a lot of merit. there is a direct incentive to be more discerning in identifying risk differentials among a set of opportunities and going about managing these risks in a prudent manner. efficient utilization of capital is the prime goal of pillar i ( mcr ) of the accord. once the basel framework is in place, banks with superior risk management skills would be able to get a competitive advantage over their counterparts. recognizing this, pakistan ’ s roadmap for implementation of basel ii accord advocates that banks adopt the standardized approach from january 2008 – progress on this front varies from bank to banks. bank ’ s ability to move towards basel ii would require them to address a number of challenges. there is, among others, need for ; ( i ) collective action to encourage corporate sector to become credit rated ; as in absence of recognized credit rating of borrowers, banks would end up allocating more capital than warranted and this would render them uncompetitive, ( ii ) development of allied and support infrastructure that facilitates the process e. g. the internal control and it systems within the banks is absolutely imperative if the framework is to succeed, ( iii ) presently the basel ii framework requires banks to apply a capital charge of 15 % of average positive gross income of last three years for operational risk ( under bia ) there is a need to clearly distinguish between a strong versus weak operational risk environment, ( iv ) availability of historical data, for the purpose of carrying out quantitative analysis, and ( v ) intensive capacity building of industry and sbp. to discuss these and other challenges sbp has set up a working group to first assess the current state of preparedness of the industry on a standard and agreed template for basel ii compliance and identify joint collaborative action to facilitate smooth transition. developing rating industry and encouraging entry of raters which have been identified under basel accord - ii would be critical for an effective implementation of basel ii for pakistani banks. sbp would have to draw its own understanding and linkages with the raters to ensure it is applying standards for weighing risks effectively across industry. sbp is in the process of developing a “ banking supervision risk assessment model ” ( bsra ) which will help sbp to better quantify the credit and market risks of the individual banks in terms of “ value at risk ” and forecast banks ’ position under various stress scenarios on a quarterly basis. bsra model would use information from the data warehouse ( data received through reporting chart of accounts ( roca )

these reports confirm that thus far banks risks are diversified and managed in line with the banking regulations. an analysis of trends in different types of risk would offer better appreciation and perspective on changes in banks ’ risk profile : credit risk : in pakistani banks, credit operations remain the main source of banks income and have been supported by strong economic activity. given its size, credit operations are a primary source of risk. supported by growth in businesses and gradual improvement in internal credit reviews, on balance credit risk have been well managed. the net npls to net loan ratio have declined in the last few years and fell to 1. 8 % by september 2006. in recent years, the macroeconomic environment has been supportive of the growth of banking systems but the growing fiscal imbalance and the external imbalances have enhanced domestic demand pressures. while the vulnerabilities of banking system have been well managed, the shocks arising from external sources can be a cause of concern. exposure to perceived risks arise from the ( i ) structural problems facing the real sector whose resolution is critical to maintain the momentum in credit operations, and ( ii ) high domestic asset prices given high interest rates, equity prices and property prices. underlying the credit growth is altering risk exposures which need to be well tracked to ensure their effective risk management. there is a broader concern that the growing domestic demand have impact on bank asset quality and the growing exposure of household sector to consumer financing could have their attendant risks. consumer finance has risen from 2. 4 % in 2002 to 14. 3 % by september 2006 and number of borrowers of consumer finance from 0. 25 million to 2. 6 million, respectively. thus far credit risks on the banking books associated with some assets has been limited. for instance, the housing finance is barely $ 1 billion ( or 2. 3 % of total loan outstanding ) and mortgage business non - existent. market risk : banks market risk exposure largely stems from the interest rate risk as the equity price and exchange rate risks are not substantial given their exposure in balance sheet is limited. interest rate risk emanates from movements in interest rates, which are determined both by the liquidity available and its response to short term rates and the future expectations of economy, the longer term yield curve. interest rates in pakistan have remained volatile in line with demand pressures during the past few years. after the 9 / 11, initially growth in liquidity resulted in fall in interest rates and by august 2003 the interest rates reached lowest levels and the differential between