The State Bank of Pakistan (SBP) has instructed commercial banks to initiate Phase II of Basel III reforms, aimed at addressing weaknesses in the pre-crisis regime and ensuring a stronger, more resilient banking sector under international standards.
The Basel III reforms were introduced by the Basel Committee on Banking Supervision (BCBS) following the 2008 Global Financial Crisis, which exposed critical flaws in the global financial system. These reforms were designed in two phases, with the SBP already having completed Phase I.
Phase I included measures such as improving capital adequacy, introducing liquidity and leverage ratios, and establishing the Domestic Systemically Important Banks (D-SIB) framework. Phase II now focuses on revising the risk-weighting regime, strengthening the leverage ratio, and introducing further enhancements to banking practices.
To ensure smooth adoption of Phase II, the SBP has issued revised guidelines on the Standardized Approach for Credit Risk. Banks are required to exclusively use ratings from credit rating agencies recognized by the SBP for capital adequacy purposes. Furthermore, they must apply ratings from approved External Credit Assessment Institutions (ECAIs) consistently across all claim types for both risk weighting and risk management, without selectively switching between agencies.
Risk Weight Assignments and Disclosure Requirements for Banks
Banks are also required to disclose the ECAIs they rely on, the mapping of rating grades to risk weights, and aggregated risk-weighted assets for each category. For risk weight assignments, a 0% weight will apply to cash owned and held at banks, gold bullion, and equivalents such as national prize bonds. Cash in the process of collection will attract a 20% weight.
Claims on the Government of Pakistan and the SBP, when denominated in Pakistani rupees, will carry a 0% risk weight. Foreign currency claims on sovereigns will depend on the relevant credit ratings from recognized ECAIs. In certain cases, claims in the domestic currency of foreign sovereigns may also qualify for a 0% risk weight, subject to host country regulations.
Banks must implement strong internal policies and systems to ensure accurate risk weight assignments and must demonstrate due diligence to the SBP.
The revised Basel III Phase II reforms will be introduced on a parallel-run basis across the banking industry from September 30, 2025, to June 30, 2026. During this period, banks, digital banks, and development finance institutions (DFIs) will be required to file capital adequacy returns under both the existing and new guidelines. This approach will help the SBP identify challenges and incorporate industry feedback before final implementation.