KARACHI - The State Bank of Pakistan advised the banks to take benefit from "Internal Capital Adequacy Assessment Programme" guidelines related to risk management, internal control which may give direction to develop institution specific processes and procedures, said a press statement issued by the SBP on Wednesday. According to the central bank, new capital regime, Basel II has departed from the conservative prescriptive approach to well deliberated forward-looking approach, and has emphasized upon adoption of risk management methodologies to assess the capital requirements for an individual financial institution. Now banks/DFIs can measure capital requirements according to their own overall risk exposures, risk management framework, internal systems and controls, and strategic plans. Keeping in view the importance of the ICAAP, all banks/DFIs have already been advised vide BSD Circular No. 8 of 2006 to develop such process. In order to facilitate the banks and supplement the already issued instructions, following paragraphs briefly explain the basic principles of the ICAAP and the regulatory requirements. ICAAP is a set of policies, methodologies, techniques, and procedures to assess the capital adequacy requirements in relation to the bank's risk profile and effectiveness of its risk management, control environment and strategic planning. This includes basic requirements to have robust governance arrangements, efficient process of managing all material risks and an effective regime for assessing and maintaining adequate capital. Establishment of ICAAP is the responsibility of an individual bank. Board of Directors and senior management shall ensure that sufficient resources are allocated for development of a comprehensive ICAAP. Besides the major risks covered in Pillar-1, banks are required to determine their capital adequacy in relation to all material inherent business risks and other risks related to external economic environment. Thus, banks are faced with the challenge of developing internal procedures and systems in order to ensure that they possess adequate capital resources in commensuration with all material risks posed to it by its operating activities. These procedures are referred as Internal Capital Adequacy Assessment Process (ICAAP) under Supervisory Review Process - Pillar-2 of Basel II. A well thought out execution of ICAAP can generate tangible competitive advantage to the concerned financial institution. Assessment of the banks' capital adequacy is not only the regulatory demand but it also creates business value for the bank itself.  All business decisions are based on the trade-off relationship of risk and return and banks are no exception. Financial industry has entered into an innovative phase resultantly a variety of complex products and services are developed and offered to customers belonging to various categories and industries. The increasing complexity of the banking business and the multi dimensional risks to which banks are exposed to necessitates the functions which ascertain, measure, and control the bank's risk situation. The profitable and continued existence of a bank is in the best interest of all stakeholders; it therefore, becomes important to detect developments, which may endanger the bank as early as possible enabling it to take suitable countermeasures. Internal capital adequacy process serves the purpose and estimates the cushion (in the form of capital) in relation to the risks, which a bank should have to protect the interest of all internal and external stakeholders. The adequacy of capital may take into consideration other factors such as external ratings, market reputation, strategic goals, and regulatory scope etc.