The State Bank of Pakistan (SBP) has instructed commercial banks to move forward with Phase II of the Basel III reforms, marking a significant step in strengthening Pakistan’s financial system under international regulatory standards. These reforms are designed to address gaps revealed by the 2008 Global Financial Crisis (GFC) and ensure that the country’s banking sector operates on a more resilient and transparent foundation.
The Basel III framework, developed by the Basel Committee on Banking Supervision (BCBS), is a comprehensive set of measures to enhance bank capital adequacy, improve risk management, and mitigate systemic risks. Implemented globally in two phases, the framework has been gradually integrated into Pakistan’s banking system under the SBP’s oversight. Phase I focused on capital adequacy, liquidity coverage, leverage ratios, and the introduction of the Domestic Systemically Important Banks (D-SIB) framework. With Phase I reforms already in place, the SBP is now transitioning to Phase II, which emphasizes revisions to the risk-weighting regime and leverage ratios, alongside further enhancements in credit and operational risk management.
As part of this process, the SBP has issued revised guidelines on the Standardized Approach for Credit Risk. A central requirement is that banks must now rely exclusively on credit ratings provided by credit rating agencies (CRAs) recognized by the SBP for capital adequacy purposes. Furthermore, banks are mandated to use External Credit Assessment Institutions (ECAIs) consistently across all claim types, both for risk weighting and broader risk management practices. The regulator has explicitly prohibited “cherry-picking” of ratings from different agencies to ensure uniformity and transparency.
Under these new instructions, banks are also required to disclose the ECAIs they use, detail the risk weights attached to various rating grades through the mapping process, and provide aggregated data on risk-weighted assets for each risk category. This increased transparency aims to align Pakistan’s financial reporting practices with global benchmarks.
The revised framework outlines specific risk weights for different asset categories. A 0% risk weight will apply to assets such as cash held by banks, cash in transit, gold bullion, and cash equivalents like national prize bonds. Cash items in the process of collection, however, will carry a 20% risk weight. Claims on the Government of Pakistan, whether federal or provincial, as well as on the SBP, when denominated and funded in Pakistani rupees, will also be assigned a 0% risk weight. Foreign currency claims on sovereigns will be risk-weighted according to credit ratings from recognized ECAIs, though claims denominated and funded in a foreign sovereign’s domestic currency may qualify for a 0% weight if permitted by the host regulator.
The SBP has emphasized that banks must establish strong internal policies, processes, and systems to ensure that risk weights are appropriately applied and backed by robust due diligence. Institutions will need to demonstrate compliance and justify their methodologies to the regulator upon request.
Implementation of these revised guidelines will follow a parallel-run approach between September 30, 2025, and June 30, 2026. During this period, banks, digital banks, and development finance institutions (DFIs) will be required to submit capital adequacy returns under both the existing and revised frameworks. This phased rollout will allow the SBP to monitor practical challenges, gather industry feedback, and make refinements before full adoption.
Analysts suggest that while these reforms may initially require banks to upgrade risk management systems and adapt reporting structures, they will ultimately align Pakistan’s financial system with global best practices. By adopting Basel III Phase II reforms, the SBP is signaling its commitment to safeguarding financial stability, enhancing investor confidence, and fostering sustainable growth in the banking sector.
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