Minimum Capital Requirements for Banks/DFIs

In order to further strengthen the solvency of individual bank/DFI, it has been decided to raise the Minimum Capital Requirements (MCR) as well as Capital Adequacy Ratio (CAR) calculated as per Basel II, as under:
i) The minimum Paid up Capital requirements for all locally incorporated banks has been raised to Rs. 23 billion (net of losses) to be achieved in a phased manner as under:

Minimum Paid up Capital (Net of losses)

Dead line by which to be increased

Rs 5 billion Rs 6 billion Rs 10 billion Rs 15 billion Rs 19 billion Rs 23 billion

31-12-2008 31-12-2009 31-12-2010 31-12-2011 31-12-2012 31-12-2013

ii) Branches of foreign banks operating in Pakistan (FBs) are also required to increase their assigned capital to Rs. 23 billion (net of losses) within the above prescribed timelines. However, those FBs, whose Head Offices hold Paid up capital (free of losses) of at least equivalent to US$ 300 million and have a CAR of at least 8% or minimum prescribed by their home regulator, whichever is higher, will be allowed with the prior approval of the State Bank to maintain the following MCR: a. FBs, operating with upto 5 branches are required to raise their assigned capital to Rs. 3 billion latest by 31st December 2010.

b. FBs operating/desirous of operating with 6 to 20 branches are required to raise their assigned capital to Rs. 6 billion by 31st December 2010. 3. In addition to the above requirements, all banks are also required to meet specific condition(s), if any, regarding capital requirement imposed on them under the Banking license issued by the State Bank of Pakistan 4. All new banks including branches of foreign banks, licensed after the date of this Circular will be required to meet the paid up/assigned capital requirement of Rs. 23 billion before commencement of their operations.
5. The required minimum CAR, on consolidated as well as on standalone basis has been increased for banks/DFIs to 10%. Those banks/DFIs whose CAR is at present less than 10% are advised to meet the shortfall latest by 31st December, 2008. Furthermore, all banks/DFIs are required to maintain variable CAR as under:

i) The variable CAR will now be based on CAMELS-S Rating assigned by the State Bank to each bank and DFI. The required variable CAR to be maintained by each bank/DFI will be determined as follows:

CAMELS-S

Required CAR effective from 31.12.2008 31.12.2009 10% 12% 14% 15%

1&2 3 4 5

10% 10% 11% 12%

ii) Banks/DFIs which, in the opinion of the State Bank, have high risk profile may be asked to further increase the required CAR by One (1) percentage point.
Those banks/DFIs whose CAR fall short from the required ratio (determined on the basis of CAMELS-S) shall meet the shortfall within 6 months from the assignment of the latest rating.

6. The required MCR and CAR can be achieved by the banks/DFIs either by fresh capital injection or retention of profits. The stock dividend declared after meeting all the legal and regulatory requirements, and duly disclosed in the annual Audited Accounts will be counted towards the required paid up capital of the bank/DFI pending completion of the formalities for issuance of bonus shares.
7. Any bank/DFI that fails to meet the minimum paid up capital requirement or CAR within the stipulated period shall render itself liable to the following actions:

i) Imposition of such restrictions on its business including restrictions on acceptance of deposits and lending as may be deemed fit by the State Bank. ii) Descheduling of the bank, thereby converting it into a non-scheduled bank.
iii) Cancellation of the banking license if the State Bank believes that the bank is not in a position to meet the minimum paid up capital requirement or CAR.

8. This circular supersedes the instructions issued vide BSD Circular No. 06 dated October 28, 2005.

The regular on-site inspection is conducted on the basis of CAMELS Framework. (Capital, Asset Quality, Management, Earnings, Liquidity, Sensitivity and System & Controls). CAMELS is an effective rating system for evaluating the soundness of financial institutions on a uniform basis and for identifying these institutions requiring special attention or concern. Here the focus of inspection is generally on risk assessment policies & procedures of the banks and control environment to keep attached risks within acceptable limits and compliance with laws, regulations and supervisory directives. In continuation of the inspection process, discussions are held with external

auditors to review banks internal controls, compliance with legislation & prudential standards and adequacy of provisions. Here it would be important to mention that BID works in close coordination with Off-Site Surveillance Desk at Banking Supervision Department and other departments in SBP. BID conducts the regular full scope examination of banks pursuant to an inspection schedule; however, flexibility exists in policy for frequency of inspections depending upon the need to maintain safety & soundness. CAMELS rating is a criteria to determine the frequency of inspection of banks as weak institutions are given greater attention. Special investigations (targeted inspections) are also conducted as and when circumstances so warrant on the basis of complaints or market reports about specific institution. Examiners document their assessment of the overall risks posed by each bank in the inspection work papers and summarize their inspection findings in the form of inspection reports. In formulating this assessment, examiners consider all available sources of information including, but not limited to: findings, scope and recency of previous inspections, ongoing monitoring efforts of off site surveillance desks, information received through pre-inspection letters or other communications, regulatory reports and published financial information, reports of internal and external auditors.

State Bank of Pakistan has been endeavoring to promote self-discipline in the financial markets of Pakistan through transparency and sufficient disclosure by the market participants. In order to augment our ongoing efforts to maximize disclosure for the benefit of stakeholders and market participants, all banks/DFIs were required to get themselves credit rated with effect from June 30, 2001. The objective was to provide another yardstick to the market participants and stakeholders for informed decision making, promote healthy competition and induce financial institutions to improve their state of financial affairs. This decision was taken after consultations with the representatives of banks/DFIs. Accordingly, banks/DFIs continuously get themselves credit rated from credit rating agencies on the panel of SBP i.e. banks/DFIs rating is updated from year to year, within six months from the date of close of each financial year. Most of the banks/DFIs have already made their credit rating public through print media and we have also compiled their ratings for the benefit of all stakeholders. Credit rating is an independent opinion expressed by the professional bodies i.e. credit rating agencies that states about capacity of an entity to meet its obligations and is based on various quantitative and qualitative factors. These ratings therefore, represent the opinions of respective rating agencies and do not reflect the views of the State Bank of Pakistan. Besides they also do not represent investment advice or should be construed as such.

STANDARD RATING SCALES AND DEFINITIONS BEING BY PAKISTAN CREDIT RATING AGENCY (PACRA) LONG USED TERM RATINGS AAA HIGHEST CREDIT QUALITY: AAA ratings denote the lowest expectation of credit risk. They are assigned only in case of exceptionally strong capacity for timely payment of financial commitments. This capacity is highly unlikely to be adversely affected by foreseeable events. AA VERY HIGH CREDIT QUALITY: AA ratings denote a very low expectation of credit risk. The capacity for timely payment of financial commitments. This capacity is not significantly vulnerable to foreseeable events. A HIGH CREDIT QUALITY: A ratings denote a low expectation of credit risk. This capacity for timely payment of financial commitments is considered strong. This capacity may, nevertheless, be more vulnerable to changes in circumstances or in economic conditions than is the case for higher ratings. BBB GOOD CREDIT QUALITY: BBB ratings indicate that there is currently a low expectation of credit risk. The capacity for timely payment of financial commitments is considered adequate, but adverse changes in circumstances and in economic conditions are more likely to impair this capacity. This is the lowest investment grade category. BB SPECULATIVE: BB ratings indicate that there is a possibility of credit risk developing, particularly as a result of adverse economic change over time; however, business or financial alternatives may be available to allow financial commitments to be met. Securities rated in this category are not investment grade. B HIGH SPECULATIVE: B ratings indicate that significant credit risk is present, but a limited margin of safety remains. Financial commitments are currently being met; however, capacity for continued payment is contingent upon a sustained, favorable business and economic environment. SHORT TERM RATINGS A1+ : Obligations supported by the highest capacity for timely repayment. A1 : Obligations supported by a strong capacity for timely repayment. A2 : Obligations supported by a satisfactory capacity for timely repayment, although such capacity may be susceptible to adverse changes in business, economic, or financial conditions. A3 : Obligations supported by an adequate capacity for timely repayment. Such capacity is more susceptible to adverse changes in business, economic, or financial condition than for obligations in higher categories. B : Obligations for which the capacity for timely repayment is susceptible to adverse changes in business, economic, or financial conditions. C : Obligations for which there is an inadequate capacity to ensure timely repayment. D : Obligations which have a high risk of default or which are currently in default.

CCC, CC, C HIGH DEFAULT RISK: Default is a real possibility. Capacity for meeting financial commitments is solely reliant upon sustained, favorable business or economic developments. A CC rating indicates that default of some kind appears probable. C ratings signal imminent default.

MEDIUM TO LONG TERM AAA : Highest Credit quality. The risk factors are negligible being only slightly more than for riskfree Government of Pakistan debt. AA+, AA, AA- : High credit quality. Protection factors are strong. Risk is modest but may vary slightly from time to time because of economic conditions. A+, A, A- : Good credit quality. Protection factors are adequate. Risk factors may vary with the possible changes in the economy. BBB+, BBB, BBB- : Adequate credit quality. Protection factors are reasonable and sufficient. Risk factors arte considered variable if changes occur in the economy. BB+, BB, BB- : Obligation deemed likely to be met when due. Protection factors are capable of weakening if changes occur in the economy. Overall quality may move up or down frequently within this category. B+, B, B- : Obligations deemed less likely to be met when due. Protection factors are capable of fluctuating widely if changes occur in the economy. Overall quality may move up or down frequently within this category or into higher or lower rating grade. CCC : Considerable uncertainty exists towards obligations when due. Protection factors are scarce and risk may be substantial.

SHORT-TERM

A-1+ : Highest certainty of timely payment short-term liquidity, including internal operating factors and / or access to alternative sources of funds, is outstanding and safety is just below risk free Government of Pakistans short-term obligations. A-1 : High certainty of payment. Liquidity factors are excellent and supported by good fundamental protection factors. Risk factors are minor. A-2 : Good certainty of timely payment. Liquidity factors and company fundamentals are sound. Although ongoing funding needs may enlarge total financing requirements, access to capital markets is good. Risk factors are small. A-3 : Satisfactory liquidity and other protection factors qualify issues as to investment grade. Risk factors are larger and subject to more variation. Nevertheless, timely payment is expected. B : Speculative investment characteristics. Liquidity may not be sufficient to ensure timely payment of obligations. C : Capacity for timely payment of obligations is doubtful D : Defaulted obligations.

CC : A high default risk. C : A very high default risk.

D : Defaulted obligations.

N.B A plus (+) or minus (-) is added to the rating symbols from AAA to B to indicate relative standing within each of those rating categories.