The State Bank of Pakistan (SBP) has issued three sets
of Prudential Regulations (PRs) under BPD Circular No. 35 dated October
28, 2003 for compliance by all banks and DFIs. The PRs are for Corporate
Banking, SMEs Financing and Consumer Financing. New PRs shall become
effective from January 1, 2004. These PRs do not supercede directives
and instructions issued by SBP in respect of areas not covered under
above regulations, which also include the instructions on penalties. The
Banks/DFIs (financial institutions) have been advised to ensure
circulation of PRs for meticulous compliance in letter and in spirit.
Non-compliance will lead to punitive action under relevant law.
Moreover, transactions structured to circumvent PRs will tantamount to
violations and shall be dealt with accordingly.
Financial crises can be highly damaging for financial
institutions and economies. The financial regulators all over the world
have been taking measures for improving financial sector regulation and
supervision. New PRs aim at protecting deposits and the banking system.
The senior management and the respective board of
directors (BODs) have to carefully review new PRs. The financial
institutions may adjudge new PRs for practicality, cost of compliance,
and impact on business growth. Regulations considered 'excessive' might
be brought to SBP attention. Problem may arise in areas such as exposure
limits for persons or groups; group definition and group companies; loan
loss provision guidelines; limit on clean facilities; loan securities
and perfection of documentation/charge; duties of BODs vis-a-vis meeting
of fee payments; role of Compliance Officer vis-a-vis Internal Auditor;
ascertaining use of funds by borrowers; and determination of Forced
Sales Value. Problem areas might first be considered at Pakistan Banks
Association, before approaching SBP for clarifications. The borrowers
would also review new PRs and might raise issues with SBP on 'excessive'
The financial institutions shall be making
preparations for effectively implementing the new PRs by January 1,
2004. In the process, organization structure and design of their
operations may perhaps be adjusted to provide good services to the
customers. The switch over to new PRs should not be a big problem
provided it is orderly and gaps identified in personnel, policies, etc
are immediately plugged. Aim is that activities pertaining to deposit
taking and extending financial facilities are handled diligently in full
compliance of applicable laws and prescribed PRs. The DFIs and foreign
banks, with fewer branches and selected clientele, might handle
transition more easily. Local banks may have to mount major efforts.
Following suggestions might facilitate the transition.
The financial institutions are required to ensure
circulation of new PRs among all their offices/branches for meticulous
compliance in letter and in spirit. Presently, new PRs for SMEs and
Consumer Financing only have Risk Management "R" section.
These would be completed only after adding three sections from PRs for
Corporate Banking, namely "G" for Corporate Governance,
"M" for Know Your Customer & Anti Money Laundering and
"O" for Operations. It would be up to the financial
institution to print one volume containing the set of three PRs or three
different self-contained volumes for Corporate, SMEs or Consumer
financing. A dedicated Cell might be useful in each institution to
immediately circulate up-dated portion of PRs, when SBP issues an
amendment or change.
New PRs prescribe that BODs should know policies,
focus on policy making/approval and leave day-to-day operations to
senior management. Some existing policies might need updating; while
others might have to be written afresh. The BODs should take stock of
existing policies and make arrangements for preparation and
implementation of all prescribed polices. Other important matters that
BODs may attend include constitution of committees/audit committee,
formats of reports regarding different financial facilities, MIS on
operational performance; databank on trade, industry, government
policies and regulations; compliance with laws, rules and regulations;
proper writing of minutes; and timely receipt of Management Letter from
external auditors. The financial institutions may adopt
'Truth-in-Lending' and clearly disclose to the customers by printed
brochures, all important terms, conditions, fees, charges and penalties.
The SBP has prescribed Fit and Proper Test for
appointment of President/Chief Executive, BODs and key executives. The
BODs and senior management should ensure that all existing key officers
meet the fit and proper criteria. New PRs require arms length dealings
with directors, employees, investors and customers. Appropriate
proformas might be developed for seeking details on matters referred to
in the PRs from directors as well as the employees. Professional
training of officers particularly those handling the financing
facilities might be undertaken, supplemented by on-the-job training
under experienced hands. Similarly, application forms and other formats
prescribed by SBP might be properly filled in and duly signed and
stamped by the customers.
It may be noted that exposure limits have exemptions
due to security or sector and are linked to the equity of the
institution. As such, determination of total exposure to a company and
the group might involve detailed calculations. It is imperative that all
linkages and exemptions are understood properly. To cope with the work
load with large number of customers and depositors, suitable computer
applications shall have to be devised and installed. The financial
institutions must develop guidelines/proformas for internal use so that
appraisal, credit reports, reports on eligibility of borrower/group,
existing exposure, exposure if loan request is accepted, documentation,
releases, use of funds etc are properly streamlined and authorized.
The financial institutions are allowed, subject to a
number of exemptions, exposure due to contingent liabilities up to ten
times of their equity. Disregarding the exemption, the exposure could be
higher than ten times. It would be prudent to also periodically
calculate gross exposure on total contingent liabilities. Credit rating
of the banks providing guarantees on behalf of the customers need to be
For corporate clients the exposure per person has
been fixed at 30% of financial institution's equity (of which maximum
20% fund-based) whereas for the Group it is 50% of equity (of which
maximum 35% fund-based). Per person financing exposure for SMEs and
Consumers has been fixed in monetary terms while overall exposure has
been linked to the equity of financial institution. Therefore, the
financial institutions shall have to carefully monitor movements in its
own equity. Any abrupt fall in equity say due to a large provision for
one or more doubtful debts might reduce equity; and as a consequence
exposure against some of the borrowers might exceed prescribed limit and
attract penalty from SBP.
Revaluation reserves play a part in the determining
exposure limit of a borrower for the first three years of valuation. In
this regard it has been provide that assets must be prudently valued by
valuers on the panel of Pakistan Bank Association. Valuation of assets
is a critical area and the financial institutions, through PBA, might
consider adopting fair and transparent procedures in selection and
monitoring of the valuers.
New PRs have defined 'the Group' and specified an
exposure limit, which is larger than the limit for an individual
borrower. The financial institutions would surely face confusion and
problems in determining the list of companies that form a group
according to the definition. The banks and the borrowers might not have
sufficient details and therefore not agree in all cases on the
subsidiary or parent company relationship, control, substantial
interest, significant influence, financial interdependence and
eligibility of a company if another company of same group is in default.
A system has to be in place to keep track of different groups and their
exposures with all institutions.
The financial institutions have to ensure that loans
have been properly utilized by the SMEs and for approved purposes. An
appropriate system should be developed and implemented for monitoring
the utilization of loans. It may be noted that the assets developed
through loans/equity generally provide main security to the financial
institutions. It must be noted that misuse or pilferage of the loan
funds/equity funds would dilute loan security and adversely affect debt
servicing performance. As such, financial institutions must pay more
attention to procurement monitoring of SMEs and other customers.
The financial institutions are required to classify
their loans/advances portfolio and make provisions in accordance with
the criteria prescribed in new PRs. They have been allowed transition
period up to December 31, 2004 to regularize their provisioning
position. It will be useful if causes of loans turning sour are also
determined and lessons used for future loaning or restructuring