Current Landscape of the Banking Sector and Emerging Trends

Financial sector plays a fundamental role in the smooth functioning of an economy. It directs financial resources to the real sector thereby helping capital formation and facilitating financial transactions. A sound and stable financial system is a pre-requisite for economic development. Pakistan’s financial sector consists of bank and non-bank financial intermediaries. The banking intermediaries include commercial banks, islamic banks, specialized banks and micro-finance banks, while non-bank intermediaries include development finance institutions, non-bank financial institutions, and insurance companies. The financial sector's overall assets amount to 75 percent of the GDP as of December 31 2017. The State Bank of Pakistan (SBP) and Securities and Exchange Commission of Pakistan (SECP), are the apex institutions regulating the financial system.

Banking sector assumes significant importance in the financial sector. It constitutes around 74 percent of the financial sector's assets and measures up to 55 percent of GDP. As of March 31 2018, 34 banks are operating in Pakistan, comprising of five  foreign banks, five  public sector banks, four specialized banks and twenty domestic private banks. The branch network comprises of more than 16000 branches spread all across  the country.

SBP ensures financial and macroeconomic stability through legal, regulatory, and supervisory frameworks. These frameworks are continuously updated to bring them in line with the best international practices. SBP’s legal framework that empowers it to regulate and supervise the financial institutions comprises of SBP Act, 1956, Banking Companies Ordinance, 1962, Microfinance Institutions Ordinance 2001 and the Foreign Exchange Regulation Act, 1947 and various other laws.

The regulatory framework, on the other hand, includes a set of policies, guidelines, prudential standards and allied processes that cover licensing regime, prudential regulations, corporate governance, capital adequacy regime, AML/CFT regime and market discipline.

Recently, SBP has revised the branch-licensing policy with a special focus to enhance financial outreach to the under-banked areas. Moreover, new modes for banking businesses have been introduced including Sales & Service Centers and Mobile Banking Units. A concept of Digital branch has also evolved and one such branch has been established at Institute of Business Administration (IBA), Karachi as a pilot project.

Besides licensing, SBP through Prudential Regulations (PRs) prescribes minimum supervisory standards for the financial institutions. PRs cover different areas including Corporate / Commercial Banking, Small & Medium Enterprise Financing, Infrastructure Financing, Agricultural Financing, Micro Financing, Housing Financing and Consumer Financing. Further, the AML/CFT regime has also been aligned with FATF recommendations, while sanction regimes have been implemented to deny banking services to the blacklisted entities/persons.

With a view to improving the corporate governance in banks, SBP has implemented a Fit & Proper Test (FPT) regime at the time of appointment of key executives of the banks and is continuously aligning it with the best international practices. The criteria for the appointment of independent directors have been revised to make their role more effective. Composition and role of sponsors/chairmen of the banks/DFIs on board’s committees have also been rationalized.  

Moreover, SBP is guiding banking sector on risk management issues. SBP has issued guidelines on interest rate risk management and compliance risk management. Moreover, new guidelines on internal audit function and revised guidelines on risk management and country risk are expected to be issued in this year.

In order to identify potential risks-that could have adverse impact on the financial system-SBP relies on its supervisory framework that consists of Off-site Supervision, on-site assessment, Surveillance and Enforcement & Resolution. Off-site supervision involves a periodic assessment of institutions based on CAELS (Capital, Asset Quality, Earnings, Liquidity and Sensitivity to other risks). To promote effective prudential conduct, SBP annually conducts prudential meetings with the Board of Directors, with the focus on key risk areas. Apart from off-site activities, SBP conducts regular on-site assessment and thematic reviews on high-risk areas. Credit risk management, Corporate Governance, AML/CFT and controls remain the key focus of these examinations and reviews. In addition, technology risk has become the major focus area. Under the surveillance function, SBP monitors liquidity positions of the financial institutions and conducts stress testing while enforcement and resolution function demands SBP to take regulatory actions against those institutions that breach rules, regulations or instructions issued by it under various statutes.

In the post global financial crisis  regulatory environment, SBP has remained adaptive by strengthening its regulatory and supervisory frameworks. Within the supervisory landscape, regulators around the globe are gradually shifting their focus from compliance based supervision to forward looking risk based supervision (RBS). SBP has also initiated work on migrating to RBS in order to advance its current supervisory regime and improve its supervisory efficiency. Further, SBP is designing and implementing a comprehensive macroprudential policy framework in the country to ensure financial stability. In this regard, establishment of Deposit Protection Corporation (DPC), a wholly owned subsidiary of SBP, is a critical step towards strengthening the financial stability regime. Besides, SBP has set guiding principles for the financial industry to facilitate in developing and implementing consumer protection framework.

Banking industry is also facing disruptions from rapid technological advancements. SBP has long recognized the importance of technology and has issued various guidelines encompassing frameworks for Enterprise Technology Governance and Risk Management, Payment Systems’ Designation, Security of Internet Banking, prevention against cyber-attack, Risk Management in Outsourcing Arrangements by Financial Institutions, etc.

It is pertinent to outline that payment systems are a critical part of financial infrastructure by assuming a facilitating role in the process of financial intermediation. SBP, in this regards, is developing a National Payment System Strategy to modernize the clearing and settlement infrastructure for reducing cost, improving efficiency, enhancing security, and strengthening its regulatory and supervisory oversight. SBP is also facilitating the entrance of non-banks in payments arena and has issued Rules for Payment System Operators and Service Providers.

Keeping in view the existing challenges and emerging trends, SBP has devised a comprehensive action plan i.e. the SBP Vision 2020. The strategic goals outlined in the plan lay great emphasis on improving the efficiency, effectiveness and fairness of the banking system along with strengthening the overall financial stability regime in order to fulfill SBP’s mission of fostering a sound and dynamic financial system.