New system of monitoring, surveillance and supervision of commercial banks and development finance institutions

Feb 16 - 22, 2004




The central bank of Pakistan has announced to introduce a new system of monitoring, surveillance and supervision of commercial banks and development finance institutions (DFIs). It will be known as Institutional Risk Assessment Framework (IRAF). Dr. Ishrat Husain, Governor, State Bank of Pakistan (SBP) has termed this 'paradigm shift'.

Under the new system, the central bank will follow a cohesive supervisory approach whereby the finding from on-site inspections, periodic reports from of-site surveillance and market information will be integrated to produce a comprehensive assessment and composite internal risk rating of commercial banks and DFIs.

According to Dr. Ishrat, "With the privatization of Habib Bank Limited (HBL), almost 80% of banking assets will be in the hands of private sector and thus the SBP will have to set up its vigilance and watchdog functions in order to protect the interest of the depositors, prevent possible emergence of systematic problems in financial sector, discourage private banks from taking excessive and unmanageable risks and take timely remedial measures."

According to the Governor, the previous system of monitoring and supervision served its purpose well when the banks were owned by the government, but market based transactions, promotion of healthy competition and improving the efficiency and services to customers require a different and new approach.

The banks, which have low rating or high probability of deterioration in financial soundness will then be taken up for prompt actions. Dr. Ishrat terms this, "A paradigm shift in the way we carry out work, but it is imperative that we adopt in response to the changing circumstances".


It may be right to say that the SBP initiative is very timely. The private sector credit off-take has shot up to Rs 156.8 billion during the first half of current financial year as against the full year target of Rs 85 billion. Therefore, the central bank should be very vigilant of the developments and must ensure that the price stability is not threatened.

According to banking sector experts the private sector credit off-take has risen due to a number of factors. These include:- 1) low interest rate, 2) huge increase in lending to agriculture, small and medium enterprises, 3) enhanced consumer loans, 4) higher cotton price, 5) enhanced credit requirement of large scale manufacturing sector, 6) boon in equities market and 7) fewer issues of term finance certificates (TFCs) by the corporates.

According to the details available at the SBP website the IRAF shall be based on the four inputs for the evaluation of banks and DFIs. These are:-



1) COMPLIANCE WITH STANDARDS, CODES AND GUIDELINES: Banks' compliance with the standards, codes as adopted in Pakistan laws and regulations, SBP's guidelines like regulatory and statutory requirements, code of corporate governance and risk management guidelines and instructions for sound business and financial practices. This input would be in the form of a self-assessment exercise carried out by the banks duly endorsed by their board of directors. This self-assessment would be validated during on-site inspections by Banking Inspection Department of the SBP. This component would carry an aggregate weightage of 20 per cent.

2) SUPERVISORY AND REGULATORY INFORMATION: Supervisory and regulatory information gathered from the findings of on-site inspection on capital adequacy, management, profitability, asset quality, liquidity, etc., off-site surveillance reports as well as enforcement/compliance status from the Banking Supervision Department and policy related issues from the Banking Policy Department will form the second component of this framework. This component would carry an aggregate weightage of 25 per cent.

3) FINANCIAL PERFORMANCE AND CONDITIONS: Financial performance and condition compiled from audited annual statements, inspection reports, off-site surveillance reports/data and quarterly/annual published accounts would form the major core of this assessment. This component would carry an aggregate weightage of 40 per cent.

4) MARKET INFORMATION AND INTELLIGENCE: Basic input for this component would be drawn from credit rating agencies, research reports and where applicable international supervisory reports. This component would carry an aggregate weightage of 15 per cent.

Based on the aggregate weightage of the four inputs, each bank/DFI would be assigned but not advised, a rating on a scale of one to five.