings assigned by recognized ECAIs. However, claims denominated in the domestic currency of foreign sovereigns and funded (i.e., met out of resources/corresponding liabilities raised in the jurisdiction) in that domestic currency may attract a risk weight of 0%, provided the host supervisor does not require a more conservative treatment. In such instances, the bank would compute its capital adequacy based on the more conservative requirements. Banks should have in place effective internal policies, processes, systems, and controls to ensure that appropriate risk weights are assigned to counterparties, and they must be able to demonstrate to the SBP that their due diligence analyses are appropriate. These revised instructions will be implemented across the industry on a parallel-run basis from September 30, 2025, to June 30, 2026 (four quarters). This approach will allow the SBP to assess practical challenges and incorporate industry feedback, if required, for final implementation. During the parallel run, banks, digital banks, and DFIs shall submit capital adequacy returns under both the existing and revised instructions.