Banking
Sector Supervision in Pakistan
State
Bank of Pakistan (SBP) which is the Central Bank of the country
has been interalia entrusted with the responsibility for an
ongoing effective supervision of the banking sector. The relevant
provisions of law which vest powers in State Bank of Pakistan
(SBP) to carry out inspection of banks are contained in the
Banking Companies Ordinance, 1962. Besides, State Bank of
Pakistan Act, 1956 and the Bank’s Nationalization Act,
1974, The Financial Institutions (Recovery of finances) Ordinance,
2001, Companies Ordinance, 1984 and Statutory Regulatory Orders
(SROs) are the relevant legislations, which cover the activities
concerning the banking sector.
The financial sector in Pakistan comprises of Commercial Banks,
Development Finance Institutions (DFIs), Microfinance Banks
(MFBs), Non-banking Finance Companies (NBFCs) (leasing companies,
Investment Banks, Discount Houses, Housing Finance Companies,
Venture Capital Companies, Mutual Funds), Modarabas, Stock
Exchange and Insurance Companies. Under the prevalent legislative
structure the supervisory responsibilities in case of Banks,
Development Finance Institutions (DFIs), and Microfinance
Banks (MFBs) falls within legal ambit of State Bank of Pakistan
while the rest of the financial institutions are monitored
by other authorities such as Securities and Exchange Commission
and Controller of Insurance.
Under the WTO commitments the operational status of branch
network of foreign banks operating in Pakistan as on 31-12-1997
has been protected and frozen. However, existing foreign banks
having less than 3 branches can have branches to the extent
of maximum number of 3 only. New foreign banks desirous of
entering banking business in Pakistan will now be required
to incorporate as domestic bank under the local laws. The
branches of foreign banks operating in Pakistan can also be
converted into a local commercial bank by incorporating under
the local laws and subject to a minimum paid up capital of
Rs.1 billion provided foreign share holding is restricted
to a maximum of 49%.
At present there are 41 scheduled banks, 6 DFIs, and 2 MFBs
operating in Pakistan whose activities are regulated and supervised
by State Bank of Pakistan. The commercial banks comprise of
3 nationalized banks, 3 privatized banks, 15 private sector
banks, 14 foreign banks, 2 provincial scheduled banks, and
4 specialized banks.
Under the Banking Companies Ordinance, 1962 the State Bank
of Pakistan is fully authorized to regulate and supervise
banks and development finance institutions. During the year
1997 some major amendments were made in the banking laws,
which gave autonomy to the State Bank in the area of banking
supervision. Under Section 40(A) of the said Ordinance it
is the responsibility of State Bank to systematically monitor
the performance of every banking company to ensure its compliance
with the statutory criteria, and banking rules & regulations.
In every case in which the management of a bank is failing
to discharge its responsibility in accordance with the applicable
statutory criteria or banking rules & regulations or is
failing to protect the interests of the depositors or for
advancing loans and finance without due regard for the best
interests of the bank or for reasons other than merit, the
State Bank is empowered to take necessary remedial steps.
The State Bank of Pakistan can, interalia, exercise the following
powers vested upon it under the Banking Companies Ordinance:-
Prohibiting the bank from giving loans, advances & credits.
Prohibiting the bank from accepting deposits. Cancel license
of a bank. Give directions to the bank as it deem fit. Remove
chairman, directors, chief executive or other managerial persons
from the office and appoint a person as chairman, director
or chief executive.
Supersede the Board of Directors. Direct prosecution of directors,
chief executive or other officer. Caution or prohibit bank
against entering into any particular transaction(s). Require
bank to make changes in management. Appoint its officers to
observe the manner in which affairs of bank/its branches/office
are conducted. Winding up the bank through high court. Apply
to Federal Government for an order of moratorium in respect
of a bank and to prepare scheme of reconstruction or amalgamation.
Impose penalties including civil money penalties.
The State Bank has framed Prudential Regulations for banks
and Rules of Business for DFIs that present a prudent operating
framework within which banks and DFIs are expected to conduct
their business in a safe and sound manner taking into account
the risks associated with their activities. These regulations
incorporate the spirit and essence of BIS regulations and
are constantly watched for possible improvement so that their
enforcement yields the best results to promote the objectives
of supervision.
The State Bank is empowered to determine Statutory Liquidity
and Cash Reserve Requirements for banks/DFIs. Presently the
Cash Reserve Requirement is 5% on weekly average basis subject
to daily minimum of 4% of Time & Demand Liabilities. In
addition to that banks are required to maintain Statutory
Liquidity Requirement (SLR) @ 15% of their Time & Demand
Liabilities. Similarly, DFIs are required to maintain SLR
of 14% and Cash Reserve of 1% of their specified liabilities.
Additionally, The Banking Companies Ordinance had been amended
in 1997 which empowers the State Bank to prescribe capital
requirements for banks. In exercise of these powers the State
Bank has laid down Minimum Capital Requirements for banks
based on Basle capital structure. The banks have to maintain
a Capital Adequacy Ratio in a way that their capital and unencumbered
general reserves are, at the minimum, 8% of their risk weighted
assets, and effective from 1st January, 2003 banks are required
to maintain a minimum paid up capital level of Rs.1 Billion.
While the off-site monitoring aspect is looked after by the
State Bank of Pakistan’s Banking Supervision Department
the responsibility for the on-site examination of the banking
system in Pakistan lies on the shoulders of the Banking Inspection
Department. This has been designed to ensure that institutions
operate in a safe and sound manner. The focus of the supervisory
efforts by the State Bank of Pakistan is on the health and
stability of the banking system in Pakistan.
Off-Site Monitoring at BSD
The
objectives of off-site surveillance over the banking system
are:-
to monitor the condition of individual banks, as well as condition
within the banking system; to provide early identification
of problems so that corrective action can be effected; and
to target scarce on-site supervisory resources to areas or
activities of greater risk.
Off-site surveillance system revolves around receipt, review
and analysis of periodic financial statements and returns
submitted to the State Bank. The off-site analysis facilitate
monitoring of each bank’s performance and its observance
of supervisory requirements over time, so that problems may
be identified as soon as these emerge. The process thus assists
in making the most effective use of scarce on-site inspection
resources. The system also works as an early warning to identify
those areas which reflect high probability of financial difficulties
so that policies and corrective actions can be designed and
implemented accordingly.
In consonance with the responsibilities envisaged under the
Core Principles recommended by the Basle Committee, the On-Site
examination capabilities at the State Bank of Pakistan have
been substantially augmented to bring them at par with the
expected international standards. While regulations have existed
for some time aimed at convergence of the essential industry
indicators to the globally accepted criteria, a risk-based
approach to evaluations has been adopted by the bank in all
its assessments. Periodic On-Site examinations of the financial
condition of institutions, falling within SBP’s jurisdictions,
remains the most effective supervisory tool, which support
Banking Supervision Departments in maintaining a proactive
approach in discharge of the statutory responsibilities.
The State Bank of Pakistan’s policy for frequency of
inspection of banks and DFIs is designed to provide flexibility
in scheduling inspections consistent with the need to maintain
safety and soundness. The policy provides a framework within
which supervisory ratings, surveillance and financial monitoring
results, and other appropriate indicators of banks soundness,
are to be considered in carrying out the State Bank of Pakistan’s
fundamental policy of subjecting each bank and non-bank financial
institution under its supervision to a periodic on-site inspection.
With a view to streamline the approach and the underlying
procedures for effective and efficient banking supervision
State Bank of Pakistan has embarked upon a major overhauling
of its own capabilities so as to bring them at par with international
practices. This entailed hiring of services of consultants
of world repute (M/s. Arthur Andersen) under the FSID Project
of the World Bank. These Consultants have compiled extensive
on-site and off-site manuals. Besides qualified and professional
trained human resource have been recruited and rigorous theoretical
and hands-on training has been provided to them. With the
shift in supervisory focus from ‘compliance oriented’
to ‘Risk Assessment Approach’ State Bank of Pakistan
has developed a uniform bank rating system in conformity with
international standards/benchmarks. Now each bank is appraised
under the CAMELSS/CAELS Rating System.
In order to portray a legitimate and true financial condition
of a bank the off-site surveillance system and the on-site
inspection functions of banking supervision work extremely
close together. As a result of these close coordination bank
ratings reflects as accurately as possible, the true financial
condition of a bank and the banking system as a whole.